What Is the Role of Institutions According to North? How Far Does This Theory Go Towards Explaining the Contours of World Development in the Pre-Modern Growth Era?

Maddison (2006) stated that he “would characterise the whole period 1000-1820 as ‘protocapitalist’”. He believes the transition from pre-modern to modern economic growth took place at around 1820. This will set the stage for this discussion. Within that period, there were two groups of countries which were differentiated by their deviation in economic growth. They were the Group A nations, which included Western Europe, Western Offshoots and Japan, while the rest of the world made up the Group B nations. The contours of world development in this era, largely shaped by Douglass North’s theory of institutions, can be categorise into two main subsets which are Gross Domestic Product (GDP) per capita and population demographics, for the purpose of this essay.

North (1990) defines institutions as “the rules of the game in a society or, more formally, are the humanly devised constraints that shape human action”. Institutions exist in every economy, in the form of either formal or informal constraints, developed to define the choice sets, within which individuals and organisations make their decisions.

Economic growth is heavily dependent on the productivity of an economy, which in turn is affected by the costs involved. In the neoclassical world of complete information, the gains of trade are only negated by the costs of production, also known as the transformation costs. North’s theory of exchange takes into account the transaction costs, which are the costs of exchange that will also reduce the benefits of trade. Institutions affect these costs which determine the profitability and feasibility of economic activities.

The role of the theory of institution is to deal with the issue of cooperation. In the real world of incomplete information and uncertainty, institutions are devised to create conducive conditions, where there are incentives and disincentives, to facilitate cooperative behaviour. In order to maximise private benefit, individuals and organisations will...