The Origins of Institutions

What causes institutions to come into existence?

One possibility is that rules and entire rule systems are shaped by long-term human experience. People may have serendipitously stumbled upon certain arrangements that allowed to them to better meet their aspirations.

It may have proved useful, for example, to adopt the custom of greeting the people one meets. It may have made the traffic flow better when everyone stayed on the same side of the road.

Useful rules tend to be perpetuated and become a tradition; if adopted by sufficient numbers of people to create a critical mass, rules are eventually followed by everyone in the community. The rules will be spontaneously enforced and emulated, as they emerge gradually and become known throughout a community.

While rules that ameliorate human interaction are reinforced, arrangements that fail to satisfy human aspirations will be rejected and abandoned. Thus, most of the rules that matter to our daily lives have evolved within society in a process of gradual feedback and adjustment.

The precise content of most institutions will evolve gradually along a steady path. We call such rules internal institutions Opens in new window, as they arise within the community and are enforced internally, that is, by spontaneous reaction from the people who are directly affected.

In analyzing how internal institutions come about, institutional economics Opens in new window can draw on the insights of moral philosophy, anthropology, psychology and sociology.

Other types of institutions Opens in new window come into existence because they are designed by someone with authority, are made explicit in legislation and regulations and are formally enforced by an authority outside, such as a government. Such rules are designed and imposed by agents who may have acquired this role by force, inheritance or as the result of a political process.

Although there tends to be much voluntary compliance, these institutions are ultimately enforced by legitimated means of coercion, for example through the police and the judiciary. We call these rules external institutions Opens in new window.

As soon as institutions are imposed and enforced externally by rulers, parliaments, or bureaucracies, a fundamental problem arises:

The political agents, who should act in the interest of the citizens, lack perfect information and often tend to exceed their mandate; they often use rules and enforcement to their own benefit.

For this and other reasons, political processes themselves need to be subjected to certain rules.

The effectiveness of external institutions depends greatly on whether they are complementary to the internally evolved institutions — for example, whether legislation supports a society’s morality, its cultural conventions, customs, and manners.

External institutions Opens in new window cause agency and compliance costs and are normally much more costly than corresponding internal institutions Opens in new window. When analyzing external institutions, one has to draw on political science and jurisprudence.