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«Inaugural-Dissertation zur Erlangung des Doktorgrades des Fachbereichs Wirtschaftswissenschaften der Johann-Wolfgang Goethe-Universität Frankfurt am ...»

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2.1. Institutionalism as a framework for an analysis of Capitalism21 Economics as a scientific discipline can be characterized methodologically as composed by the opposition of two differing schools of thought; the so-called orthodox approach and the heterodox approach. Orthodox theory is primarily represented by neoclassical economics, which stands for standard or mainstream economics that particularly is made up of neoclassical economics including its newer augmentations.22 The heterodox approach is distinguished by a pluralist attitude towards economics, with (Old or American) Institutionalism23 as one of its strands. The methodology of American Institutionalism will be described below, but the axioms of neoclassical economics will be assumed to be known. In general, this dissertation adheres to the assessment of neoclassical economics made by Blaug and Hodgson,24 who argue that in orthodox theory, formalism overshadows Issawi, 1950 [1377], p. 29f.

This analysis concentrates on the American version of Institutionalism. The insights of the German Historical School will be briefly covered in chapter 4. However, American Institutionalism shares with the German school a rejection of Ricardian economics and of laissez-faire policies derived from it. Veblen, for example, largely disagreed with German historical economists. He did not think the German School to be a modern science as in his view its members failed to develop a more general theory of the process of economic change, although recognizing its significance. In contrast to Veblen, John R. Commons felt closer to the German historical school. He said that the "so-called historical school... brought into the science the concepts of custom, property, and conflicts of interest.... The historical school led to the ethical and institutional schools....". Commons, 1934, p. 115, Mayhew, 1987, p. 908ff.

Gunnar Myrdal also calls it ―ordinary economics‖. Myrdal, 1978, p. 775. Within this dissertation, mainstream economics is defined as being primarily neoclassical economics together with its newer augmentations. The so-called neoclassical synthesis combines neoclassical methods and a Keynesian approach to macroeconomics. Mainstream economics is divided into micro- and macroeconomics, and typically includes rational choice theory, a representative agent and rational expectations. It employs induction as its methodology assuming axioms such as the rationality of individuals seeking to maximize their utility. The individual lives in a world of perfect and symmetric information, complete markets, perfect competition and nonexisting transaction costs. Mathematical models are used that include calculus, optimization, and comparative statics. See, for example, Samuelson and Nordhaus, 2010 or Blaug, 2002: ―[A]ny unemployment we see is still voluntary unemployment because the labor market, like all other markets, is always said to be in equilibrium. Money is ‗neutral‘ or, alternatively expressed, there is always a long-run vertical Phillips curve, and business cycles would never occur were it not for the fact that there are unpredictable shocks of one kind or another that, for a while, surprise us until we adjust to them‖, p. 43. However, relatively recent developments such as evolutionary, neo-Schumpetarian or behavioral economics make any distinction between orthodox and heterodox theory far less unambiguous.

The origin of the term ‗institutional economics‘ is commonly associated with Walton Hamilton who coined it in a paper presented at the Meetings of the American Economics Association in 1919. Lawson, 2005, p. 8, fn 1.

Hodgson, 2007 and Blaug, 2002.

substance and that technical specialization prevents the researcher from developing a broader methodological inquiry.25 Institutionalists object to the use of formalism in their models, for them mathematical techniques ―are recognized as the servants of, rather than the essence of, economic theory―.26 However, New Institutional Economics (NIE) can be considered to be an elaboration of mainstream economics. It can thus be regarded to distinct from the older American Institutionalism emphasized in this work. NIE is usually associated with the research of Ronald Coase and Oliver Williamson, the latter having given it the name New Institutional Economics. Other Nobel laureates such as Douglass North and most recently, Elinor Ostrom, are associated with this approach. It originated with two articles by Ronald Coase The Nature of the Firm of 1937 and The Problem of Social Cost of 1960, the latter being the source of what later came to be called the Coase Theorem.27 Its basic insights consist of the recognition of the importance of property rights, transaction costs, asymmetric information, moral hazard, adverse selection and principal-agent relations. This school of thought will be discussed briefly in chapter 3 and 4 in connection with the Varieties of Capitalism approach (VoC).28 Wilber, 1978, p. 62-64. Formalism in this view is defined as a ―method that consists of a formal system of logical relationships abstracted from any empirical content it might have in the real world… It is characterized by the use of mathematics (at least implicitly) and by the development of an axiomatic, deductive structure‖. It starts with the construction of a model that specifies assumptions and definitions including relations within the model. After creating the basic structure of the model its dynamics are deduced. In the case of microeconomic equilibrium models these dynamics lead to a steady state. This kind of model is thus also able to produce law-like statements and describes not real economic actors but ideal, rational actors whose behavior is not deduced from actual observations but from logic. Hence, the law-like statements derived from these models are nearly impossible to falsify empirically as the ceteris paribus conditions are changing. However, of course also mainstream economics evolved and for example introduced more sophisticated methods such as econometrics in order to empirically test the now even more mathematically complicated models, turning economics into a positivist science that emphasizes empirical verification. Mainstream economists are said to ―prepare econometric studies, ‗massage‘ the data on the basis of other information, vary the auxiliary hypotheses to paribus the ceteris, develop ad hoc explanations, and thus make up a story about what happened‖. Wilber, 1978, p. 70. Unquestionably, neoclassical models are very tidy and neat – ―Occam‘s Razor‖ cutting them down to their ―bare logical bone‖, so nothing of the institutionalists‘ ―messy details‖ is left. Dugger, 1979, p. 902.Trying to escape this type of economic methods, Veblen and others developed institutional economics as an alternative approach. Stinchcombe notes that for the old institutionalist theory ―reason and good sense are values, and formality a means to reason and good sense‖. Stinchcombe, 1997, p.


Hodgson, 1998, p. 173.

The Coase Theorem describes the economic efficiency of an economic allocation in the presence of externalities. The theorem states that so long as bargaining is costless and contracts can be costlessly enforced - if there are therefore no transaction costs - markets will generate an efficient outcome regardless of the initial allocation of property rights. Economic theory analyzes different property right regimes, comparing their efficiency in internalizing externalities and different institutional designs. See also Varian, 2010. It is of interest to note that George Akerlof‘s article Market for „Lemons‟ was rejected three times and took four years to be published while Coase‘s Theory of the Firm was ignored by the profession for more than two decades.

Blaug, 2002, p. 45.

This work will not rehearse the principles of NIE. For a detailed analysis please refer to Edeling, 1999 and Richter; Furubotn and Streissler, 2010. Paul A. David notes that new institutional economists assume "that There are in fact several tendencies in new institutionalism: rational-choice institutionalism, which is basically the NIE described above; historical institutionalism and sociological institutionalism. They all treat institutions as means for continuity rather than for change. If change is analyzed, then principally as brought about by exogenous shocks rather than by endogenous transformation; and such change is mostly conceived as a move towards one best practice.29 As will be elaborated in more detail below, institutions are regarded from this point of view as constraints on human behavior. Historical institutionalism emphasizes the development of political institutions, which are treated as pathdependent regularized practices. It recognizes cultural elements and the coordinating functions of institutions, but concentrates on their ―political legacies of concrete historical struggles‖, hence emphasizing their functioning as distributional instruments. In this view, continuity is created by increasing returns to power.30 Sociological institutionalism analyzes social agents that act within political institutions. It focuses on ―non-codified, informal conventions and collective scripts that regulate human behavior‖.31 The boundaries between sociological and historical institutionalism are not clear cut.32 Scholars like Wolfgang Streeck or Kathleen Thelen went beyond this dichotomy and developed their own theories of institutional change, drawing on both political and sociological institutions in a historical perspective. Their approach, among others, will be analyzed in more depth below.

(American) Institutionalists have certainly written about their methodology at length, but are mostly concerned with what institutional economics is not, or what it should be, rather than what it actually is. Their position is often established merely through criticism of the methodology of mainstream economics. This dissertation will give an overview of a possible common basis for institutional methodological techniques, together with their general principles as this work understands them. Thus, the underlying fundamentals of American Institutionalism without focusing on specific authors are examined. The cohethe present shape of things can best be explained by considering their function and particularly their function in some future state of the world…the so-called "new institutional economics" proposed to explain many current features of organizations and economic institutions in a thoroughly neoclassical fashion, by citing the respects in which these represented presently efficient solutions to resource allocation problems". David, 1994, p. 206. Chang points out that the proposed relationship between well-defined private property rights and their positive impact on economic development often is overly simplistic because the theory ignores certain forms of ownership structures (he names the Chinese Town and Village Enterprises (TVEs) as one example, see also chapter 7). Chang, 2010, p. 7-9.

Amable and Palombarini, 2009, p. 124.

Mahoney and Thelen, 2010, p. 8-10. The concept of path dependence will be briefly discussed in chapter 2.4.

Mahoney and Thelen, 2010, p. 6.

Schmidt, 2010, p. 2.

rence within this school of thought seems relatively undeveloped, Geoffrey Hodgson among others admitting that ―institutionalism may attract those economists of lesser general ability, as well as the first-rate and original minds who are willing to pay the high costs of professional isolation from the mainstream‖.33 In addition, institutional publications today ―are notoriously varied in overall quality and often lacking in theoretical precision‖.34 What unifies institutional economics seems not to be a theoretical core but rather a shared ideological viewpoint, and thus ―the support for heterodoxy comes from those who eschew orthodox policy conclusions rather than the core assumptions of the neoclassical theory‖.35 In this context, institutionalists are often accused of being atheoretical. David Hamilton notes that ―to many students of economics the suggestion that institutional or evolutionary economics might make some contributions to theory may seem a bit presumptuous, if not preposterous.…In the popular myths concerning the institutionalists, the latter are composed of individuals who once long ago objected to the rationalism of the classicists, especially that of David Ricardo….They were…verbal virtuosos who wished to add a descriptive element to economics. They were ‗literary economists‘‖.36 It is often forgotten that economists such as Veblen or Commons made important contributions to economic thinking, although it has to be admitted that institutionalism has not yet succeeded in building a complex model. However, Veblen was the first to develop a theory of economic and institutional change along ―Darwinian lines‖.37 Hamilton points to Veblen‘s consumer theory, as exposed in his book The Theory of the Leisure Class, as an alternative to standard consumer theory and one of the first theoretical contributions made by Institutionalistm.38 Veblen always argued for systematic theory, but never succeeded in developing such a theory himself.

Unquestionably the institutional method has the severe limitation that it often lacks precision, and also has to be continuously updated with new data from surveys or case studies.

If it is not supported by empirical data it easily turns into ―uncontrolled speculation‖.39 Unfortunately, many articles elaborate the writer‘s own preferences rather than present actual analysis backed up by solid research. Part of the problem lies in the great difficulty of verifying hypotheses, rendering the holistic principle of institutionalism difficult to reconcile with the demands of analysis (see below). It is also important to remember that soHodgson, 1994, p. 59.

Hodgson, 1994, p. 59.

Hodgson, 1994, p. 60, Wilber, 1978, p. 72.

Hamilton, 1973, p. 197.

Hodgson, 1998, p. 166f.

Hamilton, 1973, p. 201f., Veblen, 1964 [1899].

Wilber, 1978, p. 83.

called pattern models employed by institutionalists are always ―tentative and subject to change‖ (see also below).40 Since the construction of a pattern model is a lengthy business many economists end up making compromises, because of pressures of time or other obstacles. Institutionalism is consequently often too vague, diffuse and uncontrolled.

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