Human actions, interactions and decisions should have a certain degree of predictability that can be obtained by establishing rules. Institutions, in general, are defined by sets of rules known by the public and applicable for the community. Their existence is essential for the economic activity, as it cannot develop in a vacuum. At the same time, the type and the quality of institutions make the difference in implementing economic aspirations of individuals and in supporting economic overall growth. Institutions provide a minimum of regulations that in conjunction with the particularities and the interests of individuals and communities become the foundation for economic, political and social decision-making processes.institutions, institutionalism, decision-making, decentralization

Cioclea, Alexandra Ema

English

Research Papers in Economics

 
AN OVERVIEW ON INSTITUTIONALISM AND  
DECENTRALIZED DECISION-MAKING  
 
 
Alexandra Ema Cioclea 
”Alexandru Ioan Cuza” University of Iasi 
Doctoral School of Economics 
 
 
 
 
  Abstract 
Human  actions,  interactions  and  decisions  should  have  a  certain  degree  of 
predictability that can be obtained by establishing rules. Institutions, in general, are defined 
by sets of rules known by the public and applicable for the community. Their existence is 
essential for the economic activity, as it cannot develop in a vacuum. At the same time, the 
type and the quality of institutions make the difference in implementing economic aspirations 
of individuals and in supporting economic overall growth. 
  Institutions  provide  a  minimum  of  regulations  that  in  conjunction  with  the 
particularities and the interests of individuals and communities become the foundation for 
economic, political and social decision-making processes. 
 
  Key words: institutions, institutionalism, decision-making, decentralization 
   
  JEL Classifications: B25, D23, D73 
 
 
  Institutionalism – old and new at the same time 
The setup for institutional economy, so popular in the last decades, can be defined by 
linking decision processes to institutions and emphasizing their economic implications. The 
main idea of institutionalism, as a economic theory, is that the modern economy is a complex 
and  evolving  system, whose  effectiveness  in meeting  the heterogeneous interests of the 
people depends on a system of rules that must coordinate the human behavior, naturally 
inclined to be opportunistic. 
  In  theory,  this  set  of  rules  is  represented  by  institutions,  which  by  governing  the 
human interactions, have a decisive impact on economic growth directly correlated with the 
existence and proper functioning of institutions and values. The institutionalist approach on 
economy differs significantly from the neoclassical one, based on rationality and knowledge, 
defining institutions as external factors, independently created and developed.   Institutionalism  has  a  close  interdependence  with  legal  and  political  sciences, 
sociology, anthropology, history, organizational science, management, philosophy and tries 
to demonstrate its impact on economic behavior. 
The basic idea of institutionalism is that institutions play an extremely important role 
that  shifts  the  economic  perspective  from  specific  processes  and  outcomes  to  abstract, 
general  rules.  This  idea  is  supported  by  Friedrich  von  Hayek’s  approach  and  by  other 
members of the Austrian School. In his paper Rule of law, Legislation and Freedom, Hayek 
acknowledges  the  need  for  certain  rules  that  will  be  respected  by  the  individuals  of  a 
community  for  ensuring  order  and  effectiveness.  He  represents  the  so-called  old 
institutionalism, built on Charles Sanders Peirce’s pragmatic philosophy, which rejected the 
Cartesian  idea  of  a  rational  and  calculated  individual  and  replaced  it  with  the  idea  of  a 
organization led by traditions and daily behaviors.  
At the same time, economists such as Veblen, Commons and Mitchell have rejected 
the  neoclassical  theory  of  a  rational  and  calculated  individual  and  they  emphasized  on 
reaction rather than action, on habit and traditions. 
The next approach was the new institutionalism, supported by Ronald Coase in his 
paper The Nature of the Firm (1939). He identifies two institutions with vital impact on human 
activity  in  general  and  specially  on  economic  decisions:  the  firm  and  private  property. 
Douglas North and in the The Rise of the Western World adds the free market as being the 
most effective institution for allocating resources. Together with the already mentioned ones, 
James  Buchanan,  representing  the  “public  choice”  theory,  and  the  economist  William 
Vickery,  presenting  the  consequences  of  limited  and  asymetric  kowledge,  have  also 
contributed in developing institutionalism as an economic theory.  
These studies on institutionalism are still very up to date, especially since the authors 
have  obtained  the  Nobel  Prize  for  Economics:  Hayek  (1974),  Buchannan  (1986),  Coase 
(1991), North (1994), Vickery (1996), Williamson (2009). 
 
Defining institutions and their characteristics  
Institutions are rules of conduct, meant to coordinate the actions of individuals. They 
forbid  certain  actions  and  impose  restrictions  on  the  possible  reactions,  bringing  more 
predictability. Usually, institutions use the past successful experience and set the way people 
should  act/interact/react  in  order  to  reach  their  objectives.  They  offer  knowledge  and 
confidence that individuals’ decisions will develop as expected. 
Representing  the  old  institutionalism,  Veblen  made  special  efforts  to  analyze  the 
social realities from an institutional point of view. In his opinion the most important institution 
propriety, which is representative for the way Veblen characterizes an institution: to be based 
on collective action rather than individual, to develop in time, to consider the informal issues 
and the role of the community, to define itself at the conceptual level. Thus, Veblen sees institutions as mental structures, rather than tangible manifestations, resulting from habits 
and traditions transmitted from generation to generation. 
The  new  institutionalism  gives  a  somewhat  different  meaning  to  the  notion  of 
institution.  It  doesn’t  focus  on  social  institutions,  but  analyses  to  the  whole  institutional 
environment,  defined  by  political,  social,  economic  rules  facilitating  production  and 
commerce. Institutions are defined as a set of rules that rationalize social interactions and 
are shared by the entire community (Knight, 1992). 
There  are  reasons  for  which  defining  and  analyzing  institutions  are  important: 
institutions are independent political players, having their own goals and interests, institutions 
include restrictions that help individuals to avoid the negative effects of collective actions and 
last but not least, institutions support social players in working together for reaching their 
common goals. 
On the other hand, Douglas North argues that institutions are the result of historical 
evolution, offering rational support in decision-making. He sees institutions as tri-dimensional 
concepts, made of formal rules, informal restrictions and mechanisms making the former two 
work.  Thus,  institutions  are  at  the  same  time  pre-set  game  rules  for  society  and  also 
individual  self-imposed  restrictions,  meant  to  mediate  social  relations  and  to  support 
exchange processes between different levels. For North the main function of institutions is to 
reduce uncertainty, offering a stable and effective environment for economic exchanges. 
Unlike neo-classical theory, that sees institutions as exogenous from the economic 
players, institutionalism identifies two types of institutions: internal, as rules developed within 
a  group  as  a  result  of  past  experience  and  external,  designed  and  imposed  on  society 
through  political  decisions.  Internal  institutions  can  be  classified  according  to  how 
compliance/non – compliance  is monitored/punished: 
-  Conventions – rules that provide clear and immediate benefits for those who respect 
them and also affecting their own interest if they don’t respect them; 
-  Internalized rules – rules that individuals have learned through habit, education or 
experience,  spontaneously  and  by  reflex  respecting  them,  dealing  with  their  own 
consciousness it they don’t; 
-  Habits and manners – their breach is informally sanctioned by the community, for 
example by exclusion; 
-  Formalized internal rules – rules that have evolved from experience and that are now 
formally monitored, through mechanisms established by the group/community. 
External institutions are very much different from the internal ones, being created and 
imposed to the community through legitimate political will and the power of coercion. They 
always involve a hierarchical structure, unlike the internal ones and if not respected, the 
sanctions  are formal and possibly  applied using  force. There are three types  of external rules:  external  rules  of  conduct,  specific  directives,  and  procedural  rules.  Authors  on 
institutionalism have emphasized on the importance of external rules for many reasons: 
-  habits and conventions are ambiguous; 
-  internal rules might lead to inequities; 
-  informal sanctions do not have the desired impact; 
-  external institutions govern contract-based relationships; 
-  external institutions ensure rationalization of scarce resources; 
-  internal institutions bring the risk of discrimination and exclusion. 
  A  dilemma  appears  in  identifying  the  perfect  combination  internal  –  external 
institutions, in order to avoid creating artificial institutions, against the established order and 
to  avoid  restrictions  on  the  freedom  of  deciding  on  reaching  the  interest  of  the 
community/individual.  This  is  the  point  where  the  issue  of  decentralized  decision-making 
must  be  addressed.  Although  a  borrowed  concept  from  the  administrative  sciences, 
decentralization is important in both public and private sectors. 
 
  Decentralization and decentralized decision-making 
  Decentralization is a complex concept, having different interpretations. It is defined as 
transferring authority and responsibility from central authorities towards subordinate or quasi-
independent  governmental  structures  or  towards  private  sector  organizations.  In  order  to 
ensure  efficiency,  equity  and  economic  stability  through  decentralization  there  are  two 
essential principles that must be respected: providing funding for fulfilling the tasks and a 
coherent and consistent decision-making process. 
  Decentralization  has  different  characteristics,  political  and  social  implications  and 
specific  success  factors,  which  define  particular  types  of  decentralization:  political, 
administrative,  fiscal,  market-based  decentralization.  Identifying  the  differences  between 
these types is useful for emphasizing the need for coordination between them in order to 
ensure the success of decentralization strategies. 
  Political decentralization aims to offer citizens or their representatives more power in 
decision-making.  It  is  commonly  associates  with  political  pluralism  and  government  and 
applied  for  policy  formulation  and  implementation.  Advocates  of  political  decentralization 
march on the premise that decisions taken with greater local participation will better reflect 
the interests of society/community, rather than those taken exclusively by central authorities 
and implemented at inferior levels. 
  Administrative  decentralization  seeks  sharing  authority,  responsibility  and  financial 
resources  for  providing  public  services  on  different  administrative  levels.  It  involves 
transferring responsibility for planning, financing and management of public services from 
central  level  towards  territorial  agencies  and  authorities.  There  are  three  forms  of 
administrative decentralization: -  Deconcentration  –  considered  the  weakest  form  of  decentralization,  but  the  most 
frequently  used  in  unitary  states.  It  involves  transferring  decision-making  between 
different administrative levels; 
-  Delegation  –  is  a  more  extensive  form  of  decentralization.  The  central 
authorities/government transfer responsibility for decisions and for the management 
of  public  services  toward  semi-autonomous  structures.  These  are  fully  liable, 
however, they are often exempted from administrative rule of law; 
-  Devolution – involves transfer of authority, finance and management to autonomous 
structures of local government, led by elected managers and strongly connected to 
political decentralization. 
  Fiscal decentralization is a central component of overall decentralization. To achieve 
other forms of decentralization is essential that necessary financial resources be transferred 
to lower tiers. It can take many forms: self-financing, co-extension of local taxes, municipal 
loans. 
  Market-decentralization is the most complex form of decentralization, consisting of 
privatization  or  deregulation  and  transferring  responsibility  from  the  public  sector  to  the 
private one. Privatization and deregulation are often accompanied by policies of economic 
liberalization  and market  development.  Functions  that  were  exclusively  governmental  are 
carried  out  by  companies,  community  associations,  voluntary  associations,  NGOs. 
Privatization can vary from complete transfer of goods on the free market to public-private 
partnership in which public and private sectors work together. Deregulation involves reducing 
the  legal  constraints  on  private  sector  participation  in  delivering  public  services,  or 
encouraging competition in sectors which were state monopolies. 
  All these forms of decentralization have an important role in expanding participation in 
political, economic and social activities and can lead to more creative innovative and efficient 
solutions through local experimentation. 
 
  Conclusions 
  In this context, the institutionalist approach is important in the processes of decision-
making, especially in decentralized decision-making. Even in decentralization institutions are 
rules set to control any opportunistic behavior on all levels of authority and they assume 
different forms: habits/traditions, manners, economic and financial arrangements designed 
and implemented in order to facilitate economic exchange. These have an informal content, 
emerging  without  express  regulation,  but  are  enforced  through  the  consent  of  the 
group/community.  But  even  if  a  large  part  of  the  economic  interactions  included  in  the 
beginning  such  internal  institutions,  complex  societies  and  economies  have  found  it 
necessary to define external, formally organized institutions. They are most often based on 
informal  institutions,  but  once  their  social  and  economic  role  increased  the  need  for formalization has appeared. This includes an enforcement of coercion and sanctions from 
outside structures, because as Hayek wrote in his paper Political Order of a Free People, the 
obedience to learnt rules has become necessary to restrain those natural instincts which do 
not fin into the order of an open society. 
  Institutions are used to reduce the costs of coordination in complex systems, to limit 
and even to resolve conflicts between people, but also to protect the freedom of individuals. 
Consequently,  institutions,  internal-external,  formal-informal,  should  not  limit  decision-
making, but provide a support mechanism for decision-making, based on: 
-  safety/certainty; 
-  general applicability; 
-  openness/universality 
 
 
 
  This work was supported by the the European Social Fund in Romania, under the 
responsibility of the Managing Authority for the Sectoral Operational Programme for Human 
Resources Development 2007-2013 [grant POSDRU/88/1.5/S/47646]. 
 
 
References 
 
     DiMaggio P., Powell W.W. (1991), The New Istitutionalism in Organisational Analisys, 
Chicago, Universitz of Chicago Press; 
     Kasper W., Streit M. (1998) Institutional Economics. Social Order and Public Policy, 
Edward Elgar Publishing, UK; 
     Knight J. (1992) Institutions and Social Conflict, Cambridge University Press; 
     Merkel  D.C.  (1998)  Institutions,  Institutional  Change  and  Economic  Performance, 
Cambridge university Press; 
     Morcol, G. (2000) Handbook of Decision Making, CRC Press, UK; 
      Veblen T, (1898) The Begining of Ownership, Americam Journal of Sociology 
 

An Overview on Institutionalism and Decentralized Decision-Making

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