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Institutional Economics

Institutional economics has important applications to studies of law, business, and economic development. Prominent names in the “new” institutional economics include the Nobel laureates Ronald Coase and Douglass North, as well as Oliver Williamson, the most frequently cited economist of all time. This newer tradition was preceded in the United States in the interwar period by an influential tradition of institutional economics inspired by Thorstein Veblen (1857–1929), Wesley Mitchell (1874–1948), and John Commons (1862–1945). This older tradition dealt extensively with the interface between economic activity, law, customs, and other institutions.

Institutional Economics

An important theme exists in the old institutionalism derived from Veblen's writings in the 1890s to those of John Kenneth Galbraith (1908–2006) after World War II. Old institutionalism differs from much of mainstream economics and new institutional economics because it does not assume a given individual with given purposes or preference functions. Instead of given individuals, old institutionalism considers interactive and partially malleable agents, mutually entwined in a web of social institutions.

A frequent attack on the notion that circumstances mould individual tastes and preferences is the criticism that this leads to some kind of structural or cultural determinism. The individual, these critics say, is made a puppet of the social or cultural context. Admittedly, some old institutionalists have promoted such a view. However, such exclusively top-down ideas are not common to all old institutionalists. For instance, Veblen argued that changes in “the institutional fabric are an outcome of the conduct of the individual members of the group” while at the same time “these institutions act to direct and define the aims and end of conduct” (1919: 243). In the writings of Veblen and Commons, there is both upward and downward causation; individuals create and change institutions, just as institutions mould and constrain individuals. Old institutionalism is not necessarily confined to the cultural and institutional determinism with which it is sometimes associated.

While many recognize that individuals create and sustain institutions, the single most important characteristic of old institutionalism is the idea that the individual is socially and institutionally constituted. Consequently, conceptions of social power and learning are placed at the center of economic analysis, making it more able to address questions of structural change and long-term economic development. On the other hand, the analysis becomes much more complicated and less open to formal modeling. In normative terms, individuals are no longer taken as the best judge of their welfare. This opens up the difficult question of the discernment and evaluation of human needs.

New Institutional Economics

By contrast, a unifying theoretical project in much new institutional economics is to explain the existence of political, legal, or social institutions by reference to a model of given individual behavior, tracing out its consequences in terms of human interactions. The explanatory movement is from individuals to institutions, taking individuals as primary and given. Authors writing in this tradition have explained how money, traffic conventions, and other institutions have emerged through such interactions, often without central management or overall design.

However, in attempting to explain the origin of social institutions, new institutional economics has to presume given individuals acting in a certain context. In the original, hypothetical “state of nature” from which institutions are seen to have emerged, several weighty rules, institutions, and cultural and social norms are always presumed.

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