Institutional economics 3 Commons

1. Institutional economics 3Commons BERNARD CHAVANCE ABIK JUNE 2010

2. John R. Commons (1862-1945) • The founder of the Wisconsin School • A man of action, expert, consultant, legislator and academic • « Institutional economics » : the combination of law, economics and ethics • A theory of institutions centered on organizations • The search for a « reasonable capitalism » • The problem of « social control »

4. Main books • Proportional Representation, 1896. • Trade Unionism and Labor Problems, 1905. • Races and Immigrants in America, 1907. • J. R. Commons et al., eds., History of Labour in the United States, 4 vol., 1918-35. • Industrial Goodwill, 1919. • Legal Foundations of Capitalism, 1924. • Institutional Economics – Its Place in Political Economy, 1934. • The Economics of Collective Action, 1950.

5. Reinterpreting economic theories • Wrong postulates: natural abundance, harmony of interests (Smith), as opposed to scarcity and conflicts • Individual psychology in place of the role of institutions • What matters is the ‘social psychology of negotiations and transactions, arising out of conflicts’ (1934) • Institutional economics should subsume equilibrium theories (neoclassical) and process theories (Veblen), focusing on intentional or deliberate change

6. The institutionalized mind • ‘Individuals begin as babies. They learn the custom of language, of co-operation with other individuals, of working towards common ends, of negotiations to eliminate conflicts of interest, of subordination to the working rules of the many concerns of which they are members’ (1934) • ‘Instead of isolated individuals in a state of nature, they are always participants in transactions, members of a concern in which they come and go, citizens of an institution that lived before them and will live after them’(1934)

7. « Going concerns » • Active organizations, typical of advanced capitalism • Going concern : the joint expectation of beneficial transactions, regulated by ‘working rules’ • Three types of going concerns: economic, political, cultural • Common characteristics: duration (they survive the entry and departure of individuals), sovereignty or autonomous power, legitimate authority, working rules, sanctions and transactions • Legitimate « authoritative figures » lay down and enforce the rules of the organization

8. The State as a template for all going concerns • The American democratic State of the beginning of the twentieth century becomes in a way the generic model of any going concern • The « common law method » is the general way to devise working rules in going concerns • Sovereignty, originally an exclusive attribute of the state has been progressively extended by delegation of the latter to all other going concerns. • Diverse organizations « are, indeed, governments, since they are collective action in control of individual action through the use of sanctions »

9. Hierarchy of collective action • Commons stresses the similarities between the state and other going concerns, sometimes characterizing it as a going concern among others • But there is an essential difference between them, namely the ascendancy of state rules on other organizations’ rules, following a pattern of subordination and delegation • The physical sanctions used by the state are also superior to the economic sanctions of the economic organizations, or the moral sanctions of the cultural organizations

10. Organizations as institutions • ‘It is these going concerns, with the working rules that keep them agoing, all the way from the family, the corporation, the trade union, the trade association, up to the state itself, that we name Institutions.’ (1934) • The institution is ‘collective action in control of individual action’, more precisely ‘collective action in restraint, liberation, and expansion of individual action’ • A paradoxical liberating constraint, in the relation between individual and collective action

11. Working rules • Custom: unorganized collective action • A process of « artificial selection » by authorities when conflicts arise … • … leading to working rules or organized collective action • Every concern ‘must have its working rules, which are its laws. These spring from authority, custom, habit, initiative, or what not. They are the common law, the statute law, and the equity jurisprudence of the concern. The state, the business concern and the cultural concern are alike in their dependence on these working rules, the difference being mainly in the kinds of sanctions, whether physical, economic, or moral, which they can bring to bear in enforcing the rules.’ [1924]

12. Artificial selection • It was the starting point of Darwin, who developed by contrast the concept of « natural selection » • Veblen spoke of natural selection of institutions, but this neglects the role of human will • The way authorities of going concern decide about working rules is rather like artificial selection

13. Workable mutuality • If working rules are first established in order to mediate conflicts, they do not put an end to them • … as conflicts are a structural dimension of social reality, based on scarcity •  « The working rule is not a foreordained harmony of interest … but it actually creates, out of conflict of interests, a workable mutuality and orderly expectation of property and liberty. » (1934) • Conflicts of interests are always to be seen within going concerns

14. Transactions • The transaction is the ‘unit of transfer of legal control’, it is a concept that includes simultaneously conflict, dependence and order • Three types: bargaining transactions, managerial transactions and rationing transactions • Distinguishing what economists wrongly pack in the concept of exchange

15. Types of transactions

16. Strategic and routine transactions • Strategic transactions relate to the ‘limiting factor’ of the action, routine transactions to its ‘complementary factors’ • Limiting factor of the action: its control, carried out in the appropriate form and at the appropriate time and place, activates the complementary factors in order to obtain the desired results • Once placed under control, the limiting factor becomes complementary and another factor becomes the limiting factor • Anticipation of evolutionary theory of the firm (Nelson & Winter)

17. The common law method • The Anglo-american tradition of law • … is actually at work within going concerns… • It implies ‘making new law by deciding conflicts of interest, thus giving greater precision and organized compulsion to the unorganized working rules of custom or ethics’ (1934) • ‘The decisions, by becoming precedents, become the working rules, for the time being, of the particular organized concern.’

18. Futurity • The individual acts in the light of future reality as he sees it in the current institutional framework • ‘in the futurity-dimensions of present activity, afforded by the expectations of institutions, the human organism converts future happenings into present action. (...) What we say of Time holds of Space. It is only institutionalized brains that compass the world, and they do it through the going concerns and machines that serve as instruments.’ (1934) • A striking similarity with Keynes’ view of expectations

19. Reducing structural uncertainty • The future is marked by uncertainty, but the effect of institutions is to reduce this uncertainty: institutional economics considers a society ‘whose future is frankly recognized as unpredictable but which can be controlled somewhat by insight and collective action.’ (1934) • Another parallel with Keynes… • Who wrote to Commons in 1927: ‘there seems to me to be no other economist with whose general way of thinking I feel myself in such general accord’

20. Beyond methodological individualism and holism • The opposition between individualism and holism • Commons gives a critical weight to individual action, and develops a « volitional », « negotiational » and « transactional » psychology - differing from holist approaches • His is simultaneously distinguished from individualist theories by the prominence attributed to « collective action » and by his hierarchical view of working rules of going concerns • Sequence of relations: evolving individual actions -> evolving customs -> common-law method -> changed working rules of going concerns, by authoritative actors -> collective action -> control of individual action -> evolving individual actions -> ...