Along with fellow economic historian Robert W. Fogel, Douglass C. North was awarded the 1993 Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel. North's award was remarkable in at least one respect: where more recent winners of the Nobel Prize in economics were predominately noted for their technical and mathematical sophistication or their dedication to "blackboard economics," North's award signaled the growing influence of the New Institutional Economics - an interdisciplinary school of thought that combines economics, law, history, sociology and increasingly, as of late, cognitive science. Two years earlier, the committee awarded Ronald Coase whose work explored the significance of transaction costs and property rights - analytic tools of New Institutional Economics.

Like many economic historians, North asks: why do some nations prosper while others fail miserably? Why do some economies evolve over time and others fail to mature? What factors account for development and progress? These questions beget others such as: How well do we understand reality? How do beliefs get formed? Who's beliefs matter and how do individual beliefs aggregate into belief systems? How do they change?

North suspects that the "the incentive structure embedded in institutions" has a lot to say about these questions. In his efforts to build a theory of economic change, North looks beyond neoclassical economics, whose "elegant analytical tools cannot prescribe policies that will induce development." Such tools say much about supply and demand in a frictionless setting but they can't explain why economies evolve.

"Institutions form the incentive structure of a society and the political and economic institutions, in consequence are the underlying determinant of economic performance," he says. The metaphor most often used by North and the NIE school is scaffolding.

According to North, neoclassical economics' main conceit is that institutions (which embody certain rules and constraints) and time (which is ever changing or as North likes to say "non-ergodic") are irrelevant to understanding economic growth. That is to say, neoclassicists do not account for any scaffolding.

Some neoclassicists may find this mildly controversial. They simply don't think much about the fact that, for markets to flourish, government at a minimum must clearly define property rights, enforce contracts between individuals and parties, and enforce the rule of law with an independent and credible judiciary.

North takes his research project in a slightly different direction. He insists on modifying the rationality assumption (sometimes belief systems fail to empower man's dominance over physical reality) and extending his analysis by adding the dimension of time. Rational choice is sufficient for "evaluating opportunity costs at the supermarket, but it is wildly incorrect when it comes to making more complicated choices in a world of incomplete information and of subjective models used to interpret that incomplete information." Choices are often made even in rational states of mind based on "non-rational" considerations. The consequence of this hybrid choice is responsible for the way we erect scaffolds (institutions and organizations, rules and players) and as Friedrich Hayek showed us, test them for error.

To North, time is the embodiment not only of current experiences but the cumulative experiences of the past that make up a culture. Culture is the result of how societies perceive reality and thus how we make choices. In taking his analysis close to the periphery of cognitive science, North insists that any incentive structure developed over time requires "a theory of the way the mind perceives the world and its functioning so that the institutions will provide those incentives."

In setting out to explain economic change, North is actually very modest. He doesn't come up with a unified theory of what causes economic change; he knows that much empirical work remains to be done on institutions. In the end, he suggests even a limit to "adaptive efficiency." The ability of the United States, for example, to reform and revise its institutions (deregulation and tax reform come to mind) to solve specific economic problems and promote growth is a good example of adaptive efficiency. However, adaptive efficiency, sorely lacking in the Soviet Union, may be of limited use to intractable parts of the world.

When it comes to understanding economic change we currently know three phenomena. The quantity and quality of human beings has improved remarkably (longer lifespan, better food and medicine, greater consumption, more choices, and emigration). Second, the stock of human knowledge has exponentially grown to the point where we, unlike other species, have a tremendous command over nature. Third, we know the importance of incentives and how they are cultivated through patents, copyrights and other laws.

North maintains, "A complete theory of economic change would therefore integrate theories of demographic, stock of knowledge, and institutional change. We are far from having good theories of any one of these three, much less of the three together but we are making progress."

How we make that progress is important and this is certainly a tall order that extends beyond economics. But we can start with what neo-classicists ignored in Adam Smith. We can explain economic change and improve performance if we resolve four stumbling blocks originally identified in Adam Smith's Wealth of Nations.

1) Successful societies know how to enable impersonal exchange. A certain leap of faith is required to engage in business with people you do not know. Wealth is realized only when we can exploit the gains from large scale, 'impersonal' markets where both parties trust a system of exchange.

2) The specialization of knowledge. Knowledge has spillover effects that don't fit nicely into a price system; some way must be found to exploit rents from information. Entrepreneurs must find a way to profit from their ability to cull disparate pieces of information while governments need to foster the "public goods" aspect of research and development. .

3) Institutions must change to make sure to get the incentives right.

4) And markets require governments but "not just any government." North wisely suggests that "institutions that limit the government from preying on the market" are critical to improving performance. History bears him out here.

Taken together we might apply these prerequisites to a developing country. Institutions, more broadly, the rules of the game, must ensure that contracts be enforced between strangers willing to engage in exchange, that institutions find ways such as copyright and patents to dispense knowledge and that any gains be protected by government, which must be restrained. The United States and Western Europe appear to have a rough idea of what it takes. Yet this property rights regime eludes post-Soviet Russia

The modern age has certainly thrown up challenges to economic development; and so too will the revolution in life sciences. As the low marginal costs of creating another publication, song, software program and drug approach zero, such disruptive technologies pose new challenges to any incentive system.

On the other hand the development of open source software such as Linux, the ability of the internet to move data at unimagined speed and the fluidity of capital to flee where it is not treated well certainly point to "new artifactual structures" or property rights regimes. Who gets this right - in the face of egalitarian and anti-free trade pressures - is poised for success.

North sees economists as hanging onto a body of theory that can't explain economic change. He sees himself a heir to Hayek who called for continuous trials in the face of ubiquitous uncertainty. "Economists have the correct insight that economics is a theory of choice. But to improve the human prospect we must understand the sources of human decision making. That is a necessary condition for human survival."

This book is the result of a career long inquiry into the nature of economic change. North provides us with a compelling case that as the world becomes more complex we ought to find ways to improve our institutions beyond what economic theory currently offers. It is intellectually engrossing and should be of interest to both scholars in both the hard and soft sciences. Understanding the Process of Economic Change is a book for serious thinkers.