The Importance of Institutions

In today’s video, we discuss a topic critical to understanding economic growth: the power of institutions.

To better shed light on this, we're going to look at an example that's both tragic and extreme.

In 1945, North and South Korea were divided, ending 35 years of Japanese colonial rule over the Korean peninsula. From that point, the two Koreas took dramatically different paths. North Korea went the way of communism, and South Korea chose a relatively capitalistic, free market economy.

Now—what were the results of those choices?
In the ensuing decades after 1945, South Korea became a major car producer and exporter. The country also became a hub for music (any K-pop fans out there?), film, and consumer products. In stark contrast, North Korea's totalitarian path resulted in episodes of famine and starvation for its people.

In the end, South Korea became a thriving market economy, with the living standards of a developed country. North Korea on the other hand, essentially became a militarized state, where people lived in fear.

Why such an extreme divergence?

It all comes down to institutions.

When economists talk about institutions, they mean things like laws and regulations, such as property rights, dependable courts and political stability. Institutions also include cultural norms, such as the ones surrounding honesty, trust, and cooperation.

To put it another way, institutions guide a country's choices -- which paths to follow, which actions to take, which signals to listen to, and which ones to ignore.

More importantly, institutions define the incentives that affect all of our lives.

Going back to our example, in the years after 1945, North and South Korea took dramatically different institutional paths.

In South Korea, the institutions of capitalism and democracy, promoted cooperation and honest commercial dealing. People were incentivized to produce goods and services to meet market demand. Businesses that did not meet demand were allowed to go bankrupt, allowing the re-allocation of capital towards more valuable uses.

Against that grain, North Korea's institutions produced starkly different incentives. The totalitarian regime meant that the economy was centrally planned and directed. Most entrepreneurs didn't have the freedom to keep their own profits, resulting in few incentives to do business. Farmers also didn't have enough incentive to grow sufficient food to feed the population. This was due in part to price controls, and a lack of property rights.

As for capital, it was allocated by the state, mostly towards political and military uses. Instead of going towards science, or education, or industrial advancement, North Korea's capital went mostly towards outfitting its army, and making sure that the ruling party remained unopposed.

And now, look at how different the two countries are as a result of those differing institutions.

When it comes to economic growth, institutions are critically important. A country's institutions can have huge effects on long-term growth and prosperity. Good institutions can help turn a country into a growth miracle. Bad institutions can doom a country to economic disaster.

The key point remains: institutions are important.

They represent the choices that a country makes, and as the Korean peninsula shows you, choices on this scale can have staggering effects on a nation's present, and future.

Help us caption & translate this video!

[Yellowgary]

tyler cowen saying he listens to kpop never fails to make me laugh

[yurikocubas]

Thank you for putting subtitles below, so that the hearing-impaired can also watch your videos. Please do so in the others as well.

[christinamorrison]

Thank u soo much of this explanation we should have more teachers like this😊

[bedyjeridi]

what a great video! Keep up the good work sir.

[vinm]

Institutions.
The London Silk Weavers Institute donated its library to some dignified establishment.
And that wasn't unusual ; many Trade Unions held lectures and had libraries :
education was hungered after.
The working men's institutions as well as providing social insurance for destitute
members acted as a source of education.

[Kevin-cmkc]

I certainly agree with the general point about the importance of intitutions of course, but i dont think its really fair to say north and south korea have been the same aside from their institutions. South korea was also a dictatorship up until fairly recently. Plus South Korea have been allowed to participate in trade and the global economy as essentially a protectorate of the world hegemon. Meanwhile, north korea has been a target of exactly that world hegemon who spent decades trying to eradicate anything socialist/ communist at all costs during the cold war. Im just saying, thats going to have some pretty major impacts as well.

[MRCKify]

Sweet coincidence: I just started reviewing Douglass North's "Institutions" paper from the JEP in 1991 for class

[puneud]

The basic reference (of night light) is the convinient one. How would you explain the dark China & bright India with this theory of yours?

[apolize]

very helpful! to understand why economic development important.

[tebogokhensane]

Thank you this really helped alot for my assignment, how can I reference this in my work

[MrMel]

Living in north Korea is clearly a nightmare but south Korea is not such a market paradise. Dont forget the dictatorship during the take-off. Dont forget the role of he Government to starrt the industrialization. An agricultural reform was done. South Korea is a mixed economy such as all developped countries. Describe ALL the institutions.

[milostvp]

korea was split into north and south by force, by U.S.

[mitchellbrown]

I'm amazed how many people there are in the comments trying to excuse and explain away North Korea so it isn't a problem for their collectivist economics. And saying that it is a good country?
However the like dislike bar shows that they are only a small minority. Thankfully.

[mapc]

I think this video it's complex, and fully of simplifications. I think turns institutional incentives in ideological perspectives, that isn't correct. Institutions in a free market can be highly centralized in some sectors, and that doesn't provoke this kind of development disruption.

[yunzhuzhang]

Question regarding the practice question1: why “redistributive Justice “ isn’t included in “promoting economic growth”?

[sanpol]

great video. The truth was never so easy to be seen and understood.

[tacsystems]

What of west and east Berlin? Another example of the same region and culture with vastly different results.

[incrediblystupid_driver]

I am twelve and this helps me get an a

[SohamSinha]

This is an example how communism is confused with totalitarian regime. Totalitarian administration is a form of government. Communism is a form of economy, coming from social science. This is nothing but to confuse people about socialism and communism with authoritarian form of governance.

[abhijeetvasishtha]

Please! make a series on 'Independent India Economic History'. Highly Demanded!!