Gloomy punters, dismal science and neworacles

Institutions in Economics
May 26, 1995

The counterpart of the Labour Party's clause four in economic theory is the belief that has held unquestioned sway in the economics profession throughout the western world for the past 50 years, namely that by mimicking the methods of the natural sciences (and in particular, the physical sciences), economics could hope to achieve the same spectacular results. This was, and is, a grave mistake. The nature of the phenomena under investigation in the social sciences and in the natural sciences are fundamentally different, and therefore require different methods of analysis. So, far from being "scientific" as its proponents hoped, simply to apply unthinkingly the methods of the physical sciences to social phenomena is itself an unscientific procedure.

The consequences of this misconception have been two-fold. First, the basic principles of the subject as re-stated at the beginning of the century by Marshall were subjected to a process of increasing refinement and formalisation, according to which all elements of a non-quantifiable nature, such as historical, psychological and institutional factors were excluded from theoretical analysis. The result was an elegant structure of theory, which was the envy of all the other social sciences.

It was also a theoretical structure which was quite barren, in the sense that it could not and cannot offer any understanding of most of the important phenomena of economic activity in the contemporary world. During the process of mathematical formalisation the baby had been thrown out while the bath water was retained.

It is true that the apparatus was sometimes deployed to address questions of topical importance from the point of view of government policy. The result was invariably a display of what Schumpeter christened "the Ricardian Vice". That is to say, one small aspect of the issue under study was isolated, that one which was amenable to the application of some part of the theoretical apparatus. The analysis was then applied, and the results hailed as a guide to policy action. All the other aspects of the issue were neutralised or dismissed.

Four successive election defeats have borne in upon its most committed supporters the need for the Labour Party to question its apparently fundamental beliefs. Likewise, there has been a long decline of economics in public esteem to the point where the profession has now become as much the butt of popular jokes in this country as the life assurance salesman has long been in the United States. The turning away of government and business from professional economists to merchant bankers and management consultants for advice has been marked.

Consequently, there has arisen a groundswell of discontent within the profession which has expressed itself in a revival of interest in thinking about the part which institutions play in economic activity. This has been indicated by the publication of an increasing number of books and articles about institutional economics. Many of these have wisely begun by going back to the history of economic thought, while others have less wisely sought to represent institutions within an evolutionary theoretical framework drawn from the methods of the biological rather than the historical sciences.

The book under review falls into the former category; it looks at the work of a number of economists whose names have been associated with writings on institutional issues, and divides them into two camps which the author calls the "old institutional economics" (Veblen, Mitchell, Commons and Ayres) and the "new institutional economics". The new group includes such names as Coase, Demsetz, Alchian, and Schotter.

The author proceeds to a systematic review of these writings on institutional issues, but it is a review of method rather than of substance. Method is divided into five themes, formalism, individualism, rationality, evolution and efficiency, one theme per chapter.

The author's approach in each chapter is to try to identify the common methodological features of the older school and contrast them with common features in the new school. As he is candid enough to admit, this is not an easy task given the diversity of the work under review. The result is that he is forced to conclude at the end of each chapter that there is some merit in both points of view. Overall, the book has really not much more to say than that "the traditional dichotomies are best thought of as representing methodological or theoretical problems". Thus the reader will close the book better informed but none the wiser than he was at the beginning.

Within its own limited terms, however, the book succeeds very well. Malcolm Rutherford writes clearly and has no axe to grind. Much of the material has been published previously, but this has not been allowed to disturb the presentation.

As the author points out, the subject of institutions in economics involves the analysis of very complex systems and there are great methodological difficulties. What is required at this stage in the development of the topic, however, is creativity rather than taxonomy. Students of economics require the inspiration of new ideas.

Nothing is more dispiriting than tiresome disputes on questions of method. Disputes between so-called Keynesians and Monetarists have done as much to bring the profession of economics into disrepute as prolonged infighting has damaged the reputation of the Labour Party. It is time for a fresh start based on truly fundamental principles.

David Simpson is a professor of economics employed by Standard Life Assurance.

Institutions in Economics: The Old and the New Institutionalism

Author - Malcolm Rutherford
ISBN - 0 521 45189 2
Publisher - Cambridge University Press
Price - £30.00
Pages - 181

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