Organizations Are Not Institutions

It’s important to draw attention to a use of the term institution Opens in new window in everyday English, which deviates from our definition.

In common usage, institution is frequently applied to the concept of organization Opens in new window (which is defined as a more or less durable combination of property rights to production factors under a leader in order to achieve some shared purpose).

Thus, Organizations are purpose-driven, reasonably durable combinations of resources, which are to some extent coordinated in a hierarchical way by a leader.

Institutional economists do not call banks, universities and psychiatric hospitals institutions Opens in new window. These are organizations. Institutions are rules, organizations are players (North, 1990, p. 4).

Organizations may pursue economic purposes, for example in the form of a business partnership or a share company. They may also pursue political purposes, for example in the political organization of local or national governments, party organizations or lobby groups.

Organizations, although partly coordinated by top-down ordering, also require internal rules Opens in new window to function effectively. Many of these rules tend to be implicit because they govern frequently repeated actions between the limited numbers of members of the organization.

Examples of institutions that are embodied in organizations are established procedures, work practices and business routines. Such implicit institutional wisdom is often hard to transfer to other organizations as the transfer depends on association, imitation and emulation.

Just as certain types of knowledge Opens in new window are implicit or embodied in (built into) capital goods, so are institutions sometimes implicit in organizational structures Opens in new window.

Certain institutions incorporate implicit knowledge and are inseparably tied to certain organizational arrangements. An example is the traditional family, an organization that serves various ends for its members and embodies certain rules of conduct for mother, father and children.

The importance of implicit institutions is made clear when one compares different firms in an industry.

One often observes hard-to-explain differences in productivity between the best-practice firm and other firms in the same branch of industry, which can only be attributed to different work practices (Kreps, 1990).

These implicit institutions are sometimes given fuzzy labels such as corporate memory or organizational culture Opens in new window. The fact that some institutions are built into organizations makes it often hard to transfer them to other organizational environments, a reason why so many corporate take-overs do not work out.

The embodiment of rules also enables the owners of specialized institutional knowhow to claim property rights in their specific institutional arrangements and to extend the use of that proprietary knowhow by taking over other organizations.

To give an example:

Some of the rules on how to run an honest and competent stock exchange are so intimately tied to the implicit knowhow of those who run the stock exchange that it is hard to imagine such knowledge being disembodied from the organizational back-up.

There is no manual along the lines of “Running a Stock Exchange for Dummies”. In short, organizations are often storehouses of implicit knowledge, which is essential to their functioning.