Adaptive Efficiency Versus Allocative Efficiency:

It is adaptive rather than allocative efficiency which is the key- to sustain good economic performance. Allocative efficiency is, in a sense, static working well for a given set of institutions. However, in a situation of evolving technological and demographic changes with frequent shocks natural to the dynamic nature of changes involved, a flexible institutional matrix which can adjust to the changing context is essential to support the growth process in the economy. For this, the creation of a stable polity with complementary norms remains an essential prerequisite. Successful political/economic systems have evolved such characteristics over long periods of time. Efficient policies that are perceived to be inequitable have the potential to engender political reactions which can stall or reverse effective reforms.

The central issue of economic history and of economic development is therefore to account for the evolution of political and economic institutions that create an economic environment that induces increasing productivity.Viewed from this perspective, economic development can be equated with institutional development.