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Institutionalism: Neoclassicism’s Big-Government Twin

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It was not inevitable that economics would end up in anything like its current form.

In fact, even well after much of the basics of economics were developed, Institutionalism remained as a viable alternative. In the 1920’s and 1930’s, two of the four major economics graduate programs in the US (Columbia and Wisconsin) were primarily Institutionalist. The Institutionalists thought of themselves as the wave of the future, creating a more scientific economics that would displace the old.

Nowadays, of course, if modern economists think of Old Institutionalists at all, they often say something like Ronald Coase did: “American institutionalists…. had nothing to pass on except a mass of descriptive material waiting for a theory or a fire”.

So what happened? What is Institutionalism? As you might expect, it focuses on institutions. These are notoriously tricky to define, but their definition is something like “rules both explicit (like laws) and implicit (like social norms)”. Their method was to try to be empirical (focus on the real world) and try to avoid unrealistic simplifying assumptions in theories.

The best-known example of Institutional empiricism is Wesley Mitchell’s founding the National Bureau for Economic Research (now a stronghold of orthodox neoclassical economics) to collect data about business cycles. In terms of goals, Institutionalists wanted to be scientific (which nowadays we might interpret as being impartial, doing positive rather than normative work), but also to achieve social control. According to Malcolm Rutherford, “the phrase ‘social control’ became almost a mantra for the Institutionalists of the time”. Institutionalist Helen Everett said that social control was “perhaps their central organizing principle”. By “social control”, the Instituionalists meant that they wanted society generally to control business, though I can’t help but hear the phrase as meaning that Institutionalists wanted themselves to control society and business. Certainly,  as the “social control” mantra suggests, they were almost always pushing for more government rather than less.

The best-known Institutionalist is Thorstein Veblen, the author of “Theory of the Leisure Class”, after whom Veblen goods are named. Reading his work I have thought he is funny and a master of criticism and satire, but it starts to grate that all his criticism is unconstructive. Apparently other Institutionalists agreed: Rexford Tugwell said Veblen “had discredited orthodox economics and had undermined the business culture” but that “all the constructive work remained to be done”, and Wesley Mitchell started trying in 1910 to push Veblen toward more scientific and constructive work.

Some criticism proved constructive, in that it spurred others to create new and useful tools. Institutionalist economists criticized neoclassicals for not being consistent with the findings of other fields, especially psychology. This should remind you of behavioral economics today, and it sounds quite reasonable to try to be consistent, but it also reveals a possible flaw in behavioral economics: sometimes, economics is actually right and psychology is actually wrong. At least, the early-1900’s psychology the Institutionalists wanted to incorporate was behaviorism (confusingly named since its ideas are unrelated to behavioral economics). Behavioralists wanted to refer only to observable things, not unobservable states of mind. This criticism helped spur the creation of indifference curves (so we don’t refer to cardinal utility, which was thought to be unobservable), and the general economist insistence on only using revealed preference. That’s right, two of the very things heterodox critics of economics like to complain about today were actually developed to answer a previous generation of heterodox critics.

The movement slowly faded away after World War II, after neoclassicals proved themselves more useful in the war planning, answered some critiques of institutionalists (through the Ordinal Revolution and the Keynesian Revolution), and Samuelson and Arrow pushed ahead with their mathematics.   The Institutionalists provide an important reminder that, for better or worse, economics does not have to be the way it is and may not remain this way forever. Institutionalism was the most recent movement to pose a credible threat to orthodox economics from the outside and fail to be co-opted (the way game theory is now at the core of neoclassical economics, and behavioral economics has been appended as an asterisk), but it may not be the last.

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Written by James Bailey

April 12, 2013 at 12:29 pm