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The New Institutional Ism

The New Institutional Ism

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Published by Yaseen Rahman

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Published by: Yaseen Rahman on Aug 22, 2010
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 The New Institutionalism: Contradictory Notions of ChangeIntroduction THE NEW INSTITUTIONALISM is a relatively new theoretical perspectivethat has reached increasing levels of acceptance among socialscientists. The rise of the new institutionalism can be seen as ahistorical modification of rational choice perspectives that becamefashionable in the social sciences starting in the 1970s, though the twoperspectives are intimately linked to the "behavioral revolution" of adecade earlier. Any political scientist who consults the leading journalof the profession (in terms of overall reputation and difficulty of publication), the American Political Science Review, will find him- orherself inundated with rational choice perspectives. Political scientists,then, seem to be moving in the direction of attempting to found a"scientific" basis to their art, just as economists did earlier in thecentury. The basis of this revolution is attractive in the sense that rationalchoice perspectives seem to allow for a "universalization" of individuals' political actions, just as a market-based model allows forthe aggregation of individuals' economic behavior. More importantly,rational choice models also seem to allow political scientists to comecloser to the scientific "holy grail" of the social sciences, namely somemeasure of predictability of behavior. However, despite some clear,albeit limited, successes in terms of voting behavior models, thisambitious endeavor has faced important theoretical obstacles that arehelping to prevent its universalization as a political science model.While these problems have been discussed extensively elsewhere, [1]let us remind readers of just a few: precisely defining interests, whenboth material and non-material influences create them; explaining theeffects of identity, culture, and politics on interests and decision-making; and last but not least, explaining the dyna mics of decision-making. The argument of this commentary is that the new institutionalistperspective in economics only partially solves some of the problems of the rational choice perspective. More importantly, we suggest that,ironically, the new institutionalism's salving modifications of rationalchoice actually bring up the most important arguments against it.IINew Institutionalism's Attempt to Save Rational Choice
INSTITUTIONALISM AS A BRANCH OF ECONOMICS dates back at least tothe beginning of the twentieth century. "Old" institutionalists believe inpath dependency (i.e. the importance of historical context), theautonomy of institutions, evolutionary economics, and a holisticapproach to economics, that is, one that considers cultural and politicalfactors of motivation, interaction, and organization. Institutionalists of the old school are now branded by mainstream economists "aswhimsical advacates of an unrealistic and basically empirical researchprogramme which posed no challenge to the classical or neoclassicalhegemony." [2]By contrast, the new institutionalism draws greater legitimacy becauseof its roots in (traditional) neoclassical economic theory. Rather thanseeking to replace neoclassical economics, the new institutionalistswish only to modify the rational choice, utility-based neoclassicalmodel by relaxing some of its assumptions. The new institutionalismfocuses on the central assumption of zero transactions costs inneoclassical economic models as the main gap to be filled. Newinstitutionalists therefore seek to integrate institutional analysis withina neoclassical economic framework and to include institutional changeas an important variable to be studied. [3]Douglass North, a recent Nobel Prize winner (1993), is the mostimportant proponent and theoretician of the new institutionalism.North points out that some of the standard and necessary assumptionsof rational choice models are questionable. He notes that preferencesare not always transitive (their intensities change over time and theyare not in a stable order over time), and that "framing effects" (inwhich alternate means of presenting a problem result in differentchoices), preference reversals ("where the order of the choices on thebasis of their reported values contradicts the implied ordering in directchoice situations") and ". . . problems in the formulation, manipulation,and processing of subjective probabilities in uncertain choices" alsoexist. [4]Given the incompleteness of information and the need to developregularized behavior in the face of an ever-changing reality and largelyunique situations, patterns of behavior develop. North suggests thatinstitutions consist of these regularized interactions. In other words, forNorth an institution embodies and guides patterns of behavior. [5]North defines institutions as "the rules of the game in a society," or theconstraints that shape human interaction. [6] Unlike standardneoclassical models, institutions are considered to be independentvariables in their own right, limiting individual rationality, and affectingthe courses of societies. Through institutions, history makes itsimpression on society, constraining future choices. [7] Differences in
institutions, moreover, are the primary reasons for differences ineconomic outcomes. By implication, some institutions in somecountries are more efficient in reaching social outcomes, whichexplains, ceteris paribus, why some countries enjoy higher stand ardsof living than others. Organizations are groups of individuals bound bya common purpose to achieve objectives, and are formed within anexisting institutional framework. Nonetheless they act as agents of institutional change, by exploiting the margins of institutionalframeworks. [8] Organizations have different objectives, in line withtheir different "mental models," but the most important cue for theirbehavior is the incentive structure set up by institutions. The new institutionalism gives economic (rational) reasons for theexistence and role of institutions in societies--namely, to reducetransaction costs by internalizing them and by setting up standardrules of action. Ronald Coase explains that firms internalize some of the normal market transaction costs, such as uncertainty and lack of reputation, that exist between independent actors and agents. [9] Transaction costs cover a wide variety of other costs of production andsales that are normally assumed away in standard economic theory,but may, in many cases, prove significant to the ultimate price of thegood. The costs that are identified most frequently as transaction costsare information costs, risk costs, waiting costs, and the costs of retailing or using a middleman. Perhaps the most important factoraffecting transaction costs is the nature of property rights in a society.New institutionalists believe that changes in the institutionalarrangements of property rights can have profound effects on economic outcomes; Armen Alchian and Harold Demsetz use theenclosure acts in Great Britain as one example. [10] For the newinstitutionalism, then, as well as collective action theories, theestablishment and enforcement of private property rights are vital tothe costs of transaction and to providing the security needed for long-term investments. The absence of property rights, or the ability toenforce them at low cost, is a principle cause of underdevelopment.[11] Therefore, how transaction costs are handled by societies plays amajor role in determining the societies' economic growth rates. [12]One aspect of this, common to most collective action theories as wellas to institutionalism, is the need for selective incentives andenforcement. Incentives and enforcement ensure compliance withinstitutional rules. According to North, information on violations andthe need for mechanisms of efficient punishment, which are publicgoods, are vitally important in order to ensure low-cost transacting.Adequate enforcement allows for elaborate contracts. [13]

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