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Project 2000: Significant Works in Twentieth-Century Economic History 
 
Lance E. Davis and Douglass C. North (with the assistance of Calla  
Smorodin), _Institutional Change and American Economic Growth_.  
Cambridge: Cambridge University Press, 1971. viii + 282 pp. 
 
Review Essay by Cynthia Taft Morris, Department of Economics, Smith  
College and American University. <[log in to unmask]> 
 
 
Davis and North Launch Neoclassical Institutional Theory 
 
 
This book is an early major step in the evolution of the thinking of  
Douglass North and his collaborators on the "new" neoclassical theory  
of institutional change -- the institutional arm of the new economic  
history that began to flourish in the 1960s. Among the many notable  
later steps are _The Rise of the Western World_ (1973) with Robert  
Paul Thomas and "Constitutions and Commitment: The Evolution of  
Institutions Governing Public Choice" with Barry Weingast (1989) --  
which ranks third in citations among articles ever published in the  
_Journal of Economic History_. 
 
Lance Davis and Douglass North develop a theory of institutional  
change so familiar that it is easy to forget the theory was ever  
"new." They lay out a model where the core logic of institutional  
change is neoclassical cost-benefit analysis and the motivating drive  
for institutional change is profit maximization. The goal of the  
authors' "intellectual journey through American economic history [is]  
. . . to provide a description of the processes that have produced  
the present structure of economic institutions. That description, in  
turn, is the basis for a first (and very primitive) attempt at the  
formulation of a specified, relevant, and logical theory of the  
birth, growth, mutation, and, perhaps, death of these institutions.  
The book is a study of the sources of institutional change in  
American history. It is concerned with the relationship between  
economic organization and economic growth" (p. 4). 
 
Chapter 1 presents the concepts and definitions (institutional and  
economic environments, institutional arrangement, institutional  
instruments, and institutional innovation). An institutional  
arrangement will be innovated if the expected net gains exceed the  
expected costs. Arrangements range from purely voluntary to totally  
government controlled and operated and seek to realize economies of  
scale, lowered transactions costs, internalization of external  
economies, reduction of risk, or redistribution of income (pp. 10-11). 
 
Chapter 2 analyses the government's role in redistribution. The  
authors' purpose is to include the role of government in their theory  
of institutional change in spite of the unsatisfactory state of  
political theory. To exclude it would likely "yield a model of  
institutional change no more useful in the growth context than are  
the present models with their ceteris paribus assumptions about  
institutions" (pp.37-38). In their analysis, governments with  
effective coercive power will be the preferred vehicle for  
institutional innovations where governments are well developed but  
markets are not, where external benefits are large but property  
rights are dispersed, where benefits are substantial but indivisible,  
and where benefits are not increased and the goal is redistribution.  
The costs of using government to appropriate others' wealth and  
income depends on the numbers and heterogeneity of the persons  
organized, the feasibility of excluding outsiders from benefiting,  
the complexity of political coalitions, the rules of the political  
game, and the character of electoral suffrage. 
 
Chapter 3 specifies the dynamics of the model in the context of  
American history. The authors seek to predict both the institutional  
"level" of change and the time lag from first perception of profit  
opportunity to institutional innovation: New institutional  
arrangements will be innovated where profit or income opportunities  
appear that require institutional changes or where cost reductions  
can be achieved with new business forms or political moves  
redistributing income. Among many influences changing the benefits  
and costs of institutional innovations are changes in market size,  
technical change, changes in income expectations, organizational  
changes in closely related activities, cost reductions associated  
with government-financed information or reductions in risk, and  
political changes altering voting or property rights. All these  
except political changes have parallels in neoclassical theories of  
technical change. However, "to do no more than assert a relationship  
between income changes and arrangemental innovation is hardly a  
significant step; . . . it is our intention to offer a theory that  
helps predict (or explain) the emergence of these new or mutated  
arrangements. In particular, the theory predicts the level  
(individual, voluntary cooperative, or governmental) of the new  
institutional arrangement and the length of time that passes between  
the recognition of the potential profit and the emergence of the new  
arrangement" (p. 39). 
 
The core of chapter 3 divides the causes of varying lags between the  
perception of an innovation and its successful emergence into four  
steps: perception and organization, invention, menu selection, and  
start-up time. (i) The time lag between perceived profit and the  
organization of a "primary action group" depends on how much profits  
there are and their certainty. (ii) Where no suitable options are  
immediately available, time is required for invention. (iii) Where  
options are available, time is required to search out and select the  
most profitable ones. (iv) The start-up time for the innovation will  
vary with the "level" of institutional change, that is, according to  
whether it is an individual arrangement (shortest lag), a voluntary  
cooperative one (a longer lag because of more complex arrangements),  
or a governmental innovation (a still longer lag because political  
organization is required). 
 
The final chapter of Part I on the theory deals with the exogenous  
institutional environment, and thus the initial conditions in Davis  
and North's model of institutional change. Chapter 4 sketches  
substantial historical changes in the institutional environment: the  
rules governing the extent and weighting of voting rights, the legal  
basis for private property, and "the expectational weights that the  
community chooses to apply to the future costs and revenues of  
particular arrangemental innovations -- weights that are the product  
of experience triggered by events exogenous to the model" (p.65).  
Important sources of change in these three aspects of economic life  
are (i) the Constitution and its interpretation by the courts, (ii)  
the common law, and (iii) "the external changes in the political and  
economic life of the nation that affect the people's attitudes toward  
government" (p. 65). A lively sketch of dramatic historical changes  
and fluctuations over 175 years in each of these categories follows. 
 
Part II consists of six historical chapters in which Davis and North  
apply their model of institutional change to American economic  
history by telling vivid stories of changes in land policies,  
financial institutions, transportation, market structure in  
manufacturing, the organization of the service industry, and labor  
market changes affecting unions and education. These stories  
illustrate well the explanatory potential of their model by  
describing the history of business and labor responses to changing  
profit and income opportunities through the adoption of new  
institutions or adaptations of old ones. No attempt is made here to  
evaluate these stories since this reviewer has no specialized  
expertise in American economic history. Of necessity given space  
constraints, they are selective and reflect the specialties of the  
authors, as they themselves carefully state in the introduction to  
the book. 
 
The great strength of the neoclassical theory of institutional change  
is that it yields an insightful and plausible "explanation" of a wide  
range of institutional changes over time in individual market  
economies where the private profit motive is strong and  
neoclassical-type market supply responses are already widespread. An  
enormous volume of literature has developed in response to the work  
of Douglass North and his colleagues. North himself has been an  
outstanding leader in the expansion of the scope of applications of  
neoclassical institutional theory. 
 
The limitations of the theory are most evident in the study of  
cross-country differences in institutional responses to the  
challenges of opportunities for profit and higher incomes. The new  
economic theory of institutional change is a variant of historical  
challenge and response theories, all of which suffer from a similar  
problem. To quote Nathan Rosenberg's discussion of David Landes's  
_Unbound Prometheus_ (1969), "the industrial world is full of  
'challenges' and always has been. Why do some challenges in some  
places at certain times generate successful responses and at other  
times do not?" (1971, p. 498). Telling historical stories consistent  
ex post with theories of institutional change does not address the  
questions raised by many historical instances when profitable  
opportunities for institutional change did not bring forth historical  
responses that helped accelerate economic growth. Constrained by its  
focus on market opportunities and responses, the neoclassical  
institutional theory poorly accommodates institutional changes driven  
by nationalist, religious, or imperialist motives so intense as to  
sacrifice economic gain. Also, the theory accommodates poorly  
historical country-specific institutional developments that are the  
outcome of chance and strong path dependency such as are evident in  
historical patterns of private land acquisitions or foreign  
domination in some developing countries. 
 
The limitations to the excellent work of North and his collaborators  
are noted here as a warning that no one theory handles well the  
diversity of comparative historical experience. Casual empiricism is  
the usual practice in delimiting the countries and periods to which  
each theory applies. Because of this, the entire literature on  
institutional change is particularly weak on the diverse consequences  
of similar economic, demographic, and technological changes in  
different institutional settings. We all need to delimit more  
effectively the domains to which familiar models apply (Morris and  
Adelman, 1988, p. 32). 
 
References 
 
David S. Landes. 1969. _The Unbound Prometheus: Technological Change  
and Industrial Development in Western Europe from 1750 to the  
Present_. Cambridge: Cambridge University Press. 
 
Cynthia Taft Morris and Irma Adelman. 1988. _Comparative Patterns of  
Economic Development, 1850-1914_. Baltimore: Johns Hopkins University  
Press. 
 
Douglass C. North and Robert Paul Thomas. 1973. _The Rise of the  
Western World: A New Economic History_. Cambridge: Cambridge  
University Press. 
 
Douglass C. North and Barry Weingast. 1989. "Constitutions and  
Commitment: The Evolution of Institutions Governing Public Choice in  
Seventeenth-Century England," _Journal of Economic History_, 49  
(December): 803-832. 
 
Nathan Rosenberg. 1971. "Review of the _Unbound Prometheus_,"  
_Journal of Economic History_, 31 (June): 497-500. 
 
 
Cynthia Taft Morris is distinguished economist in residence, American  
University and Charles N. Clark Emeritus Professor of Economics,  
Smith College. She is past president of the Economic History  
Association. 
 
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