Institutional stream in modern economics: NeoIE versus NewIE

1. Institutional stream in modern economics: NeoIE versus NewIE

2. NeoIE versus NewIE – origins and main methodological and cognitive differences 1. Neo-institutional Economics (NeoIE) • Generally, alike the classical institutionalism (T. Veblen, J. R. Commons, W.C. Mitchell, J. M. Clark) : rejection of basic methodological assumptions of NCE, and methodological indiwidualism in particular • Critique of the definition of economics as a science within the mainstreram economics (scarcity definition of economics/Robbins, economics as science about efficient use of limited resources etc.) and, in particular of broadly understood neoclassical economics • In general approach, NeoIE,, alike Veblenianinstitutionalism, is a critique of the manner in which the whole process of economic development, and of development of capitalist economy, is understood. (rejectiing, however, the social pesimism of Veblen). According to NeoIE, the economic development is an evolutionary social process and not neoclassically interpretred process of equilibrium growth

3. NeoIE versus NewIE – origins and main methodological and cognitive differencesNeoinstitutional Economics • Rejection of hedonism (as philosophical and methodological foundation for research on microeconomic behavior) and the UMH (hypothesis of microeconomic rationality. Implicitly, rejection of thehomo oeconomicus concept • Adoption of psychology of instincts (Veblen), and later on (NeoIE: C.Ayres, J. M. Clark, Galbraith, Myrdal) of philsophy of pragmatism (J. Dewey; pragmatic value theory of Ayres, concept of reasonable values of Mitchell) and behavioral psychologyas foundations for the epxlanation of microeconomic activities

4. NeoIE versus NewIE – origins and main methodological and cognitive differencesNeoinstitutional Economics • Specific way of intrpretation of „economic system”, as evolutionary process whose main part is „culture” • Most important dychotomy of human being (Veblen): contradiction between the instinct of good work and the instinct of posession • Subsequent dychotomiccontradictions: • Between physical flow (flow of useful goods)and financial flow • Between „world (class) of industry” and „world of posession” (leisure class)) • Conflict between those two worlds means also conflict between cultural institutions which are useful or futile (useless) form the point of view of social and economic development

5. NeoIE versus NewIE – origins and main methodological and cognitive differencesNeoinstitutional Economics • Rejection of economic determinism and adoption of the view that develoment is mostly determined by science and technology, with inert character of culture and institutional basis (culture – technology conflict) • Rejection of the concept of objective laws or regularities in socio-economic development; one can speak only of a certain logics of development (Galbraith, Myrdal). It consist in plausible, but not necessary, adjustments of culture and institutions to the imperatives brought about by permanently developing (changing) science and technology • Social pesimism of Veblen and its rejection by his followers - postveblenian economists, neoinstitutionalists

6. NeoIE versus NewIE – origins and main methodological and cognitive differencesNeoinstitutional Economics • Rejection of neoclassical way of understanding the economic equlibrium; • Commons: equlibrium („reasonable economy”) as an optimal allocation of scarce resources which is attained not through market competition but as the outcome of „collective actions and control”; • Galbraith: equlibrium as process (and not the state) resulting from the action of countervailing powers: corporations,trade unions, the state as intermediary agent

7. NeoIE versus NewIE – origins and main methodological and cognitive differences New Institutional Economics • Two manners od interpreting NIE • As an integral part of widely understood neoclassical economics, as neoclassical theory of institutions (the so called theoretical institutionalism, as opposed to postveblenian one) • As a new paradigm in contemporary economics based on the criticism of standard neoclassical economics: • Rejection of the assumption of perfect knowledge/information • Bounded (selective) microeconomic rationality • Most decisions taken under condition of risk/uncertainty and the existence of transaction costs

8. NeoIE versus NewIE – origins and main methodological and cognitive differences New Institutional Economics • Genesis of NIE (decades of 70. and 80. of XX century) • „External” critique of „institutionaldeficit” of NCE (post-Keynesianeconomics, Ordoliberalism, NeoIE and others) • Increasingempiricalknowledge on thesignificance of institutions – bothinformal and formal – in modern economic and technological development and subsequentnecessity of theoreticalreflection on them • D. Acemoglu/J. Robinson (2012, WhyNationsFail –TheOrigins of Power, Prosperity and Poverty) • countries that are similar in terms of geography (natural resources, climate), cultureorreligionmaysubstantiallydiffer in terms of the rate of economic development and achievedsocio-economic prosperity due to the quality of theirpolitical and institutionalarrangments(e.g. North Korea and South Korea) • In the long-run, economic prosperity depends above all on the inclusiveness of economic and political institutions , whosemainpreconditionisdemocraticliberalism (e.g. criticalappraisal of China’s long-run potential of economic development)

9. NeoIE versus NewIE – origins and main methodological and cognitive differences New Institutional Economics • Origins and development of theoretical foundations: • Theory of transactions costs (R. Coase as the founder/precursorand O.E. Williamson as main follower) • Theory of property rights (main theoreticians: H. Demsetz and A.A. Alchian) TC and PR theories are two principal methodological and theoretical foundations within the main stream economics for investigations on the role of institutions in modern economies. • Some economists consider also the principal-agent theory (agency theory) one of those foundations

10. New Institutional Economics – basic categories and assertions • Property rights (economic approach) • Entitlements (rights) shaped in the historical process by • law (normative), • customs and morality which define and confine - with regard to other persons - the scope of appropriating and using economic resources and goods (in other words: laws of disposal) • Property rights as a bundle of atributes of an economic good • the right to use the good • the right to earn income from the good • the right to transfer the good to others • the right to enforce property rights

11. New Institutional Economics – basic categories and assertions • Property rights (economic approach) – cont. • Since in any economy most private goods are not pure private goods, and there are many public or semi-public goods, or common goods, whose consequence are various direct (technological) external effects in the economy, there appears the necessity of their internalization • Internalization requires changes in legal-institutional arrangements (in the so called formal institutions).Their analysis becomes then subject to economic analysis (e.g. economic theory of law - creation and enforcement - public regulation or of the state) • Fundamental function of PR consists in creating incentives for increasing the scope of (1) internalization of external effects and (2) prevention from rent-seeking economic behaviour (e.g. through the privatization)

12. New Institutional Economics – basic categories and assertions • TRANSACTION CROSS (TC) IN NARROW APPROACH (COASE, WILLIAMSON) In most general interpretation, TC are the costs of using the price (market) mechanism • Types of transactioncosts(Coase): • TC related to seeking and processinginformationwhichisnecessaryforshaping market prices of goods (ex-ante TC) • TC related to negotiations of contracts (agreements) (producers – purchasers, purchasers - deliverers, etc.), alsoincludingintra-firmcontracts (ex ante TC) • Williamson: size of TC depends on: • Specificity of assets • Frequency of contracts • TC linked to the control of execution of contracts(ex- post TC) • TC may be alsoperceivedfromtheperspective of PR Theory: costs of defininig, monitoring and enforcement of thepossesion of rights

13. New Institutional Economics – basic categories and assertions • Agency costs as transaction costs connected with the principal – agent problem/dilemma (within a given organization or outside it) • General definition of agency costs: the deviation from the principal's interest by the agent • The costs inherently associated with using an agent (e.g., the risk that agents will use organizational resource for their own benefit) and • The costs of techniques used to mitigate the problems associated with using an agent—gathering more information • Information asymmetry between the principal and the agent as contributing to moral hazardand adverse selectionproblems. • Agency costs mainly arise due to contracting costs and the divergence of control, separation of ownership and different objectives of principals (owners/shareholders)and agents (managers). • Agency costs and problems as one of funadamental challenges in contemporary big enterprises (and MNCs in particular)

14. New Institutional Economics – basic categories and assertions • TC inbroadapproach: • Coststof coordination of variousforms of economicactivity(coordination by stateversuscoordination by market) • Costswhicharenecessary for theemergence and development of markets • Costsrelated to the performance of institutionswhoseobjectiveis to monitor and enforcethepossesion of property rights

15. New Institutional Economics – basic categories and assertions • TC and PR – interdependence • inaccurate definition, and/or • attenuation of property rights, and • incapability of internalizing (private appriopriating) benefits related to PR must result in: • increasing transaction costs in the economy, • weakening of the system of microeconomic incentives • and this way, in general decline of the level of economic rationality or efficiency.

16. New Institutional Economics – basic categories and assertions • Reasons for high level of TC and theirtypesinthecountrieswithcommand-and-controleconomic system (thecountries of the so calledrealsocialism) • High TC linked to thecentral macroeconomicplanning • High TC related to a broadscope of non-market distribution of public goods • High TC of extensive system of socialtransfers • Attenuation of PR as thereason for broadoccurence of rent seekingbehaviorinthesphere of functionaldistribution of socialproduct • Rent seekingas standard (routine) behavior for menagerialstaff of state owned enterprises and theiremployees • High positional and bureaucraticrents (menagers of SOEs and politicalnomenclature)

17. New Institutional Economics – basic categories and assertions • Nature of thetransformationprocessfromthe point of view of NIE: • General definition: transitionfromsocialistC&Ceconomytowards a market economy as politically and economicallydetermined(driven) institutionalchange • Definitionbased on the TC/PR theories: transitionfromsocialistC&Ceconomytowards a market economy as a gradualtransformation of the system whichischaracterized by predomination of rent seekingmicroeconomicbehaviortowardsthe system withinwhichtheefficiency-drivenactivities of humanbeings and socialgroupsprevail

18. New Institutional Economics – basic categories and assertions Criterion of minimization of TC • General criterion of the growth of economicefficiency(at anylevelof economicgovernance) • Ittheoreticallyallows for answeringtwofundamentalquestions: • Whatisoptimalsize of the enterprise (criterion of equalizing of marginalcosts of transactionscarried out within the enterprise (hierarchy) – intra-enterprisetransactions - and marginalcosts of market transactions) • Why do existenterprises and the market as alternative co-ordinativemechanisms

19. New Institutional Economics – basic categories and assertions • New EconomicHistory (NEH) and New PoliticalEconomy (NPE) – analysis of TC inthe long-run (secular) perspective • Criterion of minimization of TC as a generalfoundation for explaininghowvariouslegal-institutional and economic systems (arrangements) changein long time periods • Effectiveinstitutional orderischaracterized by the existence of such property rights regime and microeconomicincentives system, as well as co-ordinationmechanisms, whichpermit the owners of productionfactors (orothereconomicassets) to appriopriatebenefitsresulting from the use of thosefactors (thusminimizing the scope of occurrence of externaleffects, free-rider and rent-seekingbehaviorpattern) • Institutionalequlibrium

20. New Institutional Economics – basic categories and assertions 3. Institutional equlibrium means the consistency (resulting in mutual reinforcement ) between: • Informal institutions (D. North: rules of games): customs, beliefs, religion and social myths, values, socially sccepted modes of behaviour, mental models) • Formal institutions (constitution, laws, property rights, public regualtion regimes) • Institutional arrangments (courts and tribunals, administrative and regulatory bodies etc.) • Institutional equlibrium is fundamental for the level of transaction costs

22. New Institutional Economics – basic categories and assertions • NEH and i NPE – cont. • Economictheory of state – theconcept of J. Buchannan • Pre-state period (pre-constitutive) order Itsmainfeatureis a veryhigh level of uncertainty of economicactivity (transactions, contracts, etc.). Principal task of theemerging state istherefore to establishthe so calledpre-constitutive property rightsand formalinstitutionscorresponding/related to them. The state hasalso to ensurethatadequate „rules of game” (informalinstitutiuons)areobservedin order to diminishthelevel of general uncertaintyintheeconomy and to exclude(orradicallyconfine) thepossibility of attainingeconomicbenefitsthroughthe „robbery”Thisway, theprotective state(in Buchannan’sapproach) iscrreated

23. New Institutional Economics – basic categories and assertions • Economictheory of state – theconcept of J. Buchannan • Post-constitutivepropertyrightsemerge as theoutcome of market exchange of goods and productionfactors. Ifthoseexchangecontractsare to be effective and complete, itisnecessary to: 1) liberalize (to freefrom state control) prices and trade, 2) graduallyintroduce (allow for) bothdomestic and foreign competition 3) establish capital (financial) markets All thisispossiblewhenthestatetcreatesfoundations of „soundmacroeconomicregime”, as well as whenthe state followstheregulationpolicywhichiscnsistentwith general principles of market economy. Thisway, the so calledregulativestateemerges

24. New Institutional Economics – basic categories and assertions • Economictheory of state – theconcept of J. Buchannan • As inany market economy, alsoinemerging market economiesthe state hasalso to produceor to provide public goodsor,at least, to finance thecosts of theirproduction and distribution (delivering). This means, respectively, theemergence of productive state. • Buchanan’sconceptinthecontext of interpretingthe state as outcome of socialcontract (Rousseau, Rawls and others)

25. New Institutional Economics – basic categories and assertions • State fromthe NIE perspective (withspecialreference to New PoliticalEconomy) – a general approach • NIE, and TCT and PRT inparticular, providetheoreticalargumentswhichallow for answering a fundamentalquestion: whythereexistthestate and the market as alternativemechanismsof economicco-ordination and opimization (Coasecriterion)

26. New Institutional Economics – basic categories and assertions • NIE, and NPE inparticular, identifyeconomic and socialmechanismswhichunderlaytheprocess of working out and andacceptingspecificsolutionswithinthemacroeconomic and sectoralpolicies, as well as withinthe public regulation. Furthermore, NIE helps to explainthecontradictionsbetweenthosepolicies • NIE paysattention to thenecessity of ongoingactive role of the state inthesphere of shapinglegal-constitutionalfoundations of economic order (NIE and ordoliberalism)

27. New Institutional Economics – basic categories and assertions • NEH and NPE – cont. • Economictheory of public regulationinthe market economy – general issues • Point of reference: interpretation of public regulation as specificcommodity and theneed to definethesupply of and demand on thiscommodity (political market of regulation) • Differentlyfromthe so callednormativeregulationtheory, theeconomictheory of public regulationassumesthattheregulationis (mostly) designed for attaininggoals of specificinterestgroups(enterprises and theirgroupings, business self-government, trade unions, civicinitiatives, NGOs) • Economicvs. socialpublic regulation • Public regulation of realeconomyand of financial sector

28. New Institutional Economics – basic categories and assertions • Basic assertions of ET of PR • Main resource of the state is the power to coerce (through orders, bans, prohibitions, permits, allowances, limits, public procurments etc.) • legal-administrative and economic regulatory measures: direct vs. indirect enforcement • Differences in enforcement regimes and tools as resulting from specific features of areas (sectoral – e.g. power plant sector,transport or media – and horizontal ones – e.g. environmental protection and natural resource use, education or R&D.science activities) being subject to public regulation

29. New Institutional Economics – basic categories and assertions • Basic assertions of ET of PR • Diversification of utility function of particular groups of interests • politicians (policy makers): achieving or preserving the (political) power • regulators: strengthening of regulatory institutions and their increasing independence from politicians • Economic and other entities being subject to regulation: maximization of profits, consumer surplus, social transfers, ecological benefits etc. • Regulation is usually more advantageous for producers than for consumers

30. New Institutional Economics – basic categories and assertions • Basic assertions of ET of PR • The game of group interests leads usually to optimal distribution of benefits from the regulation between entrepreneurs (deliverers of goods and commodities), politicians (as legislators) and regulatory institutions (regulators) • Regulatory game frequently (n the long run) leads to personal flows between the politics (legislative, executive/administrative and regulatory institutions) and business communities • Examples of ET of PR : capture theory of regulation, theory of regulation based on the concept of agent and principal • Ecclectic theory of PR

31. New Institutional Economics – basic categories and assertions • General definition of NIE: Based on criteria of economic rationality, as well on the assumptions of methodological individualism: • analysis of formal and informal institutions of economic and political life. • Analysis – in terms of economic rationality – of different socio-political orders and interdependencies between those orders and the performance of the economic system

32. New Institutional Economics – basic categories and assertions • Basic components of broadlyunderstood NIE • Neoinstitutionaltheory of the firm: Coase, Williamson (a „specialcase”: allocativetheory of enterprise, theory of enterprisebased on agent-principal theory) • Economictheory of politics (New PoliticalEconomyorTheory of Public Choice): Buchannan, Tullock (state, democracy, bureacracy, elections, interestgroups, public regulation) • Analysis/theory of long-run (secular) dynamics (changeability) of socio-economic systems (New EconomicHistory): North, Thomas, Vogel • New EconomicGegraphy (application of NIE to theanalysis of spatialaspects of economic performance and thechange of economicstructuresover time): M. Porter, P. Krugman