Early 20th Century American Institutionalism

Institutionalism appeared in American scholarship during the late 19th and early 20th
centuries in the works of the American institutional economists (AIE). The American
economist and sociologist Thorstein Veblen was a pivotal figure who criticized the
neoclassical approach for its focus on individuals.

Neoclassical economics is an approach to economics that relates supply and demand to an

individual's rationality and his ability to maximize utility or profit. Neoclassical economics also
uses mathematical equations to study various aspects of the economy.

He argued that individuals are shaped by their institutional and sociocultural context. He
emphasized habit, instinct, and emulation as alternatives to utility-calculation models of
behaviour. Veblen theorized institutional persistence and developed several mechanisms of
change, including conflict between institutions, exogenous shocks, and the interplay between
routines and the variable and volatile action of agents.

Although Veblen embraced an organicist approach to social science, favouring the biological
metaphor of evolution over the physical metaphor of mechanics deployed by economists, he
was explicitly antifunctionalist. He raised the possibility of social breakdown and described
history as an unfolding process that is cumulative but also crisis-ridden, rather than as a self-
balancing smoothly changing system.

A later figure among the AIE was the American economist John R. Commons, who in the
1920s and ’30s rejected the framework of the classical economists in which providence
endows individuals with freedom to enter into relations of economic exchange and
economics is separate from politics.

Classical economics or classical political economy (also known as liberal economics) is

a school of thought in economics that flourished, primarily in Britain, in the late 18th and
early-to-mid 19th century. Its main thinkers are held to be Adam Smith, Jean-Baptiste Say,
David Ricardo, Thomas Robert Malthus, and John Stuart Mill. These economists produced a
theory of market economies as largely self-regulating systems, governed by natural laws of
production and exchange (famously captured by Adam Smith's metaphor of the invisible
hand).

Commons argued that economics was a series of transactions that were made possible by
institutional supports. He identified three types of transactions: rationing, managerial, and
negotiated (associated with communism, fascism, and capitalism respectively). Institutions
have to guarantee liberty and property before negotiated transactions can occur. He defined
institutions as the working rules of collective action that are laid down and enforced by
various organizations including the state. Institutions produce order by creating expectations
toward which individuals can orient their economic behaviour. This interpretation of
institutions is at the heart of rational choice institutionalism (RCI) and the new institutional
economics (NIE).
Institutional Economics

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 (e.g.
individuals, firms, states, social norms). The earlier tradition continues today as a
leading heterodox approach to economics.

"Traditional" institutionalism rejects the reduction of institutions to simply tastes,technology,

and nature (see naturalistic fallacy). Tastes, along with expectations of the future, habits, and
motivations, not only determine the nature of institutions but are limited and shaped by them.
If people live and work in institutions on a regular basis, it shapes their world-views.
Fundamentally, this traditional institutionalism (and its modern counterpart institutionalist
political economy) demphasizes the legal foundations of an economy and the evolutionary,
habituated, and volitional processes by which institutions are erected and then.

Institutional economics focuses on learning, bounded rationality, and evolution (rather than

assume stable preferences, rationality and equilibrium). It was a central part of American
economics in the first part of the 20th century, including such famous but diverse economists
as Thorstein Veblen,Wesley Mitchell, and John R. Commons. Some institutionalists Karl
Marx as belonging to the institutionalist tradition, because he described capitalism as a
historically-bounded social system; other institutionalist economists[who?] disagree with
Marx's definition of capitalism, instead seeing defining features such as markets, money and
the private ownership of production as indeed evolving over time, but as a result of the
purposive actions of individuals.

Marxist economics comes from the ideas of a philosopher named Karl Marx applied

to economics. He created it to explain the "rules of motion" of
production and exchange under capitalism. This theory was used to argue against the middle
class theories of economics common at that time. Marx wanted this to be a tool for the
working class (the proletariat) to use to overthrow capitalism and replace it with socialism,
then with communism. Socialism, would be a step towards the disappearance of the state,
and communism would be, according to Marx, a society where goods and services would be
distributed "to each according to his need, from each according to his ability."

Marx used the Labor Theory of Value, which says that the value of a commodity is
determined by the labor required to produce it. More specifically, Marx defined the value of a
commodity as the Socially necessary labor time required to produce it, the average (taken
across all of society) time required to produce a given commodity under the average
conditions of production. It follows from this that the [working class] is responsible for the
production of all of the [value] (wealth) consumed by all members of society.
 A significant variant is the new institutional economics from the later 20th century,
which integrates later developments of neoclassical economics into the analysis. 

Neoclassical economics is an approach to economics that relates supply and demand to an

individual's rationality and his ability to maximize utility or profit. Neoclassical economics also
uses mathematical equations to study various aspects of the economy.

Law and economics has been a major theme since the publication of the Legal Foundations
of Capitalism by John R. Commons in 1924. Since then, there is heated debate on the role of
law (formal institution) on economic growth. Behavioral economics is another hallmark of
institutional economics based on what is known about psychology and cognitive science,
rather than simple assumptions of economic behavior.

The phrase, “the new institutional economics,” was coined by Oliver Williamson. It was
intended to differentiate the subject from the “old institutional economics.”

Old Institutional Economics

The Institutional Approach to Economic Theory, Walton Hamilton gave five propositions that
summarized the various aspects of Old Institutional Economics:

Institutional Economics is not defined in terms of any policy proposals.

Institutional Economics draws on many different fields of study such as psychology,

sociology, and anthropology to develop a better analysis of human behavior.

Institutions are a vital component of any economy and a major task for economics should be
to study institutions and the process of institutional change.

The economy is an open ended system subject to evolutionary change, embedded with
complex elements such as culture, social class, political power, and other variables.

The neoclassical idea of the rational utility maximizing agent is inadequate and erroneous.
Institutional Economics doesn’t take the individual as given. Instead, individuals are shaped
by institutional and cultural arrangements. The “downward causation” of institutions can
influence behavior in important 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.

To understand the core tenants of institutional economics, one need to merely look at the
origins of the American Institutionalist movement.

Tenets of institutional economics

1. Inquiry is addressed to the institutional process of providing the material means of life and
to significant problems of institutional malfunction.

2. Economics is a policy science; economic inquiry is significant only to the extent that it is
relevant to problem solving through institutional reform.
3. The method of inquiry is evolutionary; the object of inquiry is the social process; the search
is for factual explanations and causal understandings.

4. Social value judgments are a part of inquiry and must themselves be objects of analysis;
the normative-positive dichotomy is rejected.

5. All political economies evolve and are embedded in social and cultural processes;
individuals are both products and creators of these processes.

6. Institutions correlate and coordinate economic behavior in progressive and regressive

ways; problems are resolved with progressive changes in structure.

7. The growth of warranted knowledge and its application as technology are prime movers in
social change; they are both sources and means of resolving problems through institutional
adjustment.

8. The biotic and social communities are co-evolutionary and interdependent; sustainability of
either is dependent on the other.

9. Any political economy is a system of power; the locus, use, and democratic accountability
of achieved power remain priorities in analysis and policy.

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.
The American Institutionalist School.

The American Institutionalist School, commonly associated with Thorstein Veblen, John
Commons and Wesley Mitchell, was for a brief period effectively the orthodoxy in the United
States, between 1888 and the end of the 1920s.

The Institutionalist school developed in the late 1880s in the United States and was heavily
influenced by the German Historical School and the English Historicists. In the beginning,
they did not shy away from direct confrontation with Classical and then Neoclassical
economics, although their real targets were the plethora of apologists that dominated the
American scene. Deploring the universalist pretensions of much of economic theory, the
Institutionalists stressed the importance of historical, social and institutional factors which
make so-called economic "laws", contingent on these factors. Much of everything in the
economic world, they argued, was not immutable but rather conditioned by the influence of
an always changing history - whether acting on the individual directly, or indirectly through
the institutions and society which surround him.

American Institutionalists

Thorstein Veblen,

.John Rogers Commons,

.John Maurice Clark,

.Clarence Edwin Ayres,

.Gardiner Coit Means,

.Arthur R. Burns,

.Allan Garfield Gruchy,

.Allyn Abbott Young,