OLD AND NEW INSTITUTIONAL ECONOMICS: INTRODUCTION
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The nature and types of institutions
All human interaction requires a degree of predictability. Individual actions become more predictable when rules – or institutions - bind people. Institutions are needed to facilitate economic life: economic exchanges cannot function in a social vacuum. Indeed, the type and quality of institutions make a great difference to how well the members of a community are able to satisfy their economic aspirations and how fast the economy grows. In short, economic practices are embedded in rules, routines and conventions. We shall examine the nature of these institutions.
Institutions are rules of human interaction that constrain possibly opportunistic and erratic individual behaviour, thereby making human behaviour more predictable and thus facilitating the division of labour and wealth creation. Importantly, institutions constitute the individual: shaping and moulding social objectives, means of behaviour and social relationships. Institutions, to be effective, always imply some kind of sanction for rule violations.
Institutional Economics examines the two-way relationship between institutions and individuals. It is concerned with the effects of institutions on individuals, as well as the transformation of institutions through individual practices. In addition, institutional economics is inter-disciplinary: it engages, borrows and draws on other social sciences such as sociology and political economy. In many ways, the approach of institutional economics contrasts with neoclassical economics: orthodox economics assumes that institutions are fixed, and are taken as given; and remains confined within its disciplinary boundary.
There are two types of institutions: First, internal institutions evolve from human experience and incorporate solutions that have tended to serve people best in the past. Examples include customs, ethical norms, goods manners and conventions in trade, as well as natural laws. Violations of internal institutions are normally sanctioned informally; e.g. social exclusion from parties and meetings. But there are also formal sanctioning processes to enforce internal institutions; e.g. barred from professional and trade associations. In many respects, institutional economics engages with sociology, psychology and anthropology.
Second, external institutions are imposed and enforced from above, having been designed and established by political and administrative agents. An example is legislation. External institutions are enforced by explicit formal sanctions (through the law courts and legitimated use of force – the police). Here, institutional economics borrows from political and legal sciences.
In institutional economics, it is appropriate to analyse values: institutions influence how people attain their own personal objectives and are able to realise their fundamental values (such as freedom, justice, security and prosperity). Shared fundamental values in the community support cohesion and motivate people to act within the institutional framework. In that sense, institutional economics draws upon moral philosophy.
Differences within institutional economics
As well as discussing the ways to understand institutions, we shall outline the strength and weaknesses of Old Institutional Economics (OIE) and New Institutional Economics (NIE). While both approaches include institutions within economics, they differ significantly in philosophical and methodological orientation as well as in the theoretical direction and normative content. Furthermore, there are significant differences within each school.
OIE does not represent a single well-defined or unified body of thought, methodology or program of research. The first research program is focused on the effects of new technology and institutional schemes, and the ways in which established social conventions and vested interests resist such change. The second major program concentrates on law, property rights and organisations, their evolution and impact on legal and economics power, economic transactions and the distribution of income. Institutions are outcomes of formal and informal processes of conflict resolution and ability to generate ‘reasonable value’.
NIE is equally disparate body of thought. One strand is to be found in the work on property rights. Another strand concerns public choice processes. A third important element deals with organisations. Some NI economists criticise those who take the purely rent-seeking approach to government activity, and want to emphasise notions of fairness and ideology in institutional change. Some NI economists argue that more research should be dome on spontaneous, invisible-hand processes, rather than deliberation and calculation.
Often, the differences between OIE and NIE are dichotomised into:
However, these extreme positions are untenable. Rather, a better approach does not involve either/or choices.
Writers on OIE: Thorstein Veblen, Clares Ayres, John R. Commons, John Galbraith and Warren Samuels.
Writers on NIE: Oliver Williamson; Ronald Coase, Douglas North, Fredrich Hayek and Richard Langlois.