Institutional Economics

Normative Content and Public Policy

In institutional economics Opens in new window it is often appropriate to analyze values and the effects of fundamental values Opens in new window.

Institutions are often decisive for how people attain their own personal objectives and are able to realize their own aspirations. Institutions Opens in new window also impact on the values that people hold and the purposes they pursue.

Institutions thus reflect subjective notions of the relation between one individual and others in the community. Their acceptance and enforcement depend crucially on cultural notions of what society stands for.

A community’s shared fundamental values support cohesion and motivate people to act within the institutional framework.

Institutional economics therefore has to analyze human values explicitly — more precisely statements about what people appreciate as valueable — and participate in moral discourse (Palmer, 2011). In this respect, it draws on moral philosophy, the origin of modern economics.

Fundamental values Opens in new window are deeply anchored in the traditions of civilizations and are not easily changed. They form part of a community’s identity and may even be tied to firmly held religious beliefs. This has the potential of posing huge obstacles to economic and cultural change when economic development takes off in a hitherto stationary society.

The institutions Opens in new window of the market economy then have to be grafted onto the fundamental values Opens in new window of a particular society. Some civilizations come with values and social attitudes, which easily mesh with the ‘rule book’ of the market economy Opens in new window, or at least readily adjust, so that private property rights, competition and the rule of law are easily adopted.

Other realizations, however, come with value systems that reject the enjoyment of material welfare, reward for individual effort and the equality of all before the law. Smaller groups, such as indigenous tribes, then often lose their identity. Bigger groups then experience cultural distress and great difficulties in embracing modern economic growth Opens in new window (Bauer and Sen, 2004; Boettke et al., 2008).

These adjustments to the institutional infrastructure of values and basic attitudes ensure that the institutions that make the market economy will differ from one society to the next, so that ‘multiple modernities’ emerge.

Institutions—the rules that are informed by the underlying, shared values—define a community, be it a family, a neighborhood, a nation or an international professional association.

Institutions Opens in new window constitute the social cement that makes and defines a society (to employ the term American sociologist John Elster used in the title of a well-known book, Elster, 1989).

Individuals may of course belong to a great variety of different, overlapping communities, obeying differing sets of institutions; some they share with their neighbors in the same geographical area, others with people far away.

In the same vein, institutions have an inter-community dimension. Systems of economic institutions may also be more or less open to others. Openness here means that exchanges of goods and services and flows of people, capital and ideas are possible between different communities. In this respect, institutional economics shares common ground with sociology, international law and politics.


We must also distinguish between the theory and the policy of institutional economics.

Institutional theory describes, explains, and predicts the emergence and the effects of rules; it also discusses how changes of certain rules may help or hinder certain outcomes or classes of outcomes.

In this respect, institutional economics Opens in new window belongs to the realm of positive science and contributes to economic policy.

Depending on how well institutional theory works, one may go beyond this and be able to derive policy-oriented knowledge that helps to shape institutions in the real world according to certain objectives. Economists, as scientists, may give policy advice on how given objectives could be more effectively pursued under alternative sets of institutions Opens in new window.

Public policy—the systematic use of political means in the pursuit of certain objectives—will normally proceed within given institutional constraints, but policy actions may also alter institutions, either in explicit ways or as a side effect of experiences.

Institutional economists tend to focus on the interactions between public policy and institutions.

Beyond this, economists, like any other citizens, may of course articulate what they consider to be desirable, good or bad. When they do so, they should reveal their personal values and preferences, because they then adopt a normative posture.