The Evolution of Institutional Economics

Geoffrey M Hodgson

• Publisher: Routledge
• Year: 2004
• Print ISBN:
  9780415322539
• eBook ISBN:
  9781134352692
• Topic: Economics
• Subtopic: Business General
• Index: Economics

This exciting new book from Geoffrey Hodgson is eagerly awaited by social scientists from many different backgrounds. This book charts the rise, fall and renewal of institutional economics in the critical, analytical and readable style that Hodgson's fans have come to know and love, and that a new generation of readers will surely come to appreciat

Part I
Introduction

1 Nature and scope

What social science needs is less use of elaborate techniques and more courage to tackle, rather than dodge, the central issues. But to demand that is to ignore the social reasons that have made social science what it is. To understand that we must first look more deeply into its history.

John Desmond Bernal, Science in History (1957)

The old or original institutional economics has had a very bad press. The statement by Ronald Coase (1984, p. 230) that institutionalism was ‘not theoretical but anti-theoretical’ has been repeated uncountably by others, especially by ‘new’ institutionalists who are keen to maintain their maximum distance from that older and unjustifiably cursed tradition. Richard Langlois (1986, p. 5) wrote that: ‘The problem with the Historical School and many of the early Institutionalists is that they wanted an economics with institutions but without theory’. Oliver Williamson (1996b, p. 1792) similarly chimed: ‘Where they differ is that older style institutional economics was content with description, whereas newer style institutional economics holds that institutions are susceptible to analysis.’ Repeated so often by so many, this manifestly false allegation that the old institutionalism was ‘against theory’ has regrettably stuck.¹

Others, even more crudely, have resorted to ad hominem attacks. Lionel Robbins (in Seckler, 1975, p. ix) wrote that institutionalism ‘served as a war-cry congenial to quite a number of muddled and slightly disturbed spirits’. In fact, however, these allegedly ‘muddled and slightly disturbed’ people were so numerous that they dominated American economics in the interwar period, and their tradition remained prominent for a while after the Second World War.

However, suspicions are raised when many critics repeatedly and energetically dismiss the old institutionalism, without ever once providing any evidence that they have carefully read or analysed its texts. An experienced historian of ideas would smell that proverbial rat. A sociologist of religion would be reminded of the protective and palliative role of medieval incantations against heretics.

One reason why the German historical school was forgotten was the decline in the fraction of influential economists who could read or write in German. This explanation of decline does not apply to the American institutionalists.² Their works are in English and their articles are abundant in core journals of economics – such as the Quarterly Journal of Economics, the Journal of Political Economy, and the American Economic Review – from the 1890s to the 1950s. Any remotely curious academic can read this material by taking the volumes off the shelf of a half-decent library, or today by accessing the Internet.

Something odd and dubious is going on. What is at the root of this academic desire to demonize the old institutionalism without recourse to scholarly evaluation? One is drawn to the conclusion that something important and fundamental is at stake.

It is widely known that the old institutionalists were hostile to the narrow vision of economics as the ‘science of choice’ and the utility-maximizing version of ‘economic man’, which have prevailed for the second half of the twentieth century. So keen to dismiss these criticisms, many mainstream economists have resorted to the dismissive tactic of describing any broader version of their discipline, or any approach that is not based on individual utility maximization, as ‘not economics’. This is a convenient riposte to those with a more pluralist and broad-minded conception of the subject, who would attempt to obtain jobs in prestigious departments of economics, or to publish their work in esteemed economics journals. Simply dismissing their work as ‘not economics’ saves all the time and trouble of reading, understanding and engaging with their ideas.

But this tactic does not work so well with institutionalism. In the United States, the heartland of modern orthodoxy, between the two World Wars the institutionalists themselves were the mainstream. Institutionalism has as big and as genuine a historical claim to be economics as neoclassicism. Institutionalists can appeal to history and rebut the ‘not economics’ slur. Against the institutionalists, the modern critics must try something else. Invented through whatever mixture of ignorance or malice, smearing institutionalism as ‘against theory’ works even better as a device to dismiss institutionalism from consideration.

At stake here, therefore, are rival conceptions of the nature and scope of economics as a discipline. Even if American institutionalism contained many erroneous or ill-formed ideas, its broad and institutionally grounded conception of the subject cannot be readily dismissed. Institutionalism offered an approach to the study of economic phenomena that drew not from one discipline but several. It appealed to psychology, anthropology, sociology, history and elsewhere, in an attempt to understand and explain the world as it is, has been, and may be. Its foremost concern was to understand the real world rather than to develop technique for its own sake.

It is not as if everything in the garden of mainstream economics is bringing healthy fruit. The last few years have witnessed enduring global poverty, dubious practices of reckless deregulation, prolonged recessions in Japan, Russia and elsewhere, growing indebtedness and extreme turbulence in financial markets. Many economists have ignored such problems, or otherwise they have often derived unimpressive or simplistic policy recommendations. Analytically, modern economic theorists have abandoned their previous promise to derive macroeconomics from microeconomic principles. Instead they have turned to game theory, but with limited results. Modern economists are often preoccupied with formal technique rather than understanding reality. They have privileged mathematical ‘elegant toys’, as Alfred Marshall (Whitaker, 1996, p. 280) would have called them, rather than effective policies. Although there are some successes in modern mainstream economics, heretics have no monopoly on failure. It is about time that the economics profession and other social scientists took a long and serious look at American institutionalism.

The new institutionalism

Most new institutionalist writing has two important characteristics. First, there is a widespread view that institutions should be explained in terms of the interactions of individuals with given purposes or preference functions. The classic new institutionalist project is to explain institutions from a starting point of a set of given individuals. This focus on individuals as the ultimate elements in the explanation is clearly evident, for example, in North’s (1981) theory of the development of capitalism, Coase’s (1937) and Williamson’s (1975, 1985) transaction cost analysis of the firm, and Schotter’s (1981) game-theoretic analysis of institutions. In all these cases, the proposal is to start with given individuals and their interactions, and to move on to explain institutions. Second, there is an emphasis on the survival of specific institutional forms because they are alleged to lower ‘transaction costs’ relative to their alternatives.

The value of this work should not be denied. Substantial heuristic insights about the development of institutions and conventions have been gained on the basis of the assumption of given, rational individuals and by considering transaction costs. However, as explained in the following chapter, there are problems with the idea that explanations of institutions can start with given individuals in an institution-free ‘state of nature’. Turning to transaction cost explanations, they too may have value, as long as the concept of a transaction can be clearly defined, and the associated costs can be specified adequately. However, the history of the transaction cost concept reveals a deep ambiguity over such issues (Klaes, 2000a, 2000b).

Accepting the value of many contributions in the new institutionalist genre, we are still required to explain some of the things that it takes for granted. In some circumstances it is legitimate to take the individual as given, as a simplifying abstraction. But individuals nevertheless remain to be explained. The task may be postponed, but it does not disappear. Similarly, the origins of the institutional structures that carry transaction costs also require an explanation. Furthermore, these deeper questions of explanation become vital once issues such as the influence of culture, the emergence and durability of institutions, and long-term economic development, become agendas of enquiry. It is important to understand how individual interactions lead to new institutional developments. But especially in the long term, it is also important to explain – at least in principle – how institutions or circumstances can affect individuals and alter their perceptions and goals.

Causal and evolutionary explanations are important with regard to the origin, development and coevolution of individuals and institutions. Generally speaking, the new institutional economics has so far made very limited use of evolutionary modes of explanation. Genuinely evolutionary theory is about the causal explanation of origin. It is here also that the old or original institutional economics comes in.

The original institutionalism

In America, the original institutional economics had an anomalous history and a shifting identity. It acquired its name in 1918 (Hamilton, 1919). At that time, a number of individuals were recognized as its intellectual leaders, including Wesley Mitchell and John Maurice Clark. But its towering inspiration was Thorstein Veblen, whose personal and professional life was marred by scandal, and who never occupied a senior academic position. John R. Commons was later also identified as an institutional economist, and American institutionalism reached its high point of influence in the 1920s and 1930s.

American institutionalism was highly diverse, but within it there were a number of persistent themes. One of these was a focus on the nature and evolution of key institutions and their role in the economy. Another was to use insights from psychology and elsewhere to understand how institutions shaped the dispositions and mentalities of individuals. Institutional economists also made a number of contributions to the conceptual and empirical foundations of macroeconomics and the theory of economic growth. They were also preoccupied with programmes of economic stabilization and welfare. A number of subdisciplines such as economics and law, labour economics, industrial economics, agricultural economics and industrial relations were highly influenced by institutionalism in the inter-war period.³

This work is not intended to be a rounded history of American institutionalism. Instead, the aim is to look at its conceptual, philosophical and psychological foundations. It includes the story of how institutional economics acquired – and regrettably abandoned – a theoretical approach that provided a highly sophisticated understanding of the relationship between individual agents and social structures, and provided a meta-theoretical framework for understanding economic change.

American institutional economics was strongly influenced by both Marxism and the German historical school, but it was shaped still further and in more detail by developments in pragmatist philosophy and instinct–habit psychology in the last two decades of the nineteenth century. Just as significantly, Veblenian institutional economics was born out of Darwinism. Although institutionalism subsequently departed from much of its Darwinian heritage, a viable reconstruction of institutional economics involves a return to Darwinism.

In putting forward this view, I am concerned that a host of misunderstandings may emerge. I am also aware of professed misgivings that surround the question of Darwinism, even among heterodox or ‘evolutionary’ economists (Hodgson, 2002e). I explain at length in Chapters 3 to 8 below what Darwinism involves in this context. The opportunity is taken briefly here to state what Darwinism does not mean. Darwinism does not imply

• any form of racism, sexism, nationalism or imperialism,
• any moral justification of ‘the survival of the fittest’,
• that militant conflict is desirable or inevitable,
• that human inequalities or power or wealth are desirable or inevitable,
• that cooperation or altruism are unfit or unnatural,
• that evolution generally involves optimization or progress,
• that social phenomena can or should be explained in terms of biology alone,
• that organisms can or should be explained in terms of their genes alone,
• that human intention is unimportant, or
• that human agency is blind or mechanistic.

As Darwinism does not mean any of these things, then what does it mean? In brief, as well as a theory of evolutionary selection, Darwinism means causal explanation, where a cause is understood as necessarily involving transfers of matter or energy. Divine, spiritual, miraculous or uncaused causes are ruled out. Explanations of outcomes involve connected causal sequences. Furthermore, Darwinism provides a specific framework for understanding the evolution of all open, complex systems, that have varied and replicating elements with different capacities to survive. Such processes of replication and selection are not confined to biology. Darwinian evolution can occur on multiple and irreducible levels. It can apply to social institutions and customs, as well as to individuals or genes. The history of the discovery and development of this insight is a foremost theme of this work.

We differ from plants and most animals, especially in our capacities for symbolic representation, language and culture (Donald, 1991). We prefigure many actions and consequences in our minds, and act intentionally. The mechanisms of socio-economic and biotic evolution are very different. In studying socio-economic evolution we are concerned with human welfare and well-being, and not merely with survival or fecundity. All these differences are vitally important. But it does not diminish the importance or analytical value of Darwinism one iota.

After it had lost sight of its Darwinian beginnings, institutionalism went into steep decline after the Second World War. Was this merely a coincidence? It is argued here that the causes of this decline were both internal and external. External events, such as the Second World War itself, had a major role. In addition, during the 1920s and 1930s, the climate of ideas changed, undermining the pragmatist philosophy, instinct–habit psychology and Darwinian ideas that were foundational to institutionalism.

Consistent with the biological idea of paedomorphosis in the evolution of a species (Hodgson, 2001c, p. 345), institutionalism must retrace its steps back to the early decades of the twentieth century, determine where it went wrong and take a different branching path. We must ‘go back to Veblen’ and develop things anew from there. The history of ideas is not a mere academic indulgence. It is an essential means of constructing an effective institutional economics for the twenty-first century.

It took nearly a hundred years for the implications of Charles Darwin’s ideas in The Origin of Species (1859) to be accepted and fully understood within the scientific community. Philosophers have only recently appreciated the philosophical impact of Darwinism.⁴ But the significance of Darwinism for the social sciences has been largely unrecognized since Veblen.

It may take one hundred years from Veblen’s death in 1929 for him to be recognized by social scientists as one of the leading social theorists of all time. Yet this acknowledgement is hindered by Veblen’s own failure to present his ideas in systematic form. Especially in the modern age of Darwin, the philosophical weight and robustness of Veblen’s social theory exceeds that of, say, Max Weber or Talcott Parsons. Yet unlike these rivals, Veblen left us with no synthetic overview of his ideas. We have to extract them, like precious metal, from the veins of glittering insight that run sporadically throughout his works. Occasionally they have to be polished or repaired, but the treasure is nevertheless there for the taking.

I have an aversion to cults of personality and the uncritical veneration of any scientist or theorist. I am extremely uncomfortable with all types of cult or sect, including those in the academic arena. But it is my conviction that among social and economic theorists Veblen has not had his due. There is much more to Veblen than appears at first sight. He is much less of a social satirist or political propagandist, and much more of a philosopher and social theorist. At best, the...

Table of contents

• Cover Page
• Title Page
• Copyright Page
• Illustrations
• Preface
• Acknowledgements
• Dramatis Personae Principes
• Part I: Introduction
• Part II: Darwinism and the Victorian Social Sciences
• Part III: Veblenian Institutionalism
• Part IV: Institutionalism Into the Wilderness
• Part V: Beginning the Reconstruction of Institutional Economics
• Bibliography