Institutional Economics

References

• Institutional Economics Wikipedia Article

Notes

Institutional economics focuses on understanding the role of the evolutionary process and the role of institutions in shaping economic behavior. Its original focus lay in Thorstein Veblen's instinct-oriented dichotomy between technology on one side and the "ceremonial" sphere of society on the other. Its name and core elements trace back to a 1919 American Economic Review article by William H. Hamilton. Institutional economics emphasizes a broader study of institutions and views markets as a result of the complex interactions of these various institutions (e.g. individuals, firms, states, social norms). The earlier tradition continues today as a leading heterodox approach to economics.

• Traditional institutionalism rejects the reduction of institutions to simply tastes, technology, and nature.
• Institutional economics focuses on learning, bounded rationality, and evolution (rather than assuming stable preferences, rationality and equilibrium).
• • Bounded Rationality is the idea that rationality is limited when individuals make decisions, and under these limitations, rational individuals will select a decision that is satisfactory rather than optimal.
• Institutionalism was a central part of the first 20th century, including such famous but diverse economists as Thomas Veblen, Wesley Mitchell, and John R. Commons.
• A significant variant is the new institutional economics from the later 20th century, which integrates later developments of neoclassical economics into the analysis.
• The role of law in economic growth and behavioral economics are hallmarks of institutional economics.
• • Law and Economics (or Economic Analysis of Law) is the application of microeconomic theory to the analysis of law.
  • Behavioral economics is the study of the psychological, cognitive, emotional, cultural, and social factors involved in the decisions of individuals or institutions, and how these decisions deviate from those implies by classical economic theory.

Thorstein Veblen

• Thorstein Veblen (1857-1929) wrote his first and most influential book, The Theory of the Leisure Class, in 1899. In it he analyzed the motivation in capitalism for people to conspicuously consume their riches as a way of demonstrating success.
• • Conspicuous Leisure or visible leisure is engaged in for the sake of displaying and attaining social status.
• In The Theory of Business Empire, he argued that output and technology are restricted by business practice and the creation of monopolies. Businesses protect their existing capital investments and employ excessive credit, leasing to depressions and increasing military expenditure and war through business control of political power.
• He criticized consumerism and profiteering.
• Through the 1920s and after the crash of '29, his warnings of the tendency for wasteful consumption and the necessity of creating sound financial institutions seemed to ring true.
• With his 1898 article Why is Economic Not an Evolutionary Science, he became the precursor to current evolutionary economics.
• • Evolutionary economics is a school of economic thought that is inspired by evolutionary biology. It treats economic development as a process rather than an equilibrium and emphasizes change, innovation, complex interdependencies, self-evolving systems, and limited rationality as the drivers of economic evolution.

John R. Commons

• John R. Commons (1862-1945) was from the mid-west. Underlying his ideas, consolidated in Institutional Economics (1934) was the concept that the economy is a web of relationships between people and diverging interests.
• Commons thought that the government should be the mediator between existing groups (monopolies, large businesses, labor unions).

Wesley Mitchell

• Wesley Clair Mitchell (1874-1948) was an American economist known for his empirical work on business cycles and for guiding the National Bureau of Economic Research in its first decades.

Clarence Ayres

• Clarence Ayres (1891-1972) was the principal thinker of what some have called the Texas school of institutional economics.
• He developed on the ideas of Veblen with a dichotomy of technology and institutions to separate the inventive from the inherited aspects of economic structures. He claimed that technology was always one step ahead of socio-economic institutions.
• He was influenced by the philosophy of John Dewey. Like Dewey, he utilized the instrumental theory of value to analyze problems and propose solutions. According to this theory, something has value if it enhances or furthers the life process of mankind.
• A more appropriate name for Ayres- position would be that of "techno-behaviorist" rather than an institutionalist.

Adolf Berle

• Adolf 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.
• He resigned from the Paris Peace Conference, 1919, due to his dissatisfaction with the Versailles Treaty terms.
• He 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.
• In 1930s America, the typical company laws did not clearly mandate such rights.
• Berle served in FDR's administration through the depression, and was a key member of the so-called "Brain trust" developing many of the New Deal policies.

John Kenneth Galbraith

• John Kenneth Galbraith (1908-2006) worked in the New Deal administration of Franklin Delano Roosevelt. Galbraith was critical of orthodox economics throughput the late twentieth century.
• In Affluent Society (1958), Galbraith argues voters reaching a certain material wealth begin to vote against the common good.

In an age of big business, it is unrealistic to think only of markets of the classical kind. Big businesses set their own terms in the marketplace, and use their combined resources for advertising programs 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.
• While the goals of an affluent society and complicit government serve the irrational technostructure, public space is simultaneously impoverished.
• In Economics and the Public Purpose, Galbraith advocates a "new socialism" (social democracy) as the solution, with nationalization of military production and public services such as health care, plus discipled salary and price controls to reduce inequality and hamper inflation.

New institutional economics

• With the new developments in the economic theory of organizations, information, property rights, and transaction costs, an attempt was made to integrate institutionalism into more recent developments in mainstream economics, under the title new institutional economics.

Institutionalist political economy

• Traditional institutionalism is in many ways a response to the current economic orthodoxy.
• Its reintroduction is 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.

Criticism

• Critics of institutionalism have maintained that the concept of "institution" is so central for all social science that it is senseless to use it as a buzzword for a particular theoretical school. As a consequence, the elusive meaning of the concept of institution has resulted in a bewildering and never-ending debate about which scholars are "institutionalists" or not.

Response

• According to Thaler and Sustein, a person is not generally best described as an Econ, a person with mainly self-interest in mind, but rather as a Human. Institutional economics, consistent with Thaler and Sustein, see humans as social and part of the community, which has been extracted from neoclassical economics.