It will come as no surprise that Doug North's latest book is about institutions. Perhaps more surprising is that it is not about economic growth per se, but rather economic “change.” Change is a given but, in the history of the world, growth is far rarer, a phenomenon that requires many initial conditions, “adaptive efficiency,” and much good luck.

Understanding consists of 13 chapters, divided into Part 1 (“The Issues Involved in Understanding Economic Change”) and Part 2 (“The Road Ahead”). Following an introductory chapter that sets the stage, chapter 2 introduces two fundamental concepts, “uncertainty” and “ergodic.” “Uncertainty” refers to situations in which humans cannot reliably assign probabilities and, therefore, insurance is not possible. North contends that uncertainty is ubiquitous and that much human activity throughout history can be categorized as attempting to reduce uncertainty. Rich counties have succeeded in taming much natural uncertainty but at the cost of greatly complicated social interactions. Conventional economic theory proceeds as if the economy were “ergodic” that is, predictable, in an expected value sense, but North contends that the world is “non-ergodic”—unpredictable.

Chapters 3 and 4 dip into cognitive science and philosophy. In North's view, we must have a theory about belief formation before we can have a theory about institutional formation. How do humans come to have beliefs about the world? North sketches a current debate in cognitive science—is the brain better modeled as a computer or does human learning follow a “connectionist” model? He concludes that, unlike the “rational actor” model of economics, most problem solving is accomplished through “pattern recognition.” Chapter 4 is about “consciousness” and its role in human and social development. North's account is not about the origins of consciousness but rather two implications—the development of supernatural or religious beliefs and the conflict that arises when these beliefs are challenged by new knowledge about the physical world

Chapters 5 and 6 are the core of the book. Institutions are the “rules of the game,” formal and informal, and economic performance is ruled by institutional performance. Institutions fundamentally derive from beliefs about the world, accumulated over time and preserved in culture. Most changes in the institutional structure are incremental because the stimuli are marginal and because the longer an institutional structure is in place, the greater the difficulty of altering that structure (“path dependence”). Every so often, however, there are cataclysmic events, natural and man-made that result in revolutionary institutional change, such as in the formation of the Soviet Union, discussed later in the book.

Part 2 begins with chapter 7. This chapter is about the “evolving human environment” and, unlike the other chapters in the book, contains data and graphs. After chiding economic historians for spending too much time studying the Industrial Revolution, North reviews some of the basic evidence documenting just how much social and economic change has been compressed into the past few hundred years. He also emphasizes a key idea in economic growth, specialization. Specialization, in response to widening markets, leads to gains from trade. But this is trade among anonymous individuals and will not occur unless institutions develop that facilitate such trade.

Chapter 8 is about “order” and “disorder.” In North's view, the great difficulty in getting a country on the path to modern economic growth is to establish order over disorder. “Order” does not mean regulation by the state, but rather an environment in which institutions constrain behavior in ways that are growth enhancing. Successful countries are those that establish institutions that allow order to be re-established quickly when an event—such as a civil war—interrupts the growth process, as it did in the United States. Chapter 9, “Getting it Right and Getting it Wrong” discusses the characteristics of “good” institutional frameworks versus bad institutional frameworks. Countries “get it right” when belief systems and institutions adapt to new information; they get it wrong when belief systems and organizations are rigid and resistant to change.

Chapters 10 and 11 are related in that they attempt to put into practice some of the theoretical ideas developed in preceding chapters. Chapter 10 is about the “rise of the Western World” and largely recapitulates the analysis of North's earlier (and famous) work. Chapter 11, the more novel of the two, applies the institutional paradigm to the meteoric rise and fall of the Soviet Union. The Soviet system was born out of chaos. The belief system of the major protagonists—Lenin, Trotsky, and so on—derived from their observation of pre-Soviet Russia, their reading of major texts (Marx), and their own theorizing. These beliefs were implemented in ways that later proved tragic—for example, the collectivization of agriculture. Very quickly, the state became enormously powerful, with power itself an end as well as a means. When faced with failure, the Soviet state engaged in “reform”; but these reform efforts, in North's view, were a pale imitation of the adaptive efficiency of western capitalistic institutions. According to North, the fall of the Soviet Union was not so much a case of a system disintegrating but a conscious choice on the part of party officials to dismantle the state, in order to take control of assets that were perceived (often correctly) to have economic value.

Chapter 12 offers some thoughts on what sort of policy lessons can be gleaned by studying the economic past. For North, these lessons comprise both the failures, much more numerous, as well as the success stories. In view of the previous chapters, not surprisingly, he recommends very careful study of where culture comes from, as well as the malleability of culture in the face of economic and other shocks. Cultural specificity also comes through loud and clear—what worked in the past in Western Europe or the United States would not necessarily translate to other parts of the world. Chapter 13 concludes with some appropriate Nobel-like musings on the economic future. In this regard, North is not nearly as optimistic about the world-wide diffusion of economic growth as is, say, Robert Lucas.

North has written many books about institutions. If you had to recommend just one to your favorite graduate student, would Understanding the Process of Economic Change be it? In my case, the answer would be “no.” For this purpose, Understanding is too abstract, too sketchy, too little tied to hard evidence, too dependent on North's previous writings. The book also suffers from a lack of connection to recent work in economic history; for example, Robert Allen's recent book on the Soviet Union is not cited, much less discussed. For my money, the correct answer to the question just posed is North and Thomas's The Rise of the Western World. For North's many admirers, however, Understanding will no doubt be a favored addition to their bookshelves, a summing up of his life's work on the role of institutions in economic development.