Institutional Economics and Development I

Theoretical Foundations — Development Economics, Lecture 5

Prof. Dr. Claudius Gräbner-Radkowitsch

Department of Pluralist Economics, Europa-Universität Flensburg

23 October 2026

Digression: the term paper

Beyond Eurocentrism in Development

Contemporary postcolonial theory criticizes Eurocentrism in development thinking. Identify two specific tools or concepts from the course that embody this universalism and explain how they reflect Eurocentric assumptions. Also identify two theories or approaches from the course that offer alternatives to this universalism and explain how they address these limitations. Justify your choice.

  • Formal requirements
    • Word count: 1000 - 1200 words
    • Format: PDF document
    • Timing: upload your pdf via Moodle until November 4, 16:00 CET
    • Essays will be graded on a pass/fail scale; in order to register for the final exam, you need to pass the essay!
  • Important:
    • You should already be registered for the Vorleistung. Please check the registration deadline for the final exam yourself!

The Development Puzzle

Map of the Korean peninsula, North Korea highlighted

Rural scene in North Korea

Seoul skyline at dusk

The border fence between Nogales, Arizona, and Nogales, Sonora

Map of the twin cities of Nogales across the US–Mexico border

Same geography, similar resources, identical culture and same colonial heritage…

…but vastly different living conditions. Why?

 

Institutional economics claims to have the answer….

Nogales border fence: Sgt. 1st Class Gordon Hyde, US Army, public domain, via Wikimedia Commons. Other images: sources to be added.

Overview

  • What are institutions?

  • Original and New Institutional Economics

  • New Institutional Economics and Development

  • A Critical Appraisal

  • Measuring Institutions

  • Summary and Outlook

Grey: next session

What are institutions?

Influential definitions

„Institutions are the rules of the game in a society…[and] the purpose of the rules is to define the way the game is played” Douglass North (1990)

„There is only rational behavior, conditioned on expectations about the behavior and reactions of others… ‘Institution’ is just a name we give to certain parts of certain kinds of equilibria.“ Randall Calvert (1995)

„Institutions are systems of established and prevalent social rules that structure social interactions.” Geoffrey Hodgson (2006)

What are institutions?

Examples

  • Legal and Moral Foundations:
    • Property rights, contract law, constitutional rules
    • Social norms, trust, cultural practices
  • Organizational Forms:
    • Firms, markets, cooperatives, guilds
    • Central banks, regulatory agencies, courts
  • Economic Structures:
    • Agricultural vs. industrial economy
    • Market vs. subsistence economy

Broad concept with varying emphases depending on the theoretical tradition

Institutional economics

Two competing paradigms

Original Institutional Economics (OIE)

Thorstein Veblen

Veblen

John R. Commons

Commons

Clarence Ayres

Ayres

  • Emerged in the early 20th century
  • Evolutionary, historical, interdisciplinary
  • Heterogeneous research program
  • Focus: (institutional) change, power,
    social embeddedness

In between

Joseph Schumpeter

Schumpeter

Elinor Ostrom

Ostrom

New Institutional Economics (NIE)

Douglass North

North

Ronald Coase

Coase

Oliver Williamson

Williamson

  • Emerged in the 70s and 80s
  • Integrates institutions into neoclassical economics
  • Pretty coherent research program
  • Focus: growth, transaction costs, property rights, contracts

Photos via Wikimedia Commons, cropped and converted to greyscale: Veblen, Commons, Ayres public domain; Ostrom (Holger Motzkau) and Williamson (Prolineserver), CC BY-SA 3.0. Schumpeter, North, Coase: sources to be added.

Institutional economics

Two competing paradigms - a (simplistic?) overview

Original institutionalism New Institutional Economics
Actor modes Socially embedded ‘habit creature’ Rational optimizer
Institutions Habits of thought, social rules Specific rules: property rights, contracts,…
Change Evolutionary, path-dependent, power-driven Efficiency-driven, equilibria
Efficiency Maybe, but ceremonial institutions persist Eventually efficiency bias
Critical? Yes, questions power, inequality, capitalism Less so

Original Institutional Economics

01

The beginning of OIE

  • Son of Norwegian immigrants and farmers

  • Co-founder of the New School for Social Research in New York

  • Founding father of evolutionary institutional economics

  • Numerous works at the interface between economics and related disciplines

    • 1898: Why is Economics not an Evolutionary Science?
    • 1899: Theory of the Leisure Class

Portrait of Thorstein Veblen

Thorstein Bunde Veblen
(1857 - 1929)

Veblen (1898; 1899). Photo: public domain, via Wikimedia Commons; cropped, greyscale.

An Evolutionary Approach

Vision of economics as inspired by Darwinian sciences

  • Explain phenomena in terms of causal sequences (‘cumulative causation’)
    • Example: a region loses its industry, then its skilled workers and its tax base, which makes it even less attractive for new firms (Myrdal 1957)
  • Reference to Darwinian selection principles
    • Example: firms’ routines play the role of genes; routines of successful firms spread, others disappear (Nelson and Winter 1982)
  • Rejection of equilibrium-theorizing
    • Example: new technology changes habits of thought, these change institutions, which change technology again: there is no state of rest to return to

An Evolutionary Approach

Examples for methodological elements

  • Conspicuous consumption and social transmission of consumption practices
    • Example: wedding spending in rural India signals the family’s status (Bloch et al. 2004)
  • Path dependency and non-linear development
  • Relevance of both upward and downward effects → systemist framework
    • Example: next slide
  • Later writers extended Veblen’s ideas into different directions

Upward and downward effects

Institutions
rules, norms, habits of thought
Individuals
habits, preferences, actions
Downward effects
Institutions shape habits, preferences and expectations
e.g. the norm that a woman's place is at home shapes how much girls study and what they aspire to
Upward effects
Individuals create, reproduce and change institutions
e.g. as parents, these girls keep their own daughters out of paid work, and so confirm the norm

Neither level comes first: a systemist, not an individualist or holist view

Example: gender norms and women’s work, see Jayachandran (2015)

Breaking the cycle: new routines enter and spread

Institutions
rules, norms, habits of thought
Individuals
habits, preferences, actions
reproduce
shape
A new routine enters
e.g. garment factories hire young women
It spreads
copied, selected, scaled up
e.g. more factories hire women; families see daughters earn
The institution shifts
and shapes the next generation differently
e.g. near the factories, girls stay in school longer and marry later

Change from within: variation, selection, retention (Nelson and Winter 1982)

Example: Bangladesh’s garment industry, Heath and Mobarak (2015)

Institutions and their life cycle

  • Veblen: institutions as habits of thought → backward oriented
    • Shaped the progressive and critical flavor of OIE
  • Example: an institutional life cycle and ceremonial encapsulation

Institution as instrumental solution to a social problem

Emergence of normative and ceremonial dimension separated from instrumental function

Abstract norm: persistence of the rule despite irrelevance of original problem

Obsolete/degenerated institution: substitution of instrumental by ceremonial function

Your turn: place an institution on the cycle

  1. In pairs, 5 min — pick one institution you know: from home, from the university, or from development policy

  2. Which problem did it once solve? Where on the cycle is it today?

  3. Plenary — two or three examples

Different schools of evolutionary economics

Thorstein Veblen
Thorstein
Veblen
Veblen’s evolutionary-
institutional approach
OIE in the strict sense
Evolutionary / Neo-
Schumpeterian Economics
Joseph Schumpeter
Joseph Schumpeter
More in session on innovation and development
The Commons
Tradition
The Ayres
Tradition
The Radical
Tradition
John R. Commons Clarence Ayres William Waller
John R. Commons
Clarence Ayres
William Waller

New Institutional Economics

02

From old to new (?)

  • Desire to integrate institutions into mainstream economics
    • Maintain formal framework and methodological approach
    • Keep rational choice as analytical foundation
  • Key NIE Figures:

Ronald Coase

Ronald Coase:
Transaction costs

Douglass North

Douglass North:
History and economic
performance

Oliver Williamson

Oliver Williamson:
Organizations

Daron Acemoglu

James Robinson

Daron Acemoglu & James Robinson:
Development and path dependence

Williamson: Prolineserver, CC BY-SA 3.0, via Wikimedia Commons; cropped, greyscale. Coase, North, Acemoglu, Robinson: sources to be added.

NIE asks one question four times: what does a rule save?

Transaction costs

– Search costs, negotiation costs, enforcement costs

– Institutions reduce these costs

Kenya: mobile money cut the cost of sending money, so households could share risk over long distances (Jack and Suri 2014)

Property rights

– Secure, enforceable ownership → investment, exchange, development

– Institutions provide this security

Peru: land titles for urban squatters; people no longer had to guard their homes and worked more outside (Field 2007)

New Institutional Economics
and its rational choice framework

Incomplete contracts

– Contingencies always there

– Institutions for gap-filling and conflict resolution

Kenyan roses: export contracts cannot be enforced, long-term relationships fill the gap (Macchiavello and Morjaria 2015)

Principal-Agent Problems

– Asymmetric information & hierarchies → conflicts of interest

– Institutions align incentives

India: cameras plus pay per day of attendance roughly halved teacher absence (Duflo et al. 2012)

Synthesis and outlook

03

Summary

  • Institutions clearly matter for development
    • But: ‘institutions’ as a broad and contested concept
  • Two traditions with different insights:
    • OIE: Institutional change, power, path dependence, inefficiency
    • NIE: Transaction costs, property rights, efficiency (eventually)
  • Next week:
    • Famous application of NIE concepts on colonialism and global inequality
    • Critical discussion from an OIE perspective
  • Back to the puzzle: how would OIE and NIE explain Nogales and the two Koreas?

Before next week

  • Read Hodgson (2018) — the mandatory reading for this session

  • Prepare for next week: read Spithoven (2026) on Nogales — reading question on the session 6 page

  • Optional exercise: compare OIE and NIE — course website → session 5

  • Term paper: upload via Moodle until November 4, 16:00 CET

Next: New Institutional Economics and development, a critical appraisal, and how to measure institutions.

References

Bloch, F., Rao, V. and Desai, S. (2004) “Wedding celebrations as conspicuous consumption: Signaling social status in rural India,” Journal of Human Resources 39(3): 675–695.
Calvert, R. L. (1995) “Rational actors, equilibrium, and social institutions,” in J. Knight and I. Sened (eds.). Explaining social institutions. Ann Arbor: University of Michigan Press.
David, P. A. (1985) “Clio and the economics of QWERTY,” American Economic Review 75(2): 332–337.
Duflo, E., Hanna, R. and Ryan, S. P. (2012) “Incentives work: Getting teachers to come to school,” American Economic Review 102(4): 1241–1278.
Field, E. (2007) “Entitled to work: Urban property rights and labor supply in Peru,” The Quarterly Journal of Economics 122(4): 1561–1602.
Heath, R. and Mobarak, A. M. (2015) “Manufacturing growth and the lives of Bangladeshi women,” Journal of Development Economics 115: 1–15.
Hodgson, G. (2006) “What are institutions?” Journal of Economic Issues 40(1): 1–25.
Hodgson, G. M. (2018) “Taxonomic definitions in social science, with firms, markets and institutions as case studies,” Journal of Institutional Economics 84: 1–18, doi:10.1017/s1744137418000334.
Jack, W. and Suri, T. (2014) “Risk sharing and transactions costs: Evidence from Kenya’s mobile money revolution,” American Economic Review 104(1): 183–223.
Jayachandran, S. (2015) “The roots of gender inequality in developing countries,” Annual Review of Economics 7: 63–88.
Jedwab, R., Kerby, E. and Moradi, A. (2017) “History, path dependence and development: Evidence from colonial railways, settlers and cities in Kenya,” The Economic Journal 127(603): 1467–1494.
Macchiavello, R. and Morjaria, A. (2015) “The value of relationships: Evidence from a supply shock to Kenyan rose exports,” American Economic Review 105(9): 2911–2945.
Myrdal, G. (1957) Economic theory and under-developed regions, London: Duckworth.
Nelson, R. R. and Winter, S. G. (1982) An evolutionary theory of economic change, Cambridge, MA: Belknap Press of Harvard University Press.
North, D. C. (1990) Institutions, institutional change and economic performance, Cambridge: Cambridge University Press.
Spithoven, A. (2026) “Why nations fail: Geographical, cultural, and institutional dynamics,” Journal of Economic Issues 60(2): 556–564.
Veblen, T. (1898) “Why is economics not an evolutionary science?” The Quarterly Journal of Economics 12(4): 373–397.
Veblen, T. (1899) The theory of the leisure class: An economic study of institutions, New York: Macmillan.