What Is the Essence of Institutional Economics?
Hodgson, Geoffrey M., Journal of Economic Issues
The term "institutional economics" was announced by Walton Hamilton at a meeting of the American Economic Association in 1918 [Hamilton 1919]. Institutionalism dominated American economics, at least until the 1940s. Listing a number of perceived attributes of this school, Walton Hamilton [1919, 309-11] claimed that institutional economics alone could unify economic science by showing how parts of the economic system related to the whole. Institutional economics was not defined in terms of any normative stance. Hamilton [1919, 313] declared: "It is not the place of economics to pass judgments upon practical proposals." However, its appeal as a theory was that allegedly it could be used as a basis for policy. According to Hamilton [1919, 314-18], institutional economists recognized that:
The proper subject-matter of economic theory is institutions.... Economic theory is concerned with matters of process.... Economic theory must be based upon an acceptable theory of human behavior...
This was expanded by the following observations:
neo-classical economics ... neglected the influence exercised over conduct by the scheme of institutions ... Where it fails, institutionalism must strive for success ... it must discern in the variety of institutional situations impinging upon individuals the chief source of differences in the content of their behavior [1919, 318].
Hamilton"s description of institutionalism requires refinement, but in its essentials it has endured the test of time. It can be rephrased and expanded in terms of the following five propositions:
1. Although institutional economists are keen to give their theories practical relevance, institutionalism itself is not defined in terms of any policy proposals.
2. Institutionalism makes extensive use of ideas and data from other disciplines such as psychology, sociology and anthropology in order to develop a richer analysis of institutions and of human behavior.
3. Institutions are the key elements of any economy, and thus a major task for economists is to study institutions and the processes of institutional conservation, innovation and change.
4. The economy is an open and evolving system, situated in a natural environment, effected by technological changes, and embedded in a broader set of social, cultural, political, and power relationships.
5. The notion of individual agents as utility-maximising is regarded as inadequate or erroneous. Institutionalism does not take the individual as given. Individuals are affected by their institutional and cultural situations. Hence individuals do not simply (intentionally or unintentionally) create institutions. Through "reconstitutive downward causation" [Hodgson 2000] institutions affect individuals in fundamental ways.
Most of these points are direct elaborations of ideas from Hamilton's  text. However, regarding point (4), Hamilton did not mention the words "open system." The phrase did not become widely used until after 1945. Institutional economists such as K. William Kapp [1968, 8] and Shigeto Tsuru [1993, 73] made the idea of the economy as an open system one of the defining characteristics of institutionalism. Furthermore, Hamilton did not use the words "evolving" or "evolutionary," although institutionalists have become fond of these terms.
Point (1) may prove controversial, so it will be discussed in more detail below. It is perhaps the only point that any institutionalist may wish to remove from the list. Certainly, some institutionalists will wish to add to or elaborate on the above five points. The contention here is that they contain the "hard core" of the institutionalist tradition.
I further assert that the single most important defining characteristic of the old institutionalism is proposition (5). Among other schools, the new is distinguished from the old institutional economics principally in these terms. …