Economic Theory, Institutions, and Economic Policy

By Caravale, Giovanni | Atlantic Economic Journal, December 1995 | Go to article overview

Economic Theory, Institutions, and Economic Policy


Caravale, Giovanni, Atlantic Economic Journal


I. Introduction

The purpose of this paper is threefold. First, it emphasizes that reference to the institutional framework represents an integral part of economic theory if the latter is to be conceived of as a tool mainly directed to the comprehension of the functioning of actual economic systems. Conceived in this way, economic theory emerges as basically evolutionary in nature.

Second, it underscores that the integration of the institutional framework in the theoretical construct cannot be achieved with reference to the neoclassical scheme of analysis, either in its traditional or more recent versions. An alternative theoretical approach, that of Classical and Keynesian flavor, seems to offer--it is maintained--a far better chance.

Third, the paper supplies a concrete example of the relationship among economic theory, institutions, and economic policy. With reference to the complex question of incomes policy, it emphasizes the risk of relying on "theories without institutions" or on "theories with imaginary institutions" in order to identify concrete measures of economic policy.

II. Institutions and Economic Policy

It has recently been maintained by Robert Langlois and Ronald Coase, respectively, that neoclassical theory is a theory without institutions " [Langlois, 1986, p. 5], while " [early] American institutionalists ... had nothing to pass on, except a mass of descriptive material waiting for a theory, or fire" [Coase, 1984, p. 230].

I shall comment later in a more detail on the former statement. I feel, however, that it is important to emphasize at once that the substance of the point emerging from the compound sentence can be shared with no reservation whatsoever. Neither a theoretical scheme without appropriate foundation nor an institutional framework without a theory can be of any use from an economic viewpoint. Therefore, the two aspects, or the two " sides " as Pasinetti calls them [Pasinetti, 1992, p. 2], must be put together in the construction of an adequate interpretative tool.

The problem is connected with the very conception of our discipline, Economics, or--to use the old and perhaps more appropriate term-Political Economy. As I have emphasized elsewhere [Caravale, 1992], this is to be thought of as the social science whose principal aim is that of spelling out the regularities that characterize the phenomena of value, production, and distribution in given social and institutional contexts, with a view to supply points of reference for those responsible for the policy choices to be made.

The central logical moment of the process of theorizing is the identification of the model, i.e., a simplified representation of the world (or that portion of it which is the object of the analysis) capable of capturing the essential features, the fundamental traits of the reality that surrounds the political economist. It is like the drawing of a landscape or of a portrait in which the artist makes no attempt at a faithful reproduction of every single aspect of the real world, but tries only to fix on paper what appear to be the most important elements of what is being viewed. In order to be relevant, the representation of economic reality must show a series of essential, and strictly interconnected, properties:

1) The description should be significant in that it should capture the essential features of the world. In other words, it should depict, on the one hand, the dominant or systematic forces at work in the economic system (as the classics put it) and, on the other hand, the context--the institutional context--in which these forces operate.

2) The description should also be significant in that the position so described should represent a (potential) point of attraction for actual values. Should this attraction not exist or not be proved, the description--however accurate--would, in a way, remain separate from the actual working of the economic system and would, thus, be meaningless for the comprehension of the latter. …

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