New institutional economics is a school of heterodox economics, which builds on "old" institutional economics arguments about the embeddedness of economic activity in social and legal institutions, using Ronald Coase's fundamental insight about the critical role that transaction costs play in determining economic structures and performance. The ubiquity of transaction costs necessarily influences the structure of institutions including legal institutions and the choices individuals make.

New institutional economics is built upon Ronald Coase and other scholars using the kind of comparative institutional analysis advocated by the old institutionalists but with a useful new metric: transaction costs. The costs of transacting not only (positively) explain why different institutional arrangements result in differing levels of economic performance but can also (normatively) prescribe certain institutional or organizational solutions as more efficient than others.

Although no single, universally accepted set of definitions has been developed, most scholars working in law and economics follow Douglass North's definition on institutions as the "rules of the game," consisting of both the formal legal rules and the informal social norms that govern individual behavior and structure social interactions. Organizations, by contrast, are the structural mechanisms, such as courts, agencies, firms, and clubs, which utilize, alter, and enforce institutions.

New institutional economics supposes four levels of institutions, some of them subconcious, each building upon the next to form the current system.

Level 1 consists of embedded informal institutions; these include traditions, customs, values and religion. These institutions arise spontaneously over a long period of time and are very slow to change. North asks, “What is it about informal constraints that gives them such a pervasive influence upon the long run character of economies?” The answer is unknown but many lower level institutions are designed to protect Level 1 institutions.

Level 2 is where formal rules are created, for instance, a constitution. Major changes at this level are rare but are often preceded by major upheavals such as the Civil War or the American Revolution.

Level 3 is the level of governance, made necessary by the vagaries of Level 2. In a perfect world, once the rules for property rights are developed at Level 2, the government can step aside, except for enforcement and arbitration. Unfortunately, those functions are not costless and they are not simple.

Level 3 is also the level at which the game is played and contracts enter into the equation. The role of governance in contracts is to “craft order, thereby to mitigate conflict and realize mutual gains.” (Williamson) Complex rules and procedures arise in pursuit of these goals.

Level 4 is the level at which neoclassical economics operates. Under the rules of Level 3 transactions occur and prices adjust. Essentially, this is the level of the market.

New Institutional Economics concerns itself primarily with levels 2 and 3.

Major scholars associated with this school include Ronald Coase, Oliver Williamson, and Douglass North.

External links

• Introduction to new institutional economics
• ISNIE - International Society for New Institutional Economics.
• ESNIE - European School on New Institutional Economics.
• Recent impact -- a perspective on the "under-the-radar-screen" but significant impact of New Institutional Economics, even at the World Bank which has long emphasized the pre-eminence of physical capital and downplayed the role of institutions.
• Evolutionary Economics - john p birchall
• Introductory Reading List in New Institutional Economics - The Ronald Coase Institute

Sources

• Oliver E. Williamson, "The New Institutional Economics: Taking Stock, Looking Ahead (pdf)," Journal of Economic Literature, vol. 38 (September, 2000), pp. 595-613.
• North, Douglass C., "New Institutional Economics and Development." 1993 working paper (PDF file)
• North, Douglass C., "Understanding Economic Change," in Transforming Post-Communist Political Economies, Joan M. Nelson, Charles Tilly and Lee Walker, eds., Washington D. C.: National Academy Press, 1997, pp. 13-18.

Heterodox economics

Neue Institutionenökonomik