Institutions and the Economy

Francesco Duina

• Publisher: Polity
• Year: 2013
• Print ISBN: 9780745648309, 9780745648293
• eBook ISBN: 9780745637631
• Edition: 1
• Topic: Commerce
• Subtopic: Comportement organisationnel

Institutions are central to economic life. They have a major impact on consumer preferences, the actions and processes of firms, levels of wealth and poverty in countries, the growth of international trade, and much more. Indeed, none of the preconditions for economic activity - such as the existence of buyers and sellers, recognizable goods and services, and the information we need to make choices - would be in place without institutions. Institutions, then, do more than support economic life: they enable and shape it.

These insights challenge some of the most basic postulates on modern economic theory and are at the heart of many of the most exciting works in economic sociology. This book examines the role of institutions - defined as the formal and informal rules and practices that surround us as we go about our daily lives - in the economy. Illuminating complex ideas with carefully selected, vivid examples, the investigation focuses on economic activity as it unfolds at the individual, organizational, national, and international levels.

This accessible and engaging book will be essential reading for students of economic sociology, and all those interested in the intimate relationship between institutions and the economy.

Part I

Introduction

1

Institutions and the Economy

Institutions are everywhere. They affect how we eat, talk, conduct ourselves in public or in private, earn a college degree, play sports, and get married. They are both inside and outside of organizations – such as schools, hospitals, state administrative units, and baseball teams. Entire industries are rich with institutions, while international bodies such as the World Bank and the United Nations could not function without them. The objective of this book is to understand how institutions enable and shape a particular dimension of social life: the economy.

We should begin, then, by defining institutions. Alternative definitions abound, as we shall see in a few pages. This is not surprising: scholars from different intellectual traditions (from rational choice theory to neo-institutionalism, structuralism, phenomenology, and constructivism) and academic disciplines (economics, political science, and sociology above all) have over time sought to understand the nature of institutions and their impact on various aspects of social life. In this book, we adopt a definition of institutions embraced, fully or in part, by most economic sociologists.

Institutions are the formal and informal rules and practices that surround us as we go about our daily lives. At the formal level, they include public and private law (e.g., taxation and inheritance laws), standard operating procedures (SOPs) (e.g., written guidelines for how medical staff in emergency rooms should respond to patients seeking urgent attention), and the principles ordering structures in governments, firms, and various types of associations (e.g., corporate statements defining the responsibilities and missions of different departments, such as marketing or accounting). At the informal level, they include traditions (e.g., families buying and then carving pumpkins for Halloween), routines (e.g., the steps that the International Bar Association takes to distribute information to its member lawyers worldwide), norms (e.g., the expectation held by many in Scandinavian countries that health-care provision should be universal), and shared but tacit assumptions about the functioning of the world (e.g., the widely held belief among staff at the World Bank that capitalism is the best type of economic system).

Institutions, then, are neither tangible nor visible. They affect how individuals, organizations, national governments, and even international entities operate, but are not the same thing as those actors. We may say that institutions have a life of their own, but also that their existence is intimately dependent on other aspects of society. The specific rules that set salary caps for professional basketball teams in the United States reflect, for example, the interests of players and team owners, the ability of these stakeholders to organize and voice their viewpoints, and the desire of fans and media venues alike to watch evenly balanced teams play. We may also say that institutions can vary greatly from each other. A handshake is as much an institution as the policies governing minimum balances in personal checking accounts at banks or the certifications found on packages of organically grown foods.

This book investigates the impact of institutions on the economy. What do we mean, then, by “the economy”? Individuals, organizations, nations, groups of nations, and international actors all engage in economic activity. Individuals buy and sell things all the time – food, clothes, cars, phones, tickets to concerts or sports events, and much more. A great number and variety of organizations produce services and products for the marketplace, and set up themselves internally to achieve their ends. Countries have and support entire industries. Often, they also join together to create transnational marketplaces. At a more global level, international actors – such as the World Bank or the United Nations – provide funds, training, infrastructure, and other resources for economic development. All of this makes it difficult to generate a simple definition of the economy. As is the case for institutions, multiple definitions abound (Backhouse and Medema 2009). Most of those definitions, however, are not necessarily in contradiction or in tension with each other. For our purposes, then, an economy is a space where two or more actors enter into exchanges aimed at the improvement of the material or psychological wellbeing of one, some, or a large number of actors. This definition is either consistent with, or at least does not challenge, the majority of available views of what economic activity is about (see, for instance, Polanyi 1944: 31–2; Friedman 1980; Epping 2001: 3; and Wheelan 2002).

We will examine how institutions enable and shape economic life in society. The emphasis will be on “enable” and “shape.” In some academic disciplines – neoclassical economics in particular – researchers have traditionally conceived of institutions as limiting economic life, as presenting obstacles to its ideal or proper functioning. We can call this a “negative” understanding of institutions. Imposing taxes on sales, for instance, is seen as discouraging people from producing and trading goods since a third party – the state, the city government, or whoever is imposing the tax – is depriving those involved in the exchange of some benefits. In line with the perspective of most economic sociologists, we will subscribe to a more “positive” interpretation of institutions. “Enable” means that institutions make much of economic life possible in the first place. Without institutions, the economy simply could not function. Investments in new product lines or in new production facilities, for instance, require that there be an enforceable and stable legal system. This is not to say that institutions are the only necessary prerequisite for economic activity. Other factors matter a great deal too. Some, like trust, are closely related to institutions (you would trust a surgeon to operate on your leg, for instance, because you know that she has undergone standard training, acquired diplomas, and so on). Others are less related to institutions (for example, the presence of good roads and railways).

Yet institutions do more than enable economic activity to take place. They also mold and even define – “shape” in the language of this book – in profound ways the very essence of that activity. Consider, for instance, the services offered by corporate accountants. Among those accountants, it is standard practice to think of corporations as having customers, suppliers, product-lines, and so on. It is also standard practice to assume that corporations are in a constant state of flux – that their profits after taxes vary, for example, from quarter to quarter. Corporate accountants are trained to think in these terms in business schools and in professional training programs. The federal tax code requires them to adopt this perspective. Business executives, understanding all this, hire those accountants for their services. The exchange of money for accounting services thus reflects these shared perspectives and practices, the business school programs that teach them, and the tax code that enforces them – all of which are institutions. We may even say that those institutions are at the heart of the exchange.

Throughout this book, we will stress something of major importance about how, exactly, institutions enable and shape economic life: the positive contribution of institutions has little to do with efficiency – that is, with decreasing costs, efforts, or the resources required for attaining something. We might be tempted to think that, if institutions help the economy operate, they must do so by making things more efficient. This has been the position of some economists since the 1970s. In fact, consistent with our sociological stance, our analysis will show something quite different. Institutions enable and shape economic life by making some things legitimate and others not, filtering and channeling in particular ways information and data, determining the formation and articulation of preferences, making and limiting options, generating an environment that is stable over time, defining the very essence of what is available in the marketplace, and much more. Briefly put, institutions provide the foundations and supporting structures for economic life.

Thus, we will also emphasize that it is practically impossible to think of economic life as something separate from its social context (Swedberg and Granovetter 2001: 8). This will be a profound realization – one that challenges the most basic assumptions of the modern discipline of economics and one that, once grasped, has both conceptual and practical implications. First, we will be able to explain economic phenomena more fully. We will have a deeper understanding, for instance, of why some products exist in the marketplace and others do not, consumers prefer some products to others, or some countries produce more environmentally sound products than others. Thus, second, we will be in a better position to suggest ways in which certain undesirable economic outcomes may be avoided and better ones be secured. Institutions, after all, are seldom fixed and are quite often the object, and partly the result, of contention and power dynamics. Think, for example, of the policies that determine what types of snacks and drinks are available in public schools (and thus what children are likely to eat and drink), or the formal and informal principles that drive budget negotiations within national governments or how international development agencies such as the International Monetary Fund (IMF) decide to spend their funds. None of these is fixed and all can in principle be changed.

We will carry out our analysis in four steps. We will move from the very micro (individual transactions) to the most macro (the global marketplace) dimensions of the economy as follows:

• Chapter 2: institutions and the economic behavior of individuals.

• Chapter 3: institutions and the economic behavior of organizations.

• Chapter 4: institutions and the economies of nation-states.

• Chapter 5: institutions and the international economy.

Chapter 2 will focus on the economic behavior of individuals. Most of us buy or sell something nearly every day of our lives. This happens in countless places, such as grocery stores, gas stations, movie theaters, and cyberspace. Institutions impact those transactions. Imagine yourself, for instance, at one of The Gap stores buying a shirt. What is the order of events? When, exactly, does the shirt become yours and stop belonging to the store? What rights does ownership give you? The transaction would not be possible without the existence of recognized property rights and agreed-upon procedures for how exchanges should unfold – two very important sorts of institutions. We will discuss the many ways in which a number of institutions enable and shape individual-level transactions.

In chapter 3, we will turn to organizations. These include firms, industry associations (e.g., employer associations, labor unions), interest groups (e.g., women’s organizations, the American Association of Retired Persons), educational establishments (e.g., colleges, secondary public schools), hospitals, and more. The economic behavior of organizations refers to those actions and processes that organizations undertake or follow in order to acquire, manage, and distribute resources. We will try and understand that behavior. Why, for instance, do most business organizations have separate marketing, human resources, and accounting units? Most have CEOs, VPs, and secretaries. Where does this organizational design come from? What prompts organizations to conform to such a design? We will see, among other things, that organizations borrow from their environment blueprints that specify what legitimate organizations ought to look like. Those blueprints, which are institutions in their own right, seldom improve organizational efficiency or performance. But, by ensuring conformity with expectations, they give organizations access to valuable resources in society.

Chapter 4 will examine the impact of institutions on national economies. Countries like the United States or France are gigantic marketplaces. Therein, hundreds of industries (in sectors such as manufacturing, financial services, agriculture, etc.) employ millions of people. We will consider the performance of those economies and industries. We will ask why some countries perform better than others (Denmark, for instance, compared to India), and why countries specialize in certain industries and not others. We will then turn to the question of long-term transitions, and especially why countries experience major, protracted deteriorations or improvements in their economies (consider the successful trajectory of South Korea as opposed to the painful contraction of the Zimbabwean economy), and how former communist and socialist countries have migrated toward market capitalism. We will discuss the role of regulation, industrial relations, government structures and practices, and modes of interest representation. We will then examine how national economies have reacted to increased participation in the international economy. The global trade of goods and services, for instance, has put enormous pressures on labor markets, state-owned enterprises (SOEs), and trade barriers and tariffs. What role have national institutions played in mediating those pressures?

Economies are increasingly integrated at the transnational level. Chapter 5 will investigate the making and functioning of the international economy. Powerful international organizations such as the IMF and the World Bank try to stabilize and bolster the global marketplace. What sorts of rules and practices have those organizations promulgated? How have they sought to structure the international economy? Moreover, how do those organizations operate internally? How are policies formulated, interests represented, agreements reached? Further, the international economy is not necessarily global in nature. Regional trade agreements (RTAs) have mushroomed all over the world since the 1980s, with the aim of improving their member-states’ competitiveness and productivity. RTA officials have used institutions (laws especially) to create those markets. What do those institutions look like, and why? What impact have they had on economic integration? Finally, international associations – such as the International Accounting Standards Board (IASB) – try and advance the interests of a great number of businesses, interest groups, and lobbies. What have their institutional initiatives been? And what impact have those had on the international economy?

As we make our way through the chapters, we will learn a great deal about how institutions enable and shape economic life. But we will also see that certain aspects of that relationship are far from being fully understood. Culture (values, belief systems, etc.), for instance, is rarely mentioned in institutionalist analyses of the economy; however, upon closer look, culture quite often figures in those accounts. For example, when we consider the rules that individuals and organizations must follow when engaging in economic activity (e.g., food producers are required to label their food with nutritional information), we see that they almost always reflect or incorporate widespread beliefs (such as that consumers have a right to know what they are about to eat or drink). Should we say more, then, about culture as we theorize about institutions and the economy? Is culture always a part of institutions? What is the difference between culture and institutions? Similarly, when it comes to institutional change, we still only have a basic understanding of how institutions evolve over time, especially when we consider institutions that operate at the international level – for instance, the rules agreed to by the representatives of the leading economies of the world on safe banking practices. What causes international institutions to change? And how does such change affect the international economy, national institutional factors, and national economic life? We will revisit these and other related questions in the concluding chapter of the book.

Before proceeding in our investigation, we would do well to spend some time clarifying a few basic ideas. First, until the twentieth century, few researchers took the role of institutions, however defined, in the economy seriously. Economists were the first to develop a sustained research agenda on the topic, with political scientists following thereafter. It was not until the 1990s that sociologists engaged in a serious investigation of the impact of institutions on economic life. What role did institutions play in the economy according to the first researchers? How did their accounts differ from later researchers? Why are these differences important? Section A below tackles these questions.

Second, there exist multiple and sometimes conflicting definitions of institutions. In this book, we have adopted a very specific definition – one that is in line with the perspective of most economic sociologists. We should be aware of the most important alternative definitions and think about the implications of choosing one definition over the others. What do we leave out from our analysis by subscribing to the view that institutions are the formal and informal rules and practices that surround us as we go about our daily lives? How does that perspective channel our discussion? We consider these matters in section B of this chapter.

Finally, we should be clear about how the study of institutions and the economy “fits” into the larger research agenda of economic sociology. Economic sociology is a relatively new and exciting field of research, and the task before us falls squarely into its mandate. Yet it is only one part of a larger project. Section C places this book in its larger disciplinary context.

A. The Study of Institutions in the Economy

Institutions have been around us since the birth of civilization. Interestingly, however, in the case of the economy at least, they did not become an explicit subject of investigation until the twentieth century. Before then, there were very few books or articles dedicated to the study of institutions, however defined, in the economy. Scholars did not specialize in that field and there were no college-level courses on the topic. Eventually, scholars from various social scientific disciplines began to turn their attention to institutions. Among the first were economists.

Economics

Some of the first researchers to claim that institutions, however defined, are important for the economy were economists. Between 1900 and the 1930s, John R. Commons and Thorstein Veblen, among others, put forth the basic tenets of “institutional economics” (Campbell 2004: 10). Their central, and in hindsight rather basic and rather sociological in spirit, insight was that economic transactions could not happen without supporting institutions. Laws, for instance, make private property possible and define how individuals interact with each other when buying and selling something (Commons 1931). Institutional economists offered some of the earliest, qualitative, and fairly non-theoretical explorations of institutions in the economy. By the 1950s and 1960s, however, their perspectives lost ground to a different school of thought – one much more focused on individual actors, the free market, and quantitative modeling of the economy (Swedberg and Granovetter 2001: 14–18).

The new approach took the label of neoclassical economics. Its proponents thought that interactions between buyers and sellers happen spontaneously, without any supporting mechanisms or structures. Buyers want certain things; sellers wish to sell certain things. Anything interfering with such simple dynamics can only distort the normal unfolding of events. No amount of top-down coordination or planning could improve matters. Instead, left to their own devices and in pursuit of their own selfish goals, individuals would not only pursue their objectives in the best possible fashion but also, in the aggregate, engage in self-adjusting dynamics. Prices would signal to producers how much to produce of something. Investments would be channeled in the most profitable industries. An “invisible hand,” rather than governmental or other sorts of interventions, would guide the economy. A number of economists trained, or teaching, at the University of Chicago, such as Milton Friedman (1962) and George Stigler (1961; 1971), articulated these core principles of neoclassical economics especially well.

It took some time for economists to question the neoclass...

Table of contents

• Cover
• HalfTitle
• Dedication
• Title
• Copyright
• Contents
• List of Figures and Tables
• Abbreviations
• Acknowledgments
• Part I: Introduction
• Part II: The Impact of Institutions
• Part III: Conclusion
• Reference
• Index