INSTITUTIONAL ECONOMICS: HUMAN BEHAVIOUR AND VALUES

Dominant within mainstream economic theory is the idea that all action is regulated by rational calculation. Yet, criticisms of neoclassical concept of rationality emphasise the immense problems of gathering and processing sufficient information, and the uncertainty involved in making any real choice (see Simon’s concept of ‘satisficing’).

It is in the nature of information that we are ignorant of its content before we possess it. So how can we evaluate the benefits and costs of further information? This evaluation must be largely on the basis of a subjective whim or guess (Austrian economics) or rely crucially on the established routines and the assessment and experience of other economic agents (institutional approach stressing conventions and routines).

The problem is not that rationality is simply ‘bounded’ in the sense that there is too little information upon which reason can be to based, but also that there is too much information to compute and assess. The problem of the complexity and abundance of sense-data and limited computational capacity, or ability of the human brain to deal it, is the central to institutional economics.

Neoclassical theory has a strong attachment to the concept of ‘economic man’ as a rational calculator. Yet, there is no place for habits, unconscious actions and sub-rational processes, all relevant to economics. We suggest that there are multiple levels of consciousness, and not just one single, rational level.

Knowledge may be made explicit and communicated formally, or it may consist of implicit know-how, or tacit knowledge, which can probably only be acquired by practice (learning by doing). It is acquired by imitating routines, whilst some parts can be made explicit (written down in manuals). Knowledge is often generated by the spontaneous interaction of people. It can also be created when people get together in an organised way and develop new knowledge through a plan to research and develop useful ideas.

The knowledge problem derives from the fact that human beings have only a limited capacity to develop, test and apply knowledge. Ignorance therefore is a ‘constitutional’ (or essential) element of human existence. Only bits of knowledge can be concentrated in any one mind. Knowledge is used effectively only if mechanisms can be found to draw on diverse, specialised knowledge of the population.

The division of labour and knowledge allows people to specialise but require them to co-operate. Over time, people become more effective in meeting their own and other people’s wants, as they learn new and adapt or discard old knowledge. The division of labour and knowledge therefore is a dynamic, evolving concept.

One can distinguish between emergent and adaptive additions to knowledge: emergent knowledge refers to major creative breakthroughs, whereas the adaptive development of knowledge refers to the steady flow of creativity in small, stepwise improvements. Emergent additions are often the result of the discovery of ideas that were previously unknown, whereas adaptive additions are often the result of planned information search.

Knowledge evolves in a tension between a conservative instinct, which aims to retain what has proved useful and has been appreciated by others, and an experimental instinct, which derives from curiosity and the desire to meet aspirations in different ways.

The information paradox arises when we want to assess how many resources to dedicate to information search. We simply do not have the necessary information prior to incurring the expense of acquiring it. We can normally only go by past experience and seek limited information before making a decision. And once, the knowledge has been acquired, the costs of information search are sunk costs: there are no extra costs on the further use of the information.

Rationality refers to purpose-directed actions, guiding all actions towards the attainment of a goal. We can distinguish between:

• ends-means rationality, where the ends are given and actions are taken to attain a given end;
• adaptive bounded rationality, where people do not all-knowingly maximise their given objectives, but may adapt their aspirations to what is more feasible;
• entrepreneurial-creative rationality, where agents try to overcome existing constraints, whether of resource supplies, technological or institutional limits.

Rational ignorance is the behaviour of people not to acquire certain types of knowledge in the face of the costs and uncertainties of information search.

The principal-agent problem arises whenever people (or agents) act on behalf of others (principals) and when the agents have better knowledge about the operation than the principals (asymmetric information). It is then possible that agents may act in their own interests and neglect the interests of the principals (shirking, opportunistic behaviour). Moral hazard describes a situation when people act opportunistically.

Three types of motivation may be employed by principals to ensure that agents act to their best capabilities:

• agents can be aspired to make the principals’ goals their own out of love and solidarity (e.g. education, corporate identity and seminars);
• agents can be controlled by direct supervision and coercive commands (e.g. instructions, penalties and spy cameras);
• agents can follow general rules that create incentives for them to pursue the principals’ goals out of their own self-interest (e.g. bonuses and promotion).

Since people pursue values in their actions, it appropriate to incorporate the analysis of values in the analysis of institutional economics. ‘Value-free’ analysis is inadequate. Values: Freedom is the opportunity to pursue autonomously within one’s domain one’s own, self-set purposes without interference. But freedom is circumscribed by the equal freedom of others. Freedom is usually defined as the (negative) freedom from coercion and interference. Social justice means the equality of outcomes. Security relates to the confidence that people will be able to enjoy freedom into the more or less distant future. Conservation of the environment is concerned with safeguarding environmental amenities and natural resources with regard to the interests of present and future generations.