Inventing New Institutions: The Design Perspective

Abstract

We live in an era of significant changes in the prevailing economic institutions, to a considerable extent in the direction of decentralization. In the West (U.S., U.K., France) steps have been taken toward deregulation as well as privatization or denationalization of public enterprises. In the People's Republic of China, in Hungary, and most recently in the Soviet Union, reforms have been carried out or proposed to move from command to market guidance of economic processes (see, for instance, Kornai). Earlier periods witnessed trends of the opposite type: establishment of regulatory agencies, nationalization of privately owned enterprises, and the substitution of decisions made by central organs of the state for market processes. Hence, although the early development of the design theory owes a great deal to the famous exchanges between Hayek, Lange, Lerner, and Mises, recent events alone justify interest in problems of design. But design problems are not limited to those involving the grand systems for national economies. Indeed, some of the most valuable insights derive from an analysis of the internal problems of managing firms, issues raised by vertical or lateral integration of previously independent units, as well as the comparison of performance characteristics of price versus quantity guidance of production in integrated firms or other economic organizations. Some institutional changes may be viewed as purely evolutionary phenomena, induced (as analyzed by Ruttan) by changes in external factors (technological, political, or other). But often these changes contain an important element of conscious design and produce an institutional framework different from anything that existed before. It may not be incorrect to view the new institutions as invented. Although an invention involves a creative act, the science of economics should provide an analytical framework to aid in the design of new institutions or systems. Traditional economics does not do this. But two recent streams of thought, especially if integrated, can be useful for this purpose. The two are general theories (primarily normative in spirit) of resource allocation mechanisms and more specialized theories (mostly intended to explain observed phenomena) of the organizational structures of economic institutions, especially firms, markets, and hierarchies. Our purpose here is to indicate how these two approaches can be synthesized in order to strengthen each other. To accomplish this we consider, against the background of the general theory of mechanisms, some of the problems raised by the specialized models.