Institutions in the Economic Thought

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The thought that “institutions matter” is currently widely accepted in mainstream economics. However, a range of various ideas and approaches existed until this thought gained recognition. In order to understand the current situation, a brief historical overview is needed. Among the classical economists, Adam Smith was receptive to the historical approach, which inherently involved describing the changing institutional system. Analysing the operation mechanism of the market was only an instrument for Adam Smith to create a normative argument—based on the efficiency of the market—for a given institutional system. Screpanti and Zamagni (2005) reference the interpretation of James Buchanan, Gordon Tullock, and Friedrich von Hayek and go as far as to claim that Smith dealt with the comparison of various institutional structures. David Ricardo vigorously moved towards an abstract, deductive model, which was void of almost any historical or institutional content. John Stuart Mill, belonging to the classical school of economics, and Alfred Marshall, who gave a summary of the neoclassical trend, both returned to the methodology of Smith and combined deductive reasoning with historical description (Landreth and Colander 2002). However, Marshall’s approach concerning the institutions did not become generally accepted in neoclassical economics, but rather the thought—which had already been present in the works of the “founding fathers” (William Stanley Jevons, Carl Menger,1 and Leon Walras)—that economics studies the universally applicable laws concerning the allocation of scarce resources among alternative uses. It is well known that this brief definition of the subject of economics was polished to perfection by Lionel Robbins in his book titled An Essay on the Nature and Significance of Economic Science in 1932.2 In this system of thought, the aim and motivation of human action are exogenous features built on the a priori axiom of rational thinking and profit maximisation. The legal and institutional environment in which decisions are made is also considered exogenous. For Marshall, it was important that his theory provide answers to the questions of economic reality that are relevant in economic policy. The impact of his approach has faded in this respect, however. In neoclassical orthodox economics, Walras’ legacy—which was preoccupied with the internal logic of the equilibrium models—proved to be more powerful. Positivism, the main philosophical, epistemological theory of the era, also fostered the view that theory enjoys certain autonomy as opposed to reality. Pursuant to this approach, the validity of the assumptions of a model is less important than the model’s ability to forecast. This view did not leave much room to take institutions into account (Henley and Tsakalotos 1993).