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“The tools that the new economic historian inherited from the economist were not intended to deal with long-run economic change…The economist not only accepted tastes, technology, and population as given, but also he accepted equally the current basic ground rules within which both market and non-market decisions were made. For that matter, the theory did not recognize the possibility of making economic decisions via the political process. Information was assumed to be perfect and costless.”

4. Conclusion

For a long time, neo-classical economists have built models, conducted research, and prescribed policies based on theories that ignore one of the most fundamental aspects of economic life: institutions, or the formal and informal rules in society that “structure incentives in exchange, whether political, social, or economic” (North, 1992, p.5). According to North (1992), all economies have transaction costs—the multitude of costs associated with doing business every day. For North (1992), how successful a country is in achieving economic growth and prosperity in the long-run depends to a great extent on how successful it is in creating the type of political and economic institutions that minimize these transaction costs. As Acemoglu and Johnson (2005, p.950) note: “There is a growing consensus among economists and political scientists that the broad outlines of North’s story are correct: The social, economic, legal, and political organization of a society, i.e., its ‘institutions,’ is a primary determinant of economic performance.”