New institutional economics

Last updated

New institutional economics (NIE) is an economic perspective that attempts to extend economics by focusing on the social and legal norms and rules (which are institutions) that underlie economic activity and with analysis beyond earlier institutional economics and neoclassical economics. [1] It can be seen as a broadening step to include aspects excluded in neoclassical economics. It rediscovers aspects of classical political economy.

Sociology Scientific study of human society and its origins, development, organizations, and institutions

Sociology is the study of society, patterns of social relationships, social interaction and culture of everyday life. It is a social science that uses various methods of empirical investigation and critical analysis to develop a body of knowledge about social order, acceptance, and change or social evolution. Sociology is also defined as the general science of society. While some sociologists conduct research that may be applied directly to social policy and welfare, others focus primarily on refining the theoretical understanding of social processes. Subject matter ranges from the micro-sociology level of individual agency and interaction to the macro level of systems and the social structure.

Institution structure or mechanism of social order and cooperation governing the behaviour of a set of individuals within a given community

Institutions, according to Samuel P. Huntington, are "stable, valued, recurring patterns of behavior". Further, institutions can refer to mechanisms of social order, which govern the behaviour of a set of individuals within a given community. Moreover, institutions are identified with a social purpose, transcending individuals and intentions by mediating the rules that govern living behavior. According to Geoffrey M. Hodgson, it is misleading to say that an institution is a form of behavior. Instead, Hodgson states that institution are "integrated systems of rules that structure social interactions".

Institutional economics focuses on understanding the role of the evolutionary process and the role of institutions in shaping economic behaviour. Its original focus lay in Thorstein Veblen's instinct-oriented dichotomy between technology on the one side and the "ceremonial" sphere of society on the other. Its name and core elements trace back to a 1919 American Economic Review article by Walton H. Hamilton. Institutional economics emphasizes a broader study of institutions and views markets as a result of the complex interaction of these various institutions. The earlier tradition continues today as a leading heterodox approach to economics.

Contents

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 [2] and institutional design, including Law and Economics.

Ronald Coase British economist and author

Ronald Harry Coase was a British economist and author. He was the Clifton R. Musser Professor of Economics at the University of Chicago Law School, where he arrived in 1964 and remained for the rest of his life. He received the Nobel Memorial Prize in Economic Sciences in 1991.

“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, thanks to this paper.

"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.

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. [3]

Complexity characterises the behaviour of a system or model whose components interact in multiple ways and follow local rules, meaning there is no reasonable higher instruction to define the various possible interactions.

Neoclassical economics is an approach to economics focusing on the determination of goods, outputs, and income distributions in markets through supply and demand. This determination is often mediated through a hypothesized maximization of utility by income-constrained individuals and of profits by firms facing production costs and employing available information and factors of production, in accordance with rational choice theory, a theory that has come under considerable question in recent years.

Mainstream economics is the body of knowledge, theories, and models of economics, as taught by universities worldwide, that are generally accepted by economists as a basis for discussion. Also known as orthodox economics, it can be contrasted to heterodox economics, which encompasses various schools or approaches that are only accepted by their proponents, but not by economists in general.

The term 'new institutional economics' was coined by Oliver Williamson in 1975. [4]

Among the many aspects in current analyses are organizational arrangements (such as the boundary of the firm), property rights, [5] transaction costs, [6] 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.

Governance comprises all of the processes of governing – whether undertaken by the government of a state, by a market or by a network – over a social system and whether through the laws, norms, power or language of an organized society. It relates to "the processes of interaction and decision-making among the actors involved in a collective problem that lead to the creation, reinforcement, or reproduction of social norms and institutions". In lay terms, it could be described as the political processes that exist in and between formal institutions.

An ideology is a set of normative beliefs and values that a person or other entity has for non-epistemic reasons. These rely on basic assumptions about reality that may or may not have any factual basis. The term is especially used to describe systems of ideas and ideals which form the basis of economic or political theories and resultant policies. In these there are tenuous causal links between policies and outcomes owing to the large numbers of variables available, so that many key assumptions have to be made. In political science the term is used in a descriptive sense to refer to political belief systems.

Asset specificity is a term related to the inter-party relationships of a transaction. It is usually defined as the extent to which the investments made to support a particular transaction have a higher value to that transaction than they would have if they were redeployed for any other purpose. Asset specificity has been extensively studied in a variety of management and economics areas such as marketing, accounting, organizational behavior and management information systems.

Major scholars associated with the subject include Masahiko Aoki, Armen Alchian, Harold Demsetz, [7] [8] Steven N. S. Cheung, [9] [10] Avner Greif, Yoram Barzel, Claude Ménard (economist), Daron Acemoglu, and four Nobel laureates—Ronald Coase, [11] [12] Douglass North, [13] [14] Elinor Ostrom, [15] and Oliver Williamson. [16] [17] [18] A convergence of such researchers resulted in founding the Society for Institutional & Organizational Economics (formerly the International Society for New Institutional Economics) in 1997. [19]

Masahiko Aoki was a Japanese economist, Tomoye and Henri Takahashi Professor Emeritus of Japanese Studies in the Economics Department, and Senior Fellow of the Stanford Institute for Economic Policy Research and Freeman Spogli Institute for International Studies at Stanford University. Aoki was known for his work in comparative institutional analysis, corporate governance, the theory of the firm, and comparative East Asian development.

Armen Alchian American economist

Armen Albert Alchian was an Armenian-American economist and professor of economics at the University of California, Los Angeles.

Harold Demsetz American economist

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

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). [20]

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. [21] 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. [22]

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

Related Research Articles

Political economy Study of production, buying, and selling, and their relations with law, custom, and government

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 "okonomie". 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).

In economics and related disciplines, a transaction cost is a cost in making any economic trade when participating in a market.

Oliver E. Williamson American economist

Oliver Eaton Williamson is 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.

Law and economics or economic analysis of law is the application of economic theory to the analysis of law that began mostly with scholars from the Chicago school of economics. Economic concepts are used to explain the effects of laws, to assess which legal rules are economically efficient, and to predict which legal rules will be promulgated.

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 Memorial Prize in Economic Sciences winner Ronald Coase during his tenure at the London School of Economics, SUNY at Buffalo, University of Virginia, and University of Chicago.

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 personal and external costs. Private costs refer to direct costs to the producer for producing the good or service. Social cost includes these private costs and the additional costs associated with the production of the good for which are not accounted for by the free market. Mathematically, social marginal cost is the sum of private marginal cost and the external costs. For example, when selling a glass of lemonade at a lemonade stand, the private costs involved in this transaction are the costs of the lemons and the sugar and the water that are ingredients to the lemonade, the opportunity cost of the labor to combine them into lemonade, as well as any transaction costs, such as walking to the stand. An example of marginal damages associated with social costs of driving includes wear and tear, congestion, and the decreased quality of life due to drunks driving or impatience, and many people displaced from their homes and localities due to construction work. In their simplest words it is the private cost+external cost.

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.

Government failure, in the context of public economics, is an economic inefficiency caused by a government intervention, if the inefficiency would not exist in a true free market. It can be viewed in contrast to a market failure, which is an economic inefficiency that results from the free market itself, and can potentially be corrected through government regulation. The idea of government failure is associated with the policy argument that, even if particular markets may not meet the standard conditions of perfect competition required to ensure social optimality, government intervention may make matters worse rather than better.

Steven Ng-Sheong Cheung is a Hong-Kong-born 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.

In neoclassical economics, a market distortion is any event in which a market reaches a market clearing price for an item that is substantially different from the price that a market would achieve while operating under conditions of perfect competition and state enforcement of legal contracts and the ownership of private property. A distortion is "any departure from the ideal of perfect competition that therefore interferes with economic agents maximizing social welfare when they maximize their own". A proportional wage-income tax, for instance, is distortionary, whereas a lump-sum tax is not. In a competitive equilibrium, a proportional wage income tax discourages work.

In the history of economic thought, a school of economic thought is a group of economic thinkers who share or shared a common perspective on the way economies work. While economists do not always fit into particular schools, particularly in modern times, classifying economists into schools of thought is common. Economic thought may be roughly divided into three phases: premodern, early modern and modern. Systematic economic theory has been developed mainly since the beginning of what is termed the modern era.

Property rights are theoretical socially-enforced 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 four broad components and is often referred to as a bundle of rights:

  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
  4. the right to enforce property rights

Public economics is the study of government policy through the lens of economic efficiency and equity. Public economics builds on the theory of welfare economics and is ultimately used as a tool to improve social welfare.

Organizational economics involves the use of economic logic and methods to understand the existence, nature, design, and performance of organizations, especially managed ones.

References

  1. Malcolm Rutherford (2001). "Institutional Economics: Then and Now," Journal of Economic Perspectives, 15(3), pp. 185-90 (173-194).
    L. J. Alston, (2008). "new institutional economics," The New Palgrave Dictionary of Economics , 2nd Edition. Abstract.
  2. Rita Yi Man Li (2012). The Internalisation of Environmental Externalities Affecting Dwellings: A Review of Court Cases in Hong Kong," Economic Affairs, Volume 32, Issue 2, p. 81-87, June 2012, .
  3. Warren Samuels ([1987] 2008), "institutional economics" The New Palgrave Dictionary of Economics Abstract A scholarly journal particularly featuring traditional institutional economics is the Journal of Economic Issues ; see abstract links to 2008. Scholarly journals particularly featuring the new institutional economics include the Journal of Law Economics and Organization, the Journal of Economic Behavior and Organization, and the Journal of Law and Economics.
  4. Oliver E. Williamson (1975). Markets and Hierarchies, Analysis and Antitrust Implications: A Study in the Economics of Internal Organization.
  5. Dean Lueck (2008). "property law, economics and," The New Palgrave Dictionary of Economics , 2nd Edition. Abstract.
  6. M. Klaes (2008). "transaction costs, history of," The New Palgrave Dictionary of Economics, 2nd Edition. Abstract.
  7. Harold Demsetz (1967). "Toward a Theory of Property Rights," American Economic Review, 57(2), pp. 347-359 [ dead link ].
  8. Harold Demsetz (1969) "Information and Efficiency: Another Viewpoint," Journal of Law and Economics, 12(1), pp. [ dead link ].
  9. Steven N. S. Cheung (1970). "The Structure of a Contract and the Theory of a Non-Exclusive Resource," Journal of Law and Economics, 13(1), pp. 49-70.
  10. S. N. S. Cheung (1973). "The Fable of the Bees: An Economic Investigation," Journal of Law and Economics, 16(1), pp. 11-33.
  11. Ronald Coase (1998). "The New Institutional Economics," American Economic Review, 88(2), pp. 72-74.
  12. R. H. Coase (1991). "The Institutional Structure of Production," Nobel Prize Lecture PDF, reprinted in 1992, American Economic Review, 82(4), pp. 713-719.
  13. Douglass C. North (1990). Institutions, Institutional Change and Economic Performance, Cambridge University Press.
  14. 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.
  15. 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.
  16. 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.
  17. Keefer, Philip; Knack, Stephen (2005). "Social capital, social norms and the New Institutional Economics". Handbook of New Institutional Economics. pp. 700–725.
  18. "Introductory Reading List: New Institutional Economics". Ronald Coase Institute.
  19. "History". Society for Institutional & Organizational Economics. Retrieved 3 February 2016.
  20. Rita Yi Man Li (2014). "The Institutional Analysis of Fittings in Residential Units in Law, Economics and Finance of the Real Estate Market 2014, pp 45-61" .
  21. North, Douglass C. "Transaction Costs, institutions, and Economic Performance." International Center for Economic Growth (n.d.): n. pag. Khousachonine.ucoz.com. Web.
  22. Williamson, Oliver (2000). "The 'New Institutional Economics: Taking Stock, Looking Ahead". Journal of Economic Literature. CiteSeerX   10.1.1.128.7824 .

Further reading

https://mpra.ub.uni-muenchen.de/73232/