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Apart from Marxism, which has also the character of a social movement, institutional economics has become the principal school of heterodox thought in economics. Originating in and still concentrated largely, but by no means exclusively, within the United States, institutionalism has served the dual functions of providing critiques of mainstream neoclassical (and Marxian) economics and producing an alternative conception of the economy, and of doing economic research and analysis. In so doing, it has represented in part a continuation of the German and English historical traditions, including Max Weber, as well as other writers such as John Hobson.

Early Position

The place of institutional economics thus described applies principally to the post-Second World War period. During the interwar period, the picture was substantially different. For most economists, institutionalist ideas and theories were very much a part of economics. Many economists, typified by Frank William Taussig, John Maurice Clark, Friedrich von Wieser and Joseph A. Schumpeter, did not make a fundamental distinction in their own work between institutional and neoclassical economics or, if they did differentiate the two, nonetheless pursued both modes of doing economics. They could work on aspects of the problem of organization and control and on the institutional foundations of markets pretty much simultaneously with work on the theory of competition and the working of pure abstract markets, with each enriching the other. Some economists were less eclectic in their orientation. They continued the antagonism of Thorstein Veblen, on the one hand, or developed the antagonism of those suspicious of institutionalism as another form of interventionism and as largely unreceptive to the development of mathematical formalism in economic theory, on the other hand. The work of Malcolm Rutherford and others has shown a discipline largely undifferentiated in terms of institutionalism versus neoclassicism during the interwar period.

The precise relationship of heterodox institutional economics to orthodox neoclassical economics in the post-Second World War period is complicated by several considerations: the awkward sociological status of heterodoxy within the discipline; the ambivalence within institutionalism as to the relationship, some institutionalists feeling that the two schools are complementary and others that the two are mutually exclusive; and the presence within institutionalism of two different and to some extent conflicting traditions, one emanating from Thorstein Veblen and continuing through Clarence Ayres, the other starting with John R. Commons. The Veblen–Ayres tradition focuses on the progressive role of technology and the inhibitive role of institutions; the Commons tradition is less enamoured of the imperatives of technology and approaches institutions, as modes of collective action, more neutrally; both groups accept that actual economic performance is a function, inter alia, of both technology and institutions. Notwithstanding their differences, there is a common core of institutional analysis of perhaps no greater variety of formulation than within neoclassicism or Marxism.

Relation to Mainstream Economics

Mainstream economists maintain that the central economic problems are the allocation of resources, the distribution of income, and the determination of the levels of income, output and prices. In contrast, institutional economists assert the primacy of the problem of the organization and control of the economic system, that is, its structure of power. Thus, whereas orthodox economists have a strong tendency to identify the economy solely with the market, institutional economists argue that the market is itself an institution, comprised of a host of subsidiary institutions, and interactive with other institutional complexes in society. In short, the economy is more than the market mechanism: it includes the institutions which form, structure, and operate through, or channel the operation of, the market. The fundamental institutionalist position is that it is not the market but the organizational structure of the larger economy which effectively allocates resources.

To the extent, then, that institutional and neoclassical economists study the same questions (for example, resource allocation) the institutionalists generally encompass a broader or deeper set of explanatory variables: instead of having price and resource allocation be a function of demand and supply in a purely conceptual market, these latter are in turn related to the structure of power (wealth, institutions) which help form them. Power structure in turn is related to legal rights, thence to the use of government in forming legal rights of economic significance and thereby influencing the allocation of resources, level of income, and distribution of wealth.

Institutionalists are generally less concerned with price and resource allocation per se and more with the problem of the organization and control of the economy: that is, with performance seen as specific to power (rights) structure, as well as to technology. Institutionalists are interested, for example, in the formation and role of institutions, and the interrelations between economic and legal systems and between power and belief systems.

If institutionalists insist that the economy comprises more than the market mechanism, they also object to the equilibrium and presumptive optimality modes of analysis of neoclassical economics. The search for the deterministic technical conditions of stable equilibrium, it is felt, obscures the fundamental power and choice aspects of the economy. The search for optimality, or for optimal solutions, it is also felt, is either formally empty or can be given substance only by the introduction, typically implicitly, of antecedent normative assumptions as to whose interests count, whereas in the real world such questions have to be worked out both within institutions and through contests over institutional adjustment and reformation.

Principal Ideas

The central features of institutional thought are its holism and evolutionism. Thus the further principal themes of institutional economics include the following:

  1. 1.

    A theory of social change, and an activist orientation towards social institutions, through focusing on both the substantive impact of institutions on economic performance and the processes of institutional change, treating institutions not as something to be taken as given but as man-made and changeable, both deliberatively and non-deliberatively.

  2. 2.

    A theory of social control and collective choice, or a theory of institutions, a focus on the formation and operation of institutions as both cause and consequence of the power structure and societized behaviour of individuals and subgroups, and as the mode through which economies are organized and controlled. Instead of focusing on the mechanics of choice from within opportunity sets, a focus on the formation of opportunity sets; instead of a focus on unfettered market freedom, a focus on the total, complex pattern of freedom and control, that is, on the formation and operation of the system of control through which both actual opportunity sets and multi-dimensional freedom are formed.

  3. 3.

    A theory of the economic role of government, as a principal social process through which both itself and other institutions of economic significance are in part formed and revised. Instead of treating government, law, and the system of rights as either given and/or exogenous, these are treated as both dependent and independent, and always critical, not merely aberrational, economic variables.

  4. 4.

    A theory of technology, as defining and determining the relative scarcity of all resources, as a principal force in the evolution of economic structure (including the operation of institutions) and performance, and as the basis of the logic of industrialization marking the mentality as well as the practices of modern economies.

  5. 5.

    The fundamental principle that the real determinant of resource allocation is not the market but the organizational – institutional, power – structure of society.

  6. 6.

    An emphasis on facets of the value conception which transcend price, on the values represented in and given effect by the habits and customs of social life, on the pragmatic, instrumental values ensconced in the transcendental notion of the life process of man and society, and on the constructive values latent within and given effect by the working rules of law which are both the foundation and the product of the power structure of society. Included are attempts to understand the process by which values are changed, in contrast to the orthodox assumption of given values; that is, to consider within economics such questions as where the values come from, how they are tested, and how they are changed.

In amplification of these themes one finds, for example, Veblen’s emphasis on status emulation as a principal force in the formation of economic behaviour, including (through conspicuous consumption and the making of invidious comparisons) the formation of consumer demands; Commons’s analysis of the evolution of the fundamental legal foundations of the modern economy; John Dewey’s theory of instrumental logic and social value; John Maurice Clark’s analysis of the social control of business; Wesley Mitchell’s emphasis on the economy as a pecuniary phenomenon; Commons’s and Selig Perlman’s analyses of labour unions as a mode of representing worker interests and of generating institutional change; Edwin E. Witte’s, and Commons’s, efforts at creating new institutions for the embodiment and protection of rising interests and for the creative resolution of social conflict and the development of a body of analysis of institutional genesis and adjustment; and, inter alia, Veblen’s and Ayres’s analyses of the formation of the human belief system, including that of economists, under the impact of the contest between traditional and new ways of doing things.

Apropos of the last point, institutionalists have freely pointed to the selectivity and typically implicit nature of the operative assumptions of neoclassical analysis. They insist that, by its taking institutional or power structure as given or, more typically, by its selective specification of institutions and power structure, there is a strong tendency towards selective apologetics in orthodox economics, especially in that work which is directed to the identification of ‘optimal’ solutions. The institutionalist solution to such problems is that of Gunnar Myrdal: to avoid the pretence of value-free economics by making all, or substantially all and certainly the operative, value premises explicit and by generating appraisals thereof.

Accordingly, institutional economists have tended to avoid recourse to methodological individualism and to abstain from puzzle-solving research in the context of models devoid of institutional embodiment and stressing equilibrium, optimality, and purely competitive markets. They have rather attended to theoretical and empirical analyses of real-world problems, such as the operation of particular institutions, business–government relations, and the conditions of economic development. In so far as they have dealt with economic variables at fundamental conceptual levels, such as government and rights, they have at least tried to do so in both analytically credible and non-presumptive ways.

Internal Conflict

Conflict within institutionalism has largely been on two issues. One involves the putative dichotomy of technology and institutions. The other is between those who call for government planning to modify if not replace private enterprise and those who favour private enterprise but call for strong antitrust enforcement to ensure a competitive market economy.

John Kenneth Galbraith

The best-known contemporary version of the institutionalist conception of the economy has been that of John Kenneth Galbraith. Following the course laid down by Veblen, and grafting it on to a version of Keynesian economics, Galbraith explored the corporate nature and planning modes of the business system and the impact of what he considers to be technological imperatives, the social formation of individual preferences underlying demand functions, the power and continuous interaction of the state and the corporate core of the economy, the factors and forces which influence the formation of opinion and policy in the public sector, and the inevitability of resolving conflicts of interest on the basis of some conception of public purpose.

Widespread Practice

In such fields as labour economics, industrial organization, economic development, law and economics, agricultural and natural resource economics, and macroeconomics, institutionalists, through their primary attention to power structure and belief system, in the context of their overriding concerns with social change and social control, have produced understandings of economic reality quite different from those of neoclassical economists. These contributions have come through the recent work, in addition to Galbraith, of John Adams, Jack Barbash, Kenneth E. Boulding, Dan Bromley, Thomas DeGregori, William Dugger, Daniel R. Fusfeld, Wendell C. Gordon, Allan G. Gruchy, David B. Hamilton, Gardiner C. Means, Walter C. Neale, Kenneth Parsons, Wallace Peterson, A. Allan Schmid, Robert Solo, Ron Stanfield, Paul Strassmann, Marc Tool, Harry M. Trebing and William Waller, among others. Some of this work appears in the Journal of Economic Issues, published by the Association for Evolutionary Economics. Also in the United States, institutional economists have joined with Post Keynesian economists and with varieties of political economists to explore empirically and theoretically topics central to those fields. In Europe, Geoffrey Hodgson and others have pursued the development and application of evolution theory to the array of institutionalist topics. Some have studied the formation, use and impact of technology and others, for example, the organizational theory applicable to the corporation. The European Association of Evolutionary Political Economy has become the major forum for European institutionalists, and even for many Americans.

Altogether this work has constituted an alternative analysis of the economic system, especially of capitalism but also of socialism, and a critique of both existing economic systems and orthodox schools of economics.

See Also