The last in this series of vignettes of six economists who have made a difference over the past 250 years - for better or worse - is Douglas North. Not a household name, but a Nobel Prize winner (1993) for his work as an economic historian in demonstrating the role of institutions, such as property rights and moral/ethical standards, in creating an environment for rapid economic growth.
North's academic career started as an undergraduate at the University of California Berkeley, where in his own words, he became "a convinced Marxist" with mediocre grades. After time out for World War II merchant marine service (and lots of reading), North returned to Berkeley to obtain his PhD in economics, shed his enthusiasm for Marx and joined the faculty at the University of Washington in Seattle. I had the pleasure of spending time with him when he took up residence at Washington University, St. Louis.
In 1961 North published his first major work, "The Economic Growth of the United States, 1790-1860." However, his first comprehensive study of the importance of institutions took place in his 1981 volume, "Structure and Change in Economic History."
The role of institutions. It is hard to over-emphasize the importance of this finding and its indictment of traditional, single-minded economic development policies, such as those traditionally pursued by The World Bank. These "neo-classical" policies, heavily influenced by Keynes' disciples, enshrined capital investment as the critical factor in economic growth. Given an "investment multiplier," growth was believed to be determined by the amount of capital invested; if insufficient domestic and private foreign investment was a problem, foreign aid and World Bank loans were the solution.
However, as North put it in his Nobel Prize lecture,
Neo-classical theory is simply an inappropriate tool to analyze and prescribe policies that will induce development. It is concerned with the operation of markets, not with how markets develop. How can one prescribe policies when one doesn't understand how economies develop?
He went on to say,
Institutions form the incentive structure of a society. The political and economic institutions, in consequence, are the underlying determinant of economic performance . . . . institutions are not necessarily or even usually created to be socially efficient; rather they are created to serve the interests of those with the bargaining power to create new rules . . .
A good example of growth-stimulating institutions are well-designed laws to enforce contracts and to establish patent protection, along with the moral and ethical norms that buttress them. North cites England's legislation establishing such a system in 1624 which, in his view, was a major factor in fueling the Industrial Revolution and what had been a low rate of technological change.
Who sets the rules? So, the critical question is, "What are the mindsets of those who create the rules and norms?"
. . . the difficulty of turning economies around is a function of the nature of political markets and, underlying that, the belief systems of the actors.
If the dominant goal of politicians as a class is to get rich while in office, economic performance will clearly suffer. I suggest that most West African nations appear to be in this category, even though some of them are awash in petrodollars. Performance will also suffer if an anti-market ideological mindset at the top dominates economic policy. Current day Argentina and Venezuela are sad examples.
It is especially instructive to consider the vast rule-making powers which Congress has delegated to the Executive branch of government and are leading us to "the administrative state." Today's rule-makers are no longer the drafters of our Constitution or even our elected representatives; they are the thousands of bureaucrats and a few hundred presidential appointees who pursue narrow objectives with less and less consideration for the unintended consequences of their dictats.
North's influence among other policy-oriented economists is evident in the work of such leading economists as William Easterly, Daron Acemoglu, and Agnus Deaton, all of whom minimize the importance of foreign aid and World Bank lending programs as instrumental factors in developing country economic progress. But his message is just as relevant for rich country economic growth as well.
Perhaps the bottom line in North's message for U.S. politicians and economic policymakers concerned about healthy economic growth is that they should worry more about perverse incentives and unintended consequences arising out of such initiatives as ethanol subsidies, government-backed residential mortgages, and a Medicare program that wasted $46 billion in 2014 in improper payments - and less about new ways to spend taxpayer monies.