The Institutional Economists

The orthodox economics is squarely based on the institutions of individualism, economic rationality, private property and exchange (market economy). It faces six fundamental questions: (i) will the society organized on the principles of exchange stay composed or will it fall apart (the question of existence of equilibrium)?, (ii) will such an equilibrium be unique (a multiplicity of equilibria poses difficult and embarrassing questions)?, (iii) will such an equilibrium be robust (the question of stability of equilibrium)?, (iv) will such an economy (society) be efficient?, (v) will it grow or expand forever?, and (vi) will it be just? The classical economists, Adam Smith in particular, answered all these questions affirmatively using a characteristic methodology. However, Karl Marx challenged the entire structure of faith in the merits of the exchange economy and shattered all optimism regarding the said order. Some economists, mostly using a complex of mathematical, marginalist, rationalistic, atomistic and hedonistic methodology set out to prove that answers to all those six questions were in the affirmative. They worked hard to restructure the faith in the said order centered around the market. This led to the development of what Thorstein Veblen called Neo-Classicism. In so doing, the Neo-Classicists had to distance themselves from the reality; they did not mind doing so and yet claimed that they were empiricists. This endeavour made neoclassical economics dogmatic and religious in nature. Leijonhufvud in his Life among the Econ (1973) characterized the Neoclassical economists in the most sarcastic manner.

The Institutional Economists argued that market is only one among the many institutions centering which an economy could be organized. Moreover, institutions (which were conceived by Veblen as the settled habits of thought and action prevailing at a community level) are not given but they evolve. These institutions shape and are in turn shaped by the human endeavours and the material environment in a dynamic framework. The purpose of economics, therefore, is to study the dynamics and interdependence among human psyche, motivations and endeavours on the one hand and environment and institutions on the other. Thus, Institutional Economics focuses on learning, bounded rationality, and evolution (rather than assume stable preferences, rationality and equilibrium). Veblen showed how the Leisure Class Culture is dominant although conspicuous and wasteful, and how the labour class imitates the dominant culture for their own peril. He also refused to consider the industrialists as the messiah of development; he held that they in fact sabotage, for their own financial benefits, the possibilities of development brought about by the technologists. Veblen exhorted the engineers (also the technologists and the intelligentsia) to join hands so as to dethrone the industrialists from the seat of the captainship and take charge of running the economy.

Institutional economics (which is a heterox economics) focuses on learning, bounded rationality, and evolution (rather than assume stable preferences, rationality and equilibrium). It rejects the reduction of institutions to simply tastes, technology, and nature. 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 and the evolutionary, habituated, and volitional processes by which institutions are erected and then changed. 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 Samuels, Mark 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.

The Institutional Economists
William James Charles S. Peirce
Thorstein Veblen John R. Commons
W.C. Mitchell Karl Gunnar Myrdal
John K. Galbraith Clarence E. Ayres



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