The Institutional School PDF

THE INSTITUTIONAL SCHOOL  Classicism Mercantilism Physiocracy Socialism Neoclassicism Ma...

THE INSTITUTIONAL SCHOOL  Classicism Mercantilism Physiocracy Socialism Neoclassicism Marginalism Institutionalism German Historicism  THE INSTITUTIONALIST SCHOOL ▪ An American contribution to economic thought. ▪ Began around 1900 and continues to the present ▪ Founder, Thorstein Veblen, published his first book, many articles, and book reviews ▪ Topic Outline: focus more on traditional institutionalism, not on the new institutionalism. ▪ Several key figures: I. Thorstein Veblen (who critically analyze orthodox thinking and provided the theoretical approach of institutionalist economics) II. Wesley Clair Mitchell (who stimulated empirical research with his own statistical studies) III. John Kenneth Galbraith (who popularized several institutionalist themes) ▪ Overview of the institutionalist school, back to 5 major questions: 1. The historical background of the school 2. Major tenets of the institutionalist school 3. Whom did institutionalism benefit or seek to benefit? 4. How was the institutionalist school valid, useful, or correct in its time? 5. Which tenets of the institutionalist school became lasting contributions? THE HISTORICAL BAKGROUND OF THE SCHOOL ▪ In the period between the Civil War and World War I, the achievements of American capitalism were impressive. ▪ Rapid growth made the United States the biggest and most powerful industrial system in the world. ▪ However, hours of labour were long housing often was inadequate unemployment higher education was inaccessible for most worker’s children job security was non-existent health and safe regulations were inadequate large-scale immigration tended to undermine wage rates taxation was regressive. THE HISTORICAL BAKGROUND OF THE SCHOOL ▪ The American political and economic environment of the late nineteenth century led many economists to question the assumptions and conclusions of the neoclassical school. ▪ The doctrine that minimal government interference produces the maximum social well-being increasingly seemed untenable. ▪ There was much concern about monopoly, poverty, depression, and waste. ▪ The movement for social control and reform was gathering momentum, and it was in this milieu / context / background that institutional economics grew. THE HISTORICAL BAKGROUND OF THE SCHOOL ▪ At the time two major methods of achieving social change were recognized: I. reorganize society along socialist lines II. undertake social reform, that is, ameliorate / improve conditions through government intervention in the economy. ▪ Veblen was critical of social movements and favored a radical reconstruction of society. ▪ Nevertheless, the institutionalist school he founded reflected the reformist approach. ▪ Example, the changes wrought by the New Deal in the 1930s were greatly influenced by institutionalism. THE HISTORICAL BAKGROUND OF THE SCHOOL ▪ The influence of the German historical school on American institutionalism is quite visible (Most of the leaders of the American Economic Association, which was founded in 1885, were familiar and friendly toward the German movement and its methodology.) ▪ Despite certain similarities in methodology between the German historical school and American institutionalism, the latter was not nationalistic, and it was more liberal and democratic in its outlook. MAJOR TENETS OF THE INSTITUTIONALIST SCHOOL The following describe seven key ideas of this school: 1. Holistic, broad perspective. 2. Focus on institutions. 3. Darwinian, evolutionary approach. 4. Rejection of the idea of normal equilibrium. 5. Clashes of interest. 6. Liberal, democratic reform. 7. Rejection of pleasure-pain psychology.  MAJOR TENETS 1. Holistic, broad perspective. ▪ The economy must be examined as a whole, rather than examined as small parts or separate entities isolated from the whole. ▪ A complex organism cannot be understood if each segment is treated as if it were unrelated to the larger entity. ▪ Economic activity is not merely the sum of the activities of persons motivated individually and mechanically by the desire from maximum monetary gain. (Economic activity is not just the sum of the actions of people who are driven solely by the desire to make as much money as possible. ) ▪ Institutionalists believe that even the definition of economic activity is excessively restrictive. Economics, they argue, is linked to politics, sociology, law, custom, ideology, tradition, and other aspects of human belief and experience. ▪ Institutional economics deals with social processes, social relationships, and society in all its facets / aspects.  MAJOR TENETS 2. Focus on institutions ▪ This school emphasized the role of institutions in economic life. ▪ Institution also an organized pattern of group behavior, well-established and accepted as a fundamental part of the culture. ▪ It includes customs, social habits, laws, modes of thinking, and ways of living. ▪ Economic life, said the institutionalists, is regulated by economic institutions, NOT by economic laws. ▪ The institutionalists were especially interested in analyzing and reforming the institutions of credit, monopoly, absentee ownership, labor-management relations, social security, and the distribution of income. ▪ They advocated economic planning and the mitigation of the swings of the business cycle.  MAJOR TENETS 3. Darwinian, evolutionary approach ▪ The evolutionary approach should be used in economic analysis, because society and its institutions are constantly changing. ▪ The institutionalists disagreed with the static viewpoint that sought to discover eternal economic truths without regard for differences of time and place, without concern for changes that were occurring constantly. ▪ Instead of asking “what is?” the institutionalist asked, “how did we get here, and where are we going?”. ▪ The evolution and functioning of economic institutions should be the central theme in economics. ▪ This approach requires knowledge not only of economics but also of history, cultural anthropology, political science, sociology, philosophy, and psychology.  MAJOR TENETS 4. Rejection of the idea of normal equilibrium ▪ Rather than the idea of equilibrium, institutionalists emphasized the principle of circular causation, or cumulative changes that may be either beneficial or harmful in seeking economic and social goals. ▪ The institutionalists are convinced that collective controls through government are necessary to continually correct and overcome deficiencies and maladjustments / imbalance in economic life.  MAJOR TENETS 5. Clashes of interest ▪ The institutionalists recognized major distinctions in interests, as opposed to the harmony of interests that most of their contemporaries and predecessors drew from their ideas. ▪ According to institutionalists, people are cooperative and collective creatures. ▪ They organize themselves into groups for the members’ mutual self-interest, which becomes the common interest of the group. ▪ However, the clashes of interest between group may occurred. Example, big business against small business, consumers against producers, importers against domestic producers, employers against workers. ▪ Again, a representative and impartial government must reconcile or override clashing interests for the common good and for the efficient working of the economic system.  MAJOR TENETS 6. Liberal, democratic reform ▪ The school advocated reforms welfare, bring about the more equitable distribution of wealth and income. ▪ Institutionalist school denied that market prices are adequate indices of individual and social welfare and the unregulated markets lead to the efficient allocation of resources and distribution of income. ▪ The institutionalist always spoke out against laissez-faire and favored a large role for government in economic and social affairs.  MAJOR TENETS 7. Rejection Of Pleasure-pain Psychology ▪ The institutionalists rejected the Benthamite underpinnings of economic analysis. ▪ They reached out instead for a better psychology, and some of them incorporated Freudian and behaviorist ideas into their thinking. WHOM DID INSTITUTIONALISM BENEFIT OR SEEK TO BENEFIT? ▪ The school embodied the middle-class desire for reform in an era of growing big business and banker capitalism. ▪ It represented the needs and interests of agricultural, small business, and labor groups. ▪ Government workers, reformers, humanitarians, leaders of consumers’ organizations, and union member were attracted to the institutionalist ideas, which they hoped might alter the orientation of private business enterprise in favor of their own interests. ▪ Many academicians in fields other than economics praised the institutionalists’ interdisciplinary focus and their advocacy of social change.  HOW WAS THE INSTITUTIONALIST SCHOOL VALIDE, USEFUL, OR CORRECT IN ITS TIME? ▪ The institutionalists challenged the development of rigid orthodoxy in economic thinking (most of the challenged or criticism were valid and helped to revise that type of theory). ▪ Stress on looking at the economy as a whole as part of an evolutionary process and in an institutional setting added elements of realism to economic analysis. ▪ Promoted a reform movement that effectively removed many of the rough edges of capitalism. ▪ Urged closer to social sciences. ▪ The emphasis of some of their members on inductive studies reduced the gap between economic theory and practice (gathering and analyzing statistical data became popular in government circles, among private, nonprofit research organization, among individual economists). ▪ The National Bureau of Economic Research, founded by Wesley C. Mitchell and others in 1920 is a monument to this method.  WHICH TENETS OF THE INSTITUTIONALIST SCHOOL BECAME LASTING CONTRIBUTIONS? ▪ The boarder perspective that institutionalists advocated were widely accepted by the Keynesian macroeconomics (Keynesianism and post-Keynesianism tended to co- opt and supersede institutionalism). ▪ The reform movements promoted by the institutionalists remain alive today. ▪ Greatly expanded interest in problems of economic development (involve diverse cultural factors and are dynamic and evolutionary). ▪ Lasting contributions of institutionalists are also found in other fields, such as labor relations, law and economics, and industrial organization. ▪ Traditional institutional economics still has a presence within the United States today (the membership of the Association for Evolutionary Economics is largely composed od economists who are oriented toward institutionalist methods and policy perspectives). ▪ The organization publishes the Journal of Economic Issues (remain nowadays).  KEY FIGURES OF THE INSTITUTIONALIST SCHOOL Thorstein Bunde Veblen Wesley Clair Mitchell John Kenneth Galbraith (1857 – 1929) (1874 – 1948) (1908 – 2006) KEY FIGURES OF THE INSTITUTIONALIST SCHOOL Thorstein Bunde Veblen (1857 – 1929) ▪ Founder of the institutionalist school. ▪ Completed his undergraduate college education at Carleton College, Minnesota. Received doctorate in philosophy at Yale. ▪ First and most popular book was The Theory of the Leisure Class, published in 1899. ▪ Leisure class is characterized by conspicuous consumption, a propensity to avoid useful work, and conservatism. KEY FIGURES OF THE INSTITUTIONALIST SCHOOL Thorstein Bunde Veblen (1857 – 1929) Conspicuous Consumption ▪ Those who accumulate wealth and not so care of their physical wants, or even their spiritual, esthetic, and intellectual wants. ▪ Rather, they wish to consume in a way that displays their wealth, because a show of wealth indicates powers, prestige, honor, and success in our pecuniary (monetary) culture. Such consumption must be wasteful. ▪ Poorer people must work in order to subsist, but even their pattern of spending includes an element of wasteful conspicuous consumption (Their outlook on life is imposed by the dominant leisure class). KEY FIGURES OF THE INSTITUTIONALIST SCHOOL Thorstein Bunde Veblen (1857 – 1929) Propensity To Avoid Useful Work ▪ Members of the leisure class must avoid useful, productive work. ▪ They must indulge only in wasteful or useless tasks if they are to remain reputable. “These occupations are government, war, sports, and devout observances…. These occupations are of the nature of predatory, not of productive, employment.” (Thorstein Veblen, The Theory of the Leisure Class (New York: Random House, Modern Library Edition, 1943), 40.)  KEY FIGURES OF THE INSTITUTIONALIST SCHOOL Thorstein Bunde Veblen (1857 – 1929) Conservatism ▪ Veblen asserted that the evolution of social structure has been a process of natural selection of institutions. ▪ Progress can be attributed to the survival of the fittest habits of thought and the enforced adaption of individuals to a changing environment. (Institutions must change with changing circumstances) ▪ The development of these institutions represents the development of society. ▪ The characteristic attitude of this class is indicated in the maxim that, “whatever is, is right.” but the law of natural election, as applied to human institutions, asserts that, “whatever is , is wrong.” ▪ That is, current institutions are wrong to some extent, from the evolutionary standpoint, because they do not change quickly enough to be in tune with the times. KEY FIGURES OF THE INSTITUTIONALIST SCHOOL Thorstein Bunde Veblen (1857 – 1929) Attack on Neoclassical Economics ▪ Veblen’s theory of the leisure class constituted an attack on neoclassical economics, which assumed that consumers are sovereign. ▪ Veblen also accused the neoclassicists of supporting the present scheme of the distribution of wealth and income. ▪ Business economics has been developed to defend the business community, and the questions it asks and seeks to answer are not relevant to the population as a whole. ▪ Veblen was concerned with social economics instead of business economics of price, profit, and ownership. ▪ Veblen also attacked the notion of perfect competition. He recognized that most businessman had some monopolistic control over the prices they charged and that they used advertising to strengthen their market positions. KEY FIGURES OF THE INSTITUTIONALIST SCHOOL Thorstein Bunde Veblen (1857 – 1929) Instinct of Workmanship ▪ Veblen believed that work is not generally irksome, or else the survival of the human race would be jeopardized / risked. ▪ When not harassed by overwork, people have not an aversion to work. People inherently want to do work and to do it well.  KEY FIGURES OF THE INSTITUTIONALIST SCHOOL Thorstein Bunde Veblen (1857 – 1929) Credit and Business Cycles ▪ Credit plays a special role in modern business. ▪ Borrowing money can increase profits as long as current rate of business earnings exceeds the rate of interest. ▪ The competitive use of credit in extending business operations gives an enterprise a differential advantage against other competitors, but the credit expansion has no aggregate effect on earnings or on total industrial output. ▪ In fact, aggregate net profits from industry are reduced by the amount of interest that has to be paid to creditors outside the industrial process. ▪ Veblen’s views on credit led him directly into his business-cycle theory. ▪ The extension of credit enables competing businesspeople to bid up the prices of the material capital goods used in industry (The cumulative extension of credit rests on a shaky foundation). KEY FIGURES OF THE INSTITUTIONALIST SCHOOL Thorstein Bunde Veblen (1857 – 1929) ▪ In other words, the rise in earnings will not keep pace with the rise of the nominal value of capital (capital plus loans). ▪ When this discrepancy becomes obvious, a period of liquidation begins. ▪ Along with liquidation, the industrial crisis is accompanied by credit cancellations, high discount rates, falling prices, forced sales, shrinkage of capitalization, and reduced output. ▪ The creditors take over business properties, thereby further consolidating ownership and control into fewer hands. ▪ Veblen suggested that the decline of profits and chronic depression can be remedied by an increase in the wasteful and unproductive consumption of goods as well as through monopoly. KEY FIGURES OF THE INSTITUTIONALIST SCHOOL Wesley Clair Mitchell (1874 – 1948) ▪ Veblen’s student. ▪ Great researcher whose most notable work centered on an analysis of business fluctuations. ▪ Veblen relied too much on speculations that were not verified empirically. ▪ Mitchell believed that his statistical studies would provide a firmer foundation for Veblen’s pioneering work. “Economics will develop more fruitfully in the future upon the quantitative side. The economists of today stand the best chances of improving upon the work of their predecessors if they rely more and more upon the most accurate statistical recording of observations.” (Wesley C. Mitchell, Types of Economic Theory from Mercantilism to Institutionalism, ed. Joseph Dorfman, 2 vols. (New York: Augustus M. Kelly, 1967), 2: 749, 761) KEY FIGURES OF THE INSTITUTIONALIST SCHOOL Mitchell’s Study of Business Cycles ▪ Mitchell’s greatest contribution was in the study of business fluctuations. ▪ His major on the subject first was published over two decades before the Great Depression and Keynes’s General Theory. ▪ Business-cycle theory approached a tested explanation of experience instead of an exercise logic. Through this, more explanation broadened into a theory of how our economic system works. ▪ 4 major conclusions: I. Business fluctuations arise in a money economy. II. Business cycles are widely diffused throughout the economy. III. Business fluctuations depend on the prospects for profit. IV. Fluctuations are systematically generated by the economy itself. KEY FIGURES OF THE INSTITUTIONALIST SCHOOL Mitchell’s Study of Business Cycles I. Business fluctuations arise in a money economy. ▪ Mitchell view crises and depression not as a disease of capitalism but rather as a problem arising in a society where economic activities are carried on mainly by making and spending money. II. Business cycles are widely diffused / spread throughout the economy. ▪ Because enterprises are so interdependent, business firms are bound to one another by industrial, commercial, and financial ties, so none prospers or declines without affecting others. ▪ The bonds are also channels through which the quickening or slackening of activity in one part of the economy can spread to other parts.  KEY FIGURES OF THE INSTITUTIONALIST SCHOOL Mitchell’s Study of Business Cycles III. Business fluctuations depend on the prospects for profit. ▪ The prospect of future profits plays the decisive role in determining the direction of business expansion. ▪ An account of economic fluctuations in a business economy must deal primarily with the monetary aspects of economic activity. IV. Fluctuations are systematically generated by the economy itself. ▪ Business cycles are not minor or accidental disruptions of equilibrium but rather an inherent part of the working of the economy itself. ▪ Each phase of the cycle evolves into its successor, the economy itself gradually undergoes cumulative changes. ▪ Mitchell believed; the economists of each generation will probably have recast / reform the theory of business cycles that they learned as youths. KEY FIGURES OF THE INSTITUTIONALIST SCHOOL John Kenneth Galbraith (1908 – 2006) ▪ His experience included the post of chief economist for the American Farm Bureau Federation, high positions with the U.S. government during World War II, Professor of economics at Harvard University ▪ Galbraith’s major writings constitute both an attack on neoclassical economic thought and an analysis of modern capitalism. ▪ Nearly all of the characteristics of the institutionalist school apply to his many works. ▪ Two theories were developed by Galbraith: I. The Dependence Effect II. Theory of the Firm KEY FIGURES OF THE INSTITUTIONALIST SCHOOL The Dependence Effect ▪ Orthodox economics lies with the consumer, who buys goods and services in the market in response to personal desires or demands. ▪ The neoclassical theories of consumer choice take wants as given. ▪ To say that consumers maximize their utility, said Galbraith, begs the important question of how consumers go about formulating those wants in the first place? (how you knew that these products maximize their utility in the first place?) ▪ The neoclassical theory of consumer demand emphasize on consumer sovereignty, implies that the market dictates the optimal composition of output and allocation of resources. ▪ Galbraith’s theory of consumer demand, “social imbalance” occurred when allocation of resources to public goods insufficiently / shifts resources towards private goods. ▪ Remedy would be imposed sales taxes on consumer goods and services, using the proceeds to increase the availability of public sector goods and services.  KEY FIGURES OF THE INSTITUTIONALIST SCHOOL Theory of the Firm ▪ The neoclassical theory of the firm concludes that corporate behavior and performance can best be understood by assuming that firms attempt to maximize profits. ▪ Galbraith do agree with it, but it does not describe the far more important planning sector – the 2000 or so largest firms that produce over half of the society’s output. ▪ In the planning sector, ownership and control are separated. ▪ The owners of the giant firms are the millions of holders of common stock who have no actual control over the operation of the corporation. ▪ Control is exercised by the technostructure—a professional elite (managers, engineers, scientists, product planners, market researchers, and so forth). ▪ The technostructure pursues much more complex purposes, which he categorized as protective and affirmative. KEY FIGURES OF THE INSTITUTIONALIST SCHOOL Theory of the Firm ▪ The central protective purpose of the firm is survival, which translates into the need I. to earn a profit sufficient to keep most stockholders relatively happy. II. to provide sufficient retained earning for investment and growth. ▪ The major affirmative purpose of the firm is corporate growth. ▪ Growth of output, sales, and revenue produces greater employment security and financial regards to the members of the technostructure. KEY FIGURES OF THE INSTITUTIONALIST SCHOOL Theory of the Firm Interesting Policy Implications: ▪ A public planning authority need to be established to join with the major corporations and unions to plan and coordinate economic activity. ▪ Galbraith called for government redistribution of income through public control of executive salaries, progressive taxation, and increase in minimum wage, and a negative income tax plan. ▪ Firms in the market sector should be encouraged to merge so that they can compete more effectively with the firms in the planning sector.  TUTORIAL EXERCISE 1. Compare and contrast the characteristics of the German historical school with those of the institutionalist school. In your opinion, does institutionalism more closely align with the “older” historical school or the “younger” historical school? Why or why not? 2. How do the causes and consequences of the 2007-2009 recession fit with Mitchell’s four major conclusions about the business cycle fluctuations? 3. Discuss three major tenets of the institutionalist school. THANK YOU