The Origins of American Institutional Economics

The analysis of institutions has created a rich theoretical tradition within the field of economics with many different branches and schools of thought. There is the well established “new institutional economics”, a body of work developed by Ronald Coase, Oliver Williamson, and Douglas North, which focuses primarily on transaction costs . The analysis of “organic institutions” and spontaneous order by Carl Menger and F.A. Hayek is a well known aspect of Austrian economics. And finally there is “old institutional economics”, which is usually associated with the work of Thorstein Veblen, John R. Commons, and Clarence Ayres. No doubt I left out some important names, but these distinctions create a useful picture.

One thing that I’ve noticed is that old institutional economics has received some very bad press. See Ronald Coase:

The phrase, “the new institutional economics,” was coined by Oliver Williamson. It was intended to differentiate the subject from the “old institutional economics.” John R. Commons, Wesley Mitchell, and those associated with them were men of great intellectual stature, but they were anti-theoretical, and without a theory to bind together their collection of facts, they had very little that they were able to pass on.

Claims such as these strike me as bizarre. I doubt that Coase literally thinks that old institutional economics was “anti theoretical” (1), but I still view his interpretation of the movement as completely wrong.  Any quick look at the origins of old institutional economics would show that these economists were far from being “anti-theoretical”. To understand the core tenants of institutional economics, one need to merely look at the origins of the American Institutionalist movement. The conventional view states that the “founders” of old institutionalism were Thorstein Veblen, Wesley Mitchell, and John R. Commons, but this isn’t exactly correct. Wesley Mitchell was more involved with the development of American Institutionalism as an academic movement and John. R Commons came into the picture later, around 1924. While the work of these men (and others) is extremely important and valuable, it wouldn’t be correct to say they provided much of the intellectual inspiration for American Institutionalism. That title would go to Thorstein Veblen.

In his paper Institutional Economics: Then and Now, Malcolm Rutherford states that “to appreciate the nature of early institutionalism, it is important to understand both Veblen’s influence and how it mixed with other elements to produce an appealing agenda” (Rutherford 2001: 3). Although we shouldn’t overlook the influences of the German Historical School and Darwinism, it was Veblen that brought many of these ideas together into a coherent and innovative framework. And while Veblen held many different and conflicting ideas throughout his work, a few themes stand out in particular, specifically the cumulative nature of institutional change, path dependence, how technology affects institutional change, and the “pecuniary” motives of American institutions (see my post here for some background on pecuniary motives).

Veblen did not always think existing institutions promoted the social benefit. Due to the inertia in any established scheme, institutions tended to not be in line with new technological means. In Veblen’s book Imperial Germany and the Industrial Revolution, he talks about the inefficiency of path dependence, using the example of the small coal wagons that persisted in British railway traffic until the mid-twentieth century (the “silly little bobtailed carriages”). In many cases, existing legal and social institutions in America were outdated and inadequate to deal with the modern large-scale industry that dominated during his lifetime. This line of thinking can also be found in Veblen’s book The Theory of Business Enterprisewhich goes into great depth on the conflict between the “pecuniary” motives of business institutions and the efficiency motives of the industrial sector:

The interest of the community at large demands industrial efficiency and serviceability of the product; while the business interest of the concern as such demands vendibility of the product; and the interest of those men who have the final discretion in the management of these corporate enterprises demands vendibility of the corporate capital. (Veblen 1904: 157-158)

In one way or another, these themes pervaded the work on American institutionalism (2). Using the work of Veblen as a spearhead, American institutionalism ascended during the interwar period. After Walton Hamilton published his manifesto, The Institutional Approach to Economic Theory, the institutional movement was in full swing. The group become heavily involved with the establishment of various research institutions (NBER, Brookings Institute of Economics, and others) and made various efforts in improving economic measurement. They made important contributions in economics on issues such as business cycles, the pricing behavior of firms, analysis of corporations, monopoly and competition, and many more areas. There was also noteworthy work in psychology and economics. Although the movement had legitimacy, it wasn’t without its problems. For example, institutional economics was much more empirically oriented than its orthodox (neoclassical) counterpart. Some might say it was too empirical. Take this quote by J.M. Clark:

Economics must come into closer touch with facts and embrace broader ranges of data than “orthodox” economics has hitherto done. It must establish touch with these data, either by becoming more inductive, or by much verification of results, or by taking over the accredited results of specialists in other fields, notably psychology, anthropology, jurisprudence and history. Thus the whole modern movement may be interpreted as a demand for procedure which appears more adequately scientific …

So on some level, I understand where the “anti-theoretical” claim comes from. But again, I find the interpretation extremely narrow. I suppose one could describe the singular contributions of a few institutional economists as “anti theoretical”, but to caste the entire movement aside is just wrong. It’s clear just by looking at the work of Veblen that old institutional economics has a ton of theoretical insights to offer. And while I will always respect the work of Coase, Williamson, and other new institutional economists who denigrate their predecessors, I think they are making a mistake.


Notes:

1. I’m think Coase’s use of the word “anti theoretical” echoes Koopmans in his paper “Measurement Without Theory”:

The approach of the authors is here described as empirical in the following sense: The various choices as to what to “look for,” what economic phenomena to observe, and what measures to define and compute, are made with a minimum of assistance from theoretical conceptions or hypotheses regarding the nature of the economic processes by which the variables studied are generated.

2. Of course there other strands that didn’t borrow from Veblen’s work. John R. Commons took more interest in the subject of law and economics, specifically the evolution of law as the outcome of conflict resolution. There were also many institutionalists that took interest in the relationship between instinct/habit psychology and economics.

References:

1. Coase, Ronald. The American Economic Review, Vol. 88, No. 2, Papers and Proceedings of the Hundred and Tenth Annual Meeting of the American Economic Association (May, 1998) , pp. 72-74

2. Hodgson, Geoffrey Martin, and Geoffrey Martin Hodgson. The Evolution of Institutional Economics: Agency, Structure, and Darwinism in American Institutionalism. London: Routledge, 2004. Print.

3. Koopmans, Tjalling C. “Measurement Without Theory.” The Review of Economics and Statistics 29.3 (1947): 161-72. Print.

4. Puffert, Douglas. “Path Dependence”. EH.Net Encyclopedia, edited by Robert Whaples. February 10, 2008. URL http://eh.net/encyclopedia/path-dependence/

5. Rutherford, Malcolm. “Institutional Economics: Then and Now.” Journal of Economic Perspectives 15.3 (2001): 173-94. Print.

6. Rutherford, M. “Veblen’s Evolutionary Programme: A Promise Unfulfilled.” Cambridge Journal of Economics 22.4 (1998): 463-77. Print.

7. Veblen, Thorstein. The Theory of Business Enterprise. New York: C. Scribner’s Sons, 1904. Print.

Advertisements

2 Comments

Filed under Economics, History, Home

2 responses to “The Origins of American Institutional Economics

  1. Arindam.

    ‘but they were anti-theoretical’

    They weren’t anti-theoretical, (Veblen in particular, wrote theories of both the leisure class and of business enterprise), but they were anti-capitalist, (Veblen is more radical than Marx in this respect). Of course, neoclassical economists couldn’t justify ignoring them on the grounds that they were anti-capitalist, so they fabricated the ‘anti-theoretical’ claim instead.

    • They weren’t anti-theoretical, (Veblen in particular, wrote theories of both the leisure class and of business enterprise), but they were anti-capitalist

      I disagree. Some of them were certainly anti-capitalist (Veblen especially), but many of them were not (e.g Wesley Mitchell and John R Commons were definitely not anti-capitalist). I would argue that most institutional economists during the 1920s were progressive statists. They saw the state as an important role in economic development, institutional development, and smoothing business cycles. But that doesn’t make them anti-capitalist. They also saw the important role that markets had to play as well.

      I will admit that the methodology and policy prescriptions of institutional economics were very much at odds with neoclassical economics. So in that respect they were ideological and political opponents (although this was not always the case).

      (Veblen is more radical than Marx in this respect)

      What makes you say this? I don’t know much about Marx so I can’t answer with any certainty.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s