The Contributions of Interwar Institutionalism

Mark Blaug has stated that institutionalism “was never more than a tenuous inclination to dissent from orthodox economics” (Blaug 1978: 712), and this view still finds wide currency.

Institutionalists took the task of improving economic measurement seriously. The NBER not only produced many empirical studies relating to business cycles, labor, and price movements, but also played a vital role in the development of national income accounting, through the work of Mitchell’s student, Simon Kuznets. In conjunction with the Federal Reserve, the NBER also did much to develop monetary and financial data and Morris Copeland developed flow of funds accounts. During the New Deal institu­tionalists were heavily involved in the effort to improve the statistical work of govern­ment agencies (Rutherford 2002).

As noted above, one of the claims of institutionalists was that a scientific economics would have to be consistent with “modern psychology”. A typical argument was that economics “is a science of human behavior” and any conception of human behavior that the economist may adopt “is a matter of psychology” (Clark 1918: 4). Mitchell made important early contributions in his discussions of the limitations of rational choice theory (Mitchell 1910a; 1910b), but Clark made perhaps the most interesting effort to develop the psychological basis of institutional economics (Clark 1918).

Interesting work on the economics of consumption and the household was pursued by Hazel Kyrk and Theresa McMahon. McMahon made use of Veblen’s conception of emulation in consumption, while Kyrk was critical of marginal utility theory as a basis for a theory of consumption and emphasized the social nature of the formation of consumption values. Consumption patterns relate to habitual “standards of living”, and Kyrk undertook to measure and critically analyze existing standards of living, and to create policy to help achieve higher standards of living. In her later work she discussed the household in both its producing and consuming roles, the division of labor between the sexes, employment and earnings of women, adequacy of family incomes, and issues of risks of disability, unemployment, provision for the future and social security, and the protection and education of the consumer (Kyrk 1923, 1933; McMahon 1925).

There was much work dealing with the inadequacy of the standard models of perfect competition and pure monopoly. The soft coal industry received particular attention. In that industry, investigators such as Hamilton found little that corresponded to the ideal of a competitive industry. Competition within the industry had resulted not in efficient low-cost production but in persistent excess capacity, inefficiency, irregular operation, poor working conditions and low earnings (Hamilton and Wright 1925). This repre­sented a common institutionalist theme - that, particularly under conditions of high overheads and rapid technological advance, competition could lead to “disorder” and inefficiency rather than to order and efficiency.

A related theme was that technological change had altered the structure of costs faced by firms and had altered their behavior. This argument derived from Clark’s Studies in the Economics of Overhead Costs (1923). For Clark, the growth of overhead costs as a result of capital-intensive methods of production had resulted in price discrimination, an extension of monopoly and an increase in price inflexibility over the cycle. A little later Gardiner Means (1935) developed his theory of administered pricing, which sparked a vast literature on relative price inflexibility.

On issues of corporate finance and ownership, Bonbright and Means co-authored The Holding Company, and Berle and Means The Modern Corporation and Private Property, both in 1932. These works much extended Veblen’s earlier discussions of corporate con­solidation and the separation of ownership and control. Berle and Means’s work raised important issues of agency, and whether managers would maximize profits.

On labor market issues, institutionalists concerned themselves with studying unions and the history of the labor movement, developing in the process both classifications of unions and explanations for the particular pattern of trade union development in America (Perlman 1928). Wage determination was also a problem that attracted the attention of institutionalists. Walton Hamilton’s (with Stacy May) 1923 book The Control of Wages was praised by Clark for providing not an “abstract formulation of the characteristic outcome” but a “directory of the forces to be studied” in any par­ticular case (Clark 1927: 276-7). Discussions of trade unions and wage bargaining were provided by many other institutional labor economists such as Commons (1924) and Sumner Slichter (1931).

Public utilities, including issues relating to the valuation of utility property and the proper basis for rate regulation, were major areas of institutionalist research. Both Clark and Commons devoted considerable attention to the concept of intangible property, goodwill, and valuation issues (Commons 1924; Clark 1926). Bonbright dealt with the difference between commercial and social valuation in connection with public utilities. Bonbright, Hale, and Martin Glaeser all wrote extensively on issues of public utility reg­ulation, with Hale probably having the greatest impact with his campaign of criticism of the “fair value” concept as a basis for rate regulation (Hale 1921; Bonbright 1961: 164).

In his Social Control of Business (1926) Clark argued that business cannot be regarded as a purely private affair. This idea of private business being broadly “affected with a public interest” was absolutely central to the institutionalist argument for regulation of business. Clark expresses the idea in his claim that “every business is ‘affected with a public interest’ of one sort or another” (Clark 1926: 185), and the argument also appears as a central theme in Tugwell’s early work on regulation (Tugwell 1921, 1922), and in Walton Hamilton’s and Robert Hale’s extensive writings on law and economics (Rutherford 2005b; Fried 1998).

More general interconnections between law and economics and the operation of markets were addressed by Hale, Commons, and Hamilton. Commons’s approach was the most developed and was built on his notions of the pervasiveness of distributional conflicts, of legislatures and courts as attempting to resolve conflicts (at least between those interest groups with representation), and of the evolution of the law as the outcome of these ongoing processes of conflict resolution. He developed his concept of the “trans­action” as the basic unit of analysis (later adopted by Oliver Williamson).

The institutionalist program dealing with business cycles, in the period before the depression, was centered on Wesley Mitchell’s work and that he promoted through the NBER. As noted above, Mitchell explicitly placed his work on business cycles within an institutional context by associating cycles with the functioning of the system of pecuniary institutions. Mitchell’s 1913 volume Business Cycles, with its discussion of the four-phase cycle driven by an interaction of factors such as the behavior of profit-seeking firms, the behavior of banks, and the leads and lags in the adjustment of prices and wages, became the standard institutionalist reference. At the NBER, Mitchell focused heavily on pro­moting work that would add to the understanding of business cycles, generating a stream of research studies far too long to list here, but contributing to the development of national income measures, business cycle indicators, and much more. In addition, Clark developed his concept of the accelerator out of his study of Mitchell’s 1913 work, and the accelerator mechanism soon became a standard part of cycle theory (Clark 1917). Mitchell’s work was not the only approach to business cycles to be found within institu­tionalism. Many institutionalists, including Hamilton, had an interest in the work of J.A. Hobson, and Hobson’s underconsumptionism became popular among institutionalists in the 1930s (Rutherford and DesRoches 2008).

On issues of market failure, broadly conceived, Clark (1926) discussed a large number of types of market failure in his Social Control of Business.

Finally, and intimately related to the above, institutionalists made important con­tributions to policy in their roles in the development of unemployment insurance, workmen’s compensation, social security, labor legislation, public utility regulation, agricultural price support programs, and in the promotion of government planning to create high and stable levels of output. Commons had pioneered public utility regula­tion, unemployment insurance, and workmen’s compensation in Wisconsin, and the Wisconsin model was widely influential. Many institutionalists were active members of the American Association of Labor Legislation (AALL), and the AALL promoted many reforms to labor legislation. Medical insurance programs were also pursued by the AALL, and also by the Committee on the Costs of Medical Care, which involved both Hamilton and Mitchell.

Institutionalists had significant influence within the New Deal. Many of Commons’s students played leading roles in the development of the federal social security program. Berle and Tugwell were two of Roosevelt’s original Brains Trust, and Tugwell, Means, and Mordecai Ezekiel were the leading advocates of the structuralist or planning approach that had influence in the early part of the New Deal (Barber 1996). Hamilton, Lubin, and several others were deeply involved in the labor legislation and consumer protection aspects of the New Deal. Hamilton later worked with Thurman Arnold in developing their case by case approach to anti-trust (Rutherford 2005b).