The institutional approach to the economy had its genesis in the work of Thorstein Veblen, whose The Theory of the Leisure Class (1899) introduced the term conspicuous consumption into popular lexicon. A defining characteristic of Veblen’s approach was the dichotomy between the dynamic forces of technology and the static forces of institutions. This conflict was played out in a modern business economy where the technological potential to produce goods was impeded by the demand of business enterprise that goods be sold profitably.
The terms institutionalism and institutional economics were coined in 1919 by Walton Hamilton. In an article in the American Economic Review, he presented the case that institutional economics was economic theory. This was true, Hamilton argued, because only institutional economics provided a unified approach to economic problems. Further, it rejected a laissez-faire view of the world and emphasized the role of institutions and the process of economic change. Finally, institutional economics understood the importance of habit and rejected the “pleasure and pain” of the utilitarian view of human behavior. For the next decade and a half, institutionalism gained important adherents in academia, many of whom subsequently rose to prominent policymaking positions in government.
As Yuval Yonay documented in The Struggle over the Soul of Economics (1998), institutional economics was on the rise in the interwar period and appeared poised to be a significant force in American economics. There were the labor studies of John R. Commons and his students at the University of Wisconsin. Veblen’s student, Wesley Clair Mitchell, was the first director of the National Bureau of Economic Research. His pioneering work on business cycles was based on Veblen’s The Theory of Business Enterprise (1904). Mitchell’s student, Simon Kuznets, was instrumental in developing national income accounting. Yet another institutionalist, Morris Copeland, a student of J. M. Clark’s, developed the flow of funds accounting, which in the 2000s is regularly reported by the Federal Reserve System and links the financial balance sheet with national income accounting.
Idle machines and hungry people in the 1930s were a glaring illustration of the conflict between making money and making goods. Many important institutionalists such as Rexford Guy Tugwell, an original member of Roosevelt’s Brain Trust, were involved in the economic policy changes of the New Deal era. Adolf Berle and Gardiner Means, whose The Modern Corporation and Private Property (1932) had provided an understanding of the implications of the separation of ownership and control in the modern firm, were also institutionalists in the administration.
The most significant concentration of institutional economists in the United States in the post–World War II period, other than Commons’ Wisconsin school of institutionalism, was at the University of Texas (UT) at Austin. The leading figure in the Texas School was Clarence Edwin Ayres, a philosopher turned economist who was greatly influenced by Veblen and John Dewey. The department included other figures who shared a common methodological tool (the Veblenian dichotomy) and were in agreement on economic policy; each was a strong personality, and collectively they sought to disseminate their view of the world. Though the institutionalist tradition remained at UT until the 1980s, the peak period of influence was undoubtedly in the 1950s. Another war, this time the U.S. intervention in Vietnam, divided the department and hastened the demise of institutionalism at UT.
Some have viewed institutionalism as a story outside the mainstream of economics. However, as Yonay showed, the story of the rise and fall of institutionalism is intricately tied with changes in society and the evolution of the mainstream of economics. Just as the changes of World War I and the Russian Revolution provided a context for the rise of institutionalism, it was the aftermath of the Great Depression and World War II that resulted in its decline. Within the economics profession, institutionalism was swept away by mathematics, econometrics, and Keynesian economics. By 1956 a roundtable at the annual meetings of the American Economic Association pronounced the end of institutionalism. For the next three decades, institutionalism existed in the underworld of economics. Institutionalists were pushed toward, or willingly embraced, the view that they were outside the mainstream. This tended to marginalize the institutional economists that followed Veblen.
In 1985 Martin Bronfenbrenner published an article in the American Economic Review (AER ) in which he stated that institutionalism had been pushed into “minority status although not into complete obscurity” (Bronfenbrenner 1985, p. 20). Attempts to respond to Bronfenbrenner were rebuffed by the editors of the AER. It was not until 1998 that there was again an AEA session on institutionalism, but this time it was the “new” institutionalism of Ronald Coase, Douglas North, and Oliver Williamson. This also rekindled an interest in the “original” institutional economics. The editors of the Journal of Economic Literature invited a paper on the institutional economics of Veblen and Commons.
The relationship between old and new institutionalism is an uneasy one. On the one hand, many of the new institutionalists view the Veblen-Commons-Ayres tradition to be one that is anti-theory—meaning anti-neoclassical theory. On the other hand, the old institutionalists view the new institutionalism as still wedded to outmoded views of technological change, human behavior, and the market mechanism. Despite differences that some see as significant, there is little doubt that the new institutionalism represents a recognition of the limitations of textbook economics and the validity of the concerns raised by Veblen and his followers.
If one considers Hamilton’s 1919 definition of institutional economics, it seems evident that the mainstream of economics has come a long way toward becoming institutional economics. This evolution has occurred mostly without the direct input of original institutional economists. The mainstream has sought a unified explanation through the microeconomic foundations of macroeconomics. Today neoclassical economics has recognized through the analysis of noncompetitive market structures that perfect competition does not prevail. Even the theory of contestable markets is a move beyond the stale concept of perfect competition. Virtually all economists now accept that institutions matter. Neoclassical economics has developed sophisticated economic dynamics and evolutionary game theory. The work of Herbert Simon on satisficing and bounded rationality is a recognition that the atomistic, hedonistic man of neoclassical economics is not valid, and instead humans, though they may seek their own self-interest, are constrained from doing so precisely because they have limited capacity for rational behavior.
Though there is a basic similarity between the old and the new institutionalism, the essential difference hinges on whether one believes that there is an invisible hand that guides the creation of efficient institutions or whether it is all a matter of habit, technological change, and path dependency. The new institutionalists tend to emphasize the progressive aspects of institutions, while the old institutionalists see institutions as holding back technology. A balance between these views would seem to be the most realistic view of how society evolves over time.
As Ron Stanfield explained, the bottom line is that economics has advanced. It is becoming more realistic in the face of technological and institutional change in society (Stanfield 1999, pp. 252–253). It would seem that there is now a real possibility that Hamilton’s claim will be realized in the twenty-first century: institutional economics is economic theory.
SEE ALSO Economics; Economics, Institutional; Stratification
Bronfenbrenner, Martin. 1985. Early American Leaders—Institutional and Critical Traditions. American Economic Review 7 5 (6): 13–28.
Hamilton, Walton. 1919. The Institutional Approach to Economic Theory. American Economic Review, Supplement 9 (1): 309–318.
Hodgson, Geoffrey. 1998. The Approach of Institutional Economics. Journal of Economic Literature 36 (1): 166–192.
North, Douglas C. 1990. Institutions, Institutional Change and Economic Performance. Cambridge, U.K.: Cambridge University Press.
Phillips, R. J., ed. 1995. Economic Mavericks: The Texas Institutionalists. Greenwich, CT.: JAI Press.
Stanfield, James Ronald. 1999. The Scope, Method, and Significance of Original Institutional Economics. Journal of Economic Issues 33 (2): 230–55.
Yonay, Yuval. 1998. The Struggle over the Soul of Economics: Institutionalist and Neoclassical Economists in America Between the Wars. Princeton, NJ: Princeton University Press.
Ronnie J. Phillips