The old American institutionalism was part of the pluralist mainstream of the interwar period, but declined for various reasons.
After World War II, economics, particularly in the United States, became more formalized, technical and uniform, began to give importance to rational choice and testing of predictions and became focused on the analysis of markets, expanding it to other domains of social sciences.
Tjalling Koopmans (1947) dismissed Wesley Mitchell’s institutional work as nothing more than measures, and favoured the testing of theories. Milton Friedman’s (1953) plea for testing predictions and neglecting the empirical basis of assumptions also ended the marginalist controversy. The scientific aspirations of institutionalism were undermined, its authors forgotten and (inaccurately) written off as anti-theoretical and purely descriptive. Institutionalism survived at the margins of economics, with authors such as Clarence Ayres, John Kenneth Galbraith, Simon Kuznets and Gunnar Myrdal.However, the mainstream consensus was disrupted in the 1970s and new schools of thought, somehow related to institutionalist perspectives, emerged, such as radical economics, post-Keynesian economics, Austrian economics and social economics. This entry focuses on the schools labelled institutionalist after World War II; they are diverse and not always easily identifiable, but may be divided in two groups: new institutional economics and modern institutionalism.
The term new institutional economics (NIE) was coined by Williamson (1975), and its institutional existence was illustrated by the foundation of the International Society for New Institutional Economics in 1997. The theories included in this group have in common the use of economic analysis to study institutional change (following North 1990), governance structures (transaction costs economics), property rights (property rights theory), legal rules (economic analysis of law) and political processes (public choice).
Consistent with methodological individualism, they view institutions as both equilibria resulting from interactions, and constraints to some form of rational choice. They also accept Friedmanian instrumentalism. In other words, they keep the core of neoclassical theory rejected by the old institutionalism. Probably as a consequence, they count a few laureates of the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel in their ranks: James Buchanan, Douglass North, Ronald Coase, Elinor Ostrom and Oliver Williamson.The old institutionalist ideas, however, had resurfaced in the United States as early as the 1960s with the Association for Evolutionary Economics, founded in 1965 (originating from the Wardman group formed at the initiative of Allan Gruchy in 1959), and its Journal of Economic Issues in 1966. North American members of this second group include Ayres, Daniel Bromley, Joseph Dorfman, Galbraith, Herbert Liebhafsky, Gardiner Means, Marc Tool, Warren Samuels and Allan Schmid. Maybe because of the dominance of neoclassical economics in the US, old institutionalism moved towards Europe, around the European Association for Evolutionary Political Economy founded in 1988, the Review of Political Economy, and the Cambridge Journal of Economics. European institutionalists were also influenced by John Maynard Keynes, Karl Marx and Karl Polanyi, and were more interested in themes such as organizations and evolutionism: besides Kuznets or Myrdal, we can cite Janos Kornai, Giovanni Dosi, Brian Loasby, Geoffrey Hodgson and French regulationists Michel Aglietta and Robert
Boyer. Like the “old”, this “modern” institutionalism abandons methodological individualism and substantive rationality, but stresses habits, routines, dynamics, learning and knowledge in a context of radical uncertainty. The individual is not exogenously given, but constructed by institutions: they shape preferences, means and ends, as well as power structures; causality between individuals and institutions is therefore reciprocal and mediated through habits (Hodgson 2000).
Coase occupies a special position in this division of the institutionalist world. He did not really know old institutionalism (which he nevertheless criticized). His major articles, “The nature of the firm” (Coase 1937) and “The problem of social cost” (Coase 1960), partly originated and shaped the renewal of interest in institutions. He is traditionally associated with NIE and is criticized by modern institutionalists (despite being credited as one of their sources) for his neoclassicism. He nevertheless rejected Richard Posner’s imperialism or Williamson’s stress on asset specificity, and a new look at his seminal contributions shows them to be closer to institutionalism than he (and others) believe (Medema 1996).
Even if NIE generally defines institutions as the “rules of the game” (North), while modern institutionalism views them as habits (in a Veblenian tradition), they share a common interest in studying institutions other than the market: they focus not only on the allocation of resources, but also on organization and control, albeit to different degrees; and the market itself is sometimes viewed as an institution. The firm, the market, the law and the state are the main institutions that these schools of thought study, even if some of them are also interested in macroeconomic aspects (see entries for financial economics and business cycles and growth). This entry will focus a bit more on law since (institutionalist) theories of the firm are treated in another entry of this volume. Institutionalist perspectives on law can be included in the vast “Law and Economics” movement, whose history, paralleling that of institutionalism, deserves to be separately dealt with in this introduction.
Economic-legal interactions had already been studied by, among others, the Scholastics, David Hume, Adam Smith, Jeremy Bentham, Henry Sidgwick, Arthur Pigou and German historicists. However, the “legal-economic nexus” became a central part of old institutionalism (John Commons, Robert Lee Hale, Walton Hamilton) and legal realism (Karl Lewellyn) in the 1920s and 1930s.
Then, in the 1930s, at Chicago University, Henry Simons (a former student of Frank Knight) was appointed to the Economics Department and the Law School, to which he brought Aaron Director who founded the Journal of Law and Economics in 1958. In the meantime Knight was joined in the economics department by Friedman and George Stigler after the war. In the 1940s and 1950s this “Old (Chicago School of) Law and Economics” was applying economic theory to legal problems such as antitrust and labour law. The 1960s saw the rise of the “New (Chicago School of) Law and Economics”, integrating into the old school Gary Becker’s idea of applying economic tools to non-market behaviour. Other influences were the publication of “The problem of social cost”, the consequences of which were drawn in a series of articles by Harold Demsetz (1964, 1967), as well as the seminal works of Armen Alchian (1961) and Guido Calabresi (1961). Coase was appointed to Chicago in 1964 and edited the Journal of Law and Economics for almost 20 years. The movement extended to lawyers in the 1970s, with the creation of Henry Manne’s Institute for Law Professors in 1971, as well as the foundation of the Journal of Legal Studies and the publication of Richard Posner’s Economic Analysis of Law the following year. This new Chicago school of law and economics, or economic analysis of law, applies neoclassical tools to the evaluation of legal rules. Nonetheless, new law and economics is not confined to Chicago: there are also the Yale tradition (Calabresi), Public Choice, institutional law and economics, Austrians, Marxians, critical legal studies and legal philosophy (see Mercuro and Medema 1997).The history of institutional analyses of law and economics will be approached as that of specific schools of NIE (property rights theory and economic analysis of law) and modern institutionalism (institutional law and economics) since this entry is organized around these two groups. Our division is undoubtedly questionable; still, a fundamental gap remains between economists who study institutions as new objects for amended neoclassical economics (NIE broadly defined) and those who more radically alter this vision of the world to take into account how institutions shape individuals and their behaviours. Economists of the first group are concerned with the verifiability of their predictions, those of the second with the realism of their assumptions. One author, however, defies classification, and his role will be treated first.