The theme of the second reading group was Institutional Economics, which focuses on the role of laws, culture, norms and organisations in determining how economies and populations function. The reading was Herbert Simon’s well-known 1995 paper Organisations and Markets, which argues that in modern capitalist economies, organisations rather than markets are the dominant method through which resources are allocated.
The first problem for our group was properly defining the word “institutions”, which can often feel like a deus ex machina invoked to explain away any problem. Your country is doing well? Good institutions! Not doing so well? Well, maybe you should improve your institutions! However, with a little help from Google, we came to a broad agreement on a definition: “an established rule, organisation or practice”. We could also add that institutions are generally “non-policy dependent”; they are more fundamental than specific rules or regulations.
Simon’s paper argues that a large amount of organisation is required to coordinate the division of labour, and that these organisations play a crucial role in the allocation of resources. He asks what a Martian would see if they came to earth, and saw organisations as green circles, with market relationships as red lines connecting them. Would markets dominate, with green circles as islands in a sea of red, or would the green circles be large, with relatively few red lines connecting them? Simon argues the latter (and Ha-Joon Chang, in his lecture, said that 80% of transactions occur within firms in the USA). One member did not like the analogy as it seemed simplistic and did not fully prove Simon’s point – it would not convince someone unwilling to be convinced. However, Simon does go on to offer some supporting points for his thesis.
One of his major points concerns individuals’ behaviour in mainstream economics. Simon argues that utility-maximisation, where each individual tries to follow their own goals or preferences, and which is central to neoclassical economics, simply cannot explain organisational loyalty and the employer-employee relationship. If people were ‘rational’ in the economic sense, they would skive off at every possible opportunity and only the threat of being fired or disciplined would be able to deter them. Instead, Simon points out that large differences in productivity and performance can be obtained through organisation and management, and that many people simply take pride in their jobs or identify with their organisation (one member spoke about how establishing such ‘loyalty’ at some of her retail jobs felt quite like indoctrination).
Simon also briefly criticises “new institutional” economics, which tries to approach institutions from a neoclassical perspective. He charges that these models, though they are perhaps a positive step forward, still model the individual as abstract and with innate characteristics, while institutions are unexplained, exogenous constraints. This does not get at the fundamental role of the institutions in shaping the individual, and vice-versa. We discussed specific firms such as Apple, how prevalent they are in shaping our lives – economic or otherwise – and how neoclassical economics seems ill-equipped to deal with such phenomena.
Overall there was broad agreement with the paper, although it would be interesting to hear some competing viewpoints. Having said that, what I’ve seen of this, both from conversing with economists and with eg Ronald Coase on the firm, or Gary Becker on the family – both of which were mentioned in discussion – seems to be a rather narrow attempt to reduce every economic relationship to some form of market transaction. Any organisations are presumed to be represented by an individual who has absolute authority over said organisation, whether a boss or a “breadwinner”, hence avoiding the tricky question of how the organisation actually functions. But perhaps some mainstream economists have done better – if so, we’d love to hear about it.