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What is now often referred to as the ‘old’ institutional economics was a central part of American economics during the inter-war period, and is a tradition of economics that still exists today.

The explicit identification of something called the ‘institutional approach’ to economics, or ‘institutional economics’, goes back to 1918 and to Walton Hamilton’s American Economic Association (AEA) conference paper, ‘The Institutional Approach to Economic Theory’ (Hamilton 1919).

Hamilton’s paper was a call for the profession at large to adopt the ‘institutional approach’. For Hamilton, anything that ‘aspired to the name of economic theory’ had to be (i) capable of giving unity to economic investigations of many different areas; (ii) relevant to the problem of social control; (iii) relate to institutions as both the ‘changeable elements of economic life and the agencies through which they are to be directed’; (iv) concerned with ‘process’ in the form of institutional change and development; and (v) based on an acceptable theory of human behaviour, in harmony with the ‘conclusions of modern social psychology’. According to Hamilton, only an approach to economics that focused on the institutions that make up the ‘economic order’ could meet these tests. He identified H.C. Adams, Charles Horton Cooley (his own teachers at Michigan), Thorstein Veblen and Wesley Mitchell as the leaders of this movement. At the same session of the AEA conference, J.M. Clark (Clark 1919), argued for an economics both ‘relevant to the issues of its time’ and based on an ‘ideal of scientific impartiality’. Walter Stewart (Hamilton’s friend and colleague) chaired the session, and argued that economics needed to be ‘organized around the central problem of control’, should utilize the ‘most competent thought in the related sciences of psychology and sociology’, and combine ‘the statistical method and the institutional approach’ (Stewart 1919, p. 319).

The exact timing of this effort to promote ‘institutional economics’ as a distinctive approach probably had much to do with the end of the First World War. The war had impressed upon many the great importance of improved economic data and policy analysis, and of the potential role of government in the economy. The period of reconstruction seemed to offer significant opportunities for bringing changes to the conduct of economic research, education, and policy. The 1918 session of the AEA conference was followed by further efforts to promote institutional economics. Another AEA session critical of traditional theory was organized in 1920. This featured J.M. Clark’s paper ‘Soundings in Non-Euclidian Economics’ (Clark 1921), which criticized orthodox theoretical propositions. In 1924 Mitchell argued in his presidential address to the AEA that quantitative methods would transform economics by displacing traditional theory and leading to a much greater stress on institutions (Mitchell 1925). Lionel Edie called this address ‘a genuine manifesto of quantitative and institutional economics’, one that stated ‘the faith of a very large part of the younger generation of economists’ (Edie 1927, p. 417). In the same year Rexford Tugwell edited The Trend of Economics, a book again seen as something of an institutionalist manifesto and which included papers from Mitchell and Clark as well as from younger people of institutionalist persuasion such as Tugwell himself, F.C. Mills, Sumner Slichter, Morris Copeland, and Robert Hale (Tugwell 1924).

During the inter-war period institutionalism developed a significant following, with a concentrated presence at a number of major schools and research institutes. In addition to Veblen, Hamilton, Clark, Mitchell, and Commons, who were the most visible proponents of institutionalism, there were many others associated with the movement (Rutherford 2000a, b). The two major centres for institutionalism over the whole inter-war period were Columbia and Wisconsin, at that time among the leading doctoral departments of economics in the country. Wisconsin’s department included Commons (until he retired in 1933), E.E. Witte, Harold Groves, Martin Glaeser, Selig Perlman and several others (Rutherford 2006). Columbia was an even bigger centre for institutionalism with Mitchell, Clark, Rexford Tugwell, Mills, A.R. Burns, Joseph Dorfman, Leo Wolman, Carter Goodrich, James Bonbright, and Robert Hale all in the Economics Department or Business School at various times, and Gardiner Means, Adolf A. Berle, and many other people of related views in other departments (Rutherford 2004). Chicago had an institutionalist contingent at least until Clark left for Columbia in 1926, and Walton Hamilton was at the centre of groups first at Amherst (1915–1923) and later at the Robert Brookings Graduate School (1923–1928). Other institutionalist groups existed at Texas, where Clarence Ayres joined Robert Montgomery in 1930, and in a number of other schools and colleges (Rutherford 2003, 2007).

Among research institutes, the Institute of Economics, which became part of the Brookings Institution, was heavily institutionalist in character (the research staff included Isador Lubin, and Edwin Nourse among others). The National Bureau of Economic Research (NBER) was closely associated with Mitchell’s quantitative approach and his programme of business cycle research and employed many of his Columbia colleagues and students. The quantitative and policy orientation of the work done by these organizations attracted funding from foundations such as Carnegie and Rockefeller (Rutherford 2005a).

The Sources and Appeal of Institutional Economics

The elements that went to make up the core of the institutional approach as defined by Hamilton, were all present in American economics before 1918. Institutionalism as it formed in the inter-war period was an approach to economics that derived from several sources. While the single most significant source of inspiration for institutionalism was the work of Thorstein Veblen, it is important to understand that institutionalism was a blending of ideas taken from Veblen with those from others (Rutherford 2001), and was never simply Veblenism.

At the most basic level the most important element in the institutionalist approach is the conception of the economic system as a set of evolving social institutions. In this, institutions are seen as much more than constraints on individual action. Social norms, conventions, laws, and common practices embody generally accepted ways of thinking and behaving, and they work to mould the preferences and values of individuals brought up under their sway. A good part of this orientation came from Veblen, but also from sociologists such as Charles Horton Cooley, and from a previous generation of German-influenced scholars (such as R.T. Ely and H.C. Adams). At this time, in line with the German model, sociology was commonly taught within economics departments.

On a more specific level, Veblen’s framework, which stressed the role of new technology in bringing about institutional change (by changing the underlying ways of living and thinking) and the predominantly ‘pecuniary’ character of the existing set of American institutions, was widely influential among institutionalists. Within this framework Veblen developed his analyses of ‘conspicuous consumption’; the effect of corporate finance on the ownership and control of firms; business and financial strategies for profit-making, salesmanship and advertising; the emergence of a specialist managerial class; business fluctuations; and many other topics (Veblen 1899, 1904).

For Veblen, the existing legal and social institutions of America were outmoded and inadequate for the task of the social control of modern large-scale industry. Veblen perceived a systemic failure of ‘business’ institutions to channel private economic activity in ways consistent with the public interest. He attacked the manipulative, restrictive, and unproductive tactics used by business to generate income (including consolidations, control via holding companies and interlocking directorates, financial manipulation, insider dealing, sharp practices, and unscrupulous salesmanship), the ‘waste’ generated by monopoly restriction, unemployment, conspicuous consumption, and competitive advertising, and he held out little hope of change short of a complete rejection of ‘business’ principles.

Cooley also analysed pecuniary institutions but in more measured tones, and it must be emphasized that many institutionalists, including Hamilton, Clark, Commons, and Hale placed a much greater emphasis on the evolution of legal institutions than did Veblen. Both Hamilton and Hale moved into law schools and had close connections with legal scholars of the realist school. The major sources of this emphasis on legal institutions were Ely (who taught Commons) and Adams (who taught Hamilton). This greater emphasis on law and on legal evolution helped to shift the character of institutionalism away from Veblen’s radicalism and connect it to a pragmatic philosophy, based primarily on the work of John Dewey, which looked to legislative and legal reform concerning such issues such as business regulation, labour law, collective bargaining, health and safety regulations, and consumer protection. Thus, in the hands of institutionalists such as Hamilton, Clark, Mitchell, and Commons, the problem became one of supplementing the market with other forms of ‘social control’ of business.

Another important element was the linking of institutional economics with ‘modern psychology’. Veblen had provided a particularly penetrating criticism of the hedonistic psychology implicit in marginal utility theory (Veblen 1898) and pointed to an alternative based on instinct/habit psychology. What was important for institutionalists, however, was less Veblen’s specific formulation but the impetus he gave to the idea that economics needed to be reconstructed on the basis of a theory of human behaviour in harmony with the conclusions of modern psychology (see Mitchell 1910a, b).

Finally, and of central importance to the attraction of institutionalism, was the claim that it represented the ideal of empirical science. An important influence here was Mitchell’s combination of Veblenian ideas concerning the significance of the institutions of the ‘money economy’ with the quantitative and statistical approach he had absorbed as a student at Chicago. Mitchell’s Business Cycles (1913) was enthusiastically received and widely regarded at the time as a paradigm for a scientific economics. Mitchell thought of business cycles as a phenomenon arising out of the patterns of behaviour generated by the institutions of a developed money economy (Mitchell 1927), and he explicitly connected quantitative work and the institutional approach, arguing that it is institutions that create the regularities in the behaviour of the mass of people that quantitative work analyses (Mitchell 1924, 1925). Mitchell’s quantitative bent was shared by many other institutionalists, but the scientific method, for institutionalists, was not confined to the statistical or quantitative, and included all work that was genuinely ‘investigative’ in character. It is important to comprehend that at this time it was institutionalists, not neoclassicals, who were claiming to be following the methods of natural science (Rutherford 1999), and seemed to be at one with the general movement in American social science towards greater empiricism and ‘realism’.

At its inception, then, institutionalism could be seen as a very promising programme – modern, scientific, pointing to a critical investigation and analysis of the existing economic system and its performance, in tune with the latest in psychological, social scientific, and legal research, established at leading universities and research institutes, and involved in important issues of economic policy and reform (see also Yonay 1998).

The Contributions of Interwar Institutionalism

Mark Blaug has stated that institutionalism ‘was never more than a tenuous inclination to dissent from orthodox economics’ (Blaug 1978, p. 712), and this view still finds wide currency. In fact, institutionalsm in the inter-war period was a major part of a pluralistic mainstream economics (Morgan and Rutherford 1998). That institutionalists did have a positive programme of research in mind should be clear from the above. Not all elements of this programme were pursued successfully, but there can be no doubt that institutionalists did make important positive contributions to economics, and this is particularly true of the period when institutionalism was at its peak. Just a few of these contributions will be highlighted.

Institutionalist took the task of improving economic measurement seriously. The NBER not only produced many empirical studies relating to business cycles, labour, and price movements, but also played a vital role in the development of national income accounting, through the work of Mitchell’s student, Simon Kuznets. In conjunction with the Federal Reserve, the NBER also did much to develop monetary and financial data. Moreover, during the New Deal, institutionalists were heavily involved in the effort to improve the statistical work of government agencies (Rutherford 2002).

As noted above, one of the claims of institutionalists was that a ‘scientific’ economics would have to be consistent with ‘modern’ psychology. A typical argument was that economics ‘is a science of human behaviour’ and any conception of human behaviour that the economist may adopt ‘is a matter of psychology’ (Clark 1918, p. 4). Clark made one of the most interesting efforts to develop the psychological basis of institutional economics. Building on the work of William James and Cooley, he argued that the ‘effort of decision’ is an important cost, and one that prevents maximization. Clark was considering both the costs of information gathering and of calculation, and his argument is a clear precursor of more recent conceptions of bounded rationality leading to the use of habits or routines.

Interesting work on the economics of consumption and the household, was pursued by Hazel Kyrk and Theresa McMahon. McMahon made use of Veblen’s conception of emulation in consumption, while Kyrk was critical of marginal utility theory as a basis for a theory of consumption and emphasized the social nature of the formation of consumption values. Consumption patterns relate to habitual ‘standards of living’, and Kyrk undertook to measure and critically analyse existing standards of living, and to create policy to help achieve higher standards of living. In her later work she discussed the household in both its producing and consuming roles, the division of labour between the sexes, employment and earnings of women, adequacy of family incomes, and issues of risks of disability, unemployment, provision for the future and social security, and the protection and education of the consumer (Kyrk 1923; 1933; McMahon 1925).

There was much work dealing with the inadequacy of the standard models of perfect competition and pure monopoly. The soft coal industry received particular attention. In that industry investigators such as Hamilton found little that corresponded to the ideal of a competitive industry. Competition within the industry had resulted not in efficient low-cost production but in persistent excess capacity, inefficiency, irregular operation, poor working conditions and low earnings (Hamilton and Wright 1925). This represented a common institutionalist theme – that, particularly under conditions of high overheads and rapid technological advance, competition could lead to ‘disorder’ and inefficiency rather than to order and efficiency. Institutionalists also studied such things as common pool problems in the oil industry, production cycles in agriculture, including the cobweb model and its implications for the orthodox view of ‘self-regulating’ markets, and the vast array of restrictive practices to be found in many industries (Hamilton and Associates 1938).

A related theme was that technological change had altered the structure of costs faced by firms and had altered their behaviour. This argument derived from Clark’s Overhead Costs (1923). For Clark, the growth of overhead costs as a result of capital-intensive methods of production had resulted in price discrimination, an extension of monopoly and an increase in price inflexibility over the cycle. A little later Gardiner Means (1935) developed his theory of administered pricing, which sparked a vast literature on relative price inflexibility.

On issues of corporate finance and ownership, Bonbright and Means co-authored The Holding Company, and Berle and Means The Modern Corporation and Private Property, both in 1932. These works much extended Veblen’s earlier discussions of corporate consolidation and the separation of ownership and control. Berle and Means’s work raised important issues of agency, and whether managers would maximize profits.

On labour market issues, institutionalists concerned themselves with studying unions and the history of the labour movement, developing in the process both classifications of unions and explanations for the particular pattern of trade union development in America (Perlman 1928). Wage determination was also a problem that attracted the attention of institutionalists. Walton Hamilton’s 1923 book The Control of Wages (with Stacy May) was praised by Clark for providing not an ‘abstract formulation of the characteristic outcome’ but a ‘directory of the forces to be studied’ in any particular case (Clark 1927, pp. 276–7). Discussions of trade unions and wage bargaining were provided by other institutional labour economists such as Commons (1924) and Sumner Slichter (1931). In this work much attention was given to issues of collective bargaining and systems of conciliation and mediation.

Public utilities, including issues relating to the valuation of utility property and the proper basis for rate regulation, were major areas of institutionalist research. Both Clark and Commons devoted considerable attention to the concept of intangible property, goodwill, and valuation issues (Commons 1924; Clark 1926). Bonbright dealt with the difference between commercial and social valuation in connection with public utilities. Bonbright, Hale, and Martin Glaeser all wrote extensively on issues of public utility regulation, with Hale probably having the greatest impact with his campaign of criticism of the ‘fair value’ concept as a basis for rate regulation (Hale 1921; Bonbright 1961, p. 164).

In his Social Control of Business (1926) Clark argued that business cannot be regarded as a purely private affair. This idea of private business being broadly ‘affected with a public interest’ was absolutely central to the institutionalist argument for regulation of business. Clark expresses the idea in his claim that ‘every business is “affected with a public interest” of one sort or another’ (Clark 1926, p. 185), and the argument also appears in as a central theme in Tugwell’s early work on regulation (Tugwell 1921, 1922), and in Walton Hamilton’s and Robert Hale’s extensive writings on law and economics (Rutherford 2005b; Fried 1998).

More general interconnections between law and economics and the operation of markets were addressed by Hale, Commons, and Hamilton. Commons’s approach was the most developed and was built on his notions of the pervasiveness of distributional conflicts, of legislatures and courts as attempting to resolve conflicts (at least between those interest groups with representation), and of the evolution of the law as the outcome of these ongoing processes of conflict resolution. He developed his concept of the ‘transaction’ as the basic unit of analysis (later adopted by Oliver Williamson). In turn, the terms of transactions were determined by legal rights and by economic (bargaining) power. Market transactions always involved some degree of ‘coercion’, in the sense of some degree of restriction upon alternatives (Commons 1924, 1932; Hale 1923). He also provided a theory of the behaviour of legislatures based on ‘log-rolling’, and a theory of judicial decision-making based on the concept of ‘reasonableness’, a concept that included, but was not limited to, a concern with efficiency (Commons 1932; 1934).

The institutionalist programme dealing with business cycles, in the period before the depression, was centred on Wesley Mitchell’s work and that he promoted through the NBER. As noted above, Mitchell explicitly placed his work on business cycles within an institutional context by associating cycles with the functioning of the system of pecuniary institutions. Mitchell’s 1913 volume Business Cycles, with its discussion of the four-phase cycle driven by an interaction of factors such as the behaviour of profit seeking firms, the behaviour of banks, and the leads and lags in the adjustment of prices and wages, became the standard institutionalist reference. At the NBER, Mitchell focused heavily on promoting work that would add to the understanding of business cycles, generating a stream of research studies far too long to list here, but contributing to the development of national income measures, business cycle indicators, and much more. In addition, Clark developed his concept of the accelerator out of his study of Mitchell’s 1913 work, and the accelerator mechanism soon became a standard part of cycle theory (Clark 1917). Mitchell’s work was not the only approach to business cycles to be found within institutionalism. Many institutionalists, including Hamilton, had an interest in the work of J.A. Hobson, and Hobson’s underconsumptionism became popular among institutionalists in the 1930s (Rutherford 1994).

On issues of market failure, broadly conceived, Clark (1926) discussed a large number of types of market failure in his Social Control of Business. These included monopoly, maintaining the ethical level of competition, protecting individuals where they are unable to properly judge alternatives, problems of agency, relief for people displaced by rapid economic and technological change, relief of poverty (including social security and minimum wages), regulation of advertising and the provision of information and standards, increasing equality of opportunity, externalities (‘unpaid costs of industry’), public goods (‘inappropriable services’), the wastes of ‘arms race’ types of competition (such as competitive advertising), unemployment, the interests of posterity or future generations, and any other discrepancy between private and social accounting. Slichter (1924) provided a list of problems almost as long, including the pro-cyclical behaviour of banks, overexploitation of natural resources, discrimination in employment, advertising and salesmanship, lack of market information, pollution and other external effects, uncertainty and unemployment, economic waste and inefficiency, and economic conflict. All these problems were seen as justifying some additional ‘social control’ of business activity.

Finally, and intimately related to the above, institutionalists made important contributions to policy in their roles in the development of unemployment insurance, workmen’s compensation, social security, labour legislation, public utility regulation, agricultural price support programmes, and in the promotion of government ‘planning’ to create high and stable levels of output. Commons had pioneered public utility regulation, unemployment insurance, and workmen’s compensation in Wisconsin, and the Wisconsin model was widely influential. Many institutionalists were active members of the American Association of Labor Legislation (AALL), and the AALL promoted many reforms to labour legislation. Medical insurance programmes were also pursued by the AALL, and also by the Committee on the Cost of Medical Care, which involved both Hamilton and Mitchell.

Institutionalists had significant influence within the New Deal. Many of Commons’s students played leading roles in the development of the federal social security programme. Berle and Tugwell were two of Roosevelt’s original ‘Brains Trust’, and Tugwell, Means, and Mordecai Ezekiel were the leading advocates of the ‘structuralist’ or planning approach that had influence in the early part of the New Deal (Barber 1996). Hamilton and several others were deeply involved in the labour legislation and consumer protection aspects of the New Deal. Hamilton later worked with Thurman Arnold in developing their case by case approach to anti-trust (Rutherford 2005b).

Institutional Economics After 1945

Institutionalism attained a significant position in American economics in the interwar period, both in academia and in government, but then declined in position and prestige after the Second World War. At this point institutionalism fell out of the mainstream of American economics to become a heterodox tradition on the margins of the discipline. There are quite a number of overlapping reasons for this, some of which reach back into the 1920s and 1930s, but the focus here will be limited to just a few of the more important issues.

Institutionalism clearly did not live up to its own early promise, particularly in its failure to pin down exactly what foundations in ‘modern psychology’ it was supposed to have. After the mid-1920s, psychologists abandoned the instinct/habit approach in favour of a behaviourism that became increasingly narrow and difficult to see as an adequate foundation for economics. In this climate, the enthusiasm for new psychological approaches that had played such a role in the institutionalist movement’s beginnings could not be sustained. Institutionalism probably played a part in ridding economics of explicitly hedonistic language, but it did not develop the alternative basis to convince the profession as a whole to abandon its traditional views of rationality (Lewin 1996).

It must also be said that institutionalists failed to develop their theories of social norms, technological change, legislative and judicial decision-making, transactions, and forms of business enterprise (apart from issues of ownership and control) much beyond the stage reached by Veblen and Commons. The reasons for this lack of development relate partly to the focus of interwar institutionalists on immediate and pressing policy problems, like business cycles, labour law, and social security. In addition, from the late 1920s on, sociology separated itself from economics and became established in separate departments, taking much of the subject matter of social norms and institutions with it.

It is also the case that, from the 1930s onwards, many new developments in theory and methods occurred within economics: developments that tended to displace institutionalist ideas and methods. Hicks’s revision of demand theory seemed to free economics from the shifting basis of psychology, while the work of Joan Robinson and Edward Chamberlin provided treatments of imperfect competition more amenable to neoclassical approaches. The discussion of externalities in terms of market failure was also much clarified. Neoclassicism developed a language capable of encompassing at least some of the issues of concern to institutionalists; issues that had formerly fallen outside the neoclassical theoretical compass.

Moreover, institutionalist approaches to business cycles were replaced by Keynesian ideas. In many respects, Keynesian economics took over the role of the exciting ‘new’ economics that institutionalism had played in the early 1920s. In addition, neoclassical and Keynesian economics gained an empirical component with the rise of econometrics. Institutionalists could no longer claim greater ‘scientific’ standing because of their empiricism; indeed, they were accused by Koopmans (1947) of ‘measurement without theory’; a much exaggerated view, but one often repeated and widely accepted.

In these ways more ‘orthodox’ economic theory took over those aspects of institutionalism amenable to ‘model analysis’ (Copeland 1951) while other aspects were absorbed into what became applied field areas, such as industrial organization, labour economics, and industrial relations. At least until the 1960s these field areas had only loose ties to the theoretical core of the discipline, and maintained a substantial institutional component.

Finally, a significant part of the institutionalist agenda of social reform had come to pass, both removing some of the original causes of the institutionalist movement, and prompting a reaction in the form of critiques of the expanded role for government that institutionalists had done so much to put forward.

Under these circumstances, it is not difficult to see why institutionalism slipped from being a central part of American economics to a more marginalized position. This change did not happen overnight, but was hastened by the significant amount of new hiring on the part of American universities immediately after the Second World War. These new faculty were predominantly Keynesians or neoclassicals equipped with the latest in mathematical and econometric tools. The retirement of the last of the older generation of institutionalists in the 1950s completed the process.

American institutionalism did not disappear, but it certainly changed. Insitutionalists formed the small ‘Wardman Group’ in 1959, an organization that later became the Association for Evolutionary Economics, still the primary organization of ‘old’ institutionalists in America, and the publisher of The Journal of Economic Issues. Institutionalism disassociated itself from the positivism that had gained popularity elsewhere (a positivism that, ironically, Mitchell and the NBER had played an important part in creating), and turned away from the methods and the core areas of the discipline that had been taken over by neoclassical and Keynesian economics. Institutionalists continued to work in applied areas, and to argue for more active government regulation and ‘planning’ of the economy (Gruchy 1974), but there was also something of a movement back to the broader institutional themes found in Veblen and Commons.

This tendency was especially promoted by Clarence Ayres, in his Theory of Economic Progress (1944). Ayes attempted to renew the Veblenian emphasis on technology as the driving force behind institutional change, and developed the Veblenian distinction between business and industry into a general dichotomy between the ceremonial and instrumental aspects of culture. Ayres’s charismatic personality attracted a number of students to the institutionalist ranks, and they spread his version of institutionalism to many south-western universities. The University of Texas, too, retained its institutionalist character longer than most, and in the 1960s was still the home of a substantial institutionalist group. Other institutionalist groups existed at Maryland and at Michigan State. J.K. Galbraith produced widely read and distinctly Veblenian analyses in his Affluent Society (1958) and New Industrial State (1971), while the Commons tradition in law and economics has been kept alive by Daniel Bromley, Allan Schmid, and Warren Samuels (Samuels 1971; Schmid 1978; Bromley 1989).

Perhaps the most important recent development within the ‘old’ institutionalist tradition has been the growing interest in the work of Veblen and Commons among a new generation of European economists attracted to institutional and evolutionary ideas. One outstanding example of this is to be found in the work of Geoffrey Hodgson, who has argued forcefully for the development of an institutional economics along lines he sees as having been originally pioneered by Veblen in his evolutionary and Darwinian approach to institutions and institutional change (Hodgson 1988; 2004).

See Also