May, 2003

Understanding the Process of Economic Change - Working Paper

  • Douglass North

    Department of Economics, Washington University in St. Louis
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What follows is not a theory of economic change. We are a long way from such a theory; and indeed in the neat sense of being comparable with the kind of general theories we have in economics, such a theory is probably impossible. But understanding the process of economic change is an essential prerequisite to improving economic performance. We live in a world of dynamic economic change, but the theory we employ to understand our world is static. Moreover the theory we employ is frictionless. There are no institutions, no government; in short transaction costs are zero. The tools we employ to understand and control the world of dynamic change are simply inadequate to deal with the issues. Nothing illustrates this better than the fumbling efforts we have made over the last ten years to restructure what was the Soviet, and is now the Russian economy. Understanding involves that we rethink the process of change, and not simply tinker with static models. Economic change is a result of changes, one, in the quantity and quality of human beings; two, in the stock of human knowledge, particularly as it applies to the human command over nature; and three, in the institutional matrix that defines the incentive structure of society. A complete theory of economic change would therefore integrate these three strands.