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Recognizing capital as embodied technology leads to a consideration of
reform, is assumed automatically in neoclassical economic theory. Not
whether changes in output of an economy can be explained only by
quickly seeking and finding the most efficient means of producing a given
changes in capital. I am speaking here of the ex post realization of a change
quantity of output would be considered irrational. The neoclassical problem
in output which would clearly be the case when there is a substantial inter-
has always been to find the most ˜efficient™ level of output of all those that
generational change in the type of output “ such as might occur when the
are technologically possible.3 And institutional changes, such as increasing
automobile industry changes from gasoline engines to electric motors. We
productive possibilities, is considered an outside question for neoclassical
already know about the substantial retooling necessary to bring out a new
capital theory “ but not for the reasons I have laid out here. In neoclassical
model of the present type of automobile output. 5 To advance the argument
capital theory it is merely a matter of having more of the same type or
for a capital-based explanation of secular changes in output, we should ask:
quality of capital rather than choosing a different type or quality of capital.
Are there any other bases for the accomplishment of a change in output?
In terms of Chapter 5, neoclassical capital theory is concerned with the
Clearly, we could say that desirability of a different output should affect its
achievement of an intermediate-run equilibrium.
being produced. Unfortunately, desirability would not be an adequate
explanation because desirability is neither necessary nor sufficient even
CAPITAL AS EMBODIED TECHNOLOGY when it may appear that we have the theoretical capability. Clearly,
desirability is not sufficient when we do not have even the theoretical
A further extension of the idea of embodied technology is that future (as
capabilities of a different output. To see that it may not be sufficient we
well as current) advances in technology are limited by the quality as well as
need only observe one occasion where it is not, although we have the
the growth of capital. For example, the exploration of space which made
˜know-how™. As long as one is willing to recognize real time, it is easy to
new research and development possible was itself limited by the
find such examples. The usual problem is not how to produce a desirable
development of technical capabilities. In other words, not only is the
good but how to mass-produce it. The American space shuttle programme
growth of technology limited by the changes in capital, but so is the growth
is replete with examples of goods that are produced as one-only items that
of knowledge limited. This idea was employed by Arrow in his famous
would be useful if mass-produced. Today, the most important is the fuel
[1962] capital theory article about the economic implications of learning by
cell that can produce electrical energy with virtually no pollution and a
doing.
very low cost of operation. The fact that such items can be produced (albeit
I have said that changes in capital cannot be explained by changes in
at an extremely high cost) only makes it frustrating that the means of mass-
technology. Stated another way, if we ask, ˜Why has the capital stock of a
producing them has not been found. Sometimes it takes decades before
large firm, an industry, or an economy changed?™ we cannot answer
such one-only items in the space programme see their way to the mass
˜Because there was a prior change in the technology of that firm, industry,
consumer market. This is a problem of implementation rather than
or economy, respectively.™4 It might be asked, if we exclude changes in
knowledge.
technology as bases for explaining changes in capital, what does it leave?
Of course, neoclassical theory offers another explanation. The direct reason
why capital would be changed is that the entrepreneur or manager of a firm TOWARDS A THEORY OF SOCIAL CHANGE
seeks to increase profits. The assumption of profit maximization leads to
To many anti-neoclassical economists my naive arguments in this chapter
another question. Why should changing capital be more profitable? The
would not seem to be very amazing since much of it goes against the
answer to this question can be that the output which only the new capital
neoclassical theory of the textbooks. Technology is always assumed to be
can produce may now be more desirable. Increased desirability might be
˜given™ in Marshallian models. The questions of capital theory are always
indicated by contracts, by market research, or by rising market prices. In
in terms of the quantity of homogeneous capital, and technology is always
any case, these would be the reasons for profitability and ultimately the
something independent and exogenous. The role of capital in the growth of
reasons for changing capital, that is, for institutional changes.
technology and the development of new and different goods is central to
both economic theory and economic history.
© LAWRENCE A. BOLAND
110 Principles of economics A naive theory of technology and change 111
On the basis of what I have said here it could be argued that capital NOTES
theory should be the foundation for all future improvements in economic 1 The remainder of this chapter is based on a paper I delivered to the Society for
theory and perhaps even economic history. This is simply because the the History of Technology meetings in 1967 [see Boland 1971].
growth of technology today is probably the most important aspect of the 2 One could easily see supporting evidence in the high degree of specialization
prevailing in today™s economy.
modern economic decisions of economic institutions such as firms. As
3 This is considered a low-level criterion of efficiency and requires only that the
many already agree, technology can no longer be considered exogenous; it
firm find its optimum point on its production function “ that is, it is not wasting
must be endogenous, that is, any theory of the firm, as an economic inputs.
institution, must also explain the growth of technology. 4 Except in the case where to produce the new capital the technology of the
Most neoclassical theorists are unlikely to heed the call for a rethinking production of capital itself may have changed.
5 Until recently, every time there was an energy crisis, automotive executives
of neoclassical capital theory. It is all too easy to retreat to the view that
would point out that it takes at least four years to introduce a new model.
capital is merely a commodity like any other and thus it is subject to
Executives of the Chrysler Corporation are now claiming that the lead time can
Marshall™s Principle of Substitution (i.e. to the neoclassical maximization be reduced to less than two years.
hypothesis) and thus explainable as discussed in Chapters 2 and 3. So what
can be learned from this elementary exercise in dealing with Marshall™s
secular or inter-generational run? What I have said so far can be
generalized into a simple theory of social institutions. This simple theory
says that society™s institutions are, like the firm™s capital, embodiments of
society™s social technology. Social institutions are social capital. The
evidence of learning in society is the changing of social institutions through
simple change, more elaborate reforms, or even through revolution.
Although a revolution in the case of a firm means going out of business, it
need not mean that for the case of the society as a whole. Since technology
can always be viewed as merely accepted solutions, it follows that social
institutions are merely accepted solutions to standard social problems.
Without new problems there need not be any social change. Even though
the problems solved by the current institutions are no longer interesting, we
may still have solutions for them.
This chapter constitutes the results of my early study of institutions and
technological change. In retrospect, it does seem rather naive.
Nevertheless, it suggests some interesting ideas concerning an analogy
between the neoclassical theory of capital and a more general theory of
institutional change. And the awkwardness of my naive early views did
prompt me to learn more about social change and social institutions in
general. In the next chapter I present the results of my later explorations
into a more substantial view of the role of institutions in neoclassical
economic theory.
© LAWRENCE A. BOLAND Knowledge and institutions in economic theory 113
dynamics is even sometimes alleged to be the ˜fatal flaw™ of neoclassical
8 Knowledge and institutions in theory [Robinson 1974].
economic theory So much has been made of this criticism over the last two decades that
those institutionalists among the anti-neoclassical group have turned their
attention from a study of the nature of institutions to the study of the
evolutionary aspects of any economy. So far, the institutionalists™ critical
programme of study “ called ˜evolutionary economics™ “ has failed to
persuade neoclassical economists to drop their ˜paradigm™. To the contrary,
many neoclassical theorists believe that the evolution of an economy™s
institutional setting can be explained within the neoclassical paradigm [e.g.
Buchanan and Tullock 1962]. However, it would be misleading to suggest
that this is only a methodological dispute over the ability to ˜explain
Though economic analysis and general reasoning are of wide within™. Underlying this question is a more fundamental theoretical issue
application, yet every age and every country has its own problems; and concerning the nature and role of institutions in neoclassical theory.
every change in social conditions is likely to require a new
Here I will argue that the essence of the methodological dispute lies not
development of economic doctrines.
in the depths of sterile philosophy, but in the apparently contradictory roles
Alfred Marshall [1920/49, pp. 30“1]
played by institutions in economic theory. On one hand (viz. in
neoclassical theory), institutions are tacit or given static constraints which
The failure of economists to appreciate the transitory character of the
assumed constraints and to understand the source and direction of ultimately define various equilibrium positions. On the other hand (viz. in
these changing constraints is a fundamental handicap to further economic policy analysis), institutions are explicitly dynamic or active
development of economic theory.
instruments used either to facilitate or to prevent change. Both aspects of
Douglass North [1978, p. 963]
institutions are explicitly recognized in Lance Davis and Douglass North
[1971]. Following Buchanan and Tullock, Davis and North distinguish
For more than six decades, neoclassical economics has been criticized for between the institutional environment, which includes the ˜legal ground
neglecting the social institutions that form the framework in which the rules™ that constrain on-going political and economic business, and the
neoclassical economy functions. In North America the criticisms have institutional arrangement, which provides a workable mechanism either for
come from those economists who huddle under the banner of ˜institutional operating within the ground rules or for changing them. It will be shown
economics™ and focus on the problem of explaining institutional change. that any appearance of contradiction here can easily be overcome with an
This chapter discusses the role of institutions in neoclassical economics. explicit recognition of the relationship between institutions and knowledge.
Whether there is a problem with how neoclassical economics explains the I will argue here that since the neoclassical conception of an institution
evolution of institutions is a question open to debate. Proponents of (i.e. a short-run constraint) is inherently static, all attempts to promote and
neoclassical economics argue that since one can explain any institutional defend the pro-neoclassical view will necessarily result in methodological
setting and its evolution as merely the consequences of the logic of choice failures. Moreover, if neoclassical economics is ever going to be able to
(i.e. of optimization facing given constraints), our understanding of explain the evolution of institutions then a broader view of institutions will
institutions is merely another example of neoclassical analysis (e.g. James have to be developed. I think such a broader view is possible within
Buchanan, Gordon Tullock and Douglass North). neoclassical economics. But, unless the dynamic nature of institutions is
The primary concern of some opponents of the neoclassical economics properly explained, no explanation (neoclassical or institutional) of
has been to show that the pro-neoclassical view is simply false. In evolutionary economics can ever succeed.
particular, they have seen that advocates of the neoclassical view presume I will begin by presenting the neoclassical view of institutions, namely,
that neoclassical choice theory can easily be made dynamic. Some the one where institutions are merely some of the constraints facing the
opponents go so far as to argue explicitly that this presumption is optimizer. Specific attention will again be given to the Marshallian method
completely unfounded [Shackle 1972; Hicks 1976]. The question of of dealing with the dynamics of constraints. Next, I will summarize from
© LAWRENCE A. BOLAND
114 Principles of economics Knowledge and institutions in economic theory 115
Chapter 7 my criticism of the adequacy of any neoclassical programme for take an unrealistic amount of time. More important, it would be very
dealing with questions of dynamics. Then I will present a theory of the misleading to focus on prices as the only institutional constraint. The
nature and role of institutions designed to overcome the inadequacy of the tendency to do so persists because many neoclassical economists rely on
neoclassical approach to institutional dynamics. 1 It will be based on an the normative view that price should be the only institutional constraint. As
explicit recognition of the relevant epistemological questions involved as a matter of positive economics, dealing with real-time phenomena “ which
well as the instrumental aspects of institutions. Finally, I will explain the must exist in the short run “ there are other institutions which constrain
essential relationships among time, knowledge and institutions. individual choices (see Coase™s theorem). Whether or not the existing
institutions can be explained away by assuming there are no incentives to
change them, because they are optimum, is the moot point discussed in this
THE NEOCLASSICAL VIEW OF INSTITUTIONS
chapter. Given any neoclassical model of the economy, if there are many
Within neoclassical theory, all endogenous variables are explained as the exogenous variables involved in the explanation of one or more
logical consequences of self-interested rational choice, whereby one™s endogenous variables, then formally there are many possible causal
choice may be limited by the similarly motivated rational choices of others explanations for observed changes in the endogenous variables. The
through any activity in the market. This form of rational choice involves explanations formally differ only to the extent to which changes in
maximization (or minimization) of some objective function while facing different exogenous variables are recognized as the causes.
some given constraints. The nature of the constraints facing any In these terms one can identify many types of neoclassical explanations
individual™s choice may or may not be explained as a matter of his or her which are distinguishable in terms of the method used in each to deal with
past or irreversible decisions or those of other individuals. Those the multiplicity of ˜causes™. At one extreme, we find the approach which
constraints which are not considered a matter of choice cannot be explained follows Walras and William Stanley Jevons in being concerned only with
the logical and mathematical adequacy of the neoclassical model. 4 At the
within neoclassical theory. Operative constraints which limit individuals™
choices (e.g. anything which is naturally given or beyond control, such as other extreme is Marshall™s approach, which is the foundation for virtually
the availability of resources, technology, and so forth) are by definition the all neoclassical theories of institutions.
exogenous variables of neoclassical theory. 2 Also by definition, any fixed When there are many possible causes, (causal) explanation becomes a
or exogenous variable can be seen to play a determining role (viz. in the very difficult methodological problem. And as I discussed in Chapters 2
determination of the values of the endogenous variables) only if changes in and 3, solving this problem was the central purpose of Marshall™s
that variable necessarily result in changes in the endogenous variables. 3 Principles of Economics. His solution was based on an explicit recognition
Neoclassical theory, of course, recognizes many exogenous variables, of ˜the element of Time™ and its relationship with what he called the
including institutional or socially determined constraints such as legal Principle of Continuity. As I explained before, the latter presumes that
limits and property rights. The constraints facing any individual™s choice anything that can be varied in the given amount of time must yield to the
include some ˜endogenous givens™ which are determined in concert with Principle of Substitution, that is, can be explained as a matter of optimizing
the rational choices of other individuals; for example, the givens of choice. His solution is built on two assumptions. First, he assumes away
consumer theory include market-determined prices. In this sense, some of changes in all variables which are impossible to control (such as weather)
any individual™s constraints are explained as the consequences of (the or for which there is not enough time to change them (such as cultural
equilibrium or concert of) all individuals™ choices. Moreover, any traditions). Such variables cannot be explained with his Principle of
constraint the establishment of which requires the (implicit) participation of Substitution hence they are unexplained givens or exogenous variables.
many individuals is in some sense an institution. For this reason, some Note again, such ˜exogeneity™ may depend on the amount of time under
economists might consider a system of all market-determined prices to be consideration. The second assumption is that it is possible to rank-order the
an institution whose function is to provide the decision-maker with a changeability of variables such that those that can be changed more quickly
˜summary of information about the production possibilities, resource are explained before those that are more rigid. Specifically, Marshall™s
availabilities and preferences of all other decision-makers™ [see Koopmans method of duration-ordered periods depends on an assumption about
1957, p. 53]. However, the view that a price system is a social institution is dynamics, namely, about the rate at which the given variables could be
true (if at all) only in long-run equilibrium, the attainment of which may expected to change. The rigidity of capital stock relative to the variability
© LAWRENCE A. BOLAND
116 Principles of economics Knowledge and institutions in economic theory 117
of labour is, of course, the hypothetical and only basis for the distinction recognition of something exogenous [1920/49, Book I, Chapter 3]. Since
between the long and short periods. Marshall™s long-run explanation (of prices) assumes that institutions (as
Although many variables are to be objects of choice in Marshall™s long ˜social conditions™) are exogenously given, any approach which makes
period, that period is not without some givens. He specifically noted that them endogenous requires the recognition of something else as an exogen-
˜there are very gradual ... movements of long-run equilibrium prices caused ous variable. For example, the primary exogenous variable in Douglass
by the gradual growth of knowledge, of population and of [available] North™s neoclassical theory of institutional change is what he calls
capital, and the changing conditions of demand and supply™ as well as ˜ideology™. In particular, the evolution of institutions is to be explained as
changing social conditions ˜from one generation to another™ [Marshall the result of ˜a fundamental change in ideological perspective™ [1978, p.
1920/49, p. 315]. There is nothing in Marshall™s method which prevents 974]. North adds that he sees ˜no way to account for this transformation
any neoclassical economist from attempting to explain inter-generational without the systematic study of the sociology of knowledge™ [p. 974]. Al-
changes in such variables as long-run prices or the long-run distribution of though I can agree with this courageous statement, it would create method-
resources.5 But, if the changes in the long-run variables are to be explained ological problems for the pro-neoclassical view, to which I now turn.
as the results of changes in institutions (as elements of the ˜social
conditions™), the question is begged as to whether changes in the
A CRITIQUE OF NEOCLASSICAL THEORIES OF
institutions are themselves the result of additional applications of
INSTITUTIONAL CHANGE
Marshall™s Principle of Substitution, that is, have the existing institutions
been chosen in the way that other endogenous variables are chosen (as Marshall cannot be blamed for the more recent tendency among
objects of optimization)? In other words, by including social conditions neoclassical economists to take institutions for granted. In his theory of
among the endogenous variables (i.e. among the objects of choice), market prices, he did allow for the role of changing social conditions
neoclassical economists are merely modifying Marshall™s concept of a long (including institutions) in the explanation of the history of an economy, that
period without changing his neoclassical method. Whereas institutions (as is, of the inter-generational changes of long-run prices and allocations.
˜social conditions™) are among the exogenous givens in Marshall™s long However, it must be recognized that to explain the dynamics of prices or
period, they are considered endogenous variables in the modified long- allocations, one must explain why the social conditions have changed. This
period analysis. In this manner, the modified long run forms the starting is because when changes in social conditions are considered exogenous (as
point for the neoclassical view of institutions. in the Marshallian long run), they are thereby deemed unexplainable within
In all neoclassical analyses of endogenous institutions, the prevailing the economic model. However, if the only reason the long-run endogenous
institutional constraints are viewed as the outcomes of attempts to variables (such as long-run prices) change is because social conditions
minimize costs or maximize benefits for those individuals or groups who changed, then the changes in the long-run endogenous variables remain
unexplained.7 It would seem, then, that for an adequate explanation of
are in a position to alter the institutions in the modified long run. Once the
institutional arrangement (or environment) has been established, it becomes long-run prices, the evolution of institutional constraints (on short-run
the set of ruling constraints on individual choices “ at least in the short run. optimization) must be explained. In other words, the recent concern for
In terms of the logic of choice, institutions are like capital, which by institutions among neoclassical economists is not merely idle curiosity (nor
definition is fixed in the short run and is the basis of the cost functions more neoclassical ˜imperialism™). It is a fundamental methodological
facing the decision-maker. In the modified long run, when equilibrium has requirement for a complete explanation of the dynamics of long-run prices
been reached, the optimum institutional constraints as well as the optimum and allocations.
amount of capital must have been chosen. The ultimate modified long-run There are two methodological aspects of neoclassical theories of the
evolution of institutions which deserve critical examination. 8 First, as noted
equilibrium values of all endogenous variables, including the institutional
constraints, are logically determined (for any given set of behavioural in Chapter 6, every neoclassical explanation presumes that (subject to
assumptions) by the values of the recognized exogenous variables that constraints) individuals always get what they want, that is, all individual
cannot be considered the results of optimization (either because they are decision-makers are successful. As North observes, ˜Neoclassical theory
difficult to change or their changes are beyond control). 6 simply ignores the losers.™ Although the presumption of successful
As implied early in Marshall™s book, every explanation requires the decision-making may seem plausible in most neoclassical analyses, it
© LAWRENCE A. BOLAND
118 Principles of economics Knowledge and institutions in economic theory 119
should be recognized that it implies that the individual decision-maker™s A SIMPLE THEORY OF SOCIAL INSTITUTIONS
knowledge is always correct (or otherwise, how the required true
Although I can agree with the view of North and others that the evolution
knowledge was acquired must be explained as well [see Hayek 1937/48]).
of institutions can be explained, I cannot agree that a neoclassical
In Chapter 1 and elsewhere I noted that, since there is no inductive logic,
programme by itself is methodologically sufficient. An adequate
there is no way to guarantee that the knowledge which is essential for
explanation of dynamics must recognize all limitations on successful

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