Opening Address to the Annual Conference
International Society of New Institutional Economics
Washington, DC, USA
September 17, 1999
It is a great pleasure for me to take part in the Third Annual Meeting of the International Society for New Institutional Economics. It is a great occasion for all of us, and for economics. What I have decided to talk about is the task of our Society. What I will be giving you are my personal views. They may not commend themselves always to other officers of the Society. Indeed, I’m fairly sure they won’t. But there are two distinctive features of our Society about which no one will dispute.
First of all, we are a society with a mission and that mission is to transform economics. When I speak of economics, I have in mind mainstream economics as expounded in countries in the West and particularly what is called microeconomics or price theory. Our mission is to replace the current analysis with something better, the New Institutional Economics as it has been termed by our President-elect, Oliver Williamson. I have no doubt that we will accomplish our mission. But there is still the question of how we are going to do it. This I will discuss later.
The second distinctive feature of our Society is that it is an international society. It is not an American society that foreigners can join. Our Society is truly international as is made clear by the countries of origin of presenters of papers at this meeting as well as their subjects, and of course, by the composition of our membership. I have no doubt that our international character will prove to be a great source of strength. We will be able to draw on the experience and the talent in countries all over the world. This is particularly important for the New Institutional Economics since if we are to understand the effect of different institutional arrangements on the working of the economic system, the obvious way to do this is to enlarge our studies beyond a single country and to compare what happens in different countries with differing arrangements.
It is a great pleasure to me that, through the generosity of the Earhart Foundation, so many from countries in transition from a command to a market economy have been able to attend this meeting. Theirs is an unenviable task but one which merits our support. I am reminded of a tale told to me by Frank Paish, a colleague at the London School of Economics. He was once walking in the country in England and he asked a countryman how he could get to a certain place. The countryman replied, after considerable thought, "If I were going there, I wouldn’t start from here." That’s how I feel about the plight of our members in the countries in transition to a market economy. We are certainly going to learn a great deal from their experience about what the requisites are for an efficient market system. And I hope that in some way our discussions will be of help to those in countries in transition who have to tackle this formidable task.
Let us return to our mission. Economics, over the years, has become more and more abstract and divorced from events in the real world. Economists, by and large, do not study the workings of the actual economic system. They theorize about it. As Ely Devons, an English economist, once said at a meeting, "If economists wished to study the horse, they wouldn’t go and look at horses. They’d sit in their studies and say to themselves, ‘What would I do if I were a horse?’" And they would soon discover that they would maximize their utilities. What has happened, as Harold Demsetz explained, is that economists have been fascinated by Adam Smith’s great insight — that the economic system could be coordinated by a system of prices without the need for the existence of a plan. And it is fascinating. As Hayek has said, it mobilizes that diffused knowledge that exists throughout the world. If people in Singapore learn something about a commodity that causes them to want to use more of it than they have in the past, they enter the market, the additional demand drives up the price, and consumers in Sweden, Spain, and other places reduce their consumption so that consumers in Singapore, of whom they are completely unaware, may consume more.
But this is not the end of the story. The higher price which emerges for this commodity makes it profitable for resources previously engaged in the production of quite different commodities to be used to increase its supply. This decrease in the supply of these quite different commodities increases their price, and consumers of these commodities in Germany, the United States and Burkina Faso reduce their consumption of them, which moderates the price rise experienced by consumers in Sweden and Spain and makes possible a smaller reduction in their consumption than would otherwise be the case. It’s a wonderful system. Roy Harrod, who attended Edgeworth’s
If we are to understand the effect of different institutional arrangements on the working of the economic system, the obvious way to do this is to compare what happens in different countries with differing arrangements.
lectures, used to tell how Edgeworth, when he reached the point in his lectures at which price equated supply and demand, would pause so that he and the class could savour this magic moment. But by stopping their analysis at this point, economists fail to answer one fundamental question: what determines what goods and services are traded on markets and therefore priced? What determines the flow of real goods and services and therefore the standard of living?
We can start to answer this question by going back to Adam Smith. He explained that the productivity of an economic system depends on specialization (he called it the division of labour) but as is obvious there can only be specialization if there is exchange, and whether exchange is possible depends on the costs of exchange (transaction costs as they have come to be called). Here we have to leave Adam Smith since, apart from his discussion of why the use of money is better than barter, he does not, if my memory serves me, discuss the subject. However, we know that the costs of exchange depend on the institutions of a country — the legal system (property rights and their enforcement), the political system, the educational system, the culture. These institutions in effect govern the performance of the economic system. This is the basic reason why the New Institutional Economics is so important and why, if we are to achieve our objective, we have to enlist the help of lawyers, political scientists, sociologists, anthropologists and other social scientists. This, of course, is what we are going to do in our Society. The entry of economic analysis into the other social sciences has been termed economic imperialism. We are engaged in a completely different enterprise — enlisting the help of those in the other social sciences to enable us to understand better how the economic system works.
The need for a shakeup in economics is demonstrated, so far as I am concerned, by its static character. It is still the subject that Adam Smith
Economists fail to answer one fundamental question: What determines what goods and services are traded on markets and therefore priced? What determines the flow of real goods and services and therefore the standard of living?
created. We have formalized it, elaborated it, corrected errors, changed its emphasis, but essentially it is the same subject. Physics has been completely transformed since Newton and chemistry since Lavoisier, but not economics since Smith.
The static character of economics can be made crystal clear by comparing economics and biology. Economists take pride in the fact that Darwin was influenced by Malthus — and he was influenced also, as I learned from Stephen Jay Gould, by Adam Smith. But contrast what has happened in biology since Darwin with what has happened in economics since Adam Smith or Malthus. Biology has been transformed. In The Economist earlier this month (the issue of September 4th) it was stated: "Biology is rapidly becoming as ‘hard’ a science — in all senses — as physics." Biologists have not rejected Darwin — evolution is still the core of the subject — but they look at biological processes in a completely different way. Similarly, I am not rejecting Adam Smith. We should not abandon his great insights. But I do advocate changes that will ultimately transform economics from a "soft" science into a "hard" science and in bringing this about I expect our Society to play a major role. It may seem strange that I am hoping to transform a soft science into a hard science by linking it with subjects which by repute are even softer than economics. But there is no other way. We have to take account of the effects of the legal system, the political system, etc. And if my impression is correct, their theories often have a stronger empirical base than is usual in economics. Of course, one would also hope that those social scientists attracted to the New Institutional Economics would be those who believed in rigour. To those who may feel offended by what I have said about the other social sciences, I would like to quote to you what I said about law in the Simons lecture on "Law and Economics at Chicago" in 1992. "Ernest Rutherford said that science is either physics or stamp collecting, by which he meant, I take it, that it is either engaged in analysis or in operating a filing system. Much, perhaps most, legal scholarship has been stamp collecting. Law and economics is likely to change all that…."
The great triumph of modern biology was the discovery by Watson and Crick of the structure of DNA. But to think of its discovery simply in terms of their work is to ignore that it was the culmination of the work of many people over many years. Horace Judson at the end of his survey of the history of modern biology has this to say: "Biology has proceeded not by great set-piece battles, but by multiple small-scale encounters — guerrilla actions — across the landscape. In biology, no large-scale, closely interlocking, fully worked out, ruling set of ideas has ever been overthrown…. Revolution in biology, from the beginnings of biochemistry and the study of cells, and surely in the rise of molecular biology and on to the present day, has taken place not by overturnings but by openings-up."1
I think this resembles exactly what I believe will happen in economics. The influence of the New Institutional Economics will be exerted in the various sub-disciplines of economics. Guerrilla actions will take place, which will result in the New Institutional Economics dominating first one and then another of these sub-disciplines, as indeed is beginning to happen. When this process has gone on for some time, the leaders of our profession will find themselves Kings without a Kingdom. There will be no overturning, but in Judson’s words, an opening-up. We will not replace price theory (supply and demand and all that) but will put it in a setting that will make it vastly more fruitful.
I think we can take heart from what Francis Crick has said about developments in modern biology in his book What Mad Pursuit. I will quote some of the things he has said. They seem to me very relevant to any discussion of our plans and projects because we are dealing with a subject which has been extraordinarily successful in modern times, in contrast to economics, where the performance has, in my view anyway, been somewhat dismal. I like what Crick says because he stresses the pitfalls in theoretical approaches and the need for empirical work.
As you probably know, progress in biology was greatly helped by the movement of physicists into molecular biology. This is what he says: "In nature, hybrid species are usually sterile, but in science the reverse is
In economics our choice of theories will only be fruitful if guided by empirical work.
often true. Hybrid subjects are often astonishingly fertile, whereas if a scientific discipline remains too pure it usually wilts."2 This bodes well for us since the New Institutional Economics is a hybrid subject if ever there was one. So this should give us a lot of encouragement. Certainly the entry of economists into the study of law has had a very beneficial effect. And I would expect that the intermingling of these other social sciences with economics would exert a powerful, and beneficial, influence on the development of economics.
Crick also says, "In research the frontline is almost always in a fog."3 This is inevitable since the frontline is always dealing with unsolved problems, with
We do not know, for the most part, what is true or what is false, what is significant and what is not, nor the character of the interrelations of various parts of the institutional structure of the economy. It is our aim to find out.
the data either unavailable or seemingly inconsistent. So we shouldn’t feel discouraged if we are in a fog. The job, after all, of the frontline is to dispel it. Of course, to be in a fog is not necessarily a sign that you are in the frontline.
Then again Crick says: "[I]t is virtually impossible for a theorist, by thought alone, to arrive at the correct solution to a set of biological problems…. The best a theorist can hope to do is to point an experimentalist in the right direction...."4 This is, for example, what the concept of transaction costs does. It does not of itself solve any problems but it does suggest what should be looked at to find the solutions.
Crick also says this: "It is all too easy to make some plausible simplifying assumptions, do some elaborate mathematics that appear to give a rough fit with at least some experimental data, and think one has achieved something. The chance of such an approach doing anything useful, apart from soothing the theorist’s ego, is rather small...."5 I think you know why I like this quotation.
Finally: "The basic trouble is that nature is so complex that many quite different theories can go some way to explaining the results....[W]hat constraints can be used as a guide through the jungle of possible theories? It seems to me that the only useful constraints are contained in the experimental evidence."6 What this comes down to in economics is that our choice of theories will only be fruitful if guided by empirical work.
What does all this mean for our Society? How are we to find our way through the mass of information such as is revealed by the papers presented at this meeting? How are we to emulate the triumphs of modern biology? How are we to convert the New Institutional Economics into a hard science? My answer
To discover even roughly how the institutional structure of production and exchange works will take a long time – but it will be a most interesting journey.
to these questions is essentially Hayekian. I do not think that as a society we should attempt to plan what members should do. We do not know, for the most part, what is true or what is false, what is significant and what is not, nor the character of the interrelations of various parts of the institutional structure of the economy. It is our aim to find out. We can make suggestions. We can help. But to reach our goal, it is better that members should be free to choose the problems they work on. And because of this we should be tolerant of opposing views. Sidney Webb, a founder of the London School of Economics, a socialist and later someone who was taken in by Joseph Stalin (in which he had a large company), said, and he was a good scholar, that research consisted of shooting arrows into the air to find out where the targets were. This means that we should leave people free to shoot their arrows into the air, and those arrows that find no targets are nonetheless extremely useful.
Of course, to discover even roughly how the institutional structure of production and exchange works will take a long time — but it will be a most interesting journey. But we do need to create an esprit de corps to sustain us on the journey. In my talk at the first meeting of our Society, I quoted Tolstoy’s description in War and Peace of Kutuzov, who led the Russian troops in battle against Napoleon’s invading army. I will do so again:
From long years of military experience he had learned, and with the wisdom of old age he had recognized that one man cannot guide hundreds of thousands of men struggling with death, that the fate of battles is not decided by the orders given by the commander-in-chief, nor the place in which the troops are stationed, nor the number of cannons, nor of killed, but by that intangible force called the spirit of the army, and he followed that force and led it as far as it lay in his power.
Our success does not depend on the number of papers written nor the number of citations nor the number of prizes gained by our members. It depends on the spirit of the Society. We have made a good start.
1 Horace Freeland Judson, The Eighth Day of Creation: Makers of the Revolution in Biology, New York: Simon and Schuster (1979), p. 612.↩
2 Francis Crick, What Mad Pursuit: A Personal View of Scientific Discovery, New York: Basic Books (1988), p. 150.↩
3 Ibid., p. 35.↩
4 Ibid., pp. 109-110.↩
5 Ibid., pp. 113-114.↩
6 Ibid., p. 141.↩
Note: This speech was the opening address to the annual conference of the International Society for New Institutional Economics, delivered in Washington, D.C. on September 17, 1999. It is reprinted with permission from the Newsletter of the International Society for New Institutional Economics, Volume 2, Number 2 (Fall 1999). http://www.isnie.org