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The secret of economic progress
Professor Douglass North, 1993 winner of the Nobel Prize for economics, answers key questions about the world's economic progress.
Rule No 1: Society matters
Q: The Road to Riches series examines the economic history of mankind from 10,000 years ago to the present day. What are the fundamental, universal factors which determine whether a society succeeds or fails economically?
Professor North: For a long time economic historians put all of their stress on technology and so, really the story of human beings was a story of technological change. But if that was the whole story, how would you explain the huge disparities in development? Because technology is freely available to everybody, then presumably everybody who wanted should be developed, which they clearly are not. To understand the those disparities you've got to add a new dimension, and that is how well or badly human beings organise themselves, to take advantage of technology and of resources. I'd say that is the key to understanding economic success and failure.
When I talk about organisation, I'm talking about two separate things: one is institutions, which are the structure that humans impose on human interaction; the other is social norms of behaviour. The institutions give us formal rules of the game like constitutions, laws, rules and regulations, property rights, but norms of behaviour are just as important, the kind of norms that get people to live by honesty, integrity, and things like that.
When you have that sort of a structure, a structure that both provides institutions that encourage people to be more productive, and norms of behaviour that encourage them to co-operate with each other in the course of that, then you start to make sense out of what's happened to human beings over time. And you can begin to explain the contrast between, say, parts of sub-Saharan Africa, which are the basket case of modern non-development, and the developed world.
Q: So what are the kind of institutions which best favour economic progress?
Professor North: Well, you know, we used to say the answer was very easy: we'd say the crucial factors were having well specified and developed property rights, the rule of law, a judicial system that enforces contracts, and all those things are important. But look at China today. It doesn't have well developed specified property rights, rule of law or a judicial system that's worth much, and yet it is developing. What they do have are substitutes which do approximately the same things for them. Their TVE's, Town, Village Enterprises for example, are like our firms and they have property rights that are guaranteed by local communist party officials, who stand to gain by structuring the game that way. So even though they don't fit our predisposition about the kinds of institutions, they do provide in essence the same kind of structure.
So one of the things we're learning is not to a look at obvious superficial form, but to look at whether you can do things, and to admit that every society and culture will do things somewhat differently. And the Chinese show remarkably that, with a very different heritage they're in effect creating the same kind of incentive structure.
Russia: the lessons of gangster capitalism
Q: When the Soviet Union dissolved itself, the West advised a quick transition to capitalism. But the post Soviet economy has been a disastrous failure. What went wrong?
Professor North: Heritage, the cultural heritage you have, constrains your ability to be able to evolve in the ways that are going to work. In the case of China they had a heritage of informal norms of behaviour that were very favourable to develop entrepreneurial skills, which is clear when you see that Chinese people dominate the economies of much of South Asia. Russia had no heritage of anything like this, it had been run top down, it had been feudal right up until the 1860's when feudalism was abolished, and then you had communist control from the top down. This wiped out the formal rules of the game and you had nothing to build on. And so what you had there was a fumbling effort, much of it badly misdirected by American policy in many respects, to try to create a system that works. In economics we know the kind of basic structure that will work, but we don't know how to get it, how to move from here to there. Russia has been a humbling experience in how little we know, because we can't get them to do the things that we know, if we could put in place, would work.
Q: You say Russia was "misdirected by American policy". Weren't you one of the Western economists who advised Russia to go headlong into capitalism?
Professor North: Well I went to Moscow in 1990 at the invitation of the Soviet Academy of Sciences, and while we were there, the Shatalan Plan or the 500 day plan was advanced by the Soviet Economist Shatalan. It was a programme that said that in 500 days, we were going to completely restructure the Soviet economy, we were going to introduce a market economy, we were going to develop a central bank, we were going to have prices that were going to work. We were na´ve. We were naive to incredibly na´ve. 500 days? 5,000 days more like, even if everything had worked ideally.
We knew the kinds of institutions that make economies productive. We know about what makes for productivity growth, and what makes for development. It's just we had no clue on is how to get there. We thought, for example, that you could introduce the reforms overnight. That turned out to be a disaster, because when you wiped out a set of rules, you replaced them with new ones, but the new ones didn't work, and when they didn't work, the consequence in reality was to let insiders capture most of the assets. It's possibly the greatest blunder of all of human history, what happened in Russia, in the period from 1990 onwards.
Democracy: is it essential?
Q: Both freedom and order clearly seem to be very important variables ingredients in success, but is it essential to have democracy for economic progress?
Professor North: I would say that there are lots of combinations that will work. We have illustrations of authoritarian political systems, that at least over some period of time, have introduced and supported economic rules of the game that work.
Singapore is a classic modern example. Taiwan, as it evolved was another. It was authoritarian and then evolved rules of the game. I would say, if you're going to have economic growth, you've got to have freedom because, at some point if you don't have political freedom, you're going to have some authoritarian regime that's going to get into trouble and then they're going to abrogate the things that work. Latin America has gone through this over and over again, over the last three centuries. So my long run view is that the two are very closely tied, but in the short run there's not a very good relationship between political freedom and economic growth.
Race and climate
Q: Alfred Marshall, who many see as the great founder of modern economics, says the only important variables in economic development are race and climate. What do you make of that?
Professor North: I don't think race is turning out to be a very important factor, but climate, it's quite true. If you run a regression on per capita income and how far you are from the equator - at least into temperate climates - the relationship is very, very strong. It is still strong, although getting less so, because the advent of two things: air conditioning and the elimination of a lot of tropical diseases. So down the road that is going to make less difference, but in terms of the path dependent story we're evolving, the tropical places in the world are still the poor places in the world, and that long heritage is very hard to break out of.
Africa: Colonialism and tribal culture
Q: What about sub-Saharan Africa, what explains its continuing poverty?
Professor North: I have a good friend who is a Belgian economist who has spent a lot of time in Africa. He argues that the redistributed norms that evolved in Africa, came out of out of a very simple phenomenon: that what people did when they went out to try to do better, was so haphazard in terms of the hazards of the soil, climate and so on, that it was looked on as luck.
Now, if it was luck rather than skill, then the people who were lucky ought to share that with everybody else. So you evolved redistributed norms. I think that is an oversimplification, but it has a lot to say about a world in which you don't think that individual effort produces the results that we think of as providing the proper incentives. If individual effort really doesn't produce outcomes that are favourable, then you tend to develop norms of behaviour in which you say everybody ought to share these things. Now that's the antithesis western thinking, that individual effort should be rewarded and that should be the foundation of society.
Q: But isn't colonialism at least partly to blame for the plight of many African countries?
Professor North: I wouldn't reject that, but it's only half-true. Certainly, if you look at the history of the Belgian Congo, with what Belgium did, that is a classic case of colonialism at its worst; impoverishing a country and preventing it from really evolving in any effective productive way. And I think, in general, colonialism certainly didn't lead in the direction of the economies evolving the kinds of institutional frameworks and structures that would make them able to get out of tribal societies.
But it is also true that where you didn't have colonialism, a lot of these places haven't evolved and developed either. So, it is not just colonialism. It is tribal societies that have had a heritage which has really been inimical to growth and which we're now trying to figure out and learn ways by which we can gradually evolve them in directions that will work.
Europe and America: Accelerating growth
Q: Europe and United States have achieved much stronger growth in the last half century than in the previous hundred and 50 years - why?
Professor North: I think that the common denominator has been the evolved economic political social organisation, which is conducive to growth, in both Western Europe and in the United States. On top of that you've had what many people call the second industrial revolution, but what I prefer to call the second economic revolution.
This has given us the potential for a higher rate of growth than we've had in the past, mainly because of technology. You can see it just by the way in which the labour force is distributed. Look at the turn of the 20th century: most people were in extractive industries and agriculture. If you look at the middle of the century they were in manufacturing. By the year 2000 most of them are in services, information technology and things like that. That's because we've become so productive, both in agriculture and manufacturing, we don't employ very many people in it, it's automatic machinery and equipment, so today's frontiers are those of services, of information technology and so on.
If technology dictated our future, it doesn't alone, but if it continues the same way it is, we could have living standards that are astronomical. We may do so, but that means that organisations will have to evolve ways that are complimentary and can exploit that technology, and that's never a sure thing.
Q: People are increasingly preoccupied with "globalisation" these days. How important is it?
Professor North: One of the things that I think is wrong is the current preoccupation with globalisation, as though it was something new. It is not new. We've been gradually evolving, an inter dependent world, with increasing mobility of labour, capital and goods and services for the last three or four centuries. What we observe today is that we've accelerated that process.
That's unambiguously good, in that we're much more productive, all the world becomes more productive, as we become globalised. If countries move into this, they're going to be better off, there's no question about that.
But a globalised world is an interdependent one. What happens everywhere else will ultimately affect us, and we don't know what a lot of those things are. What will that mean in terms of the transmission of diseases, transmission of conflict, transmission of instability? These are things that we don't have good answers to yet, but I suspect there are going to be very serious problems.
Q: But isn't globalisation at least bad for unskilled workers in developed countries?
Professor North: Yes and no - typical weasely answer of an economist! Yes, in the short run. There's no doubt that globalisation forces the complete restructuring of economies everywhere in the world. As new countries come into the fold and become competitive with older economies, they're going to force older economies to move out of things that they no longer have a comparative advantage in, and move into other things, and that's very difficult. We're seeing that now all over the world. To the degree you don't have perfect labour mobility, there could be higher rates of unemployment in developed countries, particularly if you have very uneven distribution of skills and knowledge in a society. That's one of the dangers I suspect. I would guess, though, that in the long run it's going to make the labour force shift and become more productive and creative, although that's not a sure thing.
Edited highlights from a recorded interview
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