Tsegabirhan W.

Giorgis, AAU, CBE, DoE, December 2018

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 Introduction
• Institutional economics remains today an influential field in economics,
despite the prevalence of orthodox neoclassical economics in most
economics departments and policy-making institutions. The interest in
this field has increased in the last fifteen years. (Parada Jairo, 2002)
• From a review of ‘Development Economics’ one recognizes a number of
long-run (root) causes of development/underdevelopment/, explaining
comparative development performance. This include: geography
(climate, malaria, landlocked countries, etc.), Institutions, history
(colonial, independence, nature of political regimes), Sustained peace
(but Israel) etc. Remember, Ethiopia & Afghanistan, two un colonized
countries remain underdeveloped, while Thailand, Turkey remain in the
middle income and Japan is one of the DCs. Moreover, indeed sustained
peace and predictable stability are preconditions for development, yet
we witness Israel has managed to develop despite the hostile Middle
East political environment. (Todaro P. Michael and Smith C. Stephen;
11th edition, 2012; pp: 91-93)
• So at least institutions come as one of the root causes that explain
comparative development performance.
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 Introduction
• If from our review of trade theories, we appreciate the importance of
productivity and innovation, if economics is all about productivity, what explains
the relative performance of economies and firms in terms of productivity and
innovation? Indeed, productivity and innovation differentials are explained by
institutions.
• The debate over public versus private ownership and planning versus market
serves little more than a packaging of ideological positions of the left, center or
right.
• There is a continuing tendency to devote insufficient academic effort and
resources to the development of reconsideration of once philosophies, new
theories, strategies, solutions to obvious economic problems like unemployment,
poverty, inequity, environmental degradation, food insecurity, etc. The failure of
every type of development strategy in the last 70-80 years or the entire 20th
century should be sufficient motivation to examine, re-examine every philosophy,
theory, strategy towards transforming the agricultural and rural societies of LDCs.
• There is a consensus that “institutions do matter”. Even mainstream neoclassical
economics has recently incorporated the study of institutions based on the
assumptions of this paradigm, modifying its former habit of ignoring institutions,
or by taking them as given. (Parada Jairo, 2002)

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 Introduction

1. No consensus on the very definition of

institutions. Reason: Primarily institutions
are complex. Secondly, neoclassical
economics has been largely dismissive of
them[Institutions].
2. We need to develop a “thorough
understanding of the concept of
institutions”.

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 But then, Contending Theories of Institutions
• Ignoring the NCE’s attempt to incorporate institutions
as one explanatory variable to explain a dependent
variable in a NCE model, there are two basic strands
of institutional economics, as an alternative to NCE. In
fact each theory of institutional economics claim to
be an alternative theory of economics. These two
strands of institutional economics are:
a. The Original Institutional Economics (OIE) based
on the tradition of Veblen, Ayres, Commons, and
Mitchell; and
b. The New Institutional Economics (NIE) based on
Ronald Coase’s theory of transaction costs.
(Parada Jairo, 2002)

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 OIE & NIE: Shared Thoughts
1. For both “institutions matter in shaping
economic behavior and economic
performance is a central tenet of both the
old and the new institutionalism, as is the
recognition that institutions themselves
change over time and often respond to
economic factors.” (Rutherford Malcolm,
1995)
2. Apart from these two shared thoughts, both
stand to be diametrically different on many
issues.
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Departure Point of Institutional Theory is Neoclassical
(Mainstream) Economics (NCE)
NCE has been essentially define by assumptions, and ideas
concerning rationality, knowledge, the economic process and the
human agent.
1. Rational, maximizing behavior by all economic agents, whereby
they are assumed to optimize according to preferences which are
exogenously given;
2. Perfect information & knowledge: The absence of chronic
information problems, including radical uncertainty concerning
the future, widespread ignorance of the structures and
parameters in a complex world, and divergence in individual
cognitions of common phenomena; and
3. A theoretical focus on movements towards or attained
equilibrium states of rest, rather than on the continuous
processes of transformation through historical time. (Hodgson
Geoffrey, 1988)
In this theory, institutions are assumed to be irrelevant or if relevant
to remain neutral.

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 New Institutional Economics (NIE)
• “Oliver Williamson coined the term ‘new institutional economics’ (in
1975) to refer to his seminal transaction cost analysis of the nature and
structure of the firm.” (Hodgson, Geoffrey, 2001). So note that essentially
NIE started as a theory of the firm not the poor small farmer. “Other
leading names associated with the ‘new’ institutional economics are
Masahiko Aoki, Ronald Coase, Mancur Olson, Douglass North and
Richard Posner.
• NIE draws on the theoretical and empirical tools of neoclassical
economics in an analyses of both the evolution of institutions and their
effects on economic behavior and outcomes in different circumstances.
(Johann, et al.(eds)(IFPRI); 2009, p. 35)
• For new economic institutionalists (NIE), or at least a good number of
them, the standard neoclassical approach based on the rational choice
model is to be extended, perhaps modified, but not abandoned.
(Rutherford Malcolm, 1995)

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 NIE Perspective

• The pre-eminent project in the ‘new

institutional economics’ has been to explain
the existence of political, legal or social
institutions by reference to a model of given,
individual behaviour, tracing out its
consequences in terms of human
interactions.” (Hodgson, Geoffrey, 2001)
• The focus of the NIE is on “mankind as
rational chooser”. The NIE takes the self-
interested, maximizing individual as a given.
(Rutherford Malcolm, 1995)
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 NIE Perspective
• Both NCE and NIE are defined by their core
assumptions, which are but methodological
instruments and approaches, but not on how
the economy operates. Their objects of a study
is the methods (assumptions) and not the
functioning of an economy, a market.
• Their core assumptions fall into their stances on
rational utility maximizer, given stable
preferences. The other assumptions are
equilibrium analysis (implied formal modeling)
and its stance on market information.

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 NIE’s Underlying Methodological Approach
• “The characteristic ‘new’ institutionalist
project is the attempt to explain the
emergence of institutions, such as the firm or
the state, by reference to a model of rational
individual behaviour, tracing out the
unintended consequences in terms of human
interactions. An initial, institution-free, ‘state
of nature’ is assumed. The explanatory
movement is from individuals to institutions,
taking individuals as given. This explanatory
approach is often described as
‘methodological individualism’.” (Hodgson,
Geoffrey, 2001)
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 NIE
• Individuals and their preference functions should be
taken as given. The commonplace statement by
mainstream economists that tastes and preferences are
not the explananda (something to be explained) of
economics thus derives directly from the individualist
tradition. Likewise, the conception of economics as ‘the
science of choice’ takes the choosing individual and her
preference functions as given. The ‘new’
institutionalism has taken such individualistic
presuppositions on board. (Hodgson, Geoffrey, 2001)
• Remember the phrase: “the consumer is sovereign’,
which means it is and should be taken as for granted,
not subjected to analysis, re-examination.
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 NIE’s Definition of Institutions
• NIE’s perspective on institutions (such as firms, markets, and property
rights) has been developed on the basis of transaction costs theory.
There is always some ‘efficiency’ rationale behind the evolutionary
process of institutions aimed at the reduction of these transaction
costs. (Parada Jairo, 2002)
• North defines institutions as “rules of the game in a society” or “human
devised constraints that shape human interaction” [North 1990, 3]. The
set of choices of an individual are defined and limited by these
institutions. (Parada Jairo, 2002)
• Institutions are “a set of formal and informal rules, including their
enforcement arrangements. These are rules of conduct that ... govern
relationships among individuals. They are the rules of the game in a
society, or are humanly devised constraints that shape human
interactions.” (Furubotn & Richter, 1998)
• Institutions are defined as formal political, social, and legal rules (as
codified, among others, in constitutions, statute law, common law, and
other regulations, as well as their respective enforcement mechanisms),
and the informal constraints that are derived from people’s attitudes,
mental models and ideologies, and that find expression in the norms,
values and conventions to which they feel bound. (Altmann Matthias,
2011, p. 138)

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 What are Institutions? NIE Conception
“The sets of working rules that are used to determine
who is eligible to make decisions in some arena, what
actions are allowed or constrained, .... what procedures
must be followed, what information must or must not
be provided, and what pay offs will be assigned to
individuals dependent on their actions. … All rules
contain prescriptions that forbid, permit, or require
some action or outcome. Working rules are those
actually used, monitored, and enforced when
individuals make choices about the actions they will
take.” (Ostrom E., Page 51)
“Institutions” are defined as the rules of society that
provide a framework of incentives that shape
economic, political, and social organization and
behavior. (Johann, et al.(eds)(IFPRI), 2009, p. xxii),
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 What are Institutions? NIE Conception

• This definition underlines the contractual

relationships or ‘terms of exchange’ between
principals and agents. (Parada Jairo, 2002)
• This definition incorporates the traditional
assumptions of neoclassical analysis of
individuals maximizing utility, subject to
constraints that make possible human
organization, thus limiting certain types of
behavior.(Parada Jairo, 2002)

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 Basic Assumptions of NIE-1
1. Methodological individualism (MI): people are different
and have varied tastes, goals, purposes, and ideas. Hence,
“society”, “the state”, “the firm”, “political parties” and
so on are not to be understood as collective entities that
behave as though they were individual agents. The
organization or collectivity per se is no longer the main
focus. They rather, should be understood in terms of the
views & behaviors of the individual members.
2. The Maximand: individuals are assumed to seek their
own interests as they perceive them and they maximize
utility subject to the constraints established by the
existing institutional structure. No dichotomy between
the theory of consumer choice and the theory of the
firm. Rather utility maximization hypothesis remains
relevant to all individual choices in all sectors, firms,
government, religious and civic organizations. (Furubotn
& Richter, 1998)
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 Basic Assumptions of NIE-2
3.Bounded Individual Rationality, Decision
makers decide in bounded decision
environment. (Furubotn & Richter, 1998)
a. Imperfect access to current information/
information asymmetry.
b. Imperfect capability to make decisions/use
information/
c. Past experience, traditions, values, norms,
religion, culture have an impact on present
decisions, i.e. Procedural rationality;

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 Basic Assumptions of NIE-3
4. Rational Incompleteness
 All of the contingencies of real life cannot be anticipated
ex ante. Hence all of our formal institutions cannot be
perfectly established;
 Thus any constitution, law, private contracts, regulations,
religion, political party, etc are inherently incomplete and
it is rational to accept that incompleteness.
 A rational lawmaker does not try to regulate everything to
the last detail. Thus there is always a gap. (Furubotn &
Richter, 1998)
5. Opportunistic Behavior
• Incompleteness would not be a problem, if everyone were
honest and trustworthy.
• Some individuals are dishonest: they may disguise
preferences, distort data, or deliberately confuse issues.
(Furubotn & Richter, 1998)
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 Basic Assumptions of NIE-4
6. Economic society: economic society involves individuals and a set of rules
or norms that assign sanctioned property rights to each member of
society. Property rights embrace the right to use and the right to gain
benefits from physical objects or intellectual works and the right to
demand certain behavior from other individuals. That latter condition
implies that contract rights exist. Society must, of course, be concerned
with contract rights and the social arrangements that regulate the
transfer of property rights.
7. Enforcement/Governance structure/: at any time, the property-rights
configuration existing in an economy is determined and guaranteed by a
governance structure and order. This refers to the system of rules plus
the their enforcement instruments. (Furubotn & Richter, 1998)
8. Equilibrium Analysis: There is an incremental and discrete change that
converges at times and diverges at another time to reach another
stability position. But both the convergent and divergent trends end up
in a stable, equilibrium position. Essentially it follows aa comparative-
statics approach, with two fixed end-points, the beginning and end
equilibrium states. NIE’s institutional change may be limited to the
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changes of formal rules of the game.
 NIE-Concluding Points
• NIE complements standard neoclassical economic theory; NIE is
not violation of the neo classical economics, rather it is a
complementary. Why? Because NIE essentially retains almost
entirely all the pillar underlying philosophical and methodological
assumptions that define NCE.
• But then it has recognized the importance of institutions, which
means then that NCE has evolved from the assumption of
institutional neutrality and hence irrelevance of institutions to
explain human behavior & economic performance, to one that
recognizes institutions as relevant and in fact strong factor to
explain human behavior and economic performance.
• The fact that it recognizes the ‘rationale of incompleteness’
implies that economic agents (hence agricultural agents) should
recognize that our knowledge, institutions are inherently
incomplete, and imperfect. But then the scope of this problem is
confined to address opportunist behavior and its danger to the
prevalence and healthy operation of private property.

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 OIE Definition of Institutions
• “A social institution as a social organization which,
through the operation of tradition, custom or legal
constraint, tends to create durable and routinized patterns
of behavior. It is this very durability and routinization, in a
highly complex and sometimes volatile world, which
makes social science with any practical application possible
at all.” (Hodgson, 1998)
• This emphasis on the cultural and institutional conditions
of human action does not necessarily lead to a rigid or
deterministic outlook. While social institutions are
important in the processes of cognition and learning, in
the formation of preferences and generally in the
motivation of action, human activity is not completely or
mechanistically determined by its institutional
arrangement. (Hodgson, 1998)
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 OIE Definition of Institutions
• In orthodoxy theories routines are explained away and
institutions are regarded as tacit or given constraints,
under which the rational, calculating individual acts.
In general they are considered as negative forces as
limits to otherwise free behavior. Some institutions
may be regarded as essential to social life, but these
are usually regarded as punctuating exceptions.
Here, the view is that even if action is free, it is
riddled with habit and routine, and permeated with
the culture and structure of the system. Institutions
are the substance, rather than merely the boundaries
of social life. (Hodgson, Geoffrey, 1998, p.134)

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Sociologist’s Definition of Institutions (For Comparison
purpose)
• As a third alternative definition which we will not give
much attention is sociologists conception of
institutions. It conceives of institutions as socially
shared values, norms, practices, habitual rituals, what
we may call them as informal institutions. For
sociologists, a human person is entire a social animal.
The major limitation of such perspective is its entire
neglect of the individual’s free will, to define his/her
intentions, conscious decisions, which may not
necessarily be dependent upon social expectations,
rules, norms, values.
• So note that OIE’s definition is different from that of
sociologist’s conception of institutions.

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 Original Institutional Economics (OIE)
• The premise of OIE is the recognition of poverty of theory, the poverty of
the assumptions of the orthodox economics. A central argument of OIE is
that conventional theory (Both NCE & NIE) is guided by an outdated and
theoretically unacceptable view of the individual which has been
inherited from the classic liberalism of the 19th century. (Hodgson, 1998)
• OIE has a different approach. For original (old as a derogatory name)
institutionalists, the neoclassical approach with its emphasis on the
rational economic actor is to be abandoned in favor of one that places
economic behavior in its cultural context. (Rutherford Malcolm, 1995)
• For OIE, 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.
• Economic theory must be based upon an acceptable theory of human
behavior.
• The economy is an open and evolving system, situated in a natural
environment, affected by technological changes, and embedded in a
broader set of social, cultural, political, and power relationships.
(Hodgson, 2000)

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 Original Institutional Economics (OIE)
• “A prominent and unifying theme of the ‘old’
institutionalism is that economic analysis has to be
grounded on the specific historical, cultural and
economic circumstances of each case. In particular,
it is held that individual motives and behaviour are
often molded by such circumstances, including by
the institutions involved. Accordingly, there was
relatively greater emphasis on specific institutional
circumstances and relatively less on grand, unifying
theories.” (Hodgson, Geoffrey, 2001)

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 Five Core Propositions of OIE-1
1. Although institutional economists are keen to give their theories
practical relevance, institutionalism itself is not defined in terms of
any policy proposals. Facts and values are not the same thing. Policy
presuppose, values, normative positions, which need not be factual
and theoretical. Any identifiable approach to economics should be
evaluated on the basis of its incisive analysis of what is, rather than
on its judgments of what ought to be.
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. The proper
subject-matter of economic theory is institutions.... Economic theory
is concerned with matters of process. (Hodgson Geoffrey, 2000)

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 Five Core Propositions of OIE-2
4. The economy is an open and evolving system, situated in a natural
environment, affected by technological and other changes, and
embedded in a broader set of social, cultural, political, and power
relationships. So the economic system is not a ‘self-balancing
mechanism’ but a ‘cumulative unfolding process’. (Hodgson , 1998)
Note that the first four characteristics, (1) to (4), are important but not
sufficient to define the old institutionalism.
5. Economic theory must be based upon an acceptable theory of human
behavior. The notion of individual agents as utility-maximizing is
regarded as inadequate or erroneous. Institutionalism does not take
the individual as given, with given purposes or preference functions.
Individuals are affected by their institutional and cultural situations.
Hence individuals do not simply (intentionally or unintentionally)
create institutions. Through "reconstitutive downward causation”
institutions affect individuals in fundamental ways. OIE holds to the
idea of interactive and partially malleable agents, mutually entwined in
a web of partially durable and self-reinforcing institutions This
proposition is the single most important defining characteristic of the
old institutionalism. (Hodgson, 2000)

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 OIE: Which Comes First, Society or the Individual, the Egg or the Hen?

• “Economic theory must be based upon an acceptable theory of human

behavior. In contrast to NCE & NIE, the idea is that in economic analysis
the individual should not always be taken as given. The general use of
given preference functions to model individuals and their behaviour is
rejected by OIE. As well as individuals interacting to form institutions,
individual purposes or preferences are molded by socioeconomic
conditions. The individual is both a producer and a product of her
circumstances. So an individual is an interactive and partially malleable
agents, mutually entwined in a web of partially durable and self-
reinforcing institutions. In OIE, the emphasis is on the malleability of
preferences and an abandonment of the notion of a fixed and given
individual preferences. Institutions are the out-come of individual
behavior and habituation, as well as institutions affecting individuals. ”
• “It is simply arbitrary to stop at one particular stage in the explanation
and say ‘it is all reducible to individuals’ just as much as to say it is ‘all
social and institutional’. The key point is that in this infinite regress
neither individual nor institutional factors have complete explanatory
primacy. The idea that all explanations have ultimately to be in terms of
individuals (or institutions) alone is thus unfounded and it is rather a
victim of “Infinite Regress”. (Hodgson, Geoffrey, 2001)

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 Human Person: Natured or Nurtured or a
Product of Both
• There is strong psychological backing to the core claim of OIE.
• The argument is related to the Psychological debate whether a
human person is ‘natured’ or ‘nurtured’(Socially conditioned).
• Nature stands for natural individual attributes, unique to the
individual biological & psychological attributes.
• Nurture stands for social conditioning of a human person, i.e.
externally driven influence of a person, which may include social,
environmental, religious, political, technological etc.
• There is no consensus whether one is more important or the
other. So far there is no settled position regarding whether a
human person is natured or nurtured. So the debate appears to
converge to the idea that a human person is a blend of both
nature and nurture (society). The person is both a social and
individual animal.

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 OIE or NIE?
• OIE has been built from a heterodox
paradigmatic view that is at variance with NIE.
• NIE remains today still on the periphery of the
neoclassical paradigm.
• There are significant differences between OIE
and NIE regarding methodology, conception of
institutions, transaction costs, the firm and the
theory of the State.
• The divide is still greater than the possible
bridges between NIE & OIE perspectives of
Institutions. (Parada Jairo, 2002)

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 Major Differences between OIE & NIE-1
The major difference areas include: methodology, the concept of institutions,
the transaction costs approach, the firm, and the state . (Parada Jairo,
2002)
a. Methodological Differences: MI, MH & Blend of the two. While NIE
adheres to methodological individualism (MI), OIE adheres to a blend
of MI and methodological holism (MH).
b. NIE like NCE adheres to equilibrium analysis and hence comparative
static analysis involving mathematical models, series of assumptions,
and hence optimization. OIE rarely uses formal models, but rather
adheres to evolutionary, qualitative, historical understanding of a
historical changes in a given socio economic, political
environment(context).
In the case of NIE, its approach is basically individualistic; its point of departure
is the individual itself. In NIE’s analysis, institutions are derived from
individual behavior, through interaction among individuals. For OIE the
focus is on the mutual development of a society(institutions) and the
individual.
OIE always underlines the role that habits, norms, and institutions play in
directing human behavior, without discarding some rationality in individual
behavior but constrained by the social and economic environment. OIE has
always questioned the utility maximizer individual which is perceived as a
‘lightning calculator’. (Parada Jairo, 2002)
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 Differences: OIE & NIE
Institutions. Both recognize institutions matter. But they
differ in understanding of institutions and their
evolution and design.
For OIE, institutions are prevalent habits of thought with
respect to particular relations and functions of the
individual and society . Institutions in OIE are viewed
from a holistic and historic standpoint, though not
wholly culture-based, without neglecting the role of
individual action, but through collective processes.
Changes in institutions occur through an
evolutionary process. Contrary to NIE, Institutions are
not simply built on some economizing device such as
the reducing transaction costs rationale. (Parada
Jairo, 2002)

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 Differences: Goal-Directed (Seeking) Behavior, vs.
Purposefulness
The difference lies in the set of possible responses to the
structural environment faced by the individual.
For NCE & NIE, the human person (rational utility
maximizing person) is assumed to have goal-seeking
behavior in response to external pressure(stimulus,
cause, rules, incentives). Goal-seeking behavior
responds in a predetermined manner to changes in
the environment. The goals are fixed or
predetermined. Behavior is regarded as a
determinate function of external inputs to given
preferences. Thus human action (behavior) is
entirely determined by external stimulus, cause,
influence, including institutions defined as rules of
the game. So the future, actions are perfectly
predictable or at least with manageable degree of
forecasting error. (Hodgson Geoffrey, 1988,)
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 Differences: Goal-Directed (Seeking) Behavior, vs.
Purposefulness
For OIE the human person is a purposeful not a goal-seeking person. The
purposeful agent is essentially different from a goal-seeking
person. A purposeful person can change her/his/ goals, and
furthermore he/she/ may actually do this without any stimulus
from outside. Human beings are regarded as purposeful systems of
this type. The capacity to change both behavior and goals without
external stimulus means that humans have a self-will, and that
some of our choices are real ones. For OIE, the human person is
assumed to have certain degree of self-will to define his/her
purpose. For OIE (Austrian school too), purpose and actions are not
entirely determined by the external environment. The individual is
assumed to have a certain degree of freedom (good will) to make a
choice as how to respond to the external pressure including
institutions. The environment is important but it does not
completely determine either what the individual aims to do or
what he or she may achieve. So human action, is partially
determined, and partially indeterminate. The influence & impact of
institutions, economic policies is therefore likely to be none at al,
partial or entire (complete) as intended or a mix of all alternatives.
The future, including actions are therefore partly predictable but
partly unforeseeable, even in terms of the calculus of probability or
risk. (Hodgson Geoffrey, 1988,)
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 Differences: Predictability of the Future, Human Action
• For NCE & NIE, since they do not recognize serious information problem,
they believe that the future is predictable, perfectly or with certain
degree of forecasting (manageable) error. Thus it is assumed any
agricultural policy and corresponding policy instruments are expected to
have predictable impact, with no room for flexibility, adjustment. The
small farmer is expected to act and behave as predicted.
• For OIE, there is no perfect prediction of the future and human action.
“We may be able to make useful and meaningful predictions concerning
some events but we can never be certain that they will be true. It may
be possible to calculate and assign probabilities to future outcomes but
these will always be tentative at most, and futile at the least, because
the future is essentially indeterminate and unknown. The partial
indeterminacy of human behavior is one major reason for this fact. So
social reality displays a degree of pattern and order, and is subject to
uncertainty and potential volatility, at the same time.” (Hodgson
Geoffrey, 1988,)
• Thus in the OIE framework, there is wide room for flexible and adaptive
policy and policy implementation to transform the small farmer.
Inherently knowledge of a small farmer is relative. The small farmer is
assumed to genuinely be free to act, not to act or partially respond to a
policy and institutional stimulus, pressures & causes. Hence there is
wider scope for understanding and hence transforming the small farmer.
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 Two Types of Institutions: Formal
 Origin: deliberately designed, purposefully created
by the state, by private enterprises, or by other
alliances or individuals in civil society.
 Form: laws, constitutions, contracts, rules,
regulations, and property rights.
 Enforcement: There are explicit mechanisms for
enforcing them
 How to change? Often it is not difficult to trace the
origins of the formal institutions. As a result it is not
difficult to make changes on the formal rules of the
game, since they can be clearly identified.
 NIE pay too much attention to formal (government,
organizational) institutions, ‘as rules of the game’ in
line with procedural justice, creating an enabling,
conducive policy environment.
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 Two types of institutions: Informal
1. Origin: Evolutionary: evolve spontaneously on the basis of the self-
interest of individuals. unintentional institutions. No formal agreement
2. Forms: implicitly deeply rooted value systems governing social
behavior: norms, ethics, customs, taboos, ideologies, trust and other
forms of social capital.
3. Transmission: They are transmitted from one generation to another
through informal teaching, socialization and imitation from older
generations.
4. Enforcement: no explicit mechanism of enforcement exists. No
legislative compulsion. There is only social disapproval, which may not
involve immediate penalty.
5. How to change? It is quite difficult and challenging to identify the very
origins, the existence and the significance of the informal institutions.
As a result it is quite challenging and time taking to change the informal
rules of the game.
6. Sociologists give emphasis on informal institutions. But OIE pays much
attention to the interaction between formal, informal institutions and
the individual. The individual needs to be understand in the context of
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 OIE’s Evolutionary Process instead of Equilibrium Analysis

• “One of the advantages of ‘evolutionary’ thinking in

economics (OIE’s perspective against NCE & NIE’s
perspectives!!) is its ability to break from the constraints of a
comparative-statics approach, with two fixed end-points (i.e.
beginning & end equilibrium states, points). Because there is
no answer to the chicken-or-egg question (question of
whether an individual or society came first), the question
itself has to be changed. The question should no longer be
‘which came first’, but ‘what processes explain the
development of both of them (society & individual)?’ The
answer to the right (latter) question implies a movement
away from comparative statics and towards a more
evolutionary and open-ended framework of analysis. Such
evolutionary explanations involve the search for ‘a theory of
the process of consecutive change, realized to be self-
continuing or self-propagating and to have no Final term’.”
(Hodgson, 2001)

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 OIE’s Institutional Change
• Economic institutions are complexes of habits, roles
and conventional behavior. If institutions are habits,
conventional behavior, institutional change is nothing
but an evolutionary change of these habits and
conventional behavior, not a change in the formal
rules of the game alone in an equilibrium state.
Because of the momentum of technological and social
changes in a society, and the clashing new
conceptions and traditions thrown up with each
innovation in management and technique, the
cumulative character of economic development can
mean crisis on occasions rather than continuous,
gradual change or advance. (Hodgson, 1998)

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 OIE: Evolutionary Institutional Changes
• In social institutions, we can find mechanisms
which play a similar evolutionary role to that
of the gene in the natural world. Such
mechanisms are organizational structures,
habits and routines. Whilst these are
malleable and do not mutate in the same
way as their analogue in biology, structures
and routines have a stable and inert quality
and tend to sustain and thus ‘pass on’ their
important characteristics through time.
(Hodgson, 1998, p.142)
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 OIE: Evolutionary Institutional Changes
• Habits and routines can enable the survival and
transmission of behavioral patterns from one institution
to another. As an important type of example, the skills
learned by a worker in a given firm become partially
embedded in his or her habits, and these will survive if
the person changes employer, or if they are ‘taught’,
explicitly or by imitation, to a colleague. Thus the habits of
employees, both within the particular firm and the social
culture, act as carriers of information, ‘unteachable
knowledge’, and skills. Note that we are not talking of
evolution here in the biological manner of passing on
characteristics from individual to individual. Whilst, of
course, individuals are intimately involved, the
transmission is not biological but from institution to
institution and in that way to individuals. (Hodgson, 1998,
p.142)
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 Routines act as Genes to Transmit Information & Knowledge

• Routines within the firm act as ‘genes’ to pass on

skills and information. From the point of view of an
evolutionary economics, routines are crucial
throughout the economy and society and not simply
to transmit managerial and work skills within the
firm. (Hodgson, 1998, p.142)
• Routines act as ‘genes’ within all social institutions,
including education system, the scientific community,
public services, trade unions, and all aspects of local
and national government. (Hodgson, 1998, p.143)
• The routines can be affected by the social culture, and
by the characteristics of the individuals concerned.
(Hodgson, 1998, p.142)

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 Routines act as Genes to Transmit Information & Knowledge

• “In contrast to orthodox Darwinian biology, economic evolution is

not always gradualistic, and rapid ‘mutations’ are possible as rapid
transformations in the social, economic and technological culture
lead to the rapid acquisitions of new skills and routines.”
(Hodgson, 1998, p.143)
• Economic evolution does not proceed in classic Darwinian terms,
where slow changes occur in generation after generation, and the
typical or ‘equilibrium’ form of an organism changes gradually
over time. Instead, it can proceed by succession of periods of
stability and crisis, of apparent equilibrium and cumulative
instability. (Hodgson, 1998, p.144)
• In NCE & NIE, agents in the present are positive and free, and
routines and constrains are simply a negative restriction upon
their freedom. In contrast, in OIE, routines play a positive as well
as negative part by passing on skills and other behavioral
information from one agent or institution to the next. (Hodgson,
1998, p.144)

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 Routines act as Genes to Transmit Information & Knowledge

• “Furthermore, action in the present has the potential

function of establishing or reinforcing future routine:
thus that which is apparently ‘free’ may act as a
rigidity or constraint in the future; and that which is
apparently ossified and inflexible may provide vital
behavioral information for the present. One feature
of human action is the intended consequences of a
purposive act. But also, through the transmission belt
of routine, and through the interaction with others in
a world which is inherently uncertain, there are
crucial unintended consequences as well.” (Hodgson,
1998, p.144)

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 Conclusion on OIE
1. Note that OIE is diametrically different from NIE and
NCE. Unlike NIE, OIE is not a complementary theory to
NCE but in fact diametrically different theory. Their
differences are fundamental.
2. Indeed, NIE recognizes imperfection, uncertainty (and
hence rationale of incompleteness!) but it shares with
NCE the idea that these imperfections and uncertainties
are manageable. Hence for both NCE & NIE, the world,
economic performances and human behaviour are
essentially predictable. The scope of the problem of
incompleteness is confined to address opportunist
behavior and its danger to the prevalence and healthy
operation of private property. So the major function of
institutions is to shape and constrain such undesired
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opportunistic behavior.
 OIE Leaves Much Space for Genuine Participation &
Learning, Flexibility
• But to the opposite of both NCE & NIE, OIE argue that our conception of
reality and our knowledge and information are inherently uncertain,
incomplete, & imperfect. For OIE the problem should not be reduced to
opportunistic behavior only. Economic agents (hence agricultural agents)
should recognize that our knowledge, institutions are inherently
incomplete, imperfect and relative. Inherently economic performance
and human behaviour are not predictable.
• Hence, OIE’ conception of the ‘rationale of incompleteness’ is quite
strong and deeper than that of NIE conception.
• So our policy makers, academics, and all other stakeholders need to be
modest with their claims on philosophical and theoretical positions,
ideological beliefs, policies and policy implementation arrangements,
plans, laws, rules, directives. This leaves wide space for genuine
participation, learning from all stakeholders. The prime functions of
institutions should therefore be to learn, accommodate different
interests, perspectives. Institutions should nurture openness to learn
from all sides of any institutional relationship. Specifically one needs to
learn from the small farmer, which may be characterized as illiterate,
marginalized, poor, but definitely not ignorant. This is the institutional
infrastructure for genuine contextual development approach.
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 Conclusion: Institutional Change in Agriculture (OIE
Perspective)
• The unit of analysis in agricultural economy and society are the
formal and informal agricultural, rural institutions, habits,
conventions, values, norms, practices, shared belief systems. Any
intervention in the agricultural sector, should then be in
understanding and positively changing these routines, habits, formal
rules of the game, practices etc. The goal is towards creating a
socially responsible, creative, analytical, critical thinking,
innovativeness in that society.
• Change is there always, it is ubiquitous, omnipresent. The issue is not
whether there will be a change or not. The issue is whether one is
changing and going to ‘heaven’ or to ‘hell’. If a government, an
organization (firm) or an individual for that matter takes charge of its
(his/her) status today hence consciously manage change in line with
its (his/her) purposes, then the way foreword is to heaven, towards
sustainable stability and peace, prosperity, democratization and
agricultural transformation. If not then the drivers of change will be
in charge of your destiny, which could be ‘hell’ instead of ‘heaven’. 47
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 Reflection Questions

1. Which of the three theories (NCE, NIE or

OIE) is more relevant to the Ethiopian small
farmer-based agriculture? Why?
2. Critically Comment on the phrase, the ‘poor
small farmer, illiterate, marginalized, with
traditional attitudes, values, knowledge
system is not ignorant’.

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 Thank You,
End for Today!

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