The rise and fall of American Institutionalism

1. The rise and fall of American Institutionalism ECON 434| Spring 2011

2. What is institutionalism? • Branch of alternative, heterodox economic traditions • Also includes Utopians, Fabian Socialists, and Neo-Marxists • Reaction to rise of neoclassical economics in late 19th/early 20th century • Especially critical of American apologists in the Gilded Age (defenders of laissez faire govt., Social Darwinism, and industrialization; critical of Progressivism, unions and populist causes that emerged to challenge unrestricted big business). • Simon Newcomb, John Bates Clark, William Graham Sumner

3. What is institutionalism? • Emphasis: Economic activity is contingent upon historical, social, and institutional factors • Focus on bounded rationality and bounded self-interest • Precursor to behavioral economics • Sociological emphasis on class, status, and power • i.e. Individuals do what they do to achieve standing in society

4. Thorstein Veblen (1857-1929) • “The hedonistic conception of man is that of a lightning calculator of pleasures and pains, who oscillates like a homogeneous globule of desire ... under the impulse of stimuli that shift him about the area but leave him intact ... He is an isolated, definitive human datum, in stable equilibrium except for the buffets of the impinging forces that displace him in one direction or another ... When the force of the impact is spent, he comes to rest, a self-contained globule of desire as before.” • Highly critical of marginal utility theory and notions of hyper-rational decision making models.

5. Veblen cont. • Theory of the Leisure Class (1899) and Theory of the Business Enterprise (1904) • Class struggle under capitalism: businessmen v. engineers • Sound familiar? • Brokers, managers, and lawyers (businessmen) united in defense of private acquisition; workers (engineers) united by “the discipline of the machine.” • Business exists for the development of the leisure class. • Conspicuous consumption: Desire to buy goods is culturally determined (not price determined). • The rich don’t invest in the economy, they invest in their status • Making goods v. making money • “Parasites”? • Contrast with Locke’s labor theory of value • Bush tax cuts?

6. The snob effect • Conspicuous consumption causes demand curves for high status goods to be upward sloping. • Prices influenced by cultural values • Why? • Psychic income received from showcasing wealth • Consumption of goods acts as a status signal D P Q

7. Veblen cont. • Economics as an evolutionary science • Echoes of Charles Darwin • Cyclical nature to economic development • Economic systems are driven by recurring conflict between groups with a vested interest in the status quo and groups excluded from the benefits the status quo provides • Humans adapt to ever-changing institutions

8. Evolutionary economics • Dynamic technological institutions • Inventions, productions, technology (“machine processes), etc. • Function of humans’ innate “idle curiosity.” • (Relatively) static ceremonial institutions • Social and economic structures • Financial institutions • Property rights

9. Critique of the neoclassical model • This cycle of incessant, unpredictable change makes deterministic orthodox economic models useless. • Constant changes in human behavior and social relations are sparked by constant changes in culture. • Human behavior = instinctive, habitual, curious • Result of the influence ceremonial and technological institutions exert

10. Conspicuous consumption today?

11. Conspicuous consumption and the financial crisis?

12. Conspicuous consumption and the financial crisis?

13. John Rogers Commons (1862-1945) • "...But the smallest unit of the institutional economists is a unit of activity -- a transaction, with its participants. Transactions intervene between the labor of the classic economists and the pleasures of the hedonic economists, simply because it is society that controls access to the forces of nature, and transactions are, not the "exchange of commodities," but the alienation and acquisition, between individuals, of the rights of property and liberty created by society, which must therefore be negotiated between the parties concerned before labor can produce, or consumers can consume, or commodities be physically exchanged..."

14. Commons cont. • The intellectual origin of the movement toward the welfare state. • Advocate of New Deal legislation • Perils of the modern economy require active government intervention

15. Commons cont. • Worked closely with politicians to formulate social policy radical for his time: • Regulation of public utilities • Industrial safety laws • Workers’ compensation • Child labor laws • Minimum wage laws • Unemployment compensation • Collective bargaining • Labor dispute mediation

16. John Kenneth Galbraith (1908-2006) • “Economics is a subject profoundly conducive to cliché, resonant with boredom. On few topics is an American audience so practiced in turning off its ears and minds. And none can say that the response is ill advised.”

17. Galbraith cont. • American Capitalism (1952) • Post-war American success arose not out of getting “prices right” but out of getting “prices wrong”; that is, by allowing industrial concentration to develop in the form of monopolies and oligopolies. • Formula for growth: allows for massive technical innovation. • Sustainable only if there is an emergence of a “countervailing power” to fight against potential abuses/corruption • Trade unions, consumer advocate organizations, active government • Combine oligopolistic power with countervailing instutions

18. Galbraith cont. • The Great Crash, 1929 (1954) • Economic history of the lead up to the Wall Street crash of 1929. • Regulation and deregulation are cyclical Corporate fraud (“the bezzle”) Prosperity Deregulation Economic downturn Regulation

19. Sound familiar? “At any given time there exists an inventory of undiscovered embezzlement in – or more precisely not in – the country’s business and banks. This inventory – it should perhaps be called the bezzle – amounts at any moment to many millions of dollars. It also varies in size with the business cycle. In good times people are relaxed, trusting, and money is plentiful. But even though money is plentiful, there are always many people who need more. Under these circumstances the rate of embezzlement grows, the rate of discovery falls off, and the bezzle increases rapidly. In depression all this is reversed. Money is watched with a narrow, suspicious eye. The man who handles it is assumed to be dishonest until he proves himself otherwise. Audits are penetrating and meticulous. Commercial morality is enormously improved. The bezzle shrinks.”

20. Galbraith cont. • The Affluent Society (1958) • Advertising undesirably inflates consumer demand • Private wealth v. public poverty • Attacks the myth of “consumer sovereignty” and the culturally hegemonic “American way of life.”

21. Modern Institutionalism • ElinorOstrom • Awarded the 2009 Nobel Prize in Economics • Research focus on common pool resources (“the commons”) with an institutionalism/public choice approach • How do culturally diverse societies develop institutional arrangements for managing natural resources that prevent resource exhaustion?

22. Practice #1 The upward sloping Veblenian demand curve implies that prices are often influenced by: • (a) a producer’s inclination to supply more at higher prices. • (b) the spending “habits” and bargain “instincts” of consumers. • (c) technological displacement caused by innovation. • (d) a consumer’s notion of other people’s values.

23. Practice #1 The upward sloping Veblenian demand curve implies that prices are often influenced by: • (a) a producer’s inclination to supply more at higher prices. • (b) the spending “habits” and bargain “instincts” of consumers. • (c) technological displacement caused by innovation. • (d) a consumer’s notion of other people’s values.

24. Practice #2 John Commons was not an advocate of: (a) worker compensation for on-the-job injuries. (b) peaceful collective bargaining. (c) unemployment insurance. (d) the marginal productivity theory of income distribution.

25. Practice #2 John Commons was not an advocate of: (a) worker compensation for on-the-job injuries. (b) peaceful collective bargaining. (c) unemployment insurance. (d) the marginal productivity theory of income distribution.

26. Practice #3 John Kenneth Galbraith believed that the effect on demand of pervasive and exorbitant advertising is: • (a) inconsequential because consumers are driven solely by self-interest. • (b) insignificant because consumers become numb after being inundated with so many marketing gimmicks. • (c) beneficial in properly aligning true market quantity supplied and quantity demanded. • (d) to lead many people to believe they need things they really don’t. • (e) to shift demands from private goods to excessive reliance on social and public goods.

27. Practice #3 John Kenneth Galbraith believed that the effect on demand of pervasive and exorbitant advertising is: • (a) inconsequential because consumers are driven solely by self-interest. • (b) insignificant because consumers become numb after being inundated with so many marketing gimmicks. • (c) beneficial in properly aligning true market quantity supplied and quantity demanded. • (d) to lead many people to believe they need things they really don’t. • (e) to shift demands from private goods to excessive reliance on social and public goods.

28. Resources • Class notes 24 • Test bank 10