Journal of Economic Literature Vol. XXXVIII (September 2000) pp. 595–613 Williamson: The New Institutional Economics The New Institutional Economics: Taking Stock, Looking Ahead OLIVER E. WILLIAMSON1 1. Introduction velopment (1994, p. 75). In considera- tion, however, of the “splendid plausi- OPEN MY DISCUSSION of the new in- bility of error” to which Lord Acton re- I stitutional economics with a confes- fers,2 we need to sort the sheep from sion, an assertion, and a recommenda- the goats. That is accomplished by ask- tion. The confession is that we are still ing each would-be theory to advance re- very ignorant about institutions. The as- futable implications to which the data sertion is that the past quarter century are applied. has witnessed enormous progress in the R. C. O. Matthews, in his presidential study of institutions. The recommenda- address to the Royal Economic Society tion is that, awaiting a unified theory, we in 1986, pronounced that “the econom- should be accepting of pluralism. ics of institutions has become one of the Chief among the causes of ignorance liveliest areas in our discipline” (Mat- is that institutions are very complex. thews 1986, p. 903). Such a pronounce- That neoclassical economics was dismis- ment was a surprise to most of the pro- sive of institutions and that much of or- fession. Hadn’t institutional economics ganization theory lacked scientific am- long since been relegated to the history bitions have also been contributing of economic thought? Whence the vitality factors. As to progress, that is what to which Matthews made reference? most of this paper is about. There being Matthews’ response was that the new many instructive lenses for studying institutional economics (NIE) turned on complex institutions, pluralism is what two propositions. First, “institutions do holds promise for overcoming our matter”; and second, “the determinants ignorance. of institutions are susceptible to analy- Speaking for myself, I subscribe to sis by the tools of economic theory” Jon Elster’s view that we work predomi- (Matthews 1986, p. 903). The second of nantly on partial mechanisms rather these is what distinguishes the NIE, it than general theories at this stage of de- being the case that institutional econo- mists of all kinds—old and new—are 1 University of California, Berkeley. owilliam@ haas.berkeley.edu. This paper was first presented unanimous in the view that institutions at the third annual meeting of the International matter. Society for New Institutional Economics in Wash- Indeed, although both the older and ington, DC in September 1999 in my capacity as president-elect. Helpful comments received there newer styles of institutional economics and from Bengt Holmstrom and John McMillan are gratefully acknowledged. 2 As quoted in Daniel Boorstin (1998, p. 281). 595 596 Journal of Economic Literature, Vol. XXXVIII (September 2000) subscribe to many of the same good ideas, 2. Four Levels of Social Analysis a progressive research program requires more. Kenneth Arrow speaks to the It will be useful for purposes of per- transformation as follows (1987, p. 734): spective to consider the four levels of social analysis that are distinguished in Why did the older institutionalist school fail Figure 1.3 The solid arrows that con- so miserably, though it contained such able nect a higher with a lower level signify analysts as Thorstein Veblen, J. R. Commons, and W. C. Mitchell? I now think that . that the higher level imposes con- [one of the answers is in the] important spe- straints on the level immediately below. cific analyses . of the New Institutional The reverse arrows that connect lower Economics movement. But it does not consist with higher levels are dashed and signal of giving new answers to the traditional ques- feedback. Although, in the fullness of tions of economics—resource allocation and the degree of utilization. Rather, it consists time, the system is fully interconnected, of answering new questions, why economic I mainly neglect these feedbacks. The institutions emerged the way they did and NIE has been concerned principally not otherwise; it merges into economic his- with levels 2 and 3. tory, but brings sharper [microanalytic] . The top level is the social embedded- reasoning to bear than had been customary. ness level. This is where the norms, cus- There is no question that the NIE toms, mores, traditions, etc. are located. has grown in stature and influence over Religion plays a large role at this level. the fourteen years since Matthews’ pro- Although Level 1 analysis is undertaken nouncement. Initial skepticism has by some economic historians and other gradually given way to respect—it being social scientists (E. C. Banfield 1958; the case that economists are very prag- Robert Putnam, Robert Leonardi, and matic people. Tell them something dif- Raffaella Nanetti 1993; Samuel Hunt- ferent and consequential about phe- ington 1996; and Victor Nee 1998), nomena that are of interest to them and Level 1 is taken as given by most insti- demonstrate that the data are corrobo- tutional economists. Institutions at this rative: that will get their attention. The level change very slowly—on the order NIE has progressed not by advancing an of centuries or millennia—whereupon overarching theory but by uncovering Douglass North poses the query, “What and explicating the microanalytic features is it about informal constraints that gives to which Arrow refers and by piling them such a pervasive influence upon block upon block until the cumulative the long-run character of economies?” value added cannot be denied. (1991, p. 111). The NIE, moreover, will not stand North does not have an answer to still. Even as institutional economics is that perplexing question, nor do I. The being incorporated within orthodoxy, concept of “embeddedness,” both at the new opportunities and challenges await. level of society and in the context of on- Both unfinished business and new proj- going network relations, has been ad- ects yet to be undertaken await the new vanced to help explicate these issues millennium. (Granovetter 1985). The vast literature I begin with a sketch of four levels of on culture (Paul DiMaggio 1994) is also social analysis, next turn to some of the pertinent. Neil Smelser and Richard good ideas out of which the NIE works, Swedberg discuss these and related issues and then examine some of the applica- in their introduction to the Handbook tions to which the NIE has been put. 3 This framework was first set out in Williamson Concluding remarks follow. (1998). Williamson: The New Institutional Economics 597 of Economic Sociology, where they ob- mainly spontaneous origins—which is to serve that different kinds of embedded- say that deliberative choice of a calcula- ness—cognitive, cultural, structural, tive kind is minimally implicated. Given and political—should be distinguished, these evolutionary origins, they are and conclude that “the concept of em- “adopted” and thereafter display a great beddedness remains in need of greater deal of inertia—some because they are theoretical specification” (1994, p. 18). functional (as with conventions); others An identification and explication of take on symbolic value with a coterie of the mechanisms through which informal true believers; many are pervasively institutions arise and are maintained linked with complementary institutions would especially help to understand the (formal and informal), etc. Be that as it slow change in Level 1 institutions. I may, the resulting institutions have a conjecture in this connection that many lasting grip on the way a society con- of these informal institutions have ducts itself. Insular societies often take 598 Journal of Economic Literature, Vol. XXXVIII (September 2000) measures to protect themselves against the response to such opportunities is “alien values.” often one of “failure.” Absent such a The second level is referred to as the window, major changes in the rules of institutional environment. The struc- the game occur on the order of decades tures observed here are partly the prod- or centuries. The European Union, uct of evolutionary processes, but de- for example, has been “in progress” for sign opportunities are also posed. Going fifty years and is still in early stages of beyond the “informal constraints (sanc- development. tions, taboos, customs, traditions, and What is often referred to as Positive codes of conduct)” of a Level 1 kind, we Political Theory (PPT) is concerned now introduce “formal rules (constitu- with working out the economic and po- tions, laws, property rights)” (North litical ramifications of Level 2 features. 1991, p. 97). This opens up the oppor- To be sure, such research also has les- tunity for first-order economizing: get sons for the normative design of better the formal rules of the game right. polities. Like the NIE of which it is a Constrained by the shadow of the part, however, PPT is predominantly an past, the design instruments at Level 2 exercise in positive analysis. The object include the executive, legislative, judi- is to better understand how things cial, and bureaucratic functions of gov- work—warts and all. The research prod- ernment as well as the distribution of uct of PPT scholarship has been noth- powers across different levels of gov- ing less than auspicious, which has been ernment (federalism). The definition good for both political science and the and enforcement of property rights and NIE. of contract laws are important features. Much of the economics of property Although such first-order choices are rights is of a Level 2 kind. Such re- unarguably important to the economic search flourished in the 1960s. A strong productivity of an economy (Nathan version of the argument is that “a pri- Rosenberg and L. E. Birdzell 1986; vate-enterprise system cannot function Ronald Coase 1992; North 1994; Brian properly unless property rights are cre- Levy and Pablo Spiller 1994; Mancur ated in resources, and, when this is Olson 1996; Witold Henisz 1998) cumu- done, someone wishing to use a re- lative change of a progressive kind is source has to pay the owner to obtain it.