The Competitiveness of Nations in a Global Knowledge-Based Economy
John R. Commons
Institutional Economics
American Economic Review,
21 (3)Dec. 1931, 648-657.
The difficulty in defining a field for the
so-called institutional economics is the uncertainty of meaning of an
institution. Sometimes an institution
seems to mean a framework of laws or natural rights within which individuals
act like inmates. Sometimes it seems
to mean the behavior of the inmates themselves. Sometimes anything additional
to or critical of the classical or hedonic economics is deemed to be
institutional. Sometimes anything
that is "economic behavior" is institutional.
Sometimes anything that is "dynamic" instead of "static," or a
"process" instead of commodities, or activity instead of feelings, or mass
action instead of individual action, or management instead of equilibrium, or
control instead of laissez faire, seems to be institutional economics.
All of these notions are doubtless involved in
institutional economics, but they may be said to be metaphors or descriptions,
whereas, a science of economic behavior requires analysis into similarities of
cause, effect or purpose, and a synthesis in a unified system of principles.
And institutional economics,
furthermore, cannot separate itself from the marvelous discoveries and insight
of the classical and psychological economists.
It should incorporate, however, in addition, the equally important
insight of the communistic, anarchistic, syndicalistic, fascistic,
co-operative and unionistic economists.
Doubtless it is the effort to cover by enumeration all of these
unco-ordinated activities of the various schools which gives to the name
institutional economics that reputation of a miscellaneous, nondescript yet
merely descriptive, character of so-called "economic behavior," which has long
since relegated the crude Historical School.
If we endeavor to find a universal circumstance,
common to all behavior known as institutional, we may define an institution as
collective action in control, liberation and expansion of individual action.
Collective action ranges all the way from
unorganized custom to the many organized going concerns, such as the family,
the corporation, the trade association, the trade union, the reserve system,
the state. The principle common to all
of them is greater or less control, liberation and expansion of individual
action by collective action.
This control of the acts of one individual
always results in, and is intended to result in, a gain or loss to another or
other individuals. If it be the
enforcement of a contract, then the debt is exactly equal to the credit
created for the benefit of the other person. A
debt is a duty enforced collectively, while the credit is a corresponding
right created by creating the duty.
The resulting social relation is an economic status, consisting of the
expectations towards which each party is directing his economic behavior.
On the debt and duty side it is the
status of conformity to collective action. On
the credit and right side it is a status of security created by the
expectation of the said conformity. This
is known as "incorporeal" property.
Or, the collective control takes the form of a
tabu or prohibition of certain acts, such as acts of interference,
infringement, trespass; and this prohibition creates an economic status of
liberty for the person thus made immune. But
the liberty of one person may be accompanied by prospective gain or loss to a
correlative person, and the economic status thus created is exposure to the
liberty of the other. An employer is
exposed to the liberty of the employee to work or not to work, and the
employee is exposed to the liberty of the employer to hire or fire. The
typical case of liberty and exposure is the goodwill of a business.
This is coming to be distinguished as
"intangible" property.
Either the state, or a corporation, or a cartel,
or a holding company, or a co-operative association, or a trade union, or an
employers' association, or a trade association, or a joint trade agreement of
two associations, or a stock exchange, or a board of trade, may lay down and
enforce the rules which determine for individuals this bundle of correlative
and reciprocal economic relationships. Indeed, these collective acts of
economic organizations are at times more powerful than the collective action
of the political concern, the state.
Stated in the language of ethics and law, to be developed below, all collective acts establish relations of rights, duties, no rights and no duties. Stated in the language of individual behavior, what they require is performance, avoidance, forbearance by individuals. Stated in the language of the resulting economic status of individuals, what they provide is security, conformity, liberty and exposure. Stated in language of cause, effect or purpose, the common principles running through all of them are the principles of scarcity, efficiency, futurity, the working rules of collective action and the limiting and complementary factors of economic theory. Stated in language of the operation of working rules on individual action, they are expressed by the auxiliary verbs of what the individual can, cannot, must, must not, may or may not do. He "can" or "cannot," because collective action will or will not come to his aid. He "must" or "must not," because collective action will compel him. He "may," because collective action will permit him and protect him. He "may not," because collective action will prevent him.
It is because of these volitional auxiliary
verbs that the familiar term "working rules" is appropriate to indicate the
universal principle of cause, effect or purpose, common to all collective
action. Working rules are continually
changing in the history of an institution, and they differ for different
institutions; but, whatever their differences, they have this
similarity that they indicate what individuals can, must, or may, do or not
do, enforced by collective sanctions.
Analysis of these collective sanctions furnishes
that correlation of economics, jurisprudence and ethics which is prerequisite
to a theory of institutional economics. David
Hume found the unity of these three social sciences in the principle of
scarcity and the resulting conflict of interests, contra to Adam Smith who
isolated economics from the others on assumptions of divine providence,
earthly abundance and the resulting harmony of interests. Institutional
economics goes back to Hume. Taking
our cue from Hume and the modern use of such a term as "business ethics,"
ethics deals with the rules of conduct arising from conflict of interests,
arising, in turn, from scarcity and enforced by the moral sanctions of
collective opinion; but economics deals with the same rules of conduct
enforced by the collective economic sanctions of profit or loss in case of
obedience or disobedience, while jurisprudence deals with the same rules
enforced by the organized sanctions of violence.
Institutional economics is continually
dealing with the relative merits and efficiency of these three types of
sanctions.
From this universal principle of collective
action in control, liberation and expansion of individual action arise not
only the ethical concepts of rights and duties and the economic concepts of
security, conformity, liberty and exposure, but also of assets and
liabilities. In fact, it is from the
field of corporation finance, with its changeable assets and liabilities,
rather than from the field of wants and labor, or pains and pleasures, or
wealth and happiness, or utility and disutility, that institutional economics
derives a large part of its data and methodology.
Institutional economics is the assets
and liabilities of concerns, contrasted with Adam Smith's Wealth of Nations.
But collective action is even more universal in the unorganized form of custom than it is in the organized form of concerns. Custom has not given way to free contract and competition, as was asserted by Sir Henry Maine. Customs have merely changed with changes in economic conditions, and they may today be even more mandatory than the decrees of a dictator, who perforce is compelled to conform to them. The businessman who refuses or is unable to make use of the modern customs of the credit system, by refusing to accept or issue checks on solvent banks, although they are merely private arrangements and not legal tender, simply cannot continue in business by carrying on transactions. These instruments are customary tender, instead of legal tender, backed by the powerful sanctions of profit, loss and competition, which compel conformity. Other mandatory customs might be mentioned, such as coming to work at
If disputes arise, then the officers of an organized concern -- a credit association, the manager of a corporation, a stock exchange, a board of trade, a commercial or labor arbitrator, or finally the courts of law up to the Supreme Court of the
This is the common-law method of making law by
the decision of disputes. The
decisions, by becoming precedents, become the working rules, for the time
being, of the particular organized concern. The
historic "common law" of Anglo-American jurisprudence is only a special case
of the universal principle common to all concerns that survive, of making new
law by deciding conflicts of interest, and thus giving greater precision and
organized compulsion to the unorganized working rules of custom.
The common-law method is universal in
all collective action, but the technical "common law" of the lawyers is a body
of decisions. In short, the common-law
method is itself a custom, with variabilities, like other customs.
It is the way collective action acts
on individual action in time of conflict.
Thus collective action is more than control of
individual action -- it is, by the very act of control, as indicated by the
aforesaid auxiliary verbs, a liberation of individual action from coercion,
duress, discrimination, or unfair competition by other individuals.
And collective action is more than control and
liberation of individual action -- it is expansion of the will of the
individual far beyond what he can do by his own puny acts.
The head of a great corporation gives
orders whose obedience, enforced by collective action, executes his will at
the ends of the earth.
Thus an institution is collective action in
control, liberation and expansion of individual action.
These individual actions are really transactions instead of either individual behavior or the "exchange" of commodities. It is this shift from commodities and individuals to transactions and working rules of collective action that marks the transition from the classical and hedonic schools to the institutional schools of economic thinking. The shift is a change in the ultimate unit of economic investigation. The classic and hedonic economists, with their communistic and anarchistic offshoots, founded their theories on the relation of man to nature, but institutionalism is a relation of man to man. The smallest unit of the classic economists was a commodity produced by labor. The smallest unit of the hedonic economists was the same or similar commodity enjoyed by ultimate consumers. One was the objective side, the other the subjective side, of the same relation between the individual and the forces of nature. The outcome, in either case, was the materialistic metaphor of an automatic equilibrium, analogous to the waves of the ocean, but personified as "seeking their level." 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.
Transactions, as derived from a study of
economic theories and of the decisions of courts, may be reduced to three
economic activities, distinguishable as bargaining transactions, managerial
transactions and rationing transactions. The
participants in each of them are controlled and liberated by the working rules
of the particular type of moral, economic or political concern in question.
The bargaining transaction derives
from the familiar formula of a market, which, at the time of negotiation,
before goods are exchanged, consists of the best two buyers and the best two
sellers on that market. The others are
potential. Out of this formula arise
four relations of possible conflict of interest, on which the decisions of
courts have built four classes of working rules.
(1) The two buyers are competitors and the two
sellers are competitors, from whose competition the courts, guided by custom,
have constructed the long line of rules on fair and unfair competition.
(2) One of the buyers will buy from one of the
sellers, and one of the sellers will sell to one of the buyers, and, out of
this economic choice of opportunities, both custom and the courts have
constructed the rules of equal or unequal opportunity, which, when reduced to
decisions of disputes, become the collective rules of reasonable and
unreasonable discrimination.
(3) At the close of the negotiations, one of the
sellers, by operation of law, transfers title to one of the buyers, and one of
the buyers transfers title to money or a credit instrument to one of the
sellers. Out of this double alienation
and acquisition of title arises the issue of equality or inequality of
bargaining power, whose decisions create the rules of fair and unfair price,
or reasonable and reasonable value.
(4) But even the decisions themselves on these
disputes, or the legislative or administrative rules prescribed to guide the
decisions, may be called in question, under the American System, by an appeal
to the Supreme Court, on the ground that property or liberty has been "taken"
by the governing or judicial authority "without due process of law."
Due process of law is the working rule
of the Supreme Court for the time being, which changes with changes in custom
and class dominance, or with changes in judges, or changes in the opinions of
judges, or with changes in the customary meanings of property and liberty.
Hence the four economic issues arising out of
that unit of activity, the bargaining transaction, are competition,
discrimination, economic power and working rules.
The habitual assumption back of the decisions in
the foregoing classes of disputes is the assumption of equality of willing
buyers and willing sellers in the bargaining transactions by which the
ownership of wealth is transferred by operation of law.
Here the universal principle is
scarcity.
But the assumption back of managerial
transactions, by which the wealth itself is produced, is that of superior and
inferior. Here the universal principle
is efficiency, and the relation is between two parties, instead of the four
parties of the bargaining transaction. The
master, or manager, or foreman, or other executive, gives orders -- the
servant or workman or other subordinate must obey.
Yet a change in working rules, in
course of time, as modified by the new collective action of court decisions,
may distinguish between reasonable and unreasonable commands, willing and
unwilling obedience.
Finally the rationing transactions differ from
managerial transactions in that the superior is a collective superior while
the inferiors are individuals. Familiar
instances are the log-rolling activities of a legislature in matters of
taxation and tariff; the decrees of communist or fascist dictatorships; the
budget-making of a corporate board of directors; even the decisions of a court
or arbitrator; all of which consist in rationing either wealth or purchasing
power to subordinates without bargaining, although the negotiations are
sometimes mistaken for bargaining, and without managing, which is left to
executives. They involve negotiation,
indeed, but in the form of argument, pleading, or eloquence, because they come
under the rule of command and obedience instead of the rule of equality and
liberty. On the borderline are
partnership agreements which ration to the partners the benefits and burdens
of a joint enterprise. These rationing
transactions, likewise, in the American system, are subject finally to the
working rules (due process of law) of the Supreme Court.
In all cases we have variations and hierarchies
of the universal principle of collective action controlling, liberating and
expanding individual action in all the economic transactions of bargaining,
managing and rationing.
Since institutional economics is behavioristic,
and the behavior in question is none other than the behavior of individuals
while participating in transactions, institutional economics must make an
analysis of the economic behavior of individuals.
The peculiar quality of the human will
in all its activities, distinguishing economics from the physical sciences, is
that of choosing between alternatives. The
choice may be voluntary, or it may be an involuntary choice imposed by another
individual or by collective action. In
any case the choice is the whole mind and body in action -- that is, the will
-- whether it be physical action and reaction with nature's forces, or the
economic activity of mutually inducing others in the transaction.
Every choice, on analysis, turns out to be a
three-dimensional act, which, as may be derived from the issues arising in
disputes, is at one and the same time, a performance, an avoidance, and a
forbearance. Performance is the
exercise of power over nature or others; avoidance is its exercise in one
direction rather than the next available direction; while forbearance is the
exercise, not of the total power except at a crisis, but the exercise of a
limited degree of one's possible moral, physical or economic power.
Thus forbearance is the limit placed
on performance; performance is the actual performance; and avoidance is the
alternative performance rejected or avoided -- all at one and the same point
of time.
It is from forbearance that the doctrine of
reasonableness arises, while performance means either rendering a service,
compelling a service, or paying a debt, but avoidance is non-interference with
the performance, forbearance or avoidance of others.
Each may be a duty or a liberty, with
a corresponding right or exposure of others, and each may be enforced,
permitted, or limited by collective action according to the then working rules
of the particular concern.
If institutional economics is volitional it requires an institutional psychology to accompany it. This is the psychology of transactions, which may properly be named negotiational psychology. Nearly all historic psychologies are individualistic, since they are concerned with the relation of individuals to nature, or to other individuals, treated, however, not as citizens with rights, but as objects of nature without rights or duties. This is true all the way from Locke's copy psychology,
But these are only names and descriptions.
A scientific understanding of
negotiational psychology resolves it into the smallest number of general
principles, that is, similarities of cause, effect or purpose, to be found in
all transactions, but in varying degree. First
is the personality of participants, which, instead of the assumed equality of
economic theory, is all the differences among individuals in their powers of
inducement and their responses to inducements and sanctions.
Then are the similarities and differences of circumstance in which personalities are placed. First is scarcity or abundance of alternatives. This is inseparable from efficiency, or the capacity to bring events to happen. In all cases negotiations are directed towards future time, the universal principle of futurity. Working rules are always taken into account, since they are the expectations of what the participants can, must or may do or not do, as controlled, liberated or expanded by collective action. Then, in each transaction is always a limiting factor whose control by the sagacious negotiator, salesman, manager or politician, will determine the outcome of complementary factors in the immediate or remote future.
Thus negotiational psychology is the
transactional psychology which offers inducements and sanctions according to
the variable personalities and the present circumstances of scarcity,
efficiency, expectation, working rules and limiting factors.
Historically this transactional psychology may
he seen to have changed, and is changing continuously, so that the whole
philosophies of capitalism, fascism or communism are variabilities of it.
In the common-law decisions it is the
changing distinctions between persuasion and coercion or duress, persuasion
being considered the outcome of a reasonable status of either equality of
opportunity, or fair competition, or equality of bargaining power, or due
process of law. But economic coercion
and physical duress are denials of these economic ideals, and nearly every
case of economic conflict becomes an assumption or investigation, under its
own circumstances, of the negotiational psychology of persuasion and coercion.
Even the managerial and rationing
negotiations come under this rule of institutional change, for the psychology
of command and obedience is changed with changes in the status of conformity,
security, liberty or exposure. The
modern "personnel" management is an illustration of this kind of change in
negotiational psychology.
All of this rests on what may he distinguished
as three social relations implicit in every transaction, the relations of
conflict, dependence and order.
The parties are involved in a conflict of interests on account of the
universal principle of scarcity. Yet
they depend on each other for reciprocal alienation and acquisition of what
the other wants but does not own. Then
the working rule is not a foreordained harmony of interests, as assumed in the
hypotheses of natural rights or mechanical equilibrium of the classical and
hedonic schools, but it actually creates, out of conflict of interests, a
workable mutuality and orderly expectation of property and liberty.
Thus conflict, dependence and order
become the field of institutional economics, builded upon the principles of
scarcity, efficiency, futurity and limiting factors derived from the older
schools, but correlated under the modern notions of working rules of
collective action controlling, liberating and expanding individual action.
What then becomes of the "exchange" of physical
commodities and the production of wealth, as well as the consumption of wealth
and satisfaction of wants by consumers, which furnished the starting points of
the classical, hedonic, communist and other schools of economists?
They are merely transferred to the
future. They become expectations of
the immediate or remote future, secured by the collective action, or
"institution," of property and liberty, and available only after the
conclusion of a transaction. Transactions
are the means, under operation of law and custom, of acquiring and alienating
legal control of commodities, or legal control of the labor and management
that will produce and deliver or exchange the commodities and services,
forward to the ultimate consumers.
Institutional economics is not divorced from the
classical and psychological schools of economists -- it transfers their
theories to the future when goods will be produced or consumed or exchanged as
an outcome of present transactions. That
future may be the engineering economics of production of the classical
economists or the home economics of consumption of the hedonic economists,
which depend on physical control. But
institutional economics is legal control of commodities and labor, where the
classical and hedonic theories dealt only with physical control. legal control
is future physical control. Future physical control is the field of
engineering and home economics.
Thus it may be seen how it was that the natural
rights ideas of the economists and lawyers created the illusion of a
framework, supposed to be constructed in the past, within which present
individuals are supposed to act. It
was because they did not investigate collective action.
They assumed the fixity of existing
rights of property and liberty. But if
rights, duties, liberties and exposures are simply the changeable working
rules of all kinds of collective action, looking towards the future, then the
framework analog disappears in the actual collective action of controlling,
liberating and expanding individual action for the immediate or remote future
production, exchange, and consumption of wealth.
Consequently the final social philosophy, or
"ism" – which is usually a belief regarding human nature and its goal --
towards which institutional economics trends is not something foreordained by
divine or natural "right," or materialistic equilibrium, or "laws of nature"
-- it may he communism, fascism, capitalism. If
managerial and rationing transactions are the starting point of the
philosophy, then the end is the command and obedience of communism or fascism.
If bargaining transactions are the
units of investigation then the trend is towards the equality of opportunity,
the fair competition, the equality of bargaining power, and the due process of
law of the philosophy of liberalism and regulated capitalism.
But there may be all degrees of
combination, for the three kinds of transactions are interdependent and
variable in a world of collective action and perpetual change, which is the
uncertain future world of institutional economics.