New Institutional Economics

"I am the eyes and the ears of this institution, my friend."
--Carl the Janitor (The Breakfast Club)

As a founder of the new institutional economics (NIE), Williamson (2000) proposed a hierarchy of institutions that influence economic exchange (Figure 1). At the bottom (L4) come basic institutions of the market, such as prices and quantities, that are constantly in flux in the face of everyday transactions and exchange.

Next up (L3) comes structure that governs those everyday transactions to make them more efficient. Organizations and contracts are primary examples of such governance structure. Time horizon for change here ranges from one year (typical contract length) to a decade (consistent with time tom implement major organizational change).

L2 represents the institutional environment where formal rules for game of market exchange are made. This is the land of politics, law, and government agency that defines such things as property rights. Williamson estimates the stability of this level ranges from 10 to 100 years. Personally, I suspect change happens quicker at this level--although not as quickly as L3 change. On the short end, L2 change might occur 4-8 years in association with major government election cycles.

At the top of the hierarchy (L1) rests informal institutions embedded in human psyches such as customs, social norms, tradition, and religion. L1 is the most stable and takes generations, typically, to evolve.

Williamson posits that individuals spend most time at lower levels of the institutional hierarchy. Entrepreneurs, for example, prefer L3 and L4. Because it is costly to foray into higher levels (e.g., opportunity cost of not being close to customers, cost of lobbying), individuals only do so when expected returns are high. L1 is generally not a target for economizing behavior since change here usually requires more time that most people have on this earth.

I like this framework--particularly w.r.t. research questions that link L3 and L4 actions with L2 institutional activity. More to come...

Reference

Williamson, O.E. (2000). The new institutional economics - Taking stock, looking ahead. Journal of Economic Literature, 38(3): 595-613.