New institutional economics

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New institutional economics (NIE) is an economic perspective that attempts to extend economics by focusing on the institutions (that is to say the social and legal norms and rules) that underlie economic activity and with analysis beyond earlier institutional economics and neoclassical economics. [1] Unlike neoclassical economics, it also considers the role of culture and classical political economy in economic development. [2]

Contents

The NIE assume that individuals are rational and that they seek to maximize their preferences, but that they also have cognitive limitations, lack complete information and have difficulties monitoring and enforcing agreements. As a result, institutions form in large part as an effective way to deal with transaction costs. [3]

NIE rejects that the state is a neutral actor (rather, it can hinder or facilitate effective institutions), that there are zero transaction costs, and that actors have fixed preferences. [4]

Overview

It has its roots in two articles by Ronald Coase, "The Nature of the Firm" (1937) and "The Problem of Social Cost" (1960). In the latter, the Coase theorem (as it was subsequently termed) maintains that without transaction costs, alternative property right assignments can equivalently internalize conflicts and externalities. Thus, comparative institutional analysis arising from such assignments is required to make recommendations about efficient internalization of externalities [5] and institutional design, including Law and Economics.

Analyses are now built on a more complex set of methodological principles and criteria. They work within a modified neoclassical framework in considering both efficiency and distribution issues, in contrast to "traditional", "old" or "original" institutional economics, which is critical of mainstream neoclassical economics. [6]

The term 'new institutional economics' was coined by Oliver Williamson in 1975. [7]

Among the many aspects in current analyses are organizational arrangements (such as the boundary of the firm), property rights, [8] transaction costs, [9] credible commitments, modes of governance, persuasive abilities, social norms, ideological values, decisive perceptions, gained control, enforcement mechanism, asset specificity, human assets, social capital, asymmetric information, strategic behavior, bounded rationality, opportunism, adverse selection, moral hazard, contractual safeguards, surrounding uncertainty, monitoring costs, incentives to collude, hierarchical structures, and bargaining strength.

Major scholars associated with the subject include Masahiko Aoki, Armen Alchian, Harold Demsetz, [10] [11] Steven N. S. Cheung, [12] [13] Avner Greif, Yoram Barzel, Claude Ménard (economist), Daron Acemoglu, and four Nobel laureates—Ronald Coase, [14] [15] Douglass North, [16] [17] Elinor Ostrom, [18] and Oliver Williamson. [19] [20] [21] A convergence of such researchers resulted in founding the Society for Institutional & Organizational Economics (formerly the International Society for New Institutional Economics) in 1997. [22] Robert Keohane was influenced by NIE, resulting in his influential 1984 work of International Relations, After Hegemony: Cooperation and Discord in the World Political Economy. [23]

Herbert A. Simon criticized NIE for solely explaining organizations through market mechanisms and concepts drawn from neoclassical economics. [24] He argued that this led to "seriously incomplete" understandings of organizations. [24]

Institutional levels

Although no single, universally accepted set of definitions has been developed, most scholars doing research under the methodological principles and criteria follow Douglass North's demarcation between institutions and organizations. Institutions are the "rules of the game", both the formal legal rules and the informal social norms that govern individual behavior and structure social interactions (institutional frameworks). [25]

Organizations, by contrast, are those groups of people and the governance arrangements that they create to co-ordinate their team action against other teams performing also as organizations. To enhance their chance of survival, actions taken by organizations attempt to acquire skill sets that offer the highest return on objective goals, such as profit maximization or voter turnout. [26] Firms, Universities, clubs, medical associations, unions etc. are some examples.

Oliver Williamson characterizes four levels of social analysis. The first concerns itself with social theory, specifically the level of embeddedness and informal rules. The second is focused on the institutional environment and formal rules. It uses the economics of property rights and positive political theory. The third focuses on governance and the interactions of actors within transaction cost economics, "the play of the game." Williamson gives the example of contracts between groups to explain it. Finally, the fourth is governed by neoclassical economics, it is the allocation of resources and employment. New Institutional Economics is focused on levels two and three. [27]

Because some institutional frameworks are realities always "nested" inside other broader institutional frameworks, the clear demarcation is always blurred. A case in point is a university. When the average quality of its teaching services must be evaluated, for example, a university may be approached as an organization with its people, physical capital, the general governing rules common to all that were passed by its governing bodies etc. However, if the task consists of evaluating people's performance in a specific teaching department, for example, along with their own internal formal and informal rules, it, as a whole, enters the picture as an institution. General rules, then, form part of the broader institutional framework influencing the people's performance at the said teaching department.

See also

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Political economy The political economy is the science of the development of social production

Political economy is the study of production and trade and their relations with law, custom and government; and with the distribution of national income and wealth. As a discipline, political economy originated in moral philosophy, in the 18th century, to explore the administration of states' wealth, with "political" signifying the Greek word polity and "economy" signifying the Greek word οἰκονομία. The earliest works of political economy are usually attributed to the British scholars Adam Smith, Thomas Malthus, and David Ricardo, although they were preceded by the work of the French physiocrats, such as François Quesnay (1694–1774) and Anne-Robert-Jacques Turgot (1727–1781). There is also a tradition which is almost as long, of critique of political economy.

In economics, industrial organization is a field that builds on the theory of the firm by examining the structure of firms and markets. Industrial organization adds real-world complications to the perfectly competitive model, complications such as transaction costs, limited information, and barriers to entry of new firms that may be associated with imperfect competition. It analyzes determinants of firm and market organization and behavior on a continuum between competition and monopoly, including from government actions.

Market failure Situation where the free market allocation of goods and services is not Pareto efficient

In neoclassical economics, market failure is a situation in which the allocation of goods and services by a free market is not Pareto efficient, often leading to a net loss of economic value. Market failures can be viewed as scenarios where individuals' pursuit of pure self-interest leads to results that are not efficient– that can be improved upon from the societal point of view. The first known use of the term by economists was in 1958, but the concept has been traced back to the Victorian philosopher Henry Sidgwick. Market failures are often associated with public goods, time-inconsistent preferences, information asymmetries, non-competitive markets, principal–agent problems, or externalities.

“The Nature of the Firm” (1937), is an article by Ronald Coase. It offered an economic explanation of why individuals choose to form partnerships, companies and other business entities rather than trading bilaterally through contracts on a market. The author was awarded the Nobel Memorial Prize in Economic Sciences in 1991 in part due to this paper. Despite the honor, the paper was written when Coase was an undergraduate and he described it later in life as "little more than an undergraduate essay."

In economics and related disciplines, a transaction cost is a cost in making any economic trade when participating in a market. Oliver E. Williamson defines transaction costs as the costs of running an economic system of companies, and unlike production costs, decision-makers determine strategies of companies by measuring transaction costs and production costs. Transaction costs are the total costs of making a transaction, including the cost of planning, deciding, changing plans, resolving disputes, and after-sales. Therefore, the transaction cost is one of the most significant factors in business operation and management.

Oliver E. Williamson American economist

Oliver Eaton Williamson was an American economist, a professor at the University of California, Berkeley, and recipient of the 2009 Nobel Memorial Prize in Economic Sciences, which he shared with Elinor Ostrom.

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In law and economics, the Coase theorem describes the economic efficiency of an economic allocation or outcome in the presence of externalities. The theorem states that if trade in an externality is possible and there are sufficiently low transaction costs, bargaining will lead to a Pareto efficient outcome regardless of the initial allocation of property. In practice, obstacles to bargaining or poorly defined property rights can prevent Coasean bargaining. This 'theorem' is commonly attributed to Nobel Prize winner Ronald Coase.

Douglass North American economist

Douglass Cecil North was an American economist known for his work in economic history. He was the co-recipient of the 1993 Nobel Memorial Prize in Economic Sciences. In the words of the Nobel Committee, North and Fogel "renewed research in economic history by applying economic theory and quantitative methods in order to explain economic and institutional change."

Social cost in neoclassical economics is the sum of the private costs resulting from a transaction and the costs imposed on the consumers as a consequence of being exposed to the transaction for which they are not compensated or charged. In other words, it is the sum of private and external costs. This might be applied to any number of economic problems: for example, social cost of carbon has been explored to better understand the costs of carbon emissions for proposed economic solutions such as a carbon tax.

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The theory of the firm consists of a number of economic theories that explain and predict the nature of the firm, company, or corporation, including its existence, behaviour, structure, and relationship to the market.

Armen Alchian American economist

Armen Albert Alchian was an American economist. He spent almost his entire career at the University of California, Los Angeles (UCLA). A major microeconomic theorist, he is known as one of the founders of new institutional economics and widely acknowledged for his work on property rights.

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Steven Ng-Sheong Cheung is an American economist who specializes in the fields of transaction costs and property rights, following the approach of new institutional economics. He achieved his public fame with an economic analysis on China open-door policy after the 1980s. In his studies of economics, he focuses on economic explanation that is based on real world observation. He is also the first to introduce concepts from the Chicago School of Economics, especially price theory, into China. In 2016, Cheung claimed to have written "1,500 articles and 20 books in Chinese" during his academic career.

Harold Demsetz American economist

Harold Demsetz was an American professor of economics at the University of California at Los Angeles (UCLA).

Property rights are constructs in economics for determining how a resource or economic good is used and owned. Resources can be owned by individuals, associations, collectives, or governments. Property rights can be viewed as an attribute of an economic good. This attribute has three broad components and is often referred to as a bundle of rights in the United States:

  1. the right to use the good
  2. the right to earn income from the good
  3. the right to transfer the good to others, alter it, abandon it, or destroy it

"The Problem of Social Cost" (1960) by Ronald Coase, then a faculty member at the University of Virginia, is an article dealing with the economic problem of externalities. It draws from a number of English legal cases and statutes to illustrate Coase's belief that legal rules are only justified by reference to a cost–benefit analysis, and that nuisances that are often regarded as being the fault of one party are more symmetric conflicts between the interests of the two parties. If there are sufficiently low costs of doing a transaction, legal rules would be irrelevant to the maximization of production. Because in the real world there are costs of bargaining and information gathering, legal rules are justified to the extent of their ability to allocate rights to the most efficient right-bearer.

References

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    L. J. Alston, (2008). "new institutional economics," The New Palgrave Dictionary of Economics , 2nd Edition. Abstract.
  2. Maridal, J. Haavard (2013). "Cultural impact on national economic growth". The Journal of Socio-Economics. 47: 136–146. doi:10.1016/j.socec.2012.08.002.
  3. Powell, Walter W.; DiMaggio, Paul J. (1991). The New Institutionalism in Organizational Analysis. University of Chicago Press. doi:10.7208/chicago/9780226185941.001.0001. ISBN   978-0-226-67709-5.
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  17. Douglass C. North (1995). "The New Institutional Economics and Third World Development," in The New Institutional Economics and Third World Development, J. Harriss, J. Hunter, and C. M. Lewis, ed., pp. 17-26.
  18. Elinor Ostrom (2005). "Doing Institutional Analysis: Digging Deeper than Markets and Hierarchies," Handbook of New Institutional Economics, C. Ménard and M. Shirley, eds. Handbook of New Institutional Economics, pp. 819 -848. Springer.
  19. Oliver E. Williamson (2000). "The New Institutional Economics: Taking Stock, Looking Ahead," Journal of Economic Literature , 38(3), pp. 595-613 Archived May 11, 2011, at the Wayback Machine (press +).Dzionek-Kozłowska, Joanna; Matera, Rafał (October 2015). "New Institutional Economics' Perspective on Wealth and Poverty of Nations. Concise Review and General Remarks on Acemoglu and Robinson's Concept". Annals of the Alexandru Ioan Cuza University - Economics. 62 (1): 11–18. doi: 10.1515/aicue-2015-0032 .
  20. Keefer, Philip; Knack, Stephen (2005). "Social capital, social norms and the New Institutional Economics". Handbook of New Institutional Economics. pp. 700–725.
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  22. "History". Society for Institutional & Organizational Economics. Retrieved 3 February 2016.
  23. Keohane, Robert O. (2020). "Understanding Multilateral Institutions in Easy and Hard Times". Annual Review of Political Science. 23 (1): 1–18. doi: 10.1146/annurev-polisci-050918-042625 . ISSN   1094-2939.
  24. 1 2 Simon, Herbert A (1991-05-01). "Organizations and Markets". Journal of Economic Perspectives. 5 (2): 25–44. doi:10.1257/jep.5.2.25. ISSN   0895-3309.
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Further reading