The Political Coase Theorem: Identifying Differences between Neoclassical and Critical Institutionalism

By Vira, Bhaskar | Journal of Economic Issues, September 1997 | Go to article overview

The Political Coase Theorem: Identifying Differences between Neoclassical and Critical Institutionalism


Vira, Bhaskar, Journal of Economic Issues


Institutional analysis has traditionally described the comparative performance of different economies and has attempted to explain the dynamics of economic transformation. This paper analyzes issues relating to institutional performance and to the process of institutional change. It reviews some recent institutional literature and draws upon the distinction between the neoclassical approach represented by New Institutional Economics and the more critical tradition associated with old institutionalism.(1) The paper argues, along with the critical institutionalists, that efficiency is not a value-neutral goal for institutional analysis and that it is necessary to discuss the ethical assumptions that are implicit in the choice of evaluative criteria. Furthermore, although neoclassical institutionalists admit the possibility that socially desirable institutional change may not always be forthcoming, this paper suggests that explanations in this tradition pay inadequate attention to understanding the nature of the political process and that such accounts tend to explain institutional failure using the device of high transaction costs in the political market. In contrast to this neoclassical literature, it is argued here that it is difficult to generalize about the potential success of institutional innovations without analyzing the configuration of political forces in society and without explicitly identifying winners and losers from the process of institutional change.

Evaluating Institutional Performance

If one of the objectives of institutional analysis is to compare the performance of economies, it is necessary to discuss the criterion for evaluation. While there may be agreement that the normative goal of public policy should be to promote outcomes deemed to be socially desirable, it has been recognized since the work of Arrow [1951] that it is difficult to define consistent and complete rules for social choice that satisfy fairly "mild-looking conditions of reasonableness" [Sen 1987, 34n]. The choice of any evaluative criterion inevitably involves making ethical and moral judgments. An important difference between neoclassical and critical institutionalists is the extent to which they recognize and discuss these value judgments, which are implicit in the choice of performance indicators. Critical institutional literature is concerned as much with the normative content of institutional arrangements as it is with the positive analysis of institutional change.

Efficiency is a commonly used indicator of institutional performance, defined in terms of Pareto optimality. For instance, Binger and Hoffman [1989, 69] suggest that "we can view more or less efficient institutions as being more or less effective at exhausting the public gains from exchange." Introducing a volume on Rethinking Institutional Analysis and Development, Nicholson [1993, 4] argues that "institutional innovation contributes to economic development by providing more efficient ways of organizing economic activity" and goes on to suggest that the collected essays "serve to elucidate strategies that will improve the efficiency of institutional choices" [1993, 6]. Furubotn and Richter [1989, 3], however, warn that the use of Pareto-optimality as a criterion confronts the "well-known problems of welfare economics," since there are multiple Pareto-optimal points on the welfare frontier, and these cannot be compared without making value judgments. The non-uniqueness of the Pareto-optimum reflects alternative initial endowments.(2) Furthermore, as Samuels [1992, 65] points out: "There are an infinite number of Pareto-optima reflecting the many other assumptions and the multiplicity of substantive contents of each of them. Pareto-optimum varies, for example, with income and wealth distribution, with the power structure and, most significantly for policy issues, with the law." Then, what needs to be recognized is that since it is the institutional structure that defines what is Pareto optimal, it is meaningless to use this as an evaluative criterion for institutional analysis. …

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