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Institutional economics
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Institutional economics, known by some as institutionalist political economy, focuses on understanding the role of human-made institutions in shaping economic behaviour. The institutional economists were typically critical of American social, financial and business institutions. What is now called new institutional economics, is a very different creature politically, but still focuses on the role of institutions in reducing transaction costs. Heterodox institutional economics emphasizes a broader study of institutions and views markets as a result of the complex interaction of these various institutions (e.g.
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Institutional economics, known by some as institutionalist political economy, focuses on understanding the role of human-made institutions in shaping economic behaviour. The institutional economists were typically critical of American social, financial and business institutions. What is now called new institutional economics, is a very different creature politically, but still focuses on the role of institutions in reducing transaction costs. Heterodox institutional economics emphasizes a broader study of institutions and views markets as a result of the complex interaction of these various institutions (e.g. individuals, firms, states, social norms). Law and economics has been a major theme since the publication of the Legal Foundation of Capitalism by John R. Commons in 1924. Behavioral economics is another hallmark of institutional economics based on what is known about psychology and cognitive science, rather than simple assumptions of economic behavior.
Institutional economics
Institutional economics focuses on learning, bounded rationality, and evolution (rather than assume stable preferences, rationality and equilibrium). It was once the main school of economics in the United States, including such famous but diverse economists as Thorstein Veblen, Wesley Mitchell, and John R. Commons. Some institutionalists see Karl Marx as belonging to the institutionalist tradition because he described capitalism as a historically bounded social system; other institutionalist economists disagree with Marx's definition of capitalism, instead seeing defining features such as markets, money and the private ownership of production as indeed evolving over time, but as a result of the purposive actions of individuals.
"Traditional" institutionalism rejects the reduction of institutions to simply tastes, technology, and nature (see naturalistic fallacy). Tastes, along with expectations of the future, habits, and motivations, not only determine the nature of institutions but are limited and shaped by them. If people live and work in institutions on a regular basis, it shapes their world-views. Fundamentally, this traditional institutionalism (and its modern counter-part institutionalist political economy) emphasizes the legal foundations of an economy (see John R. Commons) and the evolutionary, habituated, and volitional processes by which institutions are erected and then changed (see John Dewey, Thorstein Veblen, and Daniel Bromley.) The vacillations of institutions are necessarily a result of the very incentives created by such institutions, and are thus endogenous. Emphatically, traditional institutionalism is in many ways a response to the current economic orthodoxy; its reintroduction in the form of institutionalist political economy is thus an explicit challenge to neoclassical economics, since it is based on the fundamental premise
that neoclassicists oppose: that economics cannot be separated from the political and social system within which it is embedded. Some of the authors associated with this school include Robert Frank, Warren J. Samuels, Mark R. Tool, Geoffrey Hodgson, Daniel Bromley, Jonathan Nitzan, Shimshon Bichler, Elinor Ostrom, Anne Mayhew, John Kenneth Galbraith and Gunnar Myrdal, but even the sociologist C. Wright Mills was highly influenced by the institutionalist approach in his major studies.
Thorstein Veblen
Thorstein Veblen (1857-1929) wrote his first and most influential book while he was at the University of Chicago, on The Theory of the Leisure Class (1899). In it he criticised materialistic culture and wealthy people who conspicuously consumed their riches as a way of demonstrating success. Conspicuous leisure was another focus of Veblen's critique. In The Theory of Business Enterprise (1904) Veblen distinguished production for people to use things and production for pure profit, arguing that the former is often hindered because businesses pursue the latter. Output and technological advance are restricted by business practices and the creation of monopolies. Businesses protect their existing capital investments and employ excessive credit, leading to depressions and increasing military expenditure and war through business control of political power. These two books, focusing on criticism first of consumerism, and second of profiteering, did not advocate change.
Through the 1920s and after the Wall Street Crash of 1929 Thorstein Veblen's warnings of the tendency for wasteful consumption and the necessity of creating sound financial institutions seemed to ring true. Veblen remains a leading critic, which cautions against the excesses of "the American way".
John R. Commons
John R. Commons (1862-1945) also came from mid-Western America. Underlying his ideas, consolidated in Institutional Economics (1934) was the concept that the economy is a web of relationships between people with diverging interests. There are monopolies, large corporations, labour disputes and fluctuating business cycles. They do however have an interest in resolving these disputes. Government, thought Commons, ought to be the mediator between the conflicting groups. Commons himself devoted much of his time to advisory and mediation work on government boards and industrial commissions.
Adolf Berle
Adolf A. Berle (1895-1971) was one of the first authors to combine legal and economic analysis, and his work stands as a founding pillar of thought in modern corporate governance. Like Keynes, Berle was at the Paris Peace Conference, 1919, but subsequently resigned from his diplomatic job dissatisfied with the Versailles Treaty terms. In his book with Gardiner C. Means, The Modern Corporation and Private Property (1932), he detailed the evolution in the contemporary economy of big business, and argued that those who controlled big firms should be better held to account. Directors of companies are held to account to the shareholders of companies, or not, by the rules found in company law statutes. This might include rights to elect and fire the management, require for regular general meetings, accounting standards, and so on. In 1930s America, the typical company laws (e.g. in Delaware) did not clearly mandate such rights. Berle argued that the unaccountable directors of companies were therefore apt to funnel the fruits of enterprise profits into their own pockets, as well as manage in their own interests. The ability to do this was supported by the fact that the majority of shareholders in big public companies were single individuals, with scant means of communication, in short, divided and conquered. Berle served in President Franklin Delano Roosevelt's administration through the depression, and was a key member of the so called "Brain trust" developing many of the New Deal policies. In 1967, Berle and Means issued a revised edition of their work, in which the preface added a new dimension. It was not only the separation of controllers of companies from the owners as shareholders at stake. They posed the question of what the corporate structure was really meant to achieve.
“Stockholders toil not, neither do they spin, to earn [dividends and share price increases]. They are beneficiaries by position only. Justification for their inheritance... can be founded only upon social grounds... that justification turns on the distribution as well as the existence of wealth. Its force exists only in direct ratio to the number of individuals who hold such wealth. Justification for the stockholder's existence thus depends on increasing distribution within the American population. Ideally the stockholder's position will be impregnable only when every American family has its fragment of that position and of the wealth by which the opportunity to develop individuality becomes fully actualized.”
John Kenneth Galbraith
John Kenneth Galbraith (1908-2006) worked in the New Deal administration of Franklin Delano Roosevelt. Although he wrote later, and was more developed than the earlier institutional economists, Galbraith was critical of orthodox economics throughout the late twentieth century. In The Affluent Society (1958), Galbraith argues voters reaching a certain material wealth begin to vote against the common good. He coins the term "conventional wisdom" to refer to the orthodox ideas that underpin the resulting conservative consensus.
In an age of big business, it is unrealistic to think of markets of the classical kind. Big businesses set their own terms in the marketplace, and use their combined resources for advertising programmes to support demand for their own products. As a result, individual preferences actually reflect the preferences of entrenched corporations, a "dependence effect", and the economy as a whole is geared to irrational goals. In The New Industrial State Galbraith argues that economic decisions are planned by a private-bureaucracy, a technostructure of experts who manipulate marketing and public relations channels. This hierarchy is self serving, profits are no longer the prime motivator, and even managers are not in control. Because they are the new planners, corporations detest risk, require steady economic and stable markets. They recruit governments to serve their interests with fiscal and monetary policy, for instance adhering to monetarist policies which enrich money-lenders in the City through increases in interest rates. While the goals of an affluent society and complicit government serve the irrational technostructure, public space is simultaneously impoverished. Galbraith paints the picture of stepping from penthouse villas onto unpaved streets, from landscaped gardens to unkempt public parks. In Economics and the Public Purpose (1973) Galbraith advocates a "new socialism" as the solution, nationalising military production and public services such as health care, introducing disciplined salary and price controls to reduce inequality.
Clarence Ayres
John Dewey
Wesley Mitchell
New institutional economics
With the development of theories of asymmetric and distributed information an attempt was made to integrate institutionalism into mainstream neoclassical economics, under the title new institutional economics. However, this latter variant of institutionalism failed to supersede the classical school, because heterodox economists argue it was heir to what they perceive as the flaws of neoclassical economics. Specifically, new institutional economics failed to avoid criticisms of reductionism and lack of realism: these were leveled at neoclassical economics for effectively ignoring institutions, and at new institutional economics for attempting to reduce institutions to 'rational' and 'efficient' resolutions to the problem of transaction costs.
Institutionalism today
Modern institutionalism thus contains diverse strains, including the new institutional economics represented by people like Nobel Prize winner Douglass North and institutional political economy, i.e. "old" or "critical" institutionalism (an approach radically opposed to mainstream neoclassical economics) associated with the Cambridge economist Ha-Joon Chang, Daniel Bromley (University of Wisconsin-Madison), Warren Samuels (Michigan State University), and Geoffrey Hodgson from University of Hertfordshire.
See also
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