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Macrofoundations

Macrofoundations

FROM MICROFOUNDATIONS TO THE MACROFOUNDATIONS OF ECONOMIC ACTIVITY

THEORETICAL, EMPIRICAL, AND POLICY SIGNIFICANCE OF MACROFOUNDATIONS

BIBLIOGRAPHY

The macrofoundations of economic activity consist of institutions (rules, norms, laws, and conventions) that define the social context within which economic processes take place. These economic processes include individual decision-making, production, exchange, and the determination of aggregate output and employment. Note that macrofoundations as defined here are understood strictly as social structures that shape the processes responsible for generating both microeconomic and macroeconomic outcomes. This is not to overlook the fact that the latter, themselves, frequently provide a type of macrofoundation for the former. For example, the existence of involuntary unemployment creates a social context that can be expected to impact significantly on the behavior of individual workers.

Macrofoundations can differ between regions and over time. They play an important role in supplementing the price mechanism as a means of coordinating economic activity.

FROM MICROFOUNDATIONS TO THE MACROFOUNDATIONS OF ECONOMIC ACTIVITY

Economists have long been interested in the microeconomic underpinnings of economic decisions and outcomes. This microfoundations project deems individual decision making to be the root source of all economic phenomena, and hence the basic building block of all economic theory. But an important oversight of this project is that, as much as individuals create the societies in which they live, so, too, does society shape and mold individualstheir preferences, habits, beliefs, aspirations, and so forth. For example, exposure to the customs and laws of North America causes individuals to habitually keep to the right when driving on the road, and to regard such behavior as normal. But exposure to the customs and laws of the United Kingdom would result in the same individuals habitually keeping to the left, and coming to regard this different behavior as normal. The macrofoundations project calls attention to the importance of the social context in which economic activity takes place, and the role of this social context as a determinant of economic decisions and outcomes.

In particular, the macrofoundations of an economy are understood to supplement the workings of the price mechanism as a means of coordinating economic activity. Keynesian macroeconomists have long doubted the capacity of the price mechanism to coordinate economic activity so as to automatically create full employment. The macrofoundations project goes further, pointing out that the price mechanism does not even suffice to ensure the orderly reproduction of the economy from one period to the next, at any level of economic activity. Hence the price mechanism alone cannot coordinate expectations if there is fundamental uncertainty about the future (including the future states of markets and the prices determined therein). Nor can it coordinate actions pursuant to conflicts of interest that occur outside the sphere of market exchangefor example, at the point of production. But the economys macrofoundations can assist in the coordination of both expectations formation and conflict resolution. By specifying behavioral procedures of the form in event of x, do y, they provide a source of information about likely future actions and outcomes, and hence a basis for forming expectations in what would otherwise be a world of behavioral flux. For example, it is easier for workers to predict their future income if their employer is committed to a convention of retaining employees on current terms regardless of trade fluctuations, than it would be if wages and employment were made contingent on the future state of the labor market.

Furthermore, macrofoundations can ameliorate conflict, by regularizing relations between parties with mutually exclusive interests. For example, the conventional authority that is vested in a production supervisor can be used to settle disputes amongst subordinate operatives that might otherwise create prolonged disruptions to a production process. (Note that this last example draws attention to the fact that institutions sometimes codify power relations. Some economists regard the lattertogether with related concepts such as the class structure of capitalism and the associated unequal ownership of wealthas also being part of the economys macrofoundations.) In this way, the macrofoundations of economic activity have been likened to a computers operating system, providing a stable macroscopic environment within which particular actions (in the case of a computer, tasks using specialized software; in the case of an economy, specific economic activities) take place.

THEORETICAL, EMPIRICAL, AND POLICY SIGNIFICANCE OF MACROFOUNDATIONS

The existence of macrofoundations poses several challenges for economic theory. First and most obviously, it raises questions about the level of aggregation at which economic inquiry should begin. Rather than starting with an isolated individual conceived sui generis, the existence of macrofoundations necessitates that consideration be given to the societal norms, conventions, laws, and so forth to which the individual is exposed if his or her decision making and behavior are to be understood. This, in turn, requires a search for the macrofoundations pertinent to different particular facets of economic activity (such as corporate behavior, the workings of the labor market, or the determination of macroeconomic outcomes). Some economists believe that what is necessary in this regard is appeal to stylized facts about the operation of actually existing economies. This means that the macrofoundations project can be associated with economic theory that is spatially and temporally contingent rather than universal.

The macrofoundations project has already had an impact on empirical inquiry, with studies suggesting that economic outcomes such as unemployment can be explained by means of exclusive reference to macroinstitutional variables. Finally, the concept of macrofoundations has important policy implications. It suggests that, rather than treating the economy as a given state of nature, policymakers can (and do) contribute to the constitution of the economy by creating institutions that add to its macrofoundations. These include laws governing the limits to and operation of markets, and conventions (such as the Taylor rule in monetary economics) that determine the objectives and pursuit of policy interventions.

SEE ALSO Economics, Keynesian; Macroeconomics; Microeconomics; Microfoundations; Policy, Monetary; Taylor Rule

BIBLIOGRAPHY

Colander, David C. 1993. The Macrofoundations of Micro. Eastern Economic Journal 19 (4): 447457.

Colander, David C., ed. 1996. Beyond Microfoundations: Post Walrasian Macroeconomics. Cambridge, U.K.: Cambridge University Press.

Cornwall, Wendy. 1999. The Institutional Determinants of Unemployment. In Growth, Employment, and Inflation: Essays in Honour of John Cornwall, ed. Mark Setterfield. 254269. London: Macmillan.

Hodgson, Geoffrey M. 1994. The Return of Institutional Economics. In The Handbook of Economic Sociology, eds. Neil J. Smelser and Richard Swedburg. 5876. Princeton, NJ: Princeton University Press.

Kotz, David M., Terrence McDonough, and Michael Reich. 1994. Social Structures of Accumulation: The Political Economy of Growth and Crisis. Cambridge, U.K.: Cambridge University Press.

Mark Setterfield

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