In late 19th century America, conditions were ripe for a new school

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The American Institutional School and its Leading Proponents
Amanda Ireland
In late 19th century America, conditions were ripe for the emergence of a new school of economic thought. The abstract
models of European classical and neo-classical economics had been crudely transplanted into a quite different cultural
setting. “While the European capitalist was still caught in the shadow of a feudal past, the American money-maker basked
in the sun – there were no inhibitions on his drive to power or in the enjoyment of his wealth.” (Heilbroner, 1999, p214).
Various ultra conservative economists of the time were essentially “apologists” for the status quo of new industrial
capitalism and its unchecked greed, bloody confrontation between labor and capitalists, and financial and agricultural crises
(New School, 2008). However, the apologists’ often moralistic and theoretically loose orthodoxy was energetically
attacked by a group of American economists who had been trained in the methods and philosophy of the German Historical
school and who argued that “economic behavior and thus economic ‘laws’ were contingent upon their historical, social and
institutional context” (ibid.). Much as Karl Marx used a historical materialist approach in his economic theories, Historical
School economists such as Richard T Ely (1854-1943) responded to classical thinking with a controversial labor, socialist
and empirical view, paving the way for a new heterodox school.
The initial theoretical framework for Institutional thinking was provided by Thorstein Veblen (1857-1929), a secondgeneration Norwegian immigrant from the Minnesota frontier. Veblen developed an alternative theory of human
development that offered rich new insights into economic behavior and a sharp critique of classical and neoclassical
economics. In his collection of early essays: The Place of Science in Modern Civilization, Veblen argued that “the central
ideas of the classical system did not reflect a search for truth and reality; rather they were and are a celebration of approved
belief.” (Galbraith, 1991, p171). He posited that the rational, pleasure-maximizing economic man in classical economics
was an artificial construct and that human motivation was far more diverse. Veblen outlined his theory in the extraordinary
and hugely popular Theory of the Leisure Class in 1899. The book coined the terms “conspicuous consumption” and
“conspicuous leisure” which described not only the behaviors of a “predatory, pecuniary class” but also the lower classes
that sought to emulate them. (Veblen, 1899). Veblen regarded modern culture as little removed from the primitive,
barbarous era. While Veblen was sociologically insightful in Leisure Class, the economic implications of his theories of
human motivation served to disparage the concepts of utility and rational expectations. Along with status emulation,
Veblen argued that three “psychological instincts” drove technological advance and transformed the nature of human
society: a parental bent (general concern for future generations), idle curiosity and the instinct of workmanship. In The
Theory of Business Enterprise (1904) Veblen further articulated the instinct of workmanship and proposed a hitherto
unacknowledged dichotomy between industry and business; in which engineers’ concern with abundant production of
useful commodities conflicted with the owners’ focus on profits.
In economics, the students and followers of a great thinker often extend, refine and offer new applications for the original
train of thought and in the case of Institutionalism, further development was provided by John Commons (1862-1945) and
Wesley Mitchell (1874-1948). While Veblen had defined institutions rather loosely as “prevalent habits of thought”,
Commons offered the more precise “collective action in control, liberation and expansion of individual action” (Commons,
1931, p1). Such collective action ranged from unorganized customs to organized going concerns such as the family,
corporation, trade union and state. While Commons’ theoretical posture did not have great staying power, he left a
significant legacy in the application of institutional thinking. Commons was a pioneer of labor economics, and is also
regarded as the “spiritual father” of social security for his own and his students’ role in designing most of the progressive
Wisconsin and New Deal social legislation of the 1930s (Arestis, Sawyer, 1992). Interestingly, historicist Richard Ely was
a teacher and mentor to both Commons and Mitchell, and subsequently developed the University of Wisconsin as a
breeding ground for a new generation of Institutionalists. Here it should also be noted that Ely was founder of the
American Economic Association, which was initially dominated by Institutionalist thinkers.
“Of the three American economists customarily regarded as the fathers of American Institutionalism, Mitchell would
appear to have the most secure current reputation,“ (Arestis, Sawyer, 1992, p358). Mitchell was devoted to studying
business cycles and insisted that the economy could be properly understood only if it were “examined and evaluated as part
of the larger societal and cultural structure within which it is embedded, “ (ibid.) Mitchell’s profound contribution to
modern economics was in founding the National Bureau of Economic Research. At this stage it is important to note that
neoclassical thinking was in retreat while Institutional economics was enjoying its brief heyday. Neoclassical economists
had promised a scientific explanation of economic phenomena, but their holy grail of marginal utility hypothesis was
unobservable and unmeasureable, and seemed to be descending into “quackery” (New School, 2008). As Mitchell noted in
his presidential address to the American Statistical Association after World War II: “While I think that the development of
the social sciences offers more hope for solving our social problems than any other line of endeavor, I do not claim that
these sciences in their present state are very serviceable. They are immature, speculative, filled with controversies,”
(Fabricant, 1984, p9). If the abstract mathematics of the neoclassicists was not yet fruitful and predictive, the
Institutionalists indisputably stepped into the breach. Mitchell, for his part, insisted that “good economic theory must be
empirically grounded” (Arestis 1992, p360) and from its inception, the Bureau provided the empirical detail “…so that
theorists could proceed from reality to significant generalizations for testing.” (ibid.)
Institutional thinking was largely eclipsed by the Keynesian revolution. The Great Depression opened up a chasm between
economic orthodoxy and world events, which John Maynard Keynes filled with a new economic framework for the current,
severe and persistent economic problems. Subsequently, the neoclassical synthesis, Paretian revival, Keynesian and postKeynesian economics were the order of the day. However, Institutionalism lived on for a time, although decidedly off the
center stage of economics. Two modern economists, John Kenneth Galbraith and Robert Heilbroner, shared a talent for
publishing popular economic literature, articulating new and reformulated institutional theories, and thus provided the most
recent dissenting voices.
Galbraith (1908-2006) revived the theories of Veblen in his most famous work The Affluent Society (1958): “The
ostentation, waste, idleness and immorality of the rich were all purposeful: they were the advertisements of success in the
pecuniary culture. Work, by contrast, was merely a caste mark of inferiority […] In the central tradition the worker was
accorded the glory of honest toil. Veblen denied him even that.” (Galbraith, 1998, p46). Another Veblen idea, from Theory
of the Business Enterprise (1904), was refined by Galbraith in The New Industrial State (1967), specifically that a
“technostructure” of professional managers hold more power in large firms than owners or shareholders, undermining the
classical economic conception of the business owner. Most importantly, Galbraith attacked the principle of consumer
sovereignty central to classical economics: “As a society becomes increasingly affluent, wants are increasingly created by
the process by which they are satisfied.” (ibid., p129). Galbraith argued that the power of production and advertising
contributed to private affluence and public squalor. In American Capitalism (1952) Galbraith expounded a restraint on
economic power that appeared to replace competition, the concept of countervailing power: “private economic power is
held in check by the countervailing power of those who are subject to it.” (Galbraith, 2001, p5). Power was a favorite topic
of Galbraith’s and a focus of his dissenting economics. As President of the American Economic Association he presented
an essay, Power and the Useful Economist (1972) criticizing the economics profession for ignoring power and thus
employing irrelevant theories.
In conclusion, Institutional Economics attempted and sometimes succeeded in keeping economics real. When the analytical
tools of the profession were struggling, Institutionalists ushered in an empirical tradition that now contributes to every
branch of modern economic inquiry. When economic models of behavior appeared far-fetched, Institutionalists provided
more meaningful insights by drawing on other social sciences. This school of thought may have had its day but Galbraith
and Heilbroner offer timeless parting words: “Economics divides today as between classicists (the overwhelming number)
and institutionalists, between those committed to the inevitable and constant equilibrium and those who, which much less
claim to scientific precision, accept a world of evolution and continuing change,” (Galbraith, 1991, p129). For his part,
Heilbroner called for a “reborn worldly philosophy”: “Economics alone will not guide a country that has no vital
leadership, but leadership will lack for clear directions without the inspiration of an enlightened as well as an enlarged selfdefinition of economics,” (Heilbroner, 1999, p321).
References
Arestis, Philip, and Sawyer, Malcolm. (Eds.). (1992). Biographical Dictionary of Dissenting Economics. Aldershot, UK.
Edward Elgar.
Commons, John R., Institutional Economics, American Economic Review, Vol.21, 1931, pp.648-657.
Fabricant, Solomon. Toward a Firmer Basis of Economic Policy: The Founding of the National Bureau of Economic
Research. 1984. NBER
Galbraith, John K. A History of Economics. Penguin, 1987.London, England.
Veblen, Thorstein, The Theory of the Leisure Class, The Collected Works of Thorstein Veblen Vol. 1, 1994.
Heilbroner, Robert L. The Worldly Philosophers. 1999. Touchstone, New York, NY
History of Economic Thought
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