Institutions as a ‘grand’ theory of development North’s major contribution was to recognize the underlying role of institutions

Institutions as a ‘grand’ theory of development North’s major contribution was to recognize the underlying role of institutions

in processes of economic development and to suggest how they might be studied. He recognized that actors – in the form of organizations – might seek to change the rules but that the incentives enabling them to do so are themselves deter- mined by these institutions, and hence constrain their actions. As a consequence, when actors seek to innovate and create new opportunities, what they are ulti- mately able to achieve is constrained by existing institutions – both formal and informal – and economic development is therefore ‘path-dependent’.

As we have pointed out, North’s approach identifies the problems of imperfect and asymmetrical information. This entails two limitations: the first is that, when considered at a society-wide level and used to explain economic development, institutions continue to evolve in their efforts to address particular problems in the economy. North proposes that those involved in organizations act to further their own interests by changing the rules and

INSTITUTIONS, MARKETS AND ECONOMIC DEVELOPMENT

regulations to enable them to perform better. This creates a ‘functionalist’ view of institutions, that is, institutions exist and change to solve particular economic problems (Toye, 1995). However, as we have seen, institutions, defined as rules and norms, operate at many levels of the economy and are deeply-rooted within an array of informal norms, conventions and moral rules. We therefore need to understand these social sources and non-economic dimensions of institutions. Do institutions exist only to solve economic problems? Moreover, how can economists know if they have actually solved the underlying problems efficiently if there are no alternatives to compare them with? From the point of view of the human development approach, we would want to know whether they exist and evolve to promote human flourishing, since discrimination can be economically efficient, for example, while detracting from these goals at the same time.

A second limitation relates to the role of politics. North recognizes that it is important to have polities that enable the rules of the game to be enforced, but this leaves unanswered the question of whether the prevailing institutional set up arises because of the structure of transactions costs or because of political structures. ‘New institutional economics’ as outlined above is a theory about agents possessing different levels of information but still assumes that they have equal power. This is clearly not the case in most (if not all) societies. Some have greater opportunities and abilities to promote changes to the institutional frameworks that favour them over others. The issue of political power is therefore not adequately resolved by institutional analysis. A wider political economy analysis is required.

Thus, while these ‘new’ institutional approaches were heralded in the early 1990s as a bridge between political economy analysis and mainstream economics, and while the institutional focus has certainly widened the analysis of economic development to encompass history, it also begins to highlight the need for sociological and political analysis, and especially for careful attention to power relations (Bardhan, 1989).

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