Reflections of an Institutional Economist: Charles Whalen, Part II

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This is the second of a four-part series in which the author reflects on four decades of studying and working in the institutionalist tradition of economics. Dr. Charles Whalen is a visiting scholar at the Baldy Center for Law and Social Policy, University at Buffalo, and served as the 2018 president of the Association for Evolutionary Economics, an international organization for economists and other social scientists seeking to advance the institutionalist tradition. Whalen's remarks are summarized in four parts: Beginnings; The Nature of Institutional Economics; John R. Commons’s Continuing Relevance; and Assessing the Economy, and will be released each Monday from February 10th to March 2nd, 2020.





Reflections of an Institutional Economist
Charles Whalen[1]

Part II: What Is Institutional Economics?
Institutional economists often define their conception of economics as the science of social provisioning—the study of the ongoing process that “provides the flow of goods and services required for society to meet the needs of those who participate in its activities.”[2] To be sure, markets are important, but the market system is only one institution that influences the provisioning process. Moreover, that system can take countless forms and is shaped by history and culture. The perspective of institutional economics is much wider than that of conventional economics.

But the institutionalist perspective is characterized not just by its broad scope—its viewpoint toward economic life is also different from that found in other approaches to economics. What follows are some features of that viewpoint. In particular, I outline four key elements in the strand of institutional economics that provides a foundation for my work—a strand that builds on what institutionalists have in common with John Maynard Keynes, the tradition I call post-Keynesian institutionalism (PKI).

1. Institutions are the balancing wheel of the economy. Conventional economics suggests that economic life is kept in balance by the impersonal, equilibrating force that comes from markets, a force often described as the law of supply and demand. In contrast, by viewing the economy as part of our ever-changing culture, institutionalists instead see social institutions as the glue and governing force.

Yes, supply and demand are important in a market economy. But capitalism “is not a static or single concept.”[3] In some circumstances, the price system may exhibit equilibrating tendencies, but market dynamics in other circumstances can be destabilizing. According to PKI, even fully rational economic decisions by individuals and businesses can lead to booms, severe downturns, and economies that stall at far below potential for extended periods. Whether the economy experiences or avoids recurrent slumps and volatility depends on how we use our economic institutions to coordinate the provisioning process.

2. Finance plays a central role in a market economy. Conventional economics is constructed around a barter paradigm: money, finance, capital assets, and production can all be added, but the paradigm assumes that the central features of capitalism can be grasped without them. In contrast, PKI adopts what Hyman Minsky called a Wall Street paradigm—rooted in recognition that capitalism is driven by pursuit of financial gain, that production precedes exchange, and that finance precedes production.[4] That paradigm leads to what Dudley Dillard called a monetary theory of production, a common element in the work of Keynes and many institutionalists.[5]

Finance also plays a central role in the PKI analysis of capitalist development. According to that theory, which has roots in John R. Commons and Joseph A. Schumpeter, capitalism in the United States passed through four stages (commercial capitalism, industrial capitalism, financial capitalism, and managerial capitalism) before money-manager capitalism emerged in the early 1980s. In addition to the strong influence of institutional investors upon economic decision-making, money manager capitalism is characterized by a fast pace of financial innovation as well as by increased worker insecurity and rising income inequality.[6]

3. PKI adopts Minsky’s financial-instability hypothesis as a compelling alternative to the efficient-market hypothesis of conventional economics. According to the conventional view, investors, lenders, and other financial-market participants are not, as a group, predisposed to overconfidence and other biases. In contrast, the financial-instability hypothesis, which accommodates herd behavior and sudden changes in expectations, maintains that history demonstrates overconfidence and panic are regular features of the capitalist economic landscape.[7]

Minsky’s instability hypothesis also includes a theory of the business cycle that emphasizes evolution of the financial structure over time.[8] That theory—which is in many ways an update of theories found in the work of early institutionalists—does not offer a single explanation for all cycles, but it does shed light on the transition from one phase in a cycle to another in a coherent fashion. While overall (aggregate) demand certainly plays an important role in cycles, Minsky’s hypothesis gives special attention to the interplay of two important institutional features of our economy: (1) expensive and durable capital assets; and (2) institutions of finance that allow short-term financing and position-taking.

4. Government plays a creative role in economic life. Conventional economics maintains that the proper role of government is to serve as a corrective entity—that is, to correct for market failures such as the existence of externalities. In contrast, PKI views the government as deeply and unavoidably involved in shaping the economy by making and enforcing rules that are always evolving.

Two Michigan State economists, Warren Samuels and Allan Schmid, did much to highlight the creative role of government in the economy. For example, both stressed that government is deeply involved in the ongoing “definition and creation of the economy.”[9] They also drew attention to the role of economic and political power in influencing how government shapes economic life.

Of course, my outline is far from comprehensive. Still, PKI has proven useful to me and other institutionalists—allowing us to ground our work in a solid intellectual tradition, and providing us with starting points and analytical devices that we’ve used to dig into important economic issues.[10] But more on that later.

[1] The author is a visiting scholar at the Baldy Center for Law and Social Policy, University at Buffalo. These remarks were prepared for a two-day exploration of institutional economics, convened at Michigan State University, May 16-17, 2019.
[2] See, for example, Allan G. Gruchy, The Reconstruction of Economics: An Analysis of the Fundamentals of Institutional Economics (New York, Greenwood Press, 1987), p. 21.
[3] John R. Commons, Institutional Economics: It’s Place in Political Economy (New York: Macmillan, 1934), p. 766.
[4] See, for example, Hyman P. Minsky, Can “It” Happen Again? (Armonk, New York: M.E. Sharpe, 1982), p. 61.
[5] See Dudley Dillard, “A Monetary Theory of Production: Keynes and the Institutionalists,” Journal of Economic Issues (June 1980), pp. 255-273.
[6] See, for example, Charles J. Whalen, “Integrating Schumpeter and Keynes: Hyman Minsky’s Theory of Capitalist Development,” Journal of Economic Issues (December 2001), pp. 805–823.
[7] See, for example, Hyman P. Minsky, Stabilizing an Unstable Economy (New Haven: Yale University Press, 1986).
[8] While the financial-instability hypothesis is rooted in the work of Minsky, who died in the mid-1990s, others have applied that hypothesis to help explain more recent economic developments, including the global financial crisis. In addition, a number of Post-Keynesian institutionalists have recently made fruitful extensions to the financial-instability hypothesis by incorporating consumer spending and inequality into their analyses.
[9] See, for example, Warren J. Samuels, “Some Fundamentals of the Economic Role of Government,” Journal of Economic Issues (June 1989), pp. 427-434; A. Allan Schmid, “Government, Property, Markets…In that Order…Not Government Versus Markets,” in Nicholas Mercuro and Warren J. Samuels (eds), The Fundamental Interrelationships between Government and Property (Stamford: JAI Press, 1999), pp. 237–242.
[10] See, for example, Charles J. Whalen, “An Institutionalist Perspective on the Global Financial Crisis,” in Steven Kates (ed.), Macroeconomic Theory and Its Failings (Cheltenham, UK: Edward Elgar, 2010), pp. 235-259; and Charles J. Whalen, “Understanding Financialization: Standing on the Shoulders of Minsky,” in Victor A. Beker (ed.), Alternative Approaches to Economic Theory (London: Routledge, 2020), pp. 185-206.

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