German Economic, Monetary and Social Union and the Theory of Institutional Change

Abstract

Institutions are rules of behaviour whose compliance is enforced by mechanisms of sanctioning. They are therefore an integral part of the incentive structure of an economy. Using the differentiation of North (1990), two kinds of institutions can be distinguished: formal and informal institutions. Formal institutions are written rules like constitutions, laws and contracts; informal institutions include non-codified behavioural rules like customs, traditions and internalised institutions. According to North there is a fundamental difference between the two kinds of institutions that is of major importance for the transition of economic systems: informal institutions are far more difficult to change than formal institutions. Processes of economic transition are characterized by fundamental changes of formal institutions: the institutions of a centrally planned economy have to be replaced by institutions of a market economy. But individuals tend to internalise institutions, therefore a further important question for the success of the process of transition concerns the role of informal institutions: How fast do the individual actors adapt their customary behaviour to the new formal institutions? In this regard North proposes: ‘If individuals have been brought up with norms that eschewed competition and individual initiative, the incentive structure of market economies they will be hard put to adjust when the formal rules change.