The Sources of Institutional Economics

The elements that went to make up the core of the institutional approach as defined above were all present in American economics before 1918. Institutionalism as it formed in the interwar period was an approach to economics that derived from several sources.

research agenda or methodology of what became institutionalism in the interwar period. Veblen’s influence, whether direct or indirect, was one of the major elements provid­ing a commonality and a bond between the members of the institutionalist movement mentioned above. Veblen was important in a number of crucial respects. He provided a strong criticism of hedonism, including marginal utility theory, satirizing its concep­tion of man as a “lightning calculator of pleasures and pains” (Veblen 1898 [1961]: 389), and arguing that economics should look to more modern social-psychological theories of behavior based on instinct and habit. This was a theme actively pursued by Mitchell, Clark, and numerous others.

Veblen’s overall evolutionary framework was one which stressed the cumulative and path-dependent nature of institutional change, the role of new technology in bringing about institutional change (by changing the underlying, habitual ways of living and thinking), and the predominantly “pecuniary” character of the existing set of American institutions (that is, expressing the “business” values of pecuniary success and individual gain by money making, to the virtual exclusion of all other values). For Veblen, as for other institutionalists, institutions were more than merely constraints on individual action, but embodied generally accepted ways of thinking and behaving, and worked to mold the preferences and values of individuals brought up under their sway.

Veblen did not think of existing institutions as necessarily functioning to promote the social benefit - in fact, rather the opposite. Existing institutions, due both to the inertia inherent in any established scheme and to the defensive activities of vested interests, tended to become out of step with new technological means and with the economic issues and social problems they generated. Thus, for Veblen, the existing legal and social insti­tutions of his America were outmoded and inadequate to the task of the social control of modern large-scale industry. Again, this became a central argument in virtually all later institutional economics.

Veblen was pointing to what he perceived as a systemic failure of “business” institu­tions to channel private economic activity in ways consistent with the public interest. For Veblen, the “invisible hand” notion of the market may have been applicable to conditions of small-scale manufacturing, but not to conditions of large scale production, corporate finance, and salesmanship. Veblen was particularly harsh in his attack on the manipulative, restrictive, and unproductive tactics used by business to generate income (including consolidations, control via holding companies and interlocking directorates, financial manipulation, insider dealing, sharp practices of various kinds, and unscru­pulous salesmanship), and on the “waste” generated by monopoly restriction, busi­ness cycles, unemployment, and competitive advertising. Veblen held out little hope of change short of a complete rejection of “business” principles (Veblen 1904 [1975]; 1921).

Many of these aspects of Veblen’s thinking had significant influence on other institu­tionalists, and can easily be found displayed in the work of Hamilton, Mitchell, Clark, and others. Even Commons, who took less from Veblen than most other institutionalists, gave central importance to his analysis of intangible property, and spent considerable space discussing his ideas (Commons 1934: 649-77).

Not all aspects of Veblen’s work, however, were adopted by interwar institutionalists, and it is not difficult to find criticisms of Veblen’s methodology and of some of his spe­cific theories. As mentioned above, institutional economics was frequently and explicitly linked to quantitative and other forms of empirical research. Veblen’s own research agenda was one of providing sweeping dissections of existing institutional arrangements, but often without the careful investigation or close consideration of factual evidence that might seem to have been implied by his own many references to the “matter of fact” approach of “modern science” (Veblen 1906). Many later institutionalists, including Hamilton, Mitchell, Clark, and Tugwell, all commented adversely on Veblen’s lack of attention to what they considered proper scientific methodology (Rutherford 1999). For Hamilton, Veblen was an “emancipator,” someone who inspired but who could not have done the detailed empirical work of Hoxie, Stewart, or Mitchell (Hamilton 1958: 21-2). For Clark, Veblen provided “orientation”, a “conception of the problem”, but neglected “scientific procedure” (Clark 1927: 248-9). For Mitchell, Veblen’s conceptions of human nature were “a vast improvement” and he had “uncanny insights” (Mitchell 1928 [1936]: 412), but “like other intrepid explorers of new lands, Veblen made hasty traverses” and his “sketch maps” were “not accurate in detail” (Mitchell 1929: 68). Mitchell was highly suspicious of “speculative” approaches and he included applications of Darwinian theory to social evolution in that category.

In addition, Veblen’s overall evolutionary scheme was found to have more specific problems. Veblen’s theory of institutional evolution emphasized the role of new tech­nology bringing about institutional change via a causal process of habituation to new “disciplines” of life. Here rational appraisal of consequences plays no significant role, the process being one whereby new ways of thinking are somehow induced by new patterns of life. In the early years of the century, both Mitchell and Robert Hoxie attempted to apply Veblen’s theory, but each ran into difficulty. Mitchell’s work on the development of the “money economy” found many more factors at work in institutional evolution than Veblen suggested, and Hoxie came to reject Veblen’s hypothesis, expressed in The Theory of Business Enterprise (Veblen 1904 [1975]: 306-60), that the discipline of machine industry would tend to turn the habits of thought of unionized workers in a socialistic direction (Rutherford 1998).

Institutionalists in the interwar period obviously did share Veblen’s conception of the institutional scheme as evolving over time, of institutions establishing the context within which economic activity takes place and is to be explained, and of the “pecuni­ary” nature of existing economic institutions, but they did not pursue the development of Veblen’s specific theory of institutional evolution. Indeed, for most institutionalists the issues of the current performance of economic institutions and matters of immediate social concern took center stage, while issues of longer term institutional change were largely left aside. The major exception to this is the later work of J.R.

Outside of Veblen, institutionalists were influenced by the earlier generation of American progressive economists and social theorists such as Richard T. Ely, and H.C. Adams. Writers such as these were also concerned with institutions and institutional change, but they did not share Veblen’s radicalism and imparted a much more reform­ist position to their students. Although Veblen is often included as a part of American progressivism, along with people such as Ely, H.C. Adams, and pragmatist philosophers such as John Dewey, Veblen’s evolutionary theory gives little room for deliberative social guidance and legislative reform (Ross 1991: 213), and his work did not focus on issues such as labor law or business regulation that held a central place in the progressive literature more generally.

In the hands of institutionalists such as Hamilton, Clark, Mitchell, and Commons the problem became one of supplementing (rather than replacing) the market with other forms of “social control,” or one of “how to make production for profit turn out a larger supply of useful goods under conditions more conducive to welfare” (Mitchell 1923 [1950]: 148). While Veblen’s influence made institutionalists somewhat more critical of existing institutions than many of the previous generation of progressives, it does have to be understood that it was not Veblen alone who was the fountainhead for interwar institutionalism, but Veblen moderated by pragmatic and progressive views of science and social reform.

On the other side, this is not to say that institutionalism was simply a continuation of the work of the generation of German trained economists who had brought his­toricist ideas and a progressive reform agenda to American economics in the 1880s. Institutionalists certainly claimed H.C. Adams and R.T. Ely as predecessors, and it is also noteworthy that the combination of quantitative and statistical research with pro­gressive reformism which formed such a significant part of institutionalism had its roots in the work of German economists such as Ernest Engel and others (Grimmer-Solem 2003: 127-68). However, institutionalists saw themselves not merely as continuing that tradition, but as significantly updating, modernizing, and revitalizing it in a number of ways.

Institutionalists, following Veblen’s opinion of Schmoller (Veblen 1901), tended to be critical of German historicism for its tendency to descriptivism, and it is very notice­able that institutionalists did not usually refer to German historicists as predecessors. Veblen thought of himself as providing a more theoretical approach to institutions, and the Veblenian influence on institutionalism is an important element that separates insti­tutionalists from the previous generation of American progressive economists. Another important difference is to be found in the Social Christianity of Ely, Adams, J.B. Clark, and the younger Commons. The institutionalist literature is thoroughly secular with no important reference to the church or to Christian morality as important agents of reform (Bateman 1998). The references instead are to science, pragmatic philosophy, and to the actions of the state. Another difference is that many of the German trained economists had subsequently made an accommodation with marginalism (Yonay 1998: 39-46). This can be seen especially in the later editions of Ely’s introductory text book (Ely et al. 1908), in J.B. Clark’s work on marginal productivity theory, and also in the work done by E.R.A. Seligman and many others. Institutionalists largely rejected this accommodation. Finally, some of the progressives of the previous generation had become increasingly conservative; Ely certainly had become so. The Veblenian critique of business institutions and marginalist economics, placed together with the ideas of empirical science and Dewey’s pragmatic reformism, worked to refocus and re-energize the progressive impulse.

One final source of inspiration that needs to be mentioned is the part played by many of those involved in the formation of institutionalism in the economic planning devel­oped as a part of World War I. The war brought economists into government agencies in an unprecedented fashion. Mitchell headed the Prices Section of the War Industries Board (WIB) and worked on a large study of prices during the war, work that also involved Isador Lubin, Leo Wolman and Walter Stewart. The WIB was chaired by Robert Brookings and Brookings’ endowment of research agencies in public admin­istration and economics was inspired by his wartime experience. Mitchell’s concern with statistical and factual knowledge, and the need for improved research in the social sciences was also given special urgency by his experience of wartime administra­tion. In 1918 Mitchell became President of the American Statistical Association. His Presidential Address, “Statistics and government” (Mitchell 1919) specifically related his war experience to the need for more work on “social statistics,” and gave impetus to the founding of the NBER. Hamilton and Moulton worked with the War Labor Policies Board as economic experts dealing mainly with reconstruction issues and were keen to see some of the wartime planning apparatus retained to manage the period of reconstruction. That economists both could and should share in fixing the “foundations of a new economic organization” was the theme of Irving Fisher’s 1918 Presidential Address to the AEA (Fisher 1919: 21). Economics had established itself as an important tool for government policy formation, and the possibilities for the discipline seemed immense. This provided a critical background to the ideals of scientific investigation and social control that are so apparent in Hamilton’s manifesto and the conference session of which it was a part.