Is There Any Theory in Institutional Economics?
by A. Allan Schmid, Michigan State University
The answer to the question, "Is there any theory in institutional economics?" depends on what you expect of theory and where institutional economics starts and stops. Theory performs many roles and only welfare economics and an example of prediction and explanation can be discussed here (Samuels 1994).
Welfare Economics
If you demand deterministic conclusions about changes in aggregate welfare, then institutional economics will disappoint. John R. Commons did not have a welfare economics. For example, he did a lot of work on labor unions but did not try to prove that they were/or not efficient, increased total product, or whatever. He was content to explain their origin and growth and whose interests they served.
His concept of "reasonable value" was not something to be discovered, but to be worked out in private and public governance. He observed that different people had conflicting interests and thus to speak of aggregate welfare required a moral judgment among the conflicting parties to guide their compromises and achievement of order and peace. Commons had an up-front value judgment which drove his search for
institutions benefiting the laboring class. If you believe that failure to assume the scientific high priest role of pronouncing on the desirability of one institution over another emasculates economics and cheapens our coin, then institutionalists have no theory.
Prediction and Explanation
Institutional economics, on the other hand, does have theory directed to prediction of the substantive impacts of institutional alternatives on different groups. A good theory should identify key instrumental variables and the relationships among them to predict and understand. Institutional economics can be applied to both individual and collective decision making, though its specialty is collective choice.
Individual Choice
The theory of advantage has been worked out in great detail. Institutional economics does not have or desire another theory of profit maximization. The effects of equating marginal cost and revenue is the same in both theories. But institutional economics being a behavioral science is interested in how individuals form subjective perceptions of marginal cost and revenue and particularly how institutions affect those perceptions under uncertainty.
Let me give just one example of individual choice. The theory of advantage tells us that sunk costs should be ignored. But simple observation tells us that people frequently do not ignore fixed costs. Behavioral economics suggests that people try to avoid regret and embarrassment. To research these matters means that we will have to talk to people to learn what cues they respond to. If you have an aversion to this and prefer what Herbert Simon calls "armchair economics," you will not like institutional theory. I know you can't fully trust what people say, but it is the only game in town if analysts are not to substitute their perception for that of the actual actors. There is new theory that shows that it may be rational to consider sunk costs where there is risk and imperfect contingency markets. It remains to be seen which theory will better explain behavior.