1 Institutional stream in modern economics: NeoIE versus NewIE

2 NeoIE versus NewIE – origins and main methodological and cognitive differences 1. New Institutional Economics (NeoIE) Generally, alike the classical institutionalism (T. Veblen, J. R. Commons, W.C. Mitchell, J. M. Clark) : rejection of basic methodological assumptions of NCE, and methodological indiwidualism in particular 1. Critique of the definition of economics as a science within the mainstreram economics, and, in particular ofv broadly understood neoclassical or neo-neoclassical economics 2. In general approach, NeoIE,, alike Veblenian institutionalism, is a critique of the manner in which the whole process of economic development, and of development of capitralist economy, is understood. (rejectiing, however, the sociaal pesimism of Veblen). According to NeoIE, the economic development is an evolutionary social process and not neoclassically interpretred process of equilibrium grfowth

3 NeoIE versus NewIE – origins and main methodological and cognitive differences Neoinstitutional Economics Rejection of hedonism (as philosophical and methodological foundation for research on microeconomic behavior) and the UMH (hypothesis of micrtoeconomic rationality. Implicitly, rejection of the homo oeconomicus concept Adoption of psychology of instincts (Veblen), and later (NeoIE: C.Ayres, J. M. Clark, Galbraith, Myrdal)) of philsophy of pragmatism (J. Dewey; pragmatic value theory of Ayres, concept of reasonable values of Mitchell) and behavioral psychology as foundations for the epxlanation of microeconomic activities

4 NeoIE versus NewIE – origins and main methodological and cognitive differences Neoinstitutional Economics Specific way of intrpretation of „economic system”, as evolutionary process whose main part is „culture” 1. Most important dychotomy of human being (Veblen): contradiction between the instinct of good work and the instinct of posession 2. Subsequent dychotomic contradictions: a) Between physical flow (flow of useful goods) and financial flow b) Between „world (class) of industry” and „world of posession” (leisure class)) c) Conflict between those two worlds means also conflict between cultural institutions which are useful or futile (useless) form the point of view of social and economic development

5 NeoIE versus NewIE – origins and main methodological and cognitive differences Neoinstitutional Economics Rejection of economic determinism and adoption of the view that develoment is mostly determined by science and technology, with inert character of culture and institutional basis Rejection of the concept of objective laws or regularities in socio-economic development; one can speak only of a certain logics of development (Galbraith, Myrdal). It consist in plausible, but not necessary, adjustments of culture and institutions to the imperatives brought about by permanently developing (changing) science and technology Social pesimism of Veblen and its rejection by his followers - postveblenian economists, neoinstitutionalists

6 NeoIE versus NewIE – origins and main methodological and cognitive differences Neoinstitutional Economics Rejection of neoclassical way of understanding the economic equlibrium; 1. Commons: equlibrium („reasonable economy”) as an optimal allocation of scarce resources which is attained not through market competition but as the outcome of „collective actions and control”; 2. Galbraith: equlibrium as process (and not the state) resulting from the action of countervailing powers: corporations,trade unions, the state as intermediary agent

NeoIE versus NewIE – origins and main methodological and cognitive differences New Institutional Economics Two manners od interpreting NIE 1. As an integral part of widely understood neoclassical economics, as neoclassical theory of institutions (the so called theoretical institutionalism, as opposed to postveblenian one) 2. As a new paradigm in contemporary economics Genesis of NIE (decades of 70. and 80. of XX century) 1. „External” critique of „institutional deficit” of NCE 2. Increasing empirical knowledge on the significance of institutions – both informal and formal – in modern economic and technological development and subsequent necessity of theoretical reflection on them

8 NeoIE versus NewIE – origins and main methodological and cognitive differences New Institutional Economics Origins and development of theoretical foundations: 1. Theory of transactions costs (R. Coase as the founder/precursor and O.E. Williamson as main follower) 2. Theory of property rights (main theoreticians: H. Demsetz and A.A. Alchian) TR and PR theories are two principal methodological and theoretical foundations within the main stream economics for investigations on the role of institutions in modern economies

9 New Institutional Economics – basic categories and assertions Property rights (economic approach) 1. Entitlements (rights), shaped in the historical process by law (normative), customs and morality, which define and confine (with regard to other persons) the scope of appropriating and using economic resources and goods (in other words: laws of disposal) 2. Since most goods are not pure private goods, there occur many direct (technological) external effects in the economy and there appears the necessity of their internalization

10 New Institutional Economics – basic categories and assertions Property rights (economic approach) – cont. 3. Internalization requires changes in legal- institutional arrangements (in the so called informal institutions).Their analysis becomes subject to economic analysis 4. Fundamental function of PR is to create incentives for increasing the scope of internalization of external effects

11 New Institutional Economics – basic categories and assertions Transaction costs (KT) in narrow approach (COASE, WILLIAMSON) In broadest interpretation, TC are the costs of using the price (market) mechanism Types of transaction costs (Coase): 1. TC related to seeking and processing information which is necessary for shaping market prices of goods 2. TC related to negotiations of contracts (agreements) (producers – purchasers, purchasers - deliverers, etc.) 3. TC linked to the control of execution of contracts

New Institutional Economics – basic categories and assertions TC in broad approach: 1. Costst of coordination of various forms of economic activity (coordination by state versus coordination by market) 2. Costs which are necessary for the emergence and development of markets 12

New Institutional Economics – basic categories and assertions  TC and PR - interdependence Inaccurate definition and/or attenuation of propert rights, and incapability of internalizing (apprioprating) benefits related to them in particular, must result in increasing transaction costs in the economy, weakening of the system of microeconomic incentives, and this way in general decline of the level of economic rationality or efficiency. 13

New Institutional Economics – basic categories and assertions 5. Reasons for high level and types of TC in the countries with command-and-control system (the countries of the so called real socialism)  High TC linked to the central macroeconomic planning  High TC related to a broad scope of non-market distribution of public goods  High TC of extensive system of social transfers  Attenuation of PR as the reason for broad occurence of rent seeking behavior in the sphere of functional distribution of social product  Rent seeking as standard (routine) behavior for menagerial staff of state owned enetrprises and their employees  High positional and bureaucratic rents (menagers of SOEs and political nomenclature) 14

New Institutional Economics – basic categories and assertions Nature of the transformation process from the point of view of NIE: 1. General definition: transition from socialist C&C economy towards a market economy as politically and economically determined institutional change 2. Definition based on the TK/PR theories: transition from socialist C&C economy towards a market economy as a gradual transformation of the system which is characterized by predomination of rent seeking microeconomic behavior towards the system within which prevail the efficiency-driven activities of human beings and social groups 15

New Institutional Economics – basic categories and assertions Criterion of minimization of TC General criterion of the growth of economic efficiency It theoretically allows for answering two fundamental questions: 1. What is optimal size of the enterprise (equalizing of marginal costs of transactions carried out within the enterprise – intra-enterprise transactions - and marginal costs of market transactions) 2. Why exist enterprises and the market as alternative co-ordinative mechanisms 16

New Institutional Economics – basic categories and assertions New Economic History (NEH) and New Political Economy (NPE) – analysis of TC in the long- run (secular) perspective 1. Criterion of minimization of TC as a general foundation for expaining how varoius legal-institutional and economic systems change in long time periods 2. Effective institutional order is characterized by the existence of such property rights regime and microeconomic incentives system, as well as co- ordination mechanisms, which permit the owners of production factors to appriopriate benefits resulting from the use of those factors (thus minimizing the scope of occurrence of external effects and free-rider behavior) 17

New Institutional Economics – basic categories and assertions NEH and i NPE – cont. 3. Economic theory of state – the concept of J. Buchannan  Pre-state period (pre-constitutive order) Its main feature is a very high level of uncertainty of economic activity (transactions, contracts, etc.). Principal task of the emerging state is therefore to establish the so called pre-constitutive property rights and formal institutions corresponding/related to them. The state has also to ensure that adequate „rules of game” (informal institutiuons) are observed in order to diminish the level of general uncertainty in the economy and to exclude (or radically confine) the possibility of attaining economic benefits through the „robbery” This way, the protective state (in Buchannan’s approach) is crreated 18

New Institutional Economics – basic categories and assertions 3. Economic theory of state – the concept of J. Buchannan  Post-constitutive property rights emerge as the outcome of market exchange of goods. If those exchange contracts are to be effective and complete, it is necessary to: 1) liberalize (to free from state control) prices and trade, 2) gradually introduce (allow for) both domestic and foreign competition 3) establish capital (financial) markets All this is possible when the statet creates foundations of „sound macroeconomic regime”, as well as when the state follows the regulation policy which is cnsistent with general principles of market economy. This way, the so called regulative state emerges 19

New Institutional Economics – basic categories and assertions 3. Economic theory of state – the concept of J. Buchannan  As in any market economy, also in emerging market economies the state has also to produce or to provide public goods or,at least, to finance the costs of their production and distribution. This means, respectively, the emergence of productive state. 20

New Institutional Economics – basic categories and assertions 5. State from the NIE perspective (with special reference to New Political Economy) – a general approach  NIE, and TCT and PRT in particular, provide theoretical arguments which allow for answering a fundamental question: why there exist the state and the market as alternative mechanisms of economic co- ordination and opimization (Coase criterion) 21

New Institutional Economics – basic categories and assertions  NIE, and NPE in particular, identify economic and social mechanisms which underlay the process of working out and and accepting specific solutions within the macroeconomic and sectoral policies, as well as within the public regulation. Furthermore, NIE helps to explain the contradictions between those policies  NIE pays attention to the necessity of ongoing active role of the state in the sphere of shaping legal-constitutional foundations of economic order 22

New Institutional Economics – basic categories and assertions NEH and NPE – cont. 4. Economic theory of public regulation in the market economy Point of reference: interpretation of public regulation as specific commodity and the need to define the supply of and demand on this commodity Differently from the so called normative regulation theory, the economic theory of public regulation assumes that the regulation is (mostly) designed for attaining goals of specific interest groups 23

New Institutional Economics – basic categories and assertions 4. Economic theory of public regulation in the market economy – cont. Basic assertions of ET of PR Main resource of the state is the power to coerce  Utility function of politicians (policy makers): achieving and/or maintaining the (political) power  Regulation is usually more advantageous for producers than for consumers 24

New Institutional Economics – basic categories and assertions Basic assertions of ET of PR – cont.  The game of group interests leads usually to optimal distribution of benefits from the regulation between entrepreneurs (deliverers of goods and commodities), politicians (as legislators) and regulatory institutions (regulators)  Examples of ET of PR : capture theory of regulation), theory of regulation based on the concept of agent and principal  Ecclectic theory of PR 25

New Institutional Economics – basic categories and assertions General definition of NIE: Based on criteria of economic rationality, as well on the assumptions of methodological individualism: analysis of formal and informal institutions of economic and political life. Analysis – in terms of economic rationality – of different socio-political orders and interdependencies between those orders and the performance of the economic system 26

New Institutional Economics – basic categories and assertions Basic components of broadly understood NIE 1. Neoinstitutional theory of the firm: Coase, Williamson 2. Economic theory of politics (New Political Economy or Theory of Public Choice): Buchannan, Tullock 3. Analysis /theory of long-run (secular) dynamics (changeability) of socio-economic systems (New Economic History): North, Thomas 4. New Economic Gegraphy (application of NIE to the analysis of spatial aspects of economic performance and the change of economic structures over time) 27