Arnold Kling

The Institutions-Intensive Economy

Arnold Kling*
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Today, a modern market economy with its ever-finer division of labor depends on a constantly expanding network of trade. It requires an intricate web of social institutions to coordinate the working of markets and firms across various boundaries. At a time when the modern economy is becoming increasingly institutions-intensive, the reduction of economics to price theory is troubling enough. It is suicidal for the field to slide into a hard science of choice, ignoring the influences of society, history, culture, and politics on the working of the economy.1

 
"The plunge in manufacturing production work is indicative of the declining share of economic activity that is measurable."
Ronald Coase, the world's oldest active economist, here aptly describes the economy in the age of the Internet, giving us the expression "institutions-intensive." His famous contributions to the theory of how bargaining might address externalities and how the boundaries of the firm depend on relative institutional effectiveness turn out to be preludes to the sort of economic analysis that is needed today.

Over the course of Coase's lifetime, the locus of economic activity has been shifting, from the farm to the factory floor to the office and even to "the cloud." With each step, the concept of property has become more difficult to define, the economic entities have become more difficult to locate in time and place, the proportion of wealth that is intangible has risen, and earnings have become increasingly contingent on social constructs rather than on individual attributes.

According to Bureau of Labor Statistics data, in every year between 1939 and 1956, the proportion of total employees in the nonfarm sector classified as "manufacturing production and nonsupervisory workers" was over twenty-five percent. This figure has been falling steadily, until in the last four years it has averaged just six percent.

The plunge in manufacturing production work is indicative of the declining share of economic activity that is measurable. One hundred years ago, the output of an individual farm worker was quantifiable. In principle, farm workers could be paid on the basis of specific, tangible accomplishments—pounds of apples picked, bushels of wheat harvested, etc. The same holds for pre-industrial manufacturing, where it was possible to pay for piece work.

 

For podcasts on the decline in manufacturing jobs and measuring output, see Adam Davidson on Manufacturing and Kelly on the Future, Productivity, and the Quality of Life. For a podcast illustrating a surprising data source in a high-tech industry, see Varoufakis on Valve, Spontaneous Order, and the European Crisis.

Inside a large 20th century factory, the output of the individual worker was not as readily measured. Total output was still quantifiable, but one could not attribute a ton of steel or a shipment of refrigerators to an individual worker. Factory workers are paid to be in a particular place at a particular time. They clock in, clock out, and get paid by the hour.

In the decades following World War II, as the share of employment on the factory floor declined, what increased was clerical work. Secretaries, sales clerks, and telephone operators, like factory workers, are paid to be in a particular place at a particular time. They might receive a biweekly salary, but they are expected to work set hours.

With the advent of the Internet, work is no longer necessarily fixed in time and space. Someone can answer email on a smart phone at any time, in any location. A friend of mine in sales and support for an educational software company is typical. Because his clients span the globe, he can be called at any time of day or night. Neither they nor his boss know where he is when he picks up the phone. Usually, he is in his basement office, but sometimes he is out of town at a conference or on a family vacation. As more workers hold jobs whose contours are shaped by the Internet, the once well-defined concept of "hours worked" becomes much less precise.

It is not just the individual worker for whom output and hours worked have become harder to pin down. Entire industries, such as education, health care, finance, and government are now increasingly prominent. In each of these sectors, the very definition of "output" is not clear.

Moreover, it is often the case that the value of these services is contingent on institutional arrangements. For example, the value to an individual of a particular educational credential will depend on the licensing requirements within the field in which the person is pursuing employment. The value of pooling mortgages into securities depends on the institutional role of rating agencies, government policies, and other highly contingent social arrangements.

Garett Jones has suggested (via Twitter) that "Workers mostly build organizational capital, not final output."2 Building organizational capital means developing processes and capabilities within a firm. That is, in an institutions-intensive economy, many jobs consist of attempting to improve institutions. Business process improvement, standards-setting, and negotiating arrangements with other firms all fit within this framework.

Although we think of companies like Amazon, Apple, and Google as technology companies, these firms are institutions-intensive. Google's mechanism for auctioning ads has been the key to its profitability. Similarly, Apple's success depends in large part on institutional arrangements, such as its iTunes service and its App store. Amazon's encouragement and use of customer reviews has played an important role in the success of its online sales efforts.

In neoclassical economics, the earnings of individuals are thought to be determined by individual characteristics and decisions. Economists write down models in which earnings accrue in a deterministic fashion to human capital and physical capital. However, these models are not realistic in an institutions-intensive economy.

One example of the complexity of today's economy can be found in a recent best-selling book, The Immortal Life of Henrietta Lacks, by Rebecca Skloot.3 Cells taken from a tumor of Henrietta Lacks have been a tremendous boon to medical research, including help with the cure for polio. Skloot's book raises the issue of whether Lacks and her family were adequately compensated for this.

On the one hand, one could argue that the cells of a person's body are certainly the property of that individual, so that Lacks and her descendants are entitled to great wealth. After all, is not "self-ownership" a core foundation for the definition of property? On the other hand, one can argue that the value was created not by Lacks herself, but by the researchers.

Similar issues arise with regard to data on the Internet. Should Amazon be compensating the people who write helpful reviews? Should Facebook and Google be compensating people for providing information and services that those companies use to earn advertising revenue?

The technologically-determined income shares of neoclassical economic models do not describe our contemporary world. In an institutions-intensive economy, the pristine modeling of non-institutional factors misses out on the institutional contingencies that actually drive economic outcomes.


Footnotes
1.

Ronald Coase, "Saving Economics from the Economists." Harvard Business Review, December 2012. (Available online at http://hbr.org/2012/12/saving-economics-from-the-economists.)

2.

Tyler Cowen, "The Wisdom of Garett Jones." Marginal Revolution. Originally published on November 5, 2009.

3.

Rebecca Skloot, The Immortal Life of Henrietta Lacks. New York (Random House, Inc.), 2011.


*Arnold Kling has a Ph.D. in economics from the Massachusetts Institute of Technology. He is the author of five books, including Crisis of Abundance: Rethinking How We Pay for Health Care; Invisible Wealth: The Hidden Story of How Markets Work; and Unchecked and Unbalanced: How the Discrepancy Between Knowledge and Power Caused the Financial Crisis and Threatens Democracy. He contributed to EconLog from January 2003 through August 2012.

For more articles by Arnold Kling, see the Archive.

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