by From Lars Syll The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2024 is awarded to Daron Acemoglu, Simon Johnson and James Robinson “for studies of how institutions are formed and affect prosperity.” Daron Acemoglu and James Robinson’s work, particularly in Why Nations Fail (2012), is widely recognized within new institutional economics for its argument that inclusive political and economic institutions are key determinants of long-run prosperity and wealth, while extractive institutions perpetuate poverty and stagnation. While their framework may offer some valuable insights, a critique that could be directed at their framework is that by attributing a nation’s success or failure almost entirely to its political and economic institutions, they underplay
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from Lars Syll
The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2024 is awarded to Daron Acemoglu, Simon Johnson and James Robinson “for studies of how institutions are formed and affect prosperity.”
This is rather typical of new institutional economics, where complex historical processes are often oversimplified and fail to take height for the idiosyncracies of historical development. They also tend to underplay the role of culture and social norms in shaping institutions. By focusing almost exclusively on formal institutions, Acemoglu and Robinson’s framework may miss the importance of these more subtle but influential factors.
In mainstream economic theory, one had for a long time taken for granted that the institutional framework of social interaction had to be treated as something exogenously given and beyond the explanatory and analytical realms of theory. Institutions were for sociology and political science to handle, not for pure economics. More recently, however, the scope of economic theory has been widened through the incorporation of institutions. This has to a large extent grown from an increasing awareness of the farfetched consequences of the institutional presumptions on which much of the earlier theorizing was built. The analysis is therefore broadened by supplementing the hard core with institutional analysis. One has even attempted to explicate the economic rationale of the formation or
sustenance of institutions by endogenizing them, e. g. by applying different kinds of evolutionary theories.
In this renewed interest in extending the theory to encompass economic and political institutions among mainstream economists much of the inquiry has been centred around the analysis of property rights and transaction costs. The analysis is often aimed at generalizing microeconomic theory while retaining all the essential elements of the economic approach — stable preferences, the rational-choice model, and equilibria. The rational-choice model, with its view of individual agents trying to maximize an objective function subject to constraints, is central, and new institutional economists see its task only as “specifying both the decision maker’s objective function and his or her opportunity set. Since one is ultimately interested in the impact of different property rights structures on economies, rational individuals are not only seen as trying to maximize their utility within a given set of rules but also seeking to change the rules. It is a firmly held belief that although this kind of institutional change involves losers as well as winners, the gains are generally greater than the Iosses. Since actors may have different interests and transaction costs are positive, the development of institutions is mainly seen as a way of coping with these problems in trying to attain some sort of wealth-maximizing equilibrium.
As is clear from this description, new institutional economics performs its analysis on different levels. At the first level, the structure of economic organization and the structure of property rights are both modelled but treated as exogenous. At the second level, only the property rights structure is exogenous, and at the third level, the property rights structure is also endogenized. At the first level, the focus is on the effects of changes in constraints on equilibrium outcomes, at the second level on the equilibrium contracts resulting from the endogenised structure of economic organization, and at the third level on how competition for survival among institutions leads to equilibrium institutions. The arrangement of contracts that minimize costs survive.
Based on a rational-choice model, new institutional economics in this way purports to explain both the structure and change of institutions. What the new institutional economists try to do is basically explain institutional variation by making it endogenous. Institutions themselves are to be explained without appeal to other institutions. Institutions are “sets of rules,’ and as basic parameters of the economic system change, the incentives and behaviour of the utility-maximizing agents change, and rules that were initially efficient become inefficient. The agents’ reactions to induced “new profitable opportunities” result in the change of institutions.
A basic problem is that there is no easy way of unambiguously determining what is efficient and what is inefficient. Transaction costs and property rights can only be determined for a given institutional setup. Conjectures and comparisons in terms of efficiency can only take place from a baseline defined by status quo and ceteris paribus conditions. New institutional economics fails to adequately grasp the fact that it is the prevailing institutional structure that defines what to count as costs and benefits. To say that the inefficiency of the prevailing institutions induces institutional change is tantamount to circular reasoning since the prevailing institutions define what is effective and ineffective. A concept of institutional change that gets its force from the prospect of attaining higher efficiency as defined in status quo is tautological. We cannot define efficiency (and efficient institutions) without specifying the goals we try to attain, and to whom the benefits are to accrue. The central issue is perhaps not a loss of efficiency in abstracto, but the private costs for maintaining the basis of the economic power of a certain class. Efficiency is not an absolute but a relative concept. If we change the environment, efficiency changes with it. In particular, changing the structure of property rights radically changes what is counted as efficient.
Another problem lies in the endeavour of endogenisation itself. This runs the obvious danger of the analysis being based on an infinite regress. Traditionally, institutions were treated as the ‘non-economic bottom’ on which economic explanations ultimately have to be grounded. Endogenisation, if successful, would sweep away this lower bound. But if rules are designed to ‘reduce uncertainty’ they cannot be constantly fluctuating as responses to ‘new opportunities,’ nor can they be treated as equilibrium outcomes. A society’s fundamental institutions — such as rules of conduct, conventions, laws and language — are not equilibrium outcomes of non-cooperative games. They are, rather, the prerequisite for the very existence of such games. They furnish the arena in which the game can take place. Although (changes in) rules at level one may be explained by (changes in) rules at level two, the rules of making rules at level three have to be analytically treated as exogenous. The rules that rule society and its development cannot be completely reduced to the outcome of rational choices.