Problems with Traditional Institutional Analysis

Technical Notes

Dec 16, 2009 — Neil Boyle

What do I mean by “institutional problems?” Traditionally, they are problems that an analyst identifies in the course of analyzing the performance of an institution that can influence investment decisions of either a government body or private investor or both. Normally, the analysis compares the achievements of the institution against its stated goal and the quality and quantity of resources that are consumed in the process. Legal versions of state and corporate governance structures are incorporated as solutions to institutional problems. Rarely will an analyst reflect on the intertemporal processes that link means with ends and both with performance. To consider intertemporal processes, the analyst would be compelled to insert the assumptions of human behavior into his/her calculus. This is what Chomsky refers to as the mentalist portion of linguistic theory (Smith, 2004, p.____.), which is similar to the behavioral assumptions of bounded rationality and opportunism in Williamson’s Transaction Cost Economics theory. Consider the numerous hazardous incentives that occur in the corporate and institutional work worlds such as moral hazard, alignment hazards, contract hazards, asset specificity hazards, monitoring hazards, agency hazards, and holdup hazards, among others.

Traditionally, the human factor has remained beyond the analyst’s realm, resulting in unscientific and questionable policy outcomes. Because economic governance is an alliance of law, economics and organization theory, it is able to explore beyond the limitations of today’s understanding of contract and probe the nuances of human nature. Economic governance is akin to law: deeply profound when treated respectfully.

Traditional institutional analysis is problematic for three reasons. First, analysis is normally organized on the basis of assumptions and goals. This is a premise that reduces the exercise to a brand new proposition for each analysis, with little or questionable analytical depth and consistency across projects, countries and time. Second, it is “customary to analyze institutions by examining alternative forms of administrative organization by (i) making comparisons within the hierarchical form of governance; and (ii) assigning managerial utility as the source of bureaucratic disability and waste. And third, by emphasizing strategic planning.” (Williamson, 2007) These three reasons are discussed in detail in seriatim.

Administrative organization and management theories of the firm turn out to be inadequate in the real world. (Williamson, 2007) As a premise for institutional analysis, goals and assumptions are unscientific because they are derived neither from root causes, i.e., the bounded rationality and opportunism of human agents, nor systematically from empirical evidence. Institutional analysis limits the breadth and depth of analysis because (i) “comparisons within the generic governance mode of hierarchy excludes the more important comparisons between alternative generic modes, of markets, hybrids, and hierarchies;” (ii) analysis of bureaucratic disability and waste is done within a managerial utility framework and excludes the more important analysis of organizational structure and the misalignment with transactions that turns into maladapted operations; and (iii) strategic planning is also not enough because it approaches the problem of economic organization with a traditional lens that (1) excludes the human factors of bounded rationality and opportunism, and (2) views the firm as a production function and profit maximizer rather than also as a governance structure of “incomplete contracting in its entirety “where parties are assumed to behave perceptively with respect to present and prospective benefits and hazards.” (Williamson, 1996)

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