The Natural State

Speaker: Douglass C. North, Nobel Economics Laureate 1993

Date: Tuesday, 11th March 2008

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Lecture Synopsis

by Radhika Puri

Mr. Douglass North’s lecture focused on an ongoing dilemma in modern society today. What makes societies materially well off? Billions of dollars have been spent by countries around the world in trying to understand what constitutes economic development. Mr. North noted that disciplines like economics, political science and sociology have not adequately been able to answer this question because they are static disciplines. “The theory we have works at a point in time,” said Mr. North. “So what’s missing?” Four factors: beliefs, time, culture and institutions.

Beliefs are the way we translate the complex structure of human interaction that happens in our world. This understanding, that takes place in our brain, deals with questions of who we are and what we are doing. This is not simply done and cognitive science is a relatively unknown field. “Yet, this is very important because of the different experiences that we have. These different experiences are at the heart of problems in the world,” said Mr. North. These beliefs change over time in accordance with our experiences.

Culture is a set of beliefs and institutions, inherited from the past, that constrain the set of choices that people have. Mr. North explained that people in societies have never had true free will, have always constrained by a set of beliefs. Lastly, institutions are defined as the way we structure human interaction. They are made up of formal rules (property, judicial rules) informal rules (values that constrain the way we interact with each other) and enforcement. Mr. North noted that all institutions are imperfectly enforced and gave the analogy of professional football to illustrate his point.

The game of football has formal rules and informal ones (such as no biting). “Yet professional football in the US can not be such a gentlemanly game,” said Mr. North. Ergo: all societies work imperfectly.

Mr. North interjected the issue of violence (the desire to kill one another) as the one characteristic that distinguishes human beings from other animals. Mr. North stated:” Creating social order and providing a context within which human beings can interact with each other is an on-going dilemma of societies through history.” With the above context, Mr. North’s talk went on to discuss how societies evolved to provide social order and economic development.

The Neolithic revolution, 10,000 years ago, led to the agricultural state and the limited access social order or the natural state. This was the era where human beings settled down and gave birth to the beginnings of specialisations and division of labour. This was an effective system since it produced economic and political elites, which stood to gain by co-operating instead of fighting. Participants became rich by rent-seeking activities and limiting competition. These societies move from fragile, to stable and then mature as they develop institutions. “In the process they can manage to be quite well off,” acknowledged Mr. North.

In contrast, few countries have developed ‘open access’ societies. The key factor in these societies is competition in both economic and political markets. Rent seeking activities tend to be temporary and wealth is created through competition and wiping out monopolies. Creative destruction is an ongoing process and makes this world rich. ‘Limited access’ societies typically have per capita incomes of less than USD 10,000 and open access societies have per capita incomes of USD 20,000 to USD 30,000. Therefore, while ‘limited access’ societies thrive on access to personal knowledge, ‘open access’ societies function thrive on impersonal knowledge, rule of law and treating everyone equally.

Mr. North continued:” Since the obvious gains of open access societies over limited access ones are so vast, how do all societies move from one state to the other?” Not easily. This is why only a handful of societies have managed to achieve the transition. Elite groups, which often make up just 20 per cent of the structure, resist this change.

This is why institutions such as the World Bank and the IMF have not been able to wipe out poverty from many parts of the world. “Change has to be accomplished in such a way that the move is advantageous for the elite,” noted Mr. North. “When it does happen it transforms nations.”

For instance, China is a limited access society which is evolving very rapidly but doing so in a markedly different way from the West. In China, change started off with rights of local peasants to retain a part of their income and expanding village economies. In the West change was accomplished due to property rights and the rule of the law. Therefore, understanding the differences in the way various countries work is important to manage this change.