History
of
Economic
Thought
–
Institutionalist
Background
• Mostly American
• By the end of the 19thcentury, the US was by far the most productive industrialized economy • Like European industrialization, living standards
for working class were terrible
–Strong market power for employers who often
exploited workers
–Immigration lowered wages
–Recurring, very serious recessions
Background
•
Growth
of
monopoly
•
Government
was
mostly
Laissez
‐
Faire
•
Solutions
–Socialism
–Social reforms: save capitalism by improving
condition of the working class
•Institutionalism reflected this reformist approach
•Influenced New Deal reforms in the US
Major
Tenets
• Holistic view of the economy
–Patterns of collective action that cannot be disaggregated into
individual decisions
–Economics intertwined with political science, sociology, law,
social custom, etc…
• Focus on institutions
–Institutions are an organized pattern of group behavior including
rules and customs
• Broad view – includes social institutions like slavery or unionization of
workers
–Economic life is governed by economic institutions
• Institutionalists interested in reforming credit, monopoly, labor‐
management and income distribution
• Economic planning and mitigating business cycles
Major
Tenets
• Evolutionary approach
–Disagreed with static approach: society is constantly
changing
–Interested in how society arrived at certain conditions and
where it’s heading
–Studying formation and functioning of economic
institutions
•Requires integration of other disciplines
• Rejection of notion of equilibrium
–Maladjustment may be normal part of economy, not just a
temporary disequilibrium
•Cumulative causation
•Government can potentially correct
Major
Tenets
•
Rejection
of
harmony
of
interests
–Groups form because of mutual self‐interest but
there can be clashes between groups
–Government can reconcile clashing interests
•
Liberal
democratic
reform
–Market prices are not adequate for maximizing
social welfare (inefficient and inequitable)
•Government should help bring about a more equitable
distribution of wealth and income
Whom
did
school
seek
to
benefit?
•
Middle
‐
class
desire
for
reform
•
Small
business
and
labor
groups
How
was
school
valid
in
its
time?
• Criticism of orthodox economics led to useful
revisions of theory
• Holistic, evolutionary approach helped to
integrate real‐world institutional elements
–Narrowed gap between theory and practice
• Deep concern over business cycles and monopoly • Closer integration of economics with other social
sciences
• Emphasized gathering of data
Lasting
Contributions
• Broader perspective of economic analysis • Aggregate approach (Keynesianism) • Reform movements that challenge orthodox
economics are still alive
• Theories about growth and development have
spurred more interest in institutional issues
–Necessarily involve evolutionary and cultural factors
• Even today, only a small penetration into
mainstream economics
Thorstein Bunde Veblen
(1857
‐
1929)
• The leisure class
–Conspicuous consumption: upper class engages in
wasteful consumption in order to parade wealth
•Particularly true for non‐working women
•Working class try to emulate this behavior
•Upper class has to step up consumption when middle class
catches up
–Propensity to avoid useful work: must engage in
wasteful or useless tasks to maintain social status
•Athletic achievements show off disregard for others
–Conservatism: sheltered leisure class acts to retard the
progress of social change
Attacks
on
Neoclassical
Economics
• Classical: private consumption and allocation maximizes welfare
–Veblen: consumption of leisure class is wasteful, so government can raise overall welfare
•Process of consumption and retaliation
• Clark’s equilibration of factor payments is useless because it fails to
consider dynamics
• Hedonistic, utility‐maximizing model is inappropriate because of
constant external forces
• Attacked neoclassicists for support of the present distribution of
wealth
–Economics engineered to defend businesses and to justify private property and property incomes
• Theory of perfect competition is inappropriate given the growth of
monopoly power
Workmanship
• People have an instinct to perform useful work and do not
dislike work in reasonable amounts
–Human instinct for work and providing for dependents
–Interests of artisans (useful production) aligns with interests of
community
• Large enterprises are more interested in profit than in
production: breaks alignment of business interests and
community interests
–Production is a means to profit will be lowered if profit will
increase as a result
–Absentee owners manipulate market by reducing output and
thus keeping the price inflated
Credit
•
Firms
can
use
credit
as
a
competitive
device
to
raise
profits
in
the
short
‐
term
–But once allfirms adopt this, aggregate profits are
reduced by the amount of the interest payments
•
According
to
Veblen,
credit
just
redistributes
capital
around
the
economy
–Problem: can allow for mobilization of labor and
raw materials to raise supply
Business
Cycles
• Credit provision allows for expansion of businesses creates
collateral for even more credit
–Particularly problematic as monopolization occurs
–Eventually, this overextension of credit will burst and cause a period of liquidation
• Reduced output and consolidation of ownership into fewer hands
• Workers do not benefit in booms because wage increases do not
keep pace with price increases
–Once wages rise, profits and capital values fall
• Depression is the normalcondition of a capitalist economy
–Chronic disconnect between capitalization/credit and real productive capacity of the economy
–Can be temporarily offset by speculation, credit expansion, monopoly or wasteful spending to stimulate demand
Conflict
•
Significant
conflicts
arise
naturally
–Industry: productivity versus profit
–Workmanship versus laziness
–Absentee business owners versus community
–Buyers versus monopolists
–Stability versus extension of credit
–Meeting basic needs versus conspicuous
consumption
Resolution
• Veblen was not a socialist
–Condition of workers is improving in absolute terms,
although in relative terms they are less powerful
• Social engineers can potentially direct business
towards common good
–Eliminate credit, sabotage, unearned income
–Both workers and industrialists are motivated by self‐
interest
–Central planner with an instinctive workmanship could
potentially solve economic problems
Wesley
Clair
Mitchell
(1874
‐
1948)
•
Statistical
study
provides
a
firmer
foundation
for
institutionalism
than
Veblen’s
abstraction
•
Studied
business
cycles
based
on
historical
experience
rather
than
abstraction
–Tried to examine causes collectively rather than
identifying a single cause of fluctuations
Business
Cycles
– Regularities
• Monetary causes – business cycles arise not because of
capitalism itself but because economic activities are
carried out by making and spending money
• Wide diffusion – significant interdependence among
firms, deepened by credit market affecting most firms
• Prospects for profit –anticipationof future profits is
more important than present or past profit for
determining movement of business cycle
• Systematic – cycles are an inherent part of the
economy, not a temporary disruption (emphasized
Business
Cycles
• Expansion phase
–Rising wages and profits stimulate consumption and investment
–Inventories replenished and optimism intensifies expansion
–Capital and credit continue to rise
• Stresses to system
–Overhead costs rise
–Sticky costs like rent eventually rise
–Diminishing marginal returns: less efficient workers and
managers need to be employed
–Labor productivity falls because workers are not fearful of losing
their jobs
–Waste rises
–Buyers resist higher prices
Business
Cycles
• Collapse occurs when debtors are unable to pay
back creditors
–Expectations of reduced demand fulfill themselves
–Costs are slow to fall, so profit margins quickly decline
–Investment falls, consumer spending falls and
economy falls into recession
• Recovery
–Costs fall eventually
–More investment in capital
–Rising population sustains consumer demand
–Consumers eventually replace durable goods
Social
Planning
• Business cycles are evidence that automatic
functioning is defective
–Growth of interdependencies
–Durable goods that consumers can stop buying when the
economy is bad
–Farming excessively dependent on markets • National planning can overcome worst features of
business fluctuations while preserving economic liberty
and security
–What to accomplish?
–Fragmented planning is problematic because of
interdependencies
John
Kenneth
Galbraith
(1908
‐
2006)
•
Critic
of
neoclassical
analysis
of
capitalist
system
•
Evolutionary
approach:
need
to
adapt
ideas
to
current
situation
–Conventional wisdom is no longer relevant
–Criticized contemporary relevance of ideas, not
the original creators
–Neoclassical model is easy to teach students and
to refine because it is the status quo
Dependence
Effect
• Gigantic firms createartificial consumer wants – “As society becomes increasingly affluent, wants are increasingly created by the process
by which they are satisfied…Wants thus come to depend on output. In technical terms, it
can no longer be assumed that welfare is greater and an all‐round higher level of
production than at a lower one. The higher level of production has merely a higher level
of wants necessitating a higher level of want satisfaction.”
–Reverse of orthodox formulation, where demand lies with
the consumer and the firm satisfies it
–Galbraith considers formulation of wants to be
endogenous, while neoclassical economics takes wants as
given
–Dependence: production createsdemand
–Implication: underinvestment in public goods relative to
artificially stimulated demand for private goods
•Remedy: sales taxes on consumer goods and services
Theory
of
the
Firm
•
Neoclassical:
firms
maximize
profits
•
Market
sector
:
small
firms
–Profit maximization is a reasonable assumption
•
Planning
sector
:
2000
or
so
firms
produce
about
half
of
the
economy’s
output
–Ownership and day‐to‐day control are divorced
–This management structure may not necessarily
Theory
of
Firm
• Protective purpose– management pursues
survival of the firms
–Managers avoid competing excessively with each
other to meet protective goals
• Affirmative purpose– corporate growth
–Managers’ goal is growth in output, not necessarily
growth in profits
•Opposite of Cournot’s monopoly theory, which implies
output restriction
•Expanding job opportunities for management
•Conditional on sufficient profit to keep shareholders happy
Theory
of
the
Firm
•
Policy
implications
–Abandon antitrust regulation: consolidation is
inevitable and antitrust regulation has not worked
–Public must take control of planning structure
•Prices and wages should be controlled so gains do not
exceed gains in national productivity
•Coordinate economic plans internationally
•Redistribution of income through curbing excessive
salaries, progressive taxes and minimum wages
•Firms in the market sector should merge so that they
can compete with firms in the planning sector
