Schumpeter discusses the emergence of systems of complementary capabilities that develop
around key radical innovations to create economic growth. For example, the industrial revolution
was driven in part by changes in the means of production in the textiles industry; these changes
generated a variety of social and economic effects that then extended to other complementary
sectors, and diffused throughout the economy. During the industrial revolution, the factory
became the unit of production, moving people off farms and into cities and required clocks and
accounting systems to regulate working hours. The result was a sustained increase in the
standard of living, albeit not without certain adjustment costs.
In Schumpeter’s view, economic development is a fundamental transformation of an
economy. This includes altering the industrial structure, the educational and occupational
characteristics of the population, and indeed the entire social and institutional fabric. While
growth is measured by putting more people to work within an existing economic framework,
economic development is aimed at changing that framework so that people work more
productively, with a concomitant economy-wide shift toward higher value-added activities.
One
important conclusion from this is that, while economic growth can be measured quarterly,
realizing gains in economic development may take decades or generations. Thus, to add to the
definition, Economic Development is the means to achieve sustained increases in prosperity and
quality of life realized through innovation, lowered transaction costs, and the utilization of
capabilities towards the responsible production and diffusion of goods and services.
Economists conclude that the development of high quality institutions is the major factor
behind economic growth (Rodrik et al. 2002). Lipset (1959) argues that the efficiency of a
political jurisdiction’s social and economic institutions define economic development.
Institutions are the rules of the game, enforcement mechanisms or the accepted standard of
behavior in a society (Ostrom 1986). Institutions operate with specific rules and procedures that
lower transaction costs and inspire confidence by certifying the range of potential outcomes.
High quality institutions support productive activities and encourage capital accumulation, skill
acquisition, invention, and technology transfer (North and Thomas 1973). Rosenberg and
Birdzell (1987) highlight how the development of institutions conducive to capitalism was a
driving force in How the West Grew Rich.
Two points about institutions are relevant to solidifying our understanding of economic
development. First, there is no single institution, such as the legal system or property rights that
7
supports economic development. What matters is an underlying capability and orientation of the
social and economic organization of a society, especially the capacity to instill confidence in the
future. Formal and even informal institutions create predictability and order that allow
individuals and businesses to make investment decisions. Second, institutions are endogenous –
that is, they are the product of history, culture and historical accidents. Institutions evolve in
unexpected and idiosyncratic ways. However desirable, it is mostly not possible to transplant
organizations or sets of incentives wholesale from where they originate to other contexts where
they appear to be needed. Instead, organizations and incentives need to flow from existing
institutional arrangements. Engaging in economic development means building or augmenting
existing institutions that are critical to progress.
Giving primacy to the market hides the fact that markets would be very primitive without
government. When government works well, the private sector benefits through greater
productivity and efficient use of resources. Government also mitigates risk through a relatively
stable and predictable system of laws and money. Government provides rules and incentives –
the conditions under which modern markets are even possible, and enables the private sector to
realize its potential. More broadly, government provides for social order and predictability in
contracts and daily life. The difficult balance for the government to strike is to provide for the
realization of potential while not reducing incentives in the private sector. Thus, to further build
the definition, Economic development requires effective institutions grounded in norms of
openness, tolerance for risk, appreciation for diversity, and confidence in the realization of
mutual gain for the public and the private sector.
Economic development may be viewed as both a precursor to, and a result of, economic
growth. Economic growth provides slack resources that, if invested in economic development,
provide the basis for future economic growth (Amsden 1997). Unfortunately promoting all and
any growth is too often an easy victory to win at the expense of longer-term goals and objectives
(Rubin 1988). Indeed, many of our conceptual tools may not be quite up to the task of economic
development. Douglas North (1984) argues that neoclassical economics’ focus on short-run
optimal resource allocation is simply not well suited to the dynamic, long-term orientation that
defines the process of economic development. Consider that it takes seven years for an academic
discovery to be incorporated into an industry (Mansfield 1991) or 18 years of education to
produce a scientist.
