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20160109 Institutions


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Human institutions are immaterial constructs of human mind that define rules of behavior and cooperation, providing kind of software on which human society runs. Institutions based on technology achieved by society and in turn define to significant extent cost of transactions in this society, making it more or less prosperous comparatively to the level supported by given level of technology. Institutions are highly path-dependent and therefore could be quite different in different societies even if they are at the same technological level, leading to quite different results in terms of lives people live in these societies. Institutions are constantly changing, however it is mainly incremental change at the margins that becomes obvious only during brief disruptive changes such as revolutions when old hollowed out institutions give way to the new ones, more or less fully developed within framework of old. Institutional analysis had to be much more fully included into economic analysis for us even to begin understand why some societies are highly prosperous, while others disastrous even at the same level of technology and similar level of natural resources availability.


Part I Institutions

1 An introduction to institutions and institutional change

Author defines institutions as rules of game in the society. Obviously rules of game strongly impact outcome that is economic and societal performance of society. Author differentiates institution from organizations, the former defining what people can or cannot do, while latter are groupings of people combined in order to achieve something. Author also stresses need to separate rules of game from strategies of game. Obviously different institutions lead to different outcomes and one of main interests here is how it happens and why and how institutions change. Author clearly understands that institutions created by individuals and in turn put restriction on actions of individuals, therefore creating very interesting dynamics of human interactions.

2 Cooperation: the theoretical problem

Here author explores the theoretical foundations of institutions – need for human cooperation. Cooperation is defining factor in economic performance, but it is difficult to sustain in non-repeating situations. Author reviews work of several researches of cooperation and concludes that institutions create environment when all situation could be treated as repetitive by substituting experience from encounters by compliance with institutional rules.

3 The behavioral assumptions in a theory of institutions

Here author looks at behavioral assumption normally used and suggests modifications. He reviews 7 neoclassical behavioral assumptions and their deficiencies. The key to understand these deficiencies comes from two aspects of human behavior: motivation and deciphering the environment.

4 A transaction cost theory of exchange

This chapter is about costs of transactions and role of institutions in defining these costs. The case made here is that robust institutions dramatically decrease cost of transactions for example institution of private property assure individual that investment into planting seeds would benefit him without huge expense of continuously watching and defending planted field. The benefits of such institution as money seem to be obvious and tremendous.

5 Informal constraints

Here author looks at institution as set of informal constrains, which seems to encompass much wider area of human activities than formal constrains and play very important role in human relations. The most important role is probably facilitation of development and change of institutions via mechanism of culture, which is at the end is just a totality of informal constrains and established perception that define behavior of individuals.

6 Formal constraints

Correspondingly this chapter is about role of institutions as formal constrains on human action. The formal constrains such as laws and regulations are just a formalized expression of informal constrains of culture. The formal constrains much less susceptible to enforcement than informal and therefore play outsized role in work of institutions.

  1. Enforcement

This chapter is about enforcement of constrains, which actually defines effectiveness of institutions. Here author separately looks at self-enforcement of contracts and external enforcement both of which necessary for institutions ability to decrease cost of transactions.

  1. Institutions and transaction and transformation costs

Here author combines together results of previous discussion to finalize role of institutions in defining production and transaction costs.


Part II Institutional change

  1. Organizations, learning, and institutional change

This is about interaction between organizations and institutions. Especially important is interaction between organization and institutions when organization slowly changes institutions while developing of institution in turn could not only change, but also could destroy organizations. Author also looks in detail at the interplay between tacit and articulated explicit knowledge and how it impacts institutions, organizations, and, eventually, transaction costs.

  1. Stability and institutional change

This chapter is about stability of institutions and causes of their loosing this stability. Every institution carries inside causes of future change. The agent of change responds to incentives embodied into institutional framework. Author presents an interesting idea that change is caused by variation in relative prices that modify incentives within institutional framework until these incentives lead to dissatisfaction with existing framework and consequently to institutional change. The most important thing about change is that it is always incremental and consists in slow modification of institutional framework on the margins until at some point old framework is practically emptied out and falls, opening way for the new one. One necessary factor in this process is generation of ideology for the new framework within old one and significant group of people with deep ideological commitment to it.

  1. The path of institutional change

This is very interesting discussion of institutional change and its dependency on historical path of society’s development. This discussion as usually uses example of QWERTY to demonstrate path dependency in technology, but it expands this idea to all forms of institutions including political ones. Some examples in these areas are American Revolution with its Constitution and institutional revolution in Western Europe in XIX century when property rights substituted feudal rights as main method of resource allocation. An important note here is that similar changes in relative prices in two different societies lead to different institutional changes because they are path dependent and all societies have different paths. As example of this thesis author looks at the colonization of America by Spain and Britain. It was conducted according to the two different paths: one defined by Spanish and another by British society, leading correspondingly to institutions of Latin America and institutions of United States and Canada.


Part III Economic performance

12 Institutions, economic theory, and economic performance

This is more detailed look at theoretical implications of institutions on economic performance of society. Analysis of institutions is complex because, being just constructs of human mind, they could not be measured. However economic development of society could be used as proxy for analysis of institutional effectiveness. Eventually better institutions lead to lower transaction costs making for richer and more prosperous society. Author again looks at comparison of British-North American Path versus Spanish – South American for detailed analysis.

13 Stability and change in economic history

This chapter is about institutional change and its impact on complex and dynamic western economies and how it caused economic growth. This is a very brief overview of historical institutional changes and their link to technological changes over all known stages of development of human societies.

14 Incorporating institutional analyses into economic history: prospects and puzzles

The final chapter is about implementing result of institutional analysis into framework of overall economic analysis and some historical application that could follow from such development.


I find ideas presented in this book highly consistent with what I know about history, economic development, and human psychology. I think that the next step should go beyond just analysis of the past, but rather develop a conscious approach to design of institution including their periodic updates in order to keep them at the most effective and efficient status according to currently achieved level of technology. Obviously any conscious design will always be clumsy and unsatisfactory because of the huge difference in ability of human mind to process complexity of the world represented in language and images and actual complexity of real world, which is higher by orders of magnitude. This posits need to maximizing freedom of individuals and groups to test various theories / ideologies in various places and freedom of competition between them so individuals could pick ones they like more. The key here should be avoiding violent competition that always imposed huge costs on institutional change.



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