100 Years Since “The Institutional Approach to Economic Theory” by Walton H. Hamilton

It is now 2019, a century and a handful of months since economist and lawyer Walton Hamilton (1881-1958) published his “plea for a particular kind of [economic] theory” in the pages of the American Economic Review.  Hamilton felt that the state of the field of economics had lost its course, failing to address real problems or “truly recognize the complexity of the relations which bind human welfare to industry.” In response to these concerns, he published “The Institutional Approach to Economic Theory”.

Hamilton was writing at a time when neoclassical economic ideas were taking shape.  He describes value theory as having overcome the older system of institutional theory for dominance over the classical doctrine, and his writing is critical of the use of words like “utility” and “productivity” that are very familiar in the economic sciences today, but were still in the process of being defined.  In “The Institutional Approach to Economic Theory”, he almost unintentionally sets Institutional Economics apart from mainstream economics through his academic vehemence that institutional theory is the only real economic theory. It’s a unique paper that started as a final argument for an old way of thinking, but ended up credited with naming—if not starting—the formal sub-field.

In his paper he made many claims, chief among them that 1) there are five tests “which any body of doctrine must meet to be called economic theory” and 2) “Institutional Economics is the only way to the right sort of theory”.

Hamilton’s (1919) Five Tests for Economic Theory:

1. “Economic theory should unify economic science.
2. “Economic theory should be relevant to the modern problem of control.”
3. “The proper subject matter of economic theory is institutions.”
4. “Economic theory is concerned with matters of process.”
5. “Economic theory must be based upon an acceptable theory of human behavior.”

He spends the body of the paper describing how the neoclassical economics of the time fails each of these tests where institutional economics succeeds.  Today, in honor of the centennial of the publication that is often credited with giving IE its name, I look at how things have changed using Hamilton’s five characteristics.

“Economic theory should unify economic science.”

Hamilton writes, “The task of a general body of theory in any subject is to give unity to its investigations.”  He describes the state of the field at the end of the 1910s, where economists studied a plethora of issues (money, taxation, salesmanship) beyond value theory. “For all the constraints of neo-classical theory,” he writes, “….economics today tends to break up into a large number of overlapping but unrelated inquiries and to lose the unity which in times past has been its source of strength.”  I would say that this is truer now than it was in 1919.  While there is a certain unity to be found in standard neoclassical assumptions (which, really, continue to face the same if not stronger critiques in 2019 than they did in 1919), there exists a pretty stark divide across the kinds of work we do and the methods we use inside of the classroom.  There’s little “unity” to be found when the majority of the work we do is so specific or different that there are only a handful of other people who can fully read and appreciate it.

Would the adoption of institutional theory give more unity to investigations across economics today, as Hamilton argued then? It already does, to some degree. The common thread in much of what I read in journals today is in the discussion of the economic organization or institutional environment in which each study takes place.  That this is not always explicitly done, and that the social sciences are ill suited to the adoption of one unifying theory in general are topics for future blog posts.

“Economic theory should be relevant to the modern problem of control.” and  “The proper subject matter of economic theory is institutions.”

There are plenty who question the relevance of economists today. The NYT published an opinion piece two weeks ago titled “Blame Economists for the Mess We’re In”, that seems to simultaneously highlight our apparent irrelevance to public policy in the past with our catastrophic rise to relevance and power from the 60s onward.  This kind of history, however negatively portrayed in the NYT article, makes our relevance to the modern problem of control quite clear.  But Hamilton’s real point in the paper seems to be less about neoclassical economic theory not being relevant and more about the type of relevance it has.  He believed that it was not the place of economists to pass judgements on the proposals that came before them, but rather to “impartially gather the facts and formulate the principles necessary to an intelligent handling of such problems.”  Through focusing on institutions in economic theory, he believed we could attain this positivist relevance. He argues that one must understand the makings of the market to properly explain the outcomes of the market.  “It is not enough to assert with the neo-classicists that one receives the value of his services in the market; for, if matters subject to control are changed, he will still receive the value of his services, but he may pocket a different sum.”

Though making important points about the value of institutional awareness that are still making the rounds today, Hamilton doesn’t address the inherent value judgements one who directs industrial development or policy must make. Can economists be impartial when asked to make a comment on any kind of control?  This is a question that seems much more relevant to me today than Hamilton’s point about carefully specifying institutional structures and processes, which most economists would acknowledge easily, even if we’re not always very good at it.

“Economic theory is concerned with matters of process.”

In keeping with his previous points, but perhaps showing the papers age, Hamilton critiques the rise of quantitative methods in economics in this fourth test, cautioning against the turn to relying on statistics rather than understanding of institutional processes. His description of  “economic statics” and the addition of “economic dynamics”  as “tinkering with this or that” serve as a reminder of how irrevocably the field has changed in 100 years-- and institutional economics with it-- as mathematical modeling has become the norm.  His skepticism still resonates today, in an age where we have access to technologies that produce highly accurate but questionably relevant estimates.

“Economic theory must be based upon an acceptable theory of human behavior.”

To Hamilton’s last point-- Economics has struggled with human behavior since its conception.  The rationality and information assumptions that back modern neoclassical theory have not changed, but have rather been challenged and tempered by new bodies of research that build off them, rather than replacing them.  Behavioral economics has grown at extraordinary speeds, feeding off many of the same arguments Institutionalists made in the early 20^th century and later.

Hamilton concludes with a paragraph that I think is worth quoting in its entirety:

“The future of institutional theory is uncertain. The history of economics suggests that survival has often depended upon the ability of doctrine to fit in with the habits of thought of the times. If the next decade demands formal value theory that avoids a discussion of what the economic order is like, institutional economics will fail. If it demands an understanding of our relationship to the world in which we live, it will survive. But survival will be assisted by the development of a theory of the economic order, vital, true, and relevant to the problems of the times.”

It seems clear to me that Hamilton saw at least part of the writing on the wall, as the next decade continued away from traditional institutional economics. But he also had no way of imagining how quickly economics would grow in the decades following, or how demand for a greater understanding of our relationship to the world would persist. If Hamilton were around today, I think it likely that he would be writing a similar paper. 

Hamilton, W. H. (1919). The Institutional Approach to Economic Theory. The American Economic Review, 9(1), 309–318. Retrieved from http://www.jstor.org.proxy1.cl.msu.edu/stable/1814009