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The Game of Institutions: An insight into Institutional economics

“Whilst this planet has gone cycling on according to the fixed law of gravity, from so simple a beginning endless forms most beautiful and wonderful have been, and are being, evolved.”— On the Origin of Species, Darwin

Evolution, a rampant shuffling of possibilities, systems and structures that fail, secede, succeed and eventually collapse to the paradigm’s personal singularity — the present. The past century has seen an avalanche of newly emerging disciplines dedicated solely to inspect the evolution of nature, man, and the systems formed by the interplay. Evolutionary biology, evolutionary anthropology, evolutionary psychology — all of them try to frame the explanation of human behaviour and human culture within an overarching research paradigm commonly referred to as the Darwinian paradigm. Herein, the Darwinian theory of descent with variation in nature is extended, by hypotheses, on cultural evolution. Should this option be considered also for economics as well? This was precisely what Veblen pleaded for. He argued, the behaviour of human beings is directly associated with the change (or evolution) in existing formal and informal institutions of society. The formal institutions include structures like legal codes—these are explicit in nature; informal institutions are implicit and in turn complement the formal structures—these include customs and beliefs of individuals. For instance, some provisions of the Quran bans the use of usury, affecting insurance penetration in Islamic Countries. Institutional economics defines markets as a result of complex interactions between a myriad of institutions—both formal and informal. To simplify things, we can describe this as a game wherein the rules are being established by the institutions. One might think that we are the players playing the game, but the game is being played and we are just the characters in it following the framework being framed by the institutions.

In the Veblenian theoretical framework, the bearer of change is to be found, primarily, in technology. Technological change is an affair of the community and thus, a social interest and a social function. The fact that technology affects institutions is similar to the fact that institutions affect technology, as the causal links between institutions and technology run in both directions. Another important concept related to technological development is Creative Destruction which means the dismantling of long-standing practices in order to make way for innovation. Schumpeter describes creative destruction as the “process of industrial mutation that incessantly revolutionises the economic structure from within, incessantly destroying the old one, incessantly creating a new one.” To Schumpeter, economic development is the natural result of forces internal to the market and is created by the opportunity to seek profit. An example of creative destruction is the invention of the internet; it forced adaptation to the new era (of connectivity), and relegated to the lower rungs were the people whose services were now being sourced from elsewhere via the internet.

But by and large, how relevant is institutional economics today? Institutional economics still finds its place in debates related to the structure of national institutions, policies, and development agendas, directly or indirectly. Even the latent excitement for Joe Biden, the 46th president of the US, being inaugurated today finds its fuel in the hope for a change in institutional economics — a new administration sets the micro-atmosphere for the institutions across the nation and they, in turn, set the macro-mood for politics and economics; one administration, for example, may weave a political fabric of senate bipartisanship and the other of senate riots. Those addressing the dynamics of this micro-atmosphere are relevant questions, especially for countries that are trying to move from lower strata of development to a higher stratum. The idea of institutional economics is to help make the state take appropriate decisions to accelerate their economic and social development. Therefore, as per institutional economics, at the core of the economy lies the formal and informal organisation of the society. This organisation comes mostly from the society itself, they form (and both encompass) the institutions. Society, based on historical context and experiences makes choices for its social and political institutions which directly affects their economic and social well-being. This brings us back to our definition of this field of thought as a “game”. How many levels do these institutions (game) have? What all institutions do we focus on? and how do they change? Institutions were first described as a game by Douglas North. Furthermore, Nobel Laureate Oliver Williamson gave an encompassing framework to describe Institutions and coined the term “New Institutional Economics”. The framework that Williamson used goes onto answer the above-mentioned questions. In the figure below you’ll be able to see 4 levels of the institutions (game) he has used and the time frame, he has given for each to adapt to a change.

The classification of social, political, legal, and economic institutions into four levels is inevitably slightly arbitrary. A society’s social and cultural grounds lay confinements on the characteristics of the basic institutional environment that will be feasible at a particular point in time. Paul L. Joskow in New Institutional Economics: A Report Card gives the example that societies that have no tradition of private property and have relied instead on community-based exploitation of resources and collective allocation choices cannot be expected to adopt successfully the basic institutions of capitalism that characterize the U.S. or Western Europe overnight. Any such drastic change will be difficult to bring in instantaneously because of the social institutions. Nor will societies with hierarchical and non-democratic political systems, easily shift instantly to modern democratic political or human rights institutions. Similarly, there are certain basic societal and political institutions, such as private property rights, centralized monetary institutions, and decentralized credit institutions which if first begin to be introduced into societies in which it doesn’t align with its current state then we cannot simply assume that they will instantly have the same attributes as they do in societies with many years of experience with them. A familiar capitalist market institution may not work very well if the supporting institutional structure composed of basic institutions and compatible governance arrangements are not in place. Alternative allocation mechanisms may be better adapted to the supporting institutions that are in place at any particular point in time.

It is generally accepted that most well-organised societies are the one that clings on to the path of development first. But what do countries need to do to become more well organised? Some argue that the less organised and the developing countries will have to first abide by the conventional definitions of good governance and if they achieve that then they’ll become more like the developed countries. On the other hand, some people focus more on the process of how institutions are formed rather than how they should be. The proponents of this argument suggest that a lot of these countries can’t become organised until they are developed. For instance, in China, it wasn’t the stable property rights and rule of law that was prioritised but it was the economic efficiency and development agenda that was given the utmost precedence. Hence, they developed lots of other institutions (rather than the conventional) that gave them governance and organisational capabilities that helped them develop. A lot of such countries are now moving towards becoming a more organised and advanced society. The entire structure of both of these arguments boils down to the institutions only—one focusing upon the end, while the other on the process. It is eventually the social transformation, social evolution, that goes on to define how a country will move towards a path of development.

Hence a lot of answers to the questions posed above regarding incremental change depend upon how various institutions are operating and the future course of action depends upon this status quo. Overall, as new models are being inculcated in mainstream economics; Institutional Economics is also finding itself merging within the larger scope. It tries to blend the ideas of social norms, legal codes, and formal institutions with economics and tries to really disrupt the equilibrium. It connects the historical transformations of a country and tries to make a decision that’d best suit a country. It says that the institutional changes that bring difference with respect to economic and social changes are only a function of historical divergences and distribution of power within institutions. So simple, all the institutional formations of all the countries are just natural experiments (or games) with numerous permutations and combinations of historical divergences and transformations which now affect the well being of the society.

Next time you find yourself in the gloomy halls crowded by pale white sheets with sobbing typewriter fonts, imagine not just filing dull government documents of infinite processing longevity; imagine a game, a game of institutions that tips, balances, levels up, even glitches, and you, a player on a conquest of Institutional Economics.

By Garvit Goswami
2nd Year Undergraduate Student, SRCC
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