'Institutions' has become a keyword within recent political and scientific discussion. It reflects the widespread realisation that a well-functioning market economy presupposes an effective institutional framework to work its wonders. In the light of global turbulence, financial unrest, the developments in the former Eastern Bloc, continued underdevelopment in the 'Third World', etc., more and more businessmen, economists, and politicians (from neo-conservatives to the New Left) are converging on the idea that economic development without 'good institutions' and an effective state is impossible.
This focus on institutions raises interesting questions. First, it implies that a capitalist market economy cannot be left to itself, but is a social system in need of design and support (e.g. law and order, state governance, fiscal regulation...). From the political right to the left the emphasis on the scope and aims of governance of course differs somewhat, but the underlying premise that markets need institutional support and an effective state is becoming common ground. (1) Secondly, it has focused attention on the history of capitalist development.
However, there are also other issues that present themselves, which are seldom spelled out: For example, if the market is not 'the invisible hand' which integrates individuals in society but rather something in need of institutional integrative support from society, what good is the market? If capitalist markets do not support society, i.e. form the basis on which society rests, but rather need support from the institutions of society to work, why should the institutions of society support markets, rather than, say, community or provision based on need? Such analyses may very well lead us to question the very basics of capitalism.
In economics the defence for market capitalism is grounded foremost in neoclassical theory, which maintains that markets equalise supply and demand 'spontaneously' in 'equilibrium', traits of the market that provide for both coordination, freedom and 'efficiency' (in the sense of optimum resource allocation). (2) Charges have, however, been made against this theory for its lack of realism (regarding its basic assumptions), for its asocial character (in theorising 'utility functions' and 'factors of production', rather than actual living individuals with social relations, cultures, values etc.) and for its ahistorical approach to the economy.
In this light, it is of specific interest to focus on New Institutional Economics (NIB). Recognising the limits in neoclassical theory, NIE has gained substantial influence (most specifically in e.g. questions on policymaking and development economics) exactly because it attempts to make neoclassical economic theory more realistic, more social, and historical in its approach. (3) This is attempted by moving beyond neoclassical economics with an institutional analysis yet at the same time sticking to its basics. Furthermore--due mainly to the works of Douglass C. North--NIE has become an established tradition in economic history in explaining the rise and evolution of market capitalism. NIE can hence be defined as a 'neoclassical' institutionalism, which politically comes close to the positions of classical liberalism.
The first section of this article describes the conceptual framework of NIE, and how it differs from neoclassical economics. The second section outlines a theoretical critique of NIE. The initial focus is on the concept of 'transaction costs', which I argue is deeply problematic. Thereafter, I point to an underlying assumption of 'why not markets?' in NIE, which I argue rests on ideological rather than historical grounds. I also argue that the emphasis on institutions, ideology, and the state within NIE makes the economic sphere disappear in explanation or makes uncertain the place of that sphere in explanation.
The third section focuses on the economic history of NIE with emphasis on the work of Douglass North. …