Individuals, Organizations, Institutions: Empirical Stakes.

1. Individuals, Organizations, Institutions: Empirical Stakes. Claude Parthenay University of Cergy-Pontoise EconomiX (ParisX)

2. Introduction • Many paragdigms How to make choices??? • No consensus inside a same paradigm • The construction of empirical tools to understand how the economic world work.

3. Contents of the presentation • Origins of empirical stake • Analytical tools to understand articulation between individual agents, organizations, institutions? • Why is it difficult to choose between different paradigms? • 2. Rationality, intentionality and the construction of rules • Intentionality is one of the most controversial concept. What is the state of the art about this question?

4. 1. Origins of empirical stakes 1.1. The distinction between rules of the game and players 1.2 What must be enlightened? Rules of the game or interaction between individuals? 1.3. Explanation by rules or explanation by intentionality: the “once upon a time” economic stories. 1.4. The uncertainty assumption and its consequences for economic analysis

5. 1. Origins of empirical stakes 1.1. The distinction between rules of the game and players 1.2 What must be enlightened? Rules of the game or interaction between individuals? 1.3. Explanation by rules or explanation by intentionality: the “once upon a time” economic stories. 1.4. The uncertainty assumption and its consequences for economic analysis

6. What kinds of analytical tools? North 1990 Players Rules of the game - rules of the game - response to the institutional structure “As I have defined institutions they could include organizations since organizations also provide a structure to human interaction” [North 1993, p. 245] “Organizations are a response to the institutional structure of societies, and, in consequence, the major cause of the alteration of that institutional structure” [North 1993, p. 254]

7. What kinds of analytical tools? First conclusion It’s necessary to make a distinction between players and rules of game to understand the links between individuals, organizations and institutions. Nevertheless, organizations are a way to respond to environmental institutional rules to use at best as possible this environment or to construct new rules when formal rules’ enforcement is problematic.

8. 1. Origins of empirical stakes 1.1. The distinction between rules of the game and players 1.2 What must be enlightened? Rules of the game or interaction between individuals? 1.3. Explanation by rules or explanation by intentionality: the “once upon a time” economic stories. 1.4. The uncertainty assumption and its consequences for economic analysis

9. Human being and social rules determine individual behaviors 1 Interactions between individuals construct 2 A mix of the two propositions 3

10. Social rules determine individuals behaviors A strong holistic analysis implies behaviors deterministically dependent of institutions Methodological holism implies “the presupposition that individuals are considered as elements or components of some other entity, (…). Therefore, in order to analyze human actions and interactions and the events generated, special attention must be paid to (…) entities (groups, associations, corporations, political parties, churches, states, etc.)” [Toboso 2001, p. 767]

11. Human being and social rules determine individual behaviors 1 Interactions between individuals construct 2 A mix of the two propositions 3

12. If individual behaviors aren’t reducible to collective entities… => What is intentionality (beliefs and mental models of an individual) ? Intentionality => a reflection on rationality • Unlimited or bounded rationality? • Are there different degrees of rationality’s limitation? • Does the economic agent have only selfish behaviors?Is it necessary to take in account altruistic behaviors? To escape from strong holism => To take in account intentionality

13. 1. Origins of empirical stakes 1.1. The distinction between rules of the game and players 1.2 What must be enlightened? Rules of the game or interaction between individuals? 1.3. Explanation by rules or explanation by intentionality: the “once upon a time” economic stories. 1.4. The uncertainty assumption and its consequences for economic analysis

14. Two archetypal “once upon a time” stories to link individual agent and collective rules In the first story: “there were individuals with reasonably structured and coherent preferences, with adequate cognitive algorithms to solve the decision-action problems at hand, and (in most cases) with self-seeking restrictions on preferences themselves”. In this story “preferences, endowments and given technologies (of production and exchange)” are the most important phenomena to explain economic world “while ‘institutions’ ‘organizations’ are derived entities”. [Dosi 1995, p. 3] In the second story: “there were immediately factors of socialization and preference-formation of individuals, institutions like families shaping desires, representations and, possibly, cognitive abilities.” “Here ‘institutions’ are the primitives, while ‘preferences’ and the very notion ‘rationality’ are derived entities” [Dosi 1995, p. 3]

15. Is it possible to choose between the two “once upon a time” stories ? • Is it possible to subscribe to the rules-of-the-game view? • The logical infinite regression of the rules-of-the-game view - Institutions can’t be result of the mere interaction of individual agents “If one subscribes to the rules-of-the-game view, the one must immediately face the issues of where and how the rules originate, as well as how the rules are applied: e.g. in the polity outside the economic domain or, theoretically, in a meta game (…) Thus, the problem of infinite regression seems bound to arise” [Aoki 1998, p. 5]. it is impossible to think a free-institution world for two reasons: 1) to think a free-institution world it’s necessary to create endogenously and simultaneously all institutions; 2) even if individual agents have a strong rationality in a repeated game, the problem of multiple equilibria arises. Indeed, convergence toward equilibrium (an institution, which gives rise to behaviors’ regularity) can’t be realized without a ‘shared belief’ (an other institution).

16. It’s logically impossible to choose between the two « once upon a time » story. Consequences on empirical scholars? The question of the origin of rules is a false question in the sense that we shall never have the solution to this question. But, we know that economic agents are always confronted with institutions. And, in many situations, economic agents in the face of existing institutions must take in account these institutions.

17. Individuals agents are always confronted with institutions

18. The speed of change at each level The rules of the highest level can be a constraint for the choice at lowest level Choice is constrained but it’s is also more simple to choose. Institutions are a way to inform agent on the set of possibilities.

19. Are Williamson’s speeds of change right? “Societies make conscious efforts to instill some norms into their members, enlisting the help of parents, teachers, media, and leaders of opinion for this purpose. (…) This process of social conditioning and education can respond to changing needs much faster than the evolutionary timescale. [Dixit 2004, p. 7] “there are important feedbacks from level 3 to level 2, therefore they should be studied jointly. [Dixit 2004, p. 7]

20. What kind of rationality to understand interactions? “The failure of markets to emerge, particularly in transition economies, revealed the fragility of this assertion. Markets do not necessarily spontaneously emerge in response to opportunities for profitable exchange” [Greif 2006, p. 56] “the fact that markets are not self-enforcing and depend on customary rules for creating trust” [Jones 2006, p. 5] Very often, selfish interest is not the only one cause of behaviors. Trust, honesty and so on can have effects on individual behaviors. exchange between agents is not a spontaneous phenomenon following transaction cost theory, rules’ enforcement is not spontaneous. At three and four levels, agents are essentially selfish agents who interact with other selfish agents “opportunistic agents are given to self-interest with guile” Williamson

21. Conclusion on 1.3 Considering all economic activities always work within rules (institutions) has two important consequences for empirical economic studies: • The existing rules enlighten what it’s possible to do. • If economic interactions aren’t spontaneous phenomena, then the question “what exactly are the nature of the rules?” impacts empirical studies. Are the rules routines? How do you construct routines? How do you change the rules? Are there rules more efficient than others for successful, or growth of economy? How is it possible to introduce new rules?

22. 1. Origins of empirical stakes 1.1. The distinction between rules of the game and players 1.2 What must be enlightened? Rules of the game or interaction between individuals? 1.3. Explanation by rules or explanation by intentionality: the “once upon a time” economic stories. 1.4. The uncertainty assumption and its consequences for economic analysis

23. The assumption of uncertainty and its consequences Uncertainty is a situation in which anticipations come from inference and not from probabilistic calculations. “uncertainty according to Knight was a condition in which no probability distribution exist” uncertainty is not risk. For Knight “risk was a condition in which it was possible to derive a probability distribution of outcomes so that one could insure against such a condition.” [North 2005, p. 13]. Why uncertainty? Our mental constructions of the world… “We perceive the world before we react to it, and we react not to what we perceive, but always to what we infer” (Knight 1921, p. 201) … are imperfect … “We do not perceive the present as it is and in its totality, nor do we infer the future from the present with any high degree of dependability, nor yet do we accurately know the consequences of our own actions” (Knight, p. 202). …because, it’s impossible for an individual to go out his/her own vision of the world to examine the “real” world. An individual always looks at the world with his mental models, so he will never know what exactly the “real” world is. “To understand decision making under such conditions of uncertainty, we must understand the relationships of the mental models that individuals construct to make sense out of the world around them”. [Denzau and North 1994]

24. The uncertainty in the world of economists Economists know the world through there tools. They never have a perfect map of the world. Deductive reasoning Logical model Reality Economic reasoning We don’t know what is exactly reality Inductive reasoning Inductive model Reality Possibility of counter example

25. The choice between several paradigms Your choice to follow one paradigm comes from your utter conviction that the economic phenomenon you want to explain is better enlightened by this one paradigm. As Mintzberg tells us: “All theories are false, because all abstract from data and simplify the world they purport to describe; Our choice, then, is not between true and false theories so much as between more and less useful theories. And usefulness, to repeat, stems from detective work well done, followed by creative leaps in relevant directions.” Mintzberg 1979 ASQ, p. 384.

26. First point: Conclusion 1 We always are in a world in which institutions, organizations, and individuals interact. What kind of interactions? Role of institutions? Role of individuals? Intentionality?

27. First point: Conclusion 2 Economic agents infer from mental models infer What is a more realistic analysis? Economists No proof by reality => several paradigms at the same time => how to choose?

28. Rationality, intentionality and the construction of rules Complex and diverse individual behaviors Behavioral assumptions to include in theoretical analysis? Links with rules? “Ideas matter” [Denzau and North 1994]

29. The calculator agent in a world of imperfect information “specifying and solving a game require strong assumptions about the shared cognitive models of the players and their rationality” [Greif 2006, p. 11] Two presuppositions are important here: 1) the assumption of rationality; agents want and can satisfy there selfish interests, 2) the insurance that everybody acts with the same kind of rationality. Non self-interest behaviors?

30. The calculator agent versus the non self-interest behaviors 1. Non self-interest behaviors aren’t necessary assumptions because models are benchmarks. 2. Non self-interest behaviors are included in preferences. 3. It’s possible to include in models non self-interest behaviors.

31. Models as benchmarks We know that agents will not exactly act as in our models. Friedman (1953) as…if assumption. Nobody uses sophisticate mathematical calculus to choose an action in reality The condition of possibility to use this theoretical model is that real behaviors are close with theoretical behaviors deduced from mathematical calculus. The limit point of these theoretical models is to continue to make a “blackboard” science (to use Coase expression)

32. Non selfish interest are included in preferences Altruistic behaviors can be analyzed as tastes (the main reference here is Gary Becker (1996)) Preferences are the aim, Agency theory give adequate means. “My coauthor, Bill Meckling, and I derive the general principles of agency theory, based on the proposition that all individuals are rational beings who choose among alternatives in an effort to better themselves. This means that ultimately people are self-interested, which is frequently misinterpreted to mean they have no altruistic desires and preference for the well-being of others. In fact, it means only that people are not perfect agents for others; in other words, people will not act in the interests of others (their principals or partners) to the exclusion of their own preferences. Even the late Mother Teresa, devotes as she was to the welfare of poor of Calcutta, would probably have refused an invitation to devote her time to raising funds for the Boston Symphony Orchestra”. ([Jensen 2000, p. 5]). The limit point here, will be the contradiction between the aim of altruistic agents “to take in account interests of others” and means to reach the aim “selfish interest, which it consists taking in account his only own interests”

33. Models include non selfish- interest The agent’s capacity “to subordinate self interest to the needs of social group” can be encompassed in models because experimental economics give us several examples of situations in which agents aren’t selfish interest individuals. The ultimatum game: 10 dollars, a proposer, a responder “The experimental evidence supporting the ubiquity of non-self regarding motives, however, casts doubt on both the economist’s and the biologist’s model of the self regarding human actor. Many of these experiments examine a nexus of behaviors that we term strong reciprocity. Strong reciprocity is a predisposition to cooperate with others, and to punish (at personal cost, if necessary) those who violate the norms of cooperation, even when it is implausible to expect that these costs will be recovered at a later date” [Gintis, Bowles, Boyd, and Fehr 2005, p. 8]

34. Conclusion on the 2.1 debate

35. Rationality, intentionality and the construction of rules Complex and diverse individual behaviors “Ideas matter” [Denzau and North 1994] Behavioral assumptions to include in theoretical analysis? Links with rules?

36. The CD gap and his consequences - Rules are constructed to face lack of competency. Rules are the way to give regularities to behaviors. Making choices’ process is easier when rules to make choices are given. “Standard choice theory tries to explain behavior by matching the “competence” of an agent with the “difficulty” in selecting most preferred alternatives. It assumes for the purpose of theoretical explanation that there is no gap between an agent’s competence and the difficulty of the decision problem to be solved (hereafter called “C-D gap””[Heiner 1983, p. 562]. “The human agent in the face of such a gap will construct rules to restrict the flexibility of choices in such situations. We know these rules as institutions. By channeling choices into a smaller set of actions, institutions can improve the ability of the agent to control the environment (although there is no implication that the agent’s perceptions are correct)” [North 2005, p. 14].

37. How to make choices? - Herbert Simon: Search of satisficing decisions. Docility: “To be docile is to be tractable, manageable and above all, teachable” [Simon 1991, p. 35]. - Nelson and Winter (1982) “The argument is not that people are totally docile, nor that they are totally selfish, but that fitness calls for a measured but substantial responsiveness to social influence. In some contexts, this responsiveness implies motivation to learn or to imitate; in other contexts, willingness to obey or conform. From an evolutionary standpoint, having a considerable measure of docility is not altruism but enlightened selfishness” [Simon 1991, p. 35] “Like a truce among nations, the truce among organization members tends to give rise to a peculiar symbolic culture shared by the parties. A renewal of overt hostilities would be costly and would also involve a sharp rise in uncertainty about the future positions of the parties. Accordingly, the state of truce is ordinarily considered valuable, and a breach of its terms is not to be undertaken lightly”[Nelson & Winter 1982, p. 111]. “In routine operation, the combined effect of the rule-enforcement mechanism and other motivators is such as to leave members content to play their roles in the organizational routine – but “content” only in the sense that they are willing to continue to perform up to their usual standard” [Nelson and Winter 1982, p. 110] - Organizations are the mean to face “how to make choices”. Procedural rationality and decision making process on Simon standpoint, routines on Nelson and Winter standpoint are the organizational solutions to help human beings to make choices.

38. N & W approach, the problem of intentionality “The links between bounded rationality and routines/capabilities are not clear. I then argue that the absence in Nelson and Winter of a clear methodological individualist foundation for notions such as routines, capabilities, competencies, etc. has resulted in certain explanatory difficulties in the modern organizational approach” [Foss 2003, p. 185]. It’s necessary to distinguish individual skills and organizational routines. “In our view, clarity would be served by reserving the term ‘skills’ to the individual level and ‘routines’ to the organizational level. ‘Routines are the skills of an organization’ is a metaphorical truth not a literal truth” [Dosi, Nelson and Winter 2000, p. 5] Consequently, routines are clearly the rules for managing individual skills “It could be said that organizational routines have the major function of coordinating the skills of the organization, i.e. of turning that collectivity of skills to useful effect” [Dosi, Nelson and Winter 2000, p; 5]. Moreover, reflections on routines did not exclude the question of intentionality. “because the development of capabilities also includes elements of intentionality and deliberation, the capabilities discussion provides a bridge between the predominantly descriptive concerns of evolutionary theory and the prescriptive analysis of firm strategy. Accurate description requires acknowledgement of the role of intentionality” [Dosi, Nelson and Winter 2000, p. 12] But what is exactly intentionality in evolutionary approach?

39. How to make choices? The debate about intentionality Darwinism evolution versus lamarckian evolution Hodgson as represent of strong holism: For Hodgson, individuals are linked with their environment by social rules: institutions, communities, and habits (included habits of thought). Deliberation, calculation are individual competencies. But these competencies came from education, learning. All the actions can be explained by social causes. The Lamarckian evolution seems to keep possibility of freedom for individuals in the sense that individuals’ behaviors are possibly undetermined. Intentionality?

40. Consequences of cognitive limitation - Rules are constructed to face lack of competency. Rules are the way to give regularities to behaviors. Making choices’ process is easier when rules to make choices are given. Intentionality?

41. Williamson approach, opportunism assumption The focus of Williamson is on transaction as unit of analysis and the alternative choices between market and hierarchies to organize exchanges. Uncertainty and bounded rationality are the background to explain the existence of firms, but bounded rationality is not the subject of analysis. The bounded rationality complicates the choice of governance structure because, in many situations an individual can conceal his private information. “If human actors are not only confronted with needs to adapt to the unforeseen (by reason of bounded rationality), but are also given by strategic behavior (by reason of opportunism), then costly contractual breakdowns (refusals of cooperation, maladaptation, demands for renegotiation) may be posed. In that event, private ordering efforts to mitigate prospective contractual impasses and breakdowns, have merit”. (Williamson 2002, p. 174). is there always an opportunism’s risk? Isn’t impossible to have cooperation between honest, non cheating individuals? Is it possible to think corporate governance in which honesty, loyalty reduce cost transaction?

42. Consequences of cognitive limitation - Rules are constructed to face lack of competency. Rules are the way to give regularities to behaviors. Making choices’ process is easier when rules to make choices are given. Intentionality? Opportunism?

43. Organizations: evolutionary approah versus transaction costs approach

44. Rationality, intentionality and the construction of rules Complex and diverse individual behaviors “Ideas matter” [Denzau and North 1994] Behavioral assumptions to include in theoretical analysis? Links with rules?

45. Institutions as shared beliefs Links between mental models and institution. Institutions are shared beliefs: Aoki How to explain institutions evolution?

46. Construction of mental systems, « shared beliefs », intentionality “Individuals with common cultural backgrounds and experiences will share reasonably convergent mental models, ideologies, and institutions” [Denzau and North 1994]. Institutions as ‘shared beliefs’ “The growing literature of the new institutional economics makes abundantly clear that institutions must be explained in terms of the intentionality of human” [North 2005, p. 42].

47. North: the process of societal change “The process of societal change (…) can be summarized as follows: “reality” > beliefs > institutions > specific policies > outcomes (and, thus, altered “reality”) Mantzavinos C., North D.C., Shariq S [2004] The feedback mechanism from outcomes to reality runs through the human mind; and because the mind interprets reality actively, we have a very limited knowledge of how outcomes will be perceived and interpreted by agents. This is the main reason why mechanistic, deterministic models of economic change cannot work: ideas are the autonomous factors of socioeconomic evolution, and if we want to learn more about this process, we need to know more about the way our minds construct reality.” Mantzavinos C., North D.C., Shariq S [2004]

48. Aoki: informational approach and institution as « summarized » vision of the world Jointly construct Equilibrium Strategies Confirm and stabilize Constrain/enable Rules of the game Beliefs coordinate

49. Why are Aoki’s analysis very interisting? 1) In Aoki’s standpoint an institution is a Nash equilibrium in the sense that an individual agent has no interest to deviate from the rule. 2) This Nash equilibrium is not necessary pareto-optimal. Institutions may be inefficient insitutions. The use of game theory in Aoki’s way doesn’t implies strong assumptions about agents’ rationality. “In situations in which institutions generate behavior (…) one does not need to know more than this social rule, because institutionalized rules aggregate private information and knowledge and distribute it in compressed form.”(Greif  2006, p. 134)

50. How to change institutions?