No Free Lunch: Economics for a Fallen World: Third Edition, Revised

Chapter Ten: It’s all About the Institutions! 237 The world of central planning is necessarily static, with no change allowed since it cannot be adjusted to. Only the market system allows the full use of all market participants’ knowledge since only the market process provides the institutional structure (incentives and processes) to make use of that knowledge. INSTITUTIONS “Entrepreneurs are present in all societies. In all settings, individuals will act to better their position. Individuals will pursue opportunities to better their position and increase their wealth, defined in the broadest sense. However, the nature of feasible opportunities will be determined by the formal and informal rules of the game. Differences in institutions are one major factor in the feasible entrepreneurial opportunities in any given society. ” 3 Much of what is called “neoclassical” economics focuses on equilibrium (e.g., our supply and demand models earlier in the book) where everyone’s plans are fully in coordination. In this model, the normal condition is equilibrium, and neoclassical economists study how changes from the equilibrium condition are handled. In a market process, this is reversed. Markets are continually in a state of disequilibrium in the sense that plans are constantly not in sync, and action is taken based on the entrepreneur’s assessment of what might make the divergent plans better coordinated, or (in effect the same thing), what will bring the most profit. Let’s think once again on our dating game analogy from chapter 9. In a neoclassical economic world, we start with the position that everyone has a boyfriend or girlfriend and everyone is happy; we then ask the question, what happens to the equilibrium if one couple breaks up? The market process starts with the condition that every romantic relationship is up in the air, and there is a learning process where everyone’s plans and preferences are discovered. The process itself will help shape those preferences, and the dynamic is one of constant change in which an order emerges. The market process takes seriously the problems of shortfalls in knowledge, uncertainty, and time. One way to help guide the entrepreneur through the rigors of the market process is through institutions . What do we mean by institutions? Well, when we consider the market as a discovery process, where knowledge is transmitted and plans are coordinated through the price system as well as profits and losses, we find that institutions are any social arrangement which supports that process. Some economists think of institutions as congealed or embedded knowledge—knowledge that is “stored up” for use without the entrepreneur even knowing it (or how to use it). Institutions may contain knowledge of how things should be done that an entrepreneur today may not even be aware of; yet, he or she does those things instinctively. Consider the cultural tradition of agreeing with a handshake. Much of the actual agreements and exchanges we make every day are informal in the sense that we don’t have a written contract. If we needed to write down on a piece of Institutions: humanly devised constraints that structure and guide human interaction.