DRAFT
Common Ground for Institutional Economics and Systems Dynamics Modeling
Glen Atkinson
Department of Economics
University of Nevada, Reno
Reno, NV 89557
atkinson@ unr.nevada.edu
Prepared for presentation at the Conference of the System Dynamics Society
New Y ork, July 22, 2003
Common Ground for Institutional Economics and Systems Dynamics Modeling
In 1898 Thorstein Veblen asked, “Why is Economics not an Evolutionary
Science?” (Veblen 1898). Veblen sketched out the changes in habits of thought from
primitive animistic views of hunting and gathering and small agrarian societies to the
prevailing view of his time of a natural order inspired by the work of Isaac Newton. His
argument was that most sciences were moving beyond the view of a Newtonian natural
order and adopting the more recent evolutionary view inspired by the findings of Darwin.
In his opinion economists needed to adopt the latter view if they were to be considered
modem in approach to scholarly inquiry. In this presentation, I will outline the major
differences between these two views of economic society and suggest what the
implications are for modeling economic behavior.
My purpose in this presentation is to suggest that practitioners of systems
dynamics and institutional economists share some common ground regarding the
structure of the economy and the processes of change emanating from that structural
order. I believe that both groups endorse the Darwinian view? of cumulative change over
the Newtonian view, though their methods of inquiry are substantially different. We
should not let our methods separate us, but instead we should leam from each other.
Thus, I hope this presentation will spark an interest in continuing a dialog between our
two groups. It is obvious that this audience knows more about systems dynamics than I
do, so I will concentrate on the view of economic evolution held by institutional
economists.2 Moreover, I will concentrate on the foundations of institutional economics
rather than recent extensions and applications. A more bare-bones discussion will
highlight the possibilities and difficulties in applying systems dynamics simulations to
institutional questions.
I will begin by describing the characteristics of Newtonian order and what this
implies for change. This is done to provide a contrast in the next section to an evolving
system. In this contrast, I want to stress that the nature of the order assumed by the
theorist will dictate the processes of change. Finally, I will raise some challenges, as I
see them, in formally modeling economic systems driven by cumulative change.
Newtonian Order and Change
By the eighteenth century the powerful and important work of Isaac Newton in
physics and mathematics had captured the imaginations of intellectuals in many fields
ranging from theology, philosophy, and politics to create a worldview of physical order
and change. This worldview was the foundation of the enlightenment where divine order
and law was replaced by natural order and law (Becker 1932 and Randall 1940). The
physical universe, and by extension, the social universe, was a clockwork where change
within the mechanism was continuous but the structure remained unchanged and
unchangeable. Of the social sciences, this view was most firmly embedded in economics
and remains so today (Randall 1940, 271 and Veblen 1898, 374). In fact, Hans Lind has
recently argued that any school of economics that does not employ this view has no
discemable method (Lind 1993).3
It is critical that we understand the perceived framework of order as we engage in
a discussion of the theory of change. Without an understandable order, change would be
random and scientists would not be able to explain the changes we observe. Change must
emanate from some order for a credible scientific discipline to be possible. Classical and
institutional economists assume different causes of the order of economic systems, and
this is a fundamental difference between the two schools. David Hamilton, writing fifty-
five years after V eblen’s provocative essay, argued that one of the major differences
between the two schools was their conception of change (Hamilton 1970). Hamilton was
correct to point out the importance of the differences in the theories of change, but he had
to explain the differences in their theories of economic order to accomplish his argument.
Hamilton noted that many institutional economists thought that classical
economists* had no theory of change, but he disputed that notion. His argument was that
their theory of change was derived from their belief in natural law. He drew on the work
of Carl Becker to show how the worldview of natural law had evolved from divine law.
In medieval times the worldview was that God had created the natural and social order
and that church scholars had to be consulted to understand the operation and purpose of
the system. The spread of Newtonian ideas led scholars to replace God with nature and
Divine law with natural law. But this was not as revolutionary as was first supposed
because “... the disciples of the Newtonian philosophy had not ceased to worship. They
had only given another form and a new name to the object of worship: having denatured
God, they deified nature” (Becker 1932, 63, quoted in Hamilton 1970, 21).
What does this mean for explaining economic order and economic change? It
means that a perfect system structure was in place and change could only occur within
that structure because the structure was natural and not man-made and, therefore, beyond
the power of man to change. According to Hamilton, ”To men of the eighteenth century
the social universe, like the heavens, was made up of individually suspended bodies, an
orderly relationship among them assured by natural forces. For Newton's law of
gravitation the eighteenth- century social philosopher used ‘self-interest.’ Each individual
by exercising his ‘natural right’ to seek his own self-interest untrammeled by disturbing
elements would simply be promoting the social good as well as his own welfare”
(Hamilton 1970, 21-22). Therefore, this state of natural harmony can only be disturbed
by exogenous forces but a harmonious equilibrium would be re-established rather
quickly.
The individual in the classical system was a passive being, responding only to
stimuli to avoid pain and pursue pleasure. As Veblen said, “Spiritually, the hedonistic
man is not a prime mover. He is not the seat of a process of living, except that he is
subject to a series of permutations enforced upon him by circumstances extemal and alien
to him” (Veblen 1898, 390). Being passive, and not a prime mover, means that man is
not the source of action that can lead to cumulative change of the system.
This stable structure allows one to describe the essential nature of the economy
mathematically, and calculus was devised to map out such systems. These models
assume a set of linear relationships based on immutable laws that depict only negative
feedback loops. Nevertheless this approach has powerful appeal. According to Lind,
“the role of analysis of a mathematically described model economy is to establish with
certainty the existence of specific relationships” (Lind 1993, 9; emphasis in the original).
It is possible to establish with certainty specific relationships in a closed, non- evolving
system, especially if the individuals in the system are passive elements.
Lind’s statement of the purpose of mathematical models is one reason for the
disdain institutional economists hold for such models. However, it is not the attempt to
model the economy mathematically that is the problem. The disagreement arises from
depicting the economy as a clockwork where change is mechanistic and repetitive.
Mathematical models are simply tools to help us search for and identify pattems, and
pattem identification is essential for the success of any scientific discipline. However,
math should not be used to simply confirm some assumed natural order. As Steve Keen
said, “properly used mathematical reasoning debunks unsound economics” (Keen 2001,
268).
So if math is not the problem, then what is the problem? In my opinion the
problem is that the dominant classical school of economics is built on unsound
assumptions of a deified natural order, and deification discourages questioning the
essential assumptions. There are competing views of economics to this school but the
dominant view is in a position to disallow competing views (Y onay 1998, 75-76).
Institutional Order and Cumulative Change
A competing view is offered by institutional economics. Rather than the
economy being a natural, unchangeable structure, the economic system is shaped by
human institutions. Institutions are human created means to correlate behavior and
interaction between individuals. They are artificial rather than natural. Institutional
economists understand that order is necessary to carry on production but nature does not
provide that structure. Some institutions are formal, such as law and goverment; others
are informal, such as noms and customs. However, these are not totally separate as
courts often adapt and adopt customs as legal rules. John R. Commons gave the
following definition of an institution that relates individuals to institutions. He wrote,
“.,, an institution is collective action in control, liberation, and expansion of individual
action” (Commons 1970, 21).
Notice that the individual is liberated and his power is expanded by institutions
that also control him. How can that be? Control of one person’s action liberates another
with respect to that action, or one person’s liberty places a duty on others to respect that
tight. Rights create corresponding duties; otherwise the right would be hollow. Also,
individuals are constrained by institutions, but the power to act is expanded relative to
their power as an isolated individual. This is not the inert individual of the natural order
because, in part, individuals derive power from institutions.
This definition of the institutional order has important implications for the role of
the individual and the process of change in and of the system. Therefore, this conception
of institutions and individuals has also enormous implications for modeling economic
behavior. Individuals are affected by institutions but they are also acting within these
tules of behavior established by institutions. In contrast, the individual in classical theory
is simply choosing from given altematives. He is a passive individual only responding to
stimuli from the environment with no power to change that environment because it is a
natural order and he is simply an atom in that order.
Both Commons and Veblen attributed the importance of the passive mind of the
individual to the adoption of hedonistic psychology as a foundation of individual
behavior in classical economics (Commons 1961, 140-157 and Veblen 1898, 389-390).
Both men called for a more modem psychology to explain individual action within the
institutional structure and to explain how this action could lead to cumulative change in
the structure. Commons wrote that we need to understand the “... active concept of the
mind constructing its own tools of law, cause and effect, necessity, and so on. If the
mind is passive it perceives no relations between its ‘perishing sensations.’ But if the
mind is active, then it actually creates its own relationship between parts and the whole of
perishing sensations” (Commons 1961, 149). This is similar to Peter Senge’s more
recent observation of the power of mental models (Senge 1990, 174-204). Similarly
Veblen observed that all classical economists adopted the position that “... the human
material with which the inquiry is concemed is conceived in hedonistic terms; that is to
say, in tems of a passive and substantially inert and immutably given human nature. The
psychological and anthropological preconceptions of the economists have been those
which were accepted by social sciences some generations ago” (Veblen 1898, 389).
Veblen’s point was that these preconceptions were out of date.
The question before us, is how to model behavior that is shaped by an active
mind? In addition, we should be aware that all minds are not necessarily working in the
same direction because different individuals will be driven to act by different perceptions
and purposes. In short, this is not a system of natural harmony. Conflict is normal, and
the trick is to leam how to create mutuality so that the going concem can be kept going.
This is the task of organizations ranging from families to firms to govemments.
Dysfunctional families, bankrupt firms, and revolutionary govemments have not
mastered this proposition. It is one thing to preserve and model natural harmony; it is
quite another to model artificial going concems.
Before proceeding with the discussion of the active mind and purposeful action,
we need to remember that for the institutional economist humans are shaped by their
culture rather than being an isolated individual in a state of nature. According to
Commons, “Collective action is the general and dominating fact of social life. Humans
are bom into a process of collective action and become individualized by collective
action” (Commons 1970, 21). This individual’s behavior is more difficult to model for
several reasons. He is bom into a going society with established noms, customs, or more
generally, a distinctive culture. This individual is responding to his situation as a socio-
cultural individual rather than a hedonistic atom in a stable molecule (Jensen 1987,
1069). Second, the individual may be acting with a purpose greater than immediate self-
gratification. He may be acting to further family or civic goals. Or he may be acting
simply from habit. We may assume that any of these actions will maximize the
individual’s utility, but that is circular reasoning. Third, an individual will often act with
volition to change the rules of collective action. However, others may be acting to resist
such change, or acting to change the institutional structure to suit their purpose. Finally,
there are mutual interdependencies between institutions, which means that altering one
institution can have negative consequences for other important and effective institutions
(Foster 1981, 933-34). In other words, there will losers as well as winners in the process
of institutional adjustment rather than an outcome of natural harmony.
This concept of volition is fundamental to understanding the relation of collective
action to economic evolution. Volition is not about the ability to choose among given
altematives. It is about acting on expectations to create new altematives and this can
have positive and negative consequences beyond the actor. Volition is about acting on
expectations to expand or limit production and acting on expectations is uncertain. Ina
capitalist economy one must have legal control before production can occur and legal
control provides some security of expectations. For example, it would be impossible to
rely on a supply or demand curve in the absence of collectively sanctioned rights. Here
we see people objecting to the constraints of rules but requiring new nules to reduce
uncertainty for themselves.
Commons called this process of acting on expectations futurity, and it reverses
cause and effect in regard to time. This relation of time and causation is so important for
modeling that I will quote Commons at length.
“Production and consumption cannot be carried on without first obtaining legal control.
Possibly this changes the idea of causation. It places causation in the future instead of the
past, where it was placed by the labor theories of value of the classical and communistic
economists; or instead of in the present sensations of pain and pleasure of production and
consumption of hedonic economists since the time of Bentham. It becomes a volitional
theory of future consequences of present negotiations and transfers of legal control,
determining whether production shall go or slow, or stop, or determining the extent to
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which future consumption will be expanded or contracted or pauperized” (Commons
1961, 7).
This time sequence of cause and effect is the crucial step in understanding the
process of cumulative change in an institutional order. The individual is acting, not
simply choosing, in an uncertain environment to attempt to create a new future path
among many possible paths. However, the individual is acting within his present culture
and material circumstances. His action is necessarily another possible step in an ongoing
process. As Newton and Darwin were men of their times, they also created new habits
of thought or worldviews. Would system dynamic modeling be possible without the
ideas of Darwin or the material invention of the computer? I don’t think so.
Perhaps the coupling of Commons’ concept of futurity, or the time sequence of
cause and effect, with dynamic modeling could provide some concrete substance to
Veblen’s description of the necessary elements of an evolutionary economic theory.
Veblen explained how economists would have to frame the individual and the community
in order to develop an evolutionary theory of the economy. Veblen said that individuals
“.., are the products of his past experience, cumulatively wrought out under a given body
of traditions, conventionalities, and material circumstances; and they afford the point of
departure for the next step in the process” (Veblen 1898, 390-91). For the community he
said, “All economic change is a change in the economic community, - a change in the
community’s methods of tuming material things to account. The change is always in the
last resort a change in habits of thought. This is true even of changes in the mechanical
processes of industry” (Veblen 1898, 391).
Connecting Institutional Economics and Systems Dynamics Modeling
Both institutional economics and systems dynamics modeling are pattem
modeling processes (Radzicki 2003, 151). Institutional economics tends to use a more
qualitative methodology, using mostly descriptive statistics when quantification is
necessary and possible. Both groups attempt to explain the structure of a system and
how the system can evolve due to endogenous forces. They first construct the order,
using mental models, of the system under investigation. This is what Commons meant
when he said “... the active concept of the mind constructing its own tools of law, cause
and effect, necessity, and so on” (Commons 1961, 149). Systems dynamics modelers
take this a step further and describe dynamics of these relations with mathematically
constructed models that can be visually simulated by computers. As I understand it, these
are still group mental models that can mimic the behavior of real systems (Radzicki 2003,
151). An advantage of the models is the visual quality of the product. The audience can
see when a feedback loop tums from positive to negative, or what difference a change in
an assumption or a parameter makes in tems of the evolution of the system. The model
will show the audience where the path they are on will likely lead them, and what they
might do to alter the path toward a more desirable destination.
A fundamental similarity of the two groups of researchers is that actors are
purposefully pursuing ends, but they are caught up in the structure of the system as well.
The behavior of actors is not passive, but they are not free agents either. Arguably one of
the most important contributions of institutional economics is the concept of futurity that
expresses the time sequence of cause and effect as cause in the future and effect in the
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present. Acting on expectations is necessarily uncertain. This destroys Lind’s notion that
economic theory can establish specific relationships with certainty. Pattems of urban
growth or the evolution of industries can be depicted, but there is novelty in each city or
industry. Also, actions can be taken to alter evolution of these institutions because they
are not part of the natural order.
The evolution of a system can be examined by proposing a formal change in a set
of niles goveming the system such as a policy, a law, a treaty, etc. It would be possible
to predict a probable sequence of changes in relations of the elements of the system
structure induced by the legislation. On the other hand, one could begin by historically
modeling a series of small, unplanned steps that cumulatively lead to a transformation of
the system. In this case, one wouldn’t predict a path. Instead, the task would be to
explain the actual path created by this historical chain of events. One might then be able
use this as a generic model to help explain other similar processes.
In conclusion I suggest that institutional economists and systems dynamics
modelers could collaborate on modeling the explanation of the evolution of the
shoemaking industry from 1650 to 1895 as described by John R. Commons (Commons
1909). He explains how the interstate commerce clause of the U. S. Constitution had
unintended effects, through the widening of the market, on the production of
commodities such as shoes. Some of the consequences were a transformation of owner -
worker relations, and customer - producer relations, the definition of property, our
conception of money and it introduced the problem of managing stocks of inventories in
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manufacturing industries. This constitutional provision led to the gradual transformation
of handicraft production techniques to the creation of the factory system.
There would be two purposes to such an exercise. First, it would help us
understand to what extent our theories are similar even though our methods differ.
Second, this would not be a project limited to a single period in history. For example, the
same model might be used to explain the deflationary period of the last years of the
nineteenth century when the expansion of the railroad system led to a substantial
widening of the market. Of more importance, I would like to see if the model could be
used to mimic the widening of the market in this era of globalization.
NOTES
1 The term Darwinian view does not necessarily imply an exact application of biology to economics.
Darwin’s findings affected the infant discipline of anthropology that, in turn, affected the founders of
institutional economics. See Radzicki 1994, 49 and Veblen 1898, 373, 390, and 394.
? As you read the institutional economics literature, you will find several points of emphasis are in dispute.
However, you will find that all in the field holds the basic notion of cumulative change of economic
institutions by endogenous forces. See Radzicki 1994 and 2003 for a more complete discussion of the
similarities between systems dynamics and institutional economics.
3 See Atkinson and Oleson 1996 fora rebuttal of this argument.
* Hamilton did not distinguish between classical and neoclassical economics in terms of concepts of
change. Both groups held that only one institutional structure was consistent with the natural order.
Hence, he used the term, classical, to capture this view.
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