The New 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 and they did not mind doing so. This endeavour made neoclassical economics dogmatic and religious in nature. Leijonhufvud (1973) characterized neoclassical economics in the most sarcastic manner.

The (old) Institutionalist 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 motivations and endeavours, environment and institutions. Thus, Institutional Economics focuses on learning, bounded rationality, and evolution (rather than assume stable preferences, rationality and equilibrium). Veblen, in particular, 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.

It goes without saying that (the old) Institutional Economics was (and is even today) a heterodox economics and, therefore, uncomfortable. To make it somewhat comfortable, it had to be internalized into the Neo-Classical framework. This task was accomplished by the New Institutional Economists. The term "New Institutional Economics" was coined by Oliver Williamson in 1975. Thus seen, the New Institutional Economics (NIE) is a significantly pruned version of (the old) Institutional Economics embedded into the modified Neo-Classical framework in view of the recognition of concepts of transaction costs and market imperfections introduced by Ronald Coase. Although no single, universally accepted set of definitions has been developed, most scholars doing research under the NIE methodological principles and criteria follow Douglass North's demarcation between institutions and organizations. Institutions are the "rules of the game", consisting of both the formal legal rules and the informal social norms that govern individual behavior and structure social interactions (institutional frameworks). Organizations, by contrast, are those groups of people and the governance arrangements they create to coordinate their team action against other teams performing also as organizations. Firms, Universities, clubs, medical associations, unions etc are some examples.

Among the many concepts/aspects that are often taken into account in current NIE analyses these can be mentioned: organizational arrangements, transaction costs, credible commitments, modes of governance, persuasive abilities, social norms, ideological values, decisive perceptions, gained control, enforcement mechanism, asset specificity, human assets, social capital, asymmetric information, strategic behavior, bounded rationality, opportunism, adverse selection, moral hazard, contractual safeguards, surrounding uncertainty, monitoring costs, incentives to collude, hierarchical structures, bargaining strength, etc.

However, the New Institutional Economists have progressively been drawn towards the old institutional precepts and distanced from the Neo-Classical framework. In the amalgamation of the Neo-Classicism and (old) Institutionalism, the latter is appearing as the dominant force. For example, D.C. North, a leading New Institutional Economist, admits that institutions or a 'common cultural heritage' do reduce divergences between the mental models held by different individuals, or otherwise effect individual beliefs or goals. This is in line with the old institutional economics concerning the role of institutions in influencing individual preferences.

The New Institutional Economics
Ronald Coase Douglass Cecil North
Oliver E. Williamson Harold Demsetz
Avner Greif Robert D. Putnam

 

 

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