IEUPNYK InstEcon5_North
Institutional
economics 5
North
B. Chavance
ABIK June 2010
New institutional
economics (NIE)
Oliver Williamson (1975) : ‘new institutional
economics’ (distinct from the ‘old’, ie the American
original institutionalism)
‘Institutions matter’, and they may be analyzed with
the instruments of mainstream economic theory - with
certain adjustments
Two important branches of NIE : Williamson, North
2
Williamson (b. 1932)
3
Main books
Markets and Hierarchies: Analysis and Antitrust
Implications,1975
The Economic Institutions of Capitalism: Firms, Markets,
Relational Contracting, 1985
The mechanisms of governance, 1996
4
The nature of the firm (Coase,1937)
Coase (1937): lack of explanation for the existence of
the firm in conventional economics.
The explanation actually lies in the ‘costs of using the
price mechanism’ or the ‘operation of a market costs’:
search for appropriate prices, negotiation of separate
contracts.
If high costs : alternative of the firm, ‘market
transactions are eliminated and in place of the
complicated market structure with exchange
transactions is substituted the entrepreneur-coordinator, who directs production. (1937)
5
Transaction costs
Neoclassical economics focuses on production costs,
and neglects transaction costs
Transaction costs depend of asset specificity, and
opportunism
…‘organizational variety arises primarily in the service
of transaction cost economizing’
Choice of modes of governance (institutions), to
minimize transaction costs: markets, hierarchies
(firms), hybrids
6
Douglass North (b. 1920)
From neoclassical economic history to institutional
analysis, through a growing critical stance toward
neoclasssical tradition
‘Nobel’ prize of economics, 1993
Main books :
Institutional Change and American Economic Growth,1971
The Rise of the Western World : A New Economic History, (with
R. Thomas), 1973
Structure and Change in Economic History, 1981.
Institutions, Institutional Change and Economic Performance,
1990.
Understanding the Process of Economic Change, 2005
7
Douglass North
8
Limitations of
neoclassical theory
North: for preserving the postulate of scarcity and the
role of competition, choice under constraint,
microeconomic theory and role of relative prices
Neoclassical theory ignores institutions and time, it
neglects transaction costs, the role of ideas and
ideologies as well as that of the political process vis-àvis the economy
‘Dismantling’ the concept of rationality: limits to the
knowledge of the individual and to his capacity to
process information, role of uncertainty
9
The nature of institutions
‘Institutions are the humanly devised constraints that
structure human interaction. They are made up of
formal constraints (rules, laws, constitutions), informal
constraints (norms of behaviour, conventions, and self
imposed codes of conduct), and their enforcement
characteristics’ (1994)
Constraints, formal/informal rules, the role of
‘enforcement’
Institutions as ‘rules of the game’ (sports metaphor, no
direct reference to game theory)
10
Structures of belief
‘history demonstrates that ideas, ideologies, myths,
dogmas and prejudices matter’ (1990 )
Ideologies and institutions as ‘classes of shared mental
models’, related in a co-evolutionary process
Rules derived by a process of learning and calculation
are endogenous to the institutional structure: ‘much of
what passes for rational choice is not so much
individual cogitation as the embeddedness of the
thought process in the larger social and institutional
context’ (2005)
11
Power and institutions
Initial neoclassical position of North: institutions represent
efficient solutions to economic problems
Modified stance: institutions are actually based on power
‘Institutions are not necessarily or even usually created to
be socially efficient; rather they, or at least the formal rules,
are created to serve the interests of those with the
bargaining power to create new rules.’ (1994)
However ‘principals’ remain utilitarian rational maximizers
(neoclassical rationality assumptions remain here)
12
Efficiency and performance
The concept of efficiency is qualified (reference to
evolutionary economics: Nelson & Winter)
‘It is adaptive rather than allocative efficiency which is the
key to long run growth. Successful political/economic
systems have evolved flexible institutional structures that
can survive the shocks and changes that are a part of
successful evolution. But these systems have been a product
of long gestation. We do not know how to create adaptive
efficiency in the short run.’ (1994)
‘Performance’ of an economy is identified with long-run
growth
13
Organizations and
institutions
Original institutional economics included organizations in
institutions (or identified them)
North insists on the distinction: ‘If institutions are the rules
of the game, organizations and their entrepreneurs are the
players.’ (1990)
Organizations are made up of groups of individuals bound
by some common project to achieve objectives
The institutional framework conditions the type of
organization that will be created, as it does their evolution,
but in their turn the organizations will be at the source of
institutional change
14
The role of the institutional matrix
‘The organizations that come into existence will reflect
the opportunities provided by the institutional matrix.
That is, if the institutional framework rewards piracy
then piratical organizations will come into existence;
and if the institutional framework rewards productive
activities then organizations - firms - will come into
existence to engage in productive activities.’ (1994)
The institutional framework is ‘usually a mixed bag of
institutions that promote such productivity-raising
activities and institutions that provide barriers to entry,
encourage monopolistic restrictions, and impede the
low-cost flow of information’. (1990)
15
The process of
institutional change
The dominance of gradual change
Formal rules may be changed fast, but not informal rules
‘And economies that adopt the formal rules of another
economy will have very different performance
characteristics than the first economy because of different
informal norms and enforcement. The implication is that
transferring the formal political and economic rules of
successful Western market economies to Third World and
Eastern European economies is not a sufficient condition
for good economic performance.’ (1994)
16
The causal sequence of change
Mental models and ideologies
(beliefs)
Institutional framework of polity and economy
Incentive structure
Organizations
Policies
Performance
Sources : Denzau and North [1994] ; North [2005]
17
Causes of economic performance
‘It is the admixture of formal rules, informal norms, and enforcement
characteristics that shapes economic performance.’
‘While the rules may be changed overnight, the informal norms usually
change only gradually’
‘(R)evolutionary change is never as revolutionary as its supporters desire,
and performance will be different than anticipated. And economies that
adopt the formal rules of another economy will have very different
performance characteristics than the first economy because of different
informal norms and enforcement.’
‘(T)ransferring the formal political and economic rules of successful
Western market economies to third-world and Eastern European
economies is not a sufficient condition for good economic performance.
Privatization is not a panacea for solving poor economic performance.’
(1994)
18
Path dependent change
National paths of institutional change are marked by
phenomena of ‘path dependence’ and ‘lock in’ that
result from the complex interaction between
organizations and institutions (notions borrowed to
Brian Arthur and Paul David )
Relatively inefficient paths can be persistently
followed over fairly long historical periods
This is the most frequent case to be found in history,
while the paths consisting of lasting and cumulative
growth, while possible as forms of virtuous ‘lock in’,
are rather the exception (1990)
19
The political system
The political system plays a decisive role, because it is at
this level that the formal economic rules of the game are
established and their application controlled
Political systems that have led to assured and clearly
defined property rights have been the source of Western
prosperity
‘One gets efficient institutions by a polity that has built-in
incentives to create and enforce efficient property rights.’
(1990)
We note here a rather allocative approach of efficiency, not
adaptive
20
Polities shape economic performance
by defining and enforcing the economic rules
(a) Political institutions will be stable only if undergirded by
organizations with a stake in their perpetuation.
(b) Both institutions and belief systems must change for
successful reform since it is the mental models of the actors that
will shape choices.
(c) Developing norms of behavior that will support new rules is a
lengthy process, and in the absence of such reinforcing
mechanisms polities will tend to be unstable.
(d) While economic growth can occur in the short run with
autocratic regimes, long-run economic growth entails the
development of the rule of law. (1994)
21
Divergent historical trajectories
Structure and Change [1981]: divergent trajectories in terms of
economic development of France and Spain, on the one hand,
and England and the Netherlands, on the other, between the 16th
and 18th centuries
State or merchant class
‘Growth has been generated when the economy has provided
institutional incentives to undertake productivity-raising activities
such as the Dutch undertook. Decline has resulted from
disincentives to engage in productive activity as a consequence of
centralized political control of the economy and monopoly
privileges. The failures vastly exceed the successes. Economic
growth has been the exception; stagnation and decline have been
the rule, reflecting a persistent tendency toward failure in human
organization.’ (2005)
22
economics 5
North
B. Chavance
ABIK June 2010
New institutional
economics (NIE)
Oliver Williamson (1975) : ‘new institutional
economics’ (distinct from the ‘old’, ie the American
original institutionalism)
‘Institutions matter’, and they may be analyzed with
the instruments of mainstream economic theory - with
certain adjustments
Two important branches of NIE : Williamson, North
2
Williamson (b. 1932)
3
Main books
Markets and Hierarchies: Analysis and Antitrust
Implications,1975
The Economic Institutions of Capitalism: Firms, Markets,
Relational Contracting, 1985
The mechanisms of governance, 1996
4
The nature of the firm (Coase,1937)
Coase (1937): lack of explanation for the existence of
the firm in conventional economics.
The explanation actually lies in the ‘costs of using the
price mechanism’ or the ‘operation of a market costs’:
search for appropriate prices, negotiation of separate
contracts.
If high costs : alternative of the firm, ‘market
transactions are eliminated and in place of the
complicated market structure with exchange
transactions is substituted the entrepreneur-coordinator, who directs production. (1937)
5
Transaction costs
Neoclassical economics focuses on production costs,
and neglects transaction costs
Transaction costs depend of asset specificity, and
opportunism
…‘organizational variety arises primarily in the service
of transaction cost economizing’
Choice of modes of governance (institutions), to
minimize transaction costs: markets, hierarchies
(firms), hybrids
6
Douglass North (b. 1920)
From neoclassical economic history to institutional
analysis, through a growing critical stance toward
neoclasssical tradition
‘Nobel’ prize of economics, 1993
Main books :
Institutional Change and American Economic Growth,1971
The Rise of the Western World : A New Economic History, (with
R. Thomas), 1973
Structure and Change in Economic History, 1981.
Institutions, Institutional Change and Economic Performance,
1990.
Understanding the Process of Economic Change, 2005
7
Douglass North
8
Limitations of
neoclassical theory
North: for preserving the postulate of scarcity and the
role of competition, choice under constraint,
microeconomic theory and role of relative prices
Neoclassical theory ignores institutions and time, it
neglects transaction costs, the role of ideas and
ideologies as well as that of the political process vis-àvis the economy
‘Dismantling’ the concept of rationality: limits to the
knowledge of the individual and to his capacity to
process information, role of uncertainty
9
The nature of institutions
‘Institutions are the humanly devised constraints that
structure human interaction. They are made up of
formal constraints (rules, laws, constitutions), informal
constraints (norms of behaviour, conventions, and self
imposed codes of conduct), and their enforcement
characteristics’ (1994)
Constraints, formal/informal rules, the role of
‘enforcement’
Institutions as ‘rules of the game’ (sports metaphor, no
direct reference to game theory)
10
Structures of belief
‘history demonstrates that ideas, ideologies, myths,
dogmas and prejudices matter’ (1990 )
Ideologies and institutions as ‘classes of shared mental
models’, related in a co-evolutionary process
Rules derived by a process of learning and calculation
are endogenous to the institutional structure: ‘much of
what passes for rational choice is not so much
individual cogitation as the embeddedness of the
thought process in the larger social and institutional
context’ (2005)
11
Power and institutions
Initial neoclassical position of North: institutions represent
efficient solutions to economic problems
Modified stance: institutions are actually based on power
‘Institutions are not necessarily or even usually created to
be socially efficient; rather they, or at least the formal rules,
are created to serve the interests of those with the
bargaining power to create new rules.’ (1994)
However ‘principals’ remain utilitarian rational maximizers
(neoclassical rationality assumptions remain here)
12
Efficiency and performance
The concept of efficiency is qualified (reference to
evolutionary economics: Nelson & Winter)
‘It is adaptive rather than allocative efficiency which is the
key to long run growth. Successful political/economic
systems have evolved flexible institutional structures that
can survive the shocks and changes that are a part of
successful evolution. But these systems have been a product
of long gestation. We do not know how to create adaptive
efficiency in the short run.’ (1994)
‘Performance’ of an economy is identified with long-run
growth
13
Organizations and
institutions
Original institutional economics included organizations in
institutions (or identified them)
North insists on the distinction: ‘If institutions are the rules
of the game, organizations and their entrepreneurs are the
players.’ (1990)
Organizations are made up of groups of individuals bound
by some common project to achieve objectives
The institutional framework conditions the type of
organization that will be created, as it does their evolution,
but in their turn the organizations will be at the source of
institutional change
14
The role of the institutional matrix
‘The organizations that come into existence will reflect
the opportunities provided by the institutional matrix.
That is, if the institutional framework rewards piracy
then piratical organizations will come into existence;
and if the institutional framework rewards productive
activities then organizations - firms - will come into
existence to engage in productive activities.’ (1994)
The institutional framework is ‘usually a mixed bag of
institutions that promote such productivity-raising
activities and institutions that provide barriers to entry,
encourage monopolistic restrictions, and impede the
low-cost flow of information’. (1990)
15
The process of
institutional change
The dominance of gradual change
Formal rules may be changed fast, but not informal rules
‘And economies that adopt the formal rules of another
economy will have very different performance
characteristics than the first economy because of different
informal norms and enforcement. The implication is that
transferring the formal political and economic rules of
successful Western market economies to Third World and
Eastern European economies is not a sufficient condition
for good economic performance.’ (1994)
16
The causal sequence of change
Mental models and ideologies
(beliefs)
Institutional framework of polity and economy
Incentive structure
Organizations
Policies
Performance
Sources : Denzau and North [1994] ; North [2005]
17
Causes of economic performance
‘It is the admixture of formal rules, informal norms, and enforcement
characteristics that shapes economic performance.’
‘While the rules may be changed overnight, the informal norms usually
change only gradually’
‘(R)evolutionary change is never as revolutionary as its supporters desire,
and performance will be different than anticipated. And economies that
adopt the formal rules of another economy will have very different
performance characteristics than the first economy because of different
informal norms and enforcement.’
‘(T)ransferring the formal political and economic rules of successful
Western market economies to third-world and Eastern European
economies is not a sufficient condition for good economic performance.
Privatization is not a panacea for solving poor economic performance.’
(1994)
18
Path dependent change
National paths of institutional change are marked by
phenomena of ‘path dependence’ and ‘lock in’ that
result from the complex interaction between
organizations and institutions (notions borrowed to
Brian Arthur and Paul David )
Relatively inefficient paths can be persistently
followed over fairly long historical periods
This is the most frequent case to be found in history,
while the paths consisting of lasting and cumulative
growth, while possible as forms of virtuous ‘lock in’,
are rather the exception (1990)
19
The political system
The political system plays a decisive role, because it is at
this level that the formal economic rules of the game are
established and their application controlled
Political systems that have led to assured and clearly
defined property rights have been the source of Western
prosperity
‘One gets efficient institutions by a polity that has built-in
incentives to create and enforce efficient property rights.’
(1990)
We note here a rather allocative approach of efficiency, not
adaptive
20
Polities shape economic performance
by defining and enforcing the economic rules
(a) Political institutions will be stable only if undergirded by
organizations with a stake in their perpetuation.
(b) Both institutions and belief systems must change for
successful reform since it is the mental models of the actors that
will shape choices.
(c) Developing norms of behavior that will support new rules is a
lengthy process, and in the absence of such reinforcing
mechanisms polities will tend to be unstable.
(d) While economic growth can occur in the short run with
autocratic regimes, long-run economic growth entails the
development of the rule of law. (1994)
21
Divergent historical trajectories
Structure and Change [1981]: divergent trajectories in terms of
economic development of France and Spain, on the one hand,
and England and the Netherlands, on the other, between the 16th
and 18th centuries
State or merchant class
‘Growth has been generated when the economy has provided
institutional incentives to undertake productivity-raising activities
such as the Dutch undertook. Decline has resulted from
disincentives to engage in productive activity as a consequence of
centralized political control of the economy and monopoly
privileges. The failures vastly exceed the successes. Economic
growth has been the exception; stagnation and decline have been
the rule, reflecting a persistent tendency toward failure in human
organization.’ (2005)
22