ECONOMIC INSTITUTIONS

The analysis of economic institutions is central to the work of the classical figures of sociology-Marx, Weber, and Durkheim. These thinkers did not recognize a boundary line between sociological inquiry and economic inquiry; on the contrary, their efforts to make sense of the development of market capitalism led them to intensive analysis of market processes. Unfortunately, this thrust of sociological inquiry was largely abandoned by sociologists between World War I and the late 1960s. This was particularly true in the United States, where sociologists generally deferred to economists' claims of an exclusive mandate to study economic processes.

To be sure, there were a number of important intellectual figures during this period whose work integrated sociological and economic inquiry, but these individuals were rarely housed in sociology departments. Such economists as Thorstein Veblen, Joseph Schumpeter, and John Kenneth Galbraith have been retroactively recognized as sociologists. Similarly, the largely self-educated Hungarian scholar Karl Polanyi ([1944] 1957, 1971) is now acknowledged to have made seminal contributions to the sociological analysis of economic institutions. Yet scholars working in the sociological mainstream either ignored economic topics or tended to incorporate the perspectives of neoclassical economics.

Since the late 1960s, however, the lines of inquiry pioneered by the classical writers have been revitalized. Sociologists working in a number of different intellectual traditions and on diverse empirical topics have developed sophisticated analyses of economic processes (Swedberg 1987). No longer content to defer to the expertise of professional economists, many of these writers have developed powerful critiques of the work of neoclassical economists (Zukin and DiMaggio 1990).

Although this body of work explores a range of different economic institutions, much of it can be understood through its analysis of the way that markets work. (Analyses of other economic institutions, such as the division of labor, money, and corporate organizations, are presented elsewhere in this encyclopedia.) In particular, an emergent economic sociological conception of market processes can usefully be contrasted with the conception of the market that is implicit in most economic writings.

THE ORGANIZATION OF MARKETS

Neoclassical economists tend to assume an ideal market situation that allows changes in prices to equilibrate supply and demand. In this ideal market situation, there are multiple buyers and sellers whose transactions are fundamentally impersonal; information on the product and the price are the only relevant variables shaping the action of market participants. Contemporary economists recognize that this ideal market situation requires a basic symmetry in the information available to buyers and sellers. When there are significant differences in information, it is likely that the resulting price will diverge from the price that would effectively equilibrate supply and demand. Nevertheless, contemporary microeconomics rests on the assumption that most markets approximate the ideal situation, including information symmetry (Thurow 1983)

The sociological view of markets is fundamentally different. It stresses the embeddedness of behavior within markets, the central role of imitation in structuring markets, and the importance of blocked exchanges. The concept of embeddedness challenges the idea that impersonality is an important feature of actual market situations. While the individual actor in economic theory is a rational actor who is able to disregard his or her social ties in the market situation, the sociological actor is seen as embedded in a network of social relations at the time that he or she engages in market transactions. This embeddedness means that a wide range of social ties exert continuing influence over how the actor will both make and respond to price signals (Polanyi [1944] 1957; Granovetter 1985).

This view has two elements. First, the individual actor is decisively influenced by social ties. For example, a consumer might choose not to do business with retailers belonging to a stigmatized ethnic group, even when their prices are lower, because members of the consumer's ethnic group genuinely believe that the products of the other group will be inferior or that contact with the stigmatized group will jeopardize one's social position. The economists' argument that such an individual has a "taste for discrimination" does not adequately capture a reality in which discriminatory behavior often occurs with very little reflection because beliefs are deeply rooted. Second, the individual actor's dependence on social ties is necessary in order for him or her to accomplish a given economic goal. As Granovetter (1985) has pointed out, a purchasing officer at a corporation might well do business with a particular supplier regardless of price considerations because of longstanding ties to that individual. These ties provide assurance that the delivery will occur in a timely fashion and the merchandise will meet established quality standards. In other words, social bonds can provide protection against the uncertainties and risks that are always involved in transactions.

The standard economic view of markets tends to ignore these uncertainties; it is generally assumed that individuals will automatically obey the rules that make transactions possible. As Oliver Williamson (1975) has noted, this represents a profound inconsistency in economic analysis. While individuals are assumed to be self-interested, they are also expected to avoid guile and deception. In the real world, however, every transaction involves the risk that one party is deliberately cheating the other, and the more "impersonal" the transaction-that is, the less one party knows about the other-the greater the risk becomes.

This is one of the reasons that actual markets tend to develop structures and rules designed to constrain and to embed individual behavior. Although commodity markets and stock markets most closely resemble the pure markets of economic theory, in which rapid price changes serve to balance supply and demand, these markets tend to evolve complex social structures. At one level, such markets appear to be completely impersonal, in that there is no contact between buyers and sellers. On another level, however, the actual transactions are handled by a community of brokers who are well known to each other and who are expected to follow a particular etiquette for managing transactions. This structure has evolved to provide protection against unknown brokers who might prove unreliable and to assure that known brokers will be discouraged from cheating their colleagues and clients (Adler and Adler 1984; Baker 1984a; Burk 1988).

The central point, however, is that the particular ways in which market behaviors are embedded have real and significant consequences. On the one hand, embeddedness allows market processes to go forward by diminishing the opportunities for guile and deceit. On the other hand, embeddedness assures that factors besides price will influence the behavior of market participants, so it can no longer be assumed that price will automatically equilibrate supply and demand.

One of the main implications of the concept of embeddedness is that actual markets will be characterized by imitative behavior. Economists assume that each economic actor will calculate his or her preference schedule independently of all other actors. In the sociological view, however, actors are continually making their choices in reference to the behavior of others. In deciding the price to be asked for a particular commodity, a market participant will set it in comparison with the prices of competitors (White 1981). This is one of the key reasons that in actual markets there is often less price competition than would be suggested either by economic theory or by considerable differences across firms in the costs of production.

This role of imitation plays a particularly important role in financial panics and bubbles. Panics occur when many holders of a particular kind of asset rush to convert their holdings to cash, leading to precipitous price declines. Bubbles occur when enthusiasm for a particular asset drives prices far higher than can be justified by expected returns (Kindleberger 1978). Economists have trouble explaining the behavior of individuals in most panics or bubbles because rational actors with complete information would not engage in such irrational behavior; they would understand that the underlying value of an asset is not likely to change so dramatically in a short period of time. However, actual individuals have limited information, and they cope with uncertainty by observing the behavior of their friends and neighbors. Such observation makes them quite susceptible to the collective enthusiasms of panics and bubbles.

The threat of panics is another reason that financial markets develop institutional structures to embed individual behavior. The New York Stock Exchange, for example, has an elaborate system of specialist firms who have the responsibility to smooth out the market for particular stocks. Such firms are expected to be purchasers of last resort in situations where there are too many sellers of a stock (Baker 1984b). The idea is that such action should help to reduce the likelihood of panic. While such an institutional arrangement diverges from the economists' conception of a self-regulating market, it makes sense in the context of imitative behavior.

Furthermore, in their emphasis on the virtues of markets, neoclassical economists often suggest a vision of society as a giant bazaar in which everything is for sale. Sociologists, in contrast, are more likely to recognize that the viability of markets depends upon a wide variety of restrictions that block certain types of exchanges. Blocked exchanges are transactions that are in violation of the law or of widely shared ethical standards (Walzer 1983). Instances of blocked exchange include prohibitions on the resale of stolen merchandise, laws that prevent government officials from selling their services to the highest bidder, and the criminalization of prostitution and the purchase of certain drugs.

More subtle blocked exchanges play an important role in structuring the economy. Lawyers are not allowed to switch sides in the middle of a civil suit in response to an offer of a higher fee by the other side. Accountants are not supposed to produce a more favorable audit in response to a higher fee (Block 1990). Loan officers at a bank are prohibited from approving loans in exchange for side payments from the applicant. The members of a corporate board of directors are supposed to place their fiduciary responsibility to the shareholders ahead of their self-interest in contemplating offers to buy out the firm. In a word, there is a complicated and sometimes shifting boundary between legitimate and illegitimate transactions in contemporary economies.

The importance of blocked exchanges sheds further doubt on arguments that markets can regulate themselves without governmental interference (Polanyi [1944] 1957). The construction of any particular market involves rules as to what kinds of exchange are open and what kinds are blocked, but the incentives to violate these rules are often quite substantial. At the same time, the incentives for market participants to police each other are often lacking. Hence, there is often no alternative to a governmental role in policing the boundary between legitimate and illegitimate exchanges. Moreover, debates about social policy are often framed in a language of individual rights that is profoundly insensitive to the importance and pervasiveness of blocked exchanges. For example, when a woman serving as a surrogate mother in exchange for a fee decides she wants to keep the baby, the issue is often debated in terms of contract law. The more fundamental issue, however, is whether the society believes that the rental of wombs is a legitimate or illegitimate transaction (Rothman 1989).

VARIETIES OF MARKET SYSTEMS

A second important dimension of contemporary sociological work on economic institutions emphasizes the significant variations in the ways in which different market societies are institutionally organized. Against the common assumption that market societies will converge toward the same institutional arrangements, this work has used the comparative method to highlight significant and durable institutional differences. Out of this has come a rich body of literature on the wide variety of different "capitalisms" that can coexist at a particular moment in time. While there are a variety of typologies, this work has tended to identify an East Asian model, a Rhinish model that draws heavily on Germany and France, a social democratic model associated particularly with Sweden and Norway, and the Anglo-American model (Couch and Streeck 1997; Hollingsworth and Boyer 1997; Orru et al. 1997). While researchers have identified a wide variety of differences in economic institutions, much of this work has focused on examining differences in labor markets, capital markets, and in the markets for innovation.

The study of labor-market institutions encompasses variations in how the labor force acquires basic and advanced skills; variations in how social welfare provides citizens with income in the event of sickness, disability, unemployment, retirement, and other contingencies; variations in the rights and responsibilities that employees have in the workplace; and variations in the mechanisms for matching employees with job vacancies (Rogers and Streeck 1995; Wever and Turner 1995). The point is not simply that different countries are located on different points of a continuum in terms of variables such as union density or welfare generosity. It is rather that some of these variables tend to be grouped together, so that one can identify ideal typical complexes of institutions through which societies distribute some of the costs and benefits of economic growth. For example, studies by Dore (1997) and Streeck (1997) have sought to show how Japanese and German systems of industrial relations both differ dramatically from the Anglo-American model and work in tandem with other specific institutional features of those societies to create significant economic advantages for Japanese and German firms.

Comparative work on capital markets has generally contrasted the stock market-centered system in the United States and the United Kingdom with the bank-centered systems that have prevailed in Japan and in Continental Europe (Mizruchi and Stearns 1994; Zysman 1983). In the former firms rely primarily on stock and bond issues in impersonal markets to raise the funds required for expansion, while in the latter firms are more reliant on long-term loans from banks. This difference has important implications for corporate governance, for the size of the debt burden on corporations, for the time horizons of corporate executives, and for the openness of the economy to new entrepreneurial initiatives.

Finally, studies of the market for innovation have identified distinct varieties of what some analysts have called national innovation systems (Amable et al. 1997). This encompasses the research efforts of scientists and engineers, initiatives by government agencies to foster innovation, and the entrepreneurial activities of both public and private firms. The ways in which these elements are brought together vary significantly both in terms of the division of labor between the public sector and the private sector and the way that interactions between them are organized. Since innovation clearly weighs heavily in international economic success, some analysts have begun to examine the specific institutional features of nations that have been most effective in fostering successful innovation (Evans 1995).

This effort to identify different institutional types of capitalism has occurred during the same period in which the countries of Eastern Europe and the former Soviet Union have been making a transition from state socialism to capitalism. While some Western advisers acted as though the Anglo-American model was the only relevant model for former socialist countries to emulate, the process of transition had the effect of deepening the awareness of the institutional variations among capitalist societies (Stark and Bruszt 1998). Hungary, for example, had to make a set of decision as to how much weight to give the stock market in corporate governance and in capital allocation. This, in turn, generated increasing interest in studies showing the important differences in the relative role of stock markets and banks in different market societies.

THE SCOPE OF MARKETS

A third important dimension of contemporary sociological work on economic institutions is a concern with the geographical scope of markets. Much of the sociological tradition has been oriented to the study of national societies or of subnational units. But an understanding of the scope of international markets calls that approach into question. Markets for raw materials, finished products, services, capital, and labor cross national boundaries and exert extraordinary influence over all aspects of social life (Swedberg 1987).

The most ambitious effort to date to chart the importance of these international markets has been the world-system theory of Immanuel Wallerstein (1974a, 1974b, 1980, 1989). Instead of using national societies as the basic unit of analysis, Wallerstein has sought to shift sociological analysis to the level of the capitalist world-system. For Wallerstein, this system is comprised of a world market and a competitive state system of divided sovereignties. Any analysis of patterns within a particular national society must begin by locating that society within the larger capitalist world-system. A nation's location at the core, the periphery, or the semiperiphery of the capitalist world-system can be expected to shape the nature of its economic and political institutions.

The existence of a single unified world market is central to Wallerstein's argument. Each nation that is part of the capitalist world-system must struggle for relative advantage in that market, and this has implications for both social relations within nations and for the political-military relations among nations. Moreover, it is a central part of Wallerstein's project to detail the process by which various regions of the world have been incorporated into this unified world-system. The capitalist world-system began as a purely European phenomenon, but through colonization and the penetration of Western influence, this system became global. Regions that were once external to the system were progressively incorporated as peripheral areas that produced raw materials. Later-arriving nations such as the United States, Canada, and Japan moved to the semiperiphery and then to the core.

The contributions of Wallerstein and his followers have been extremely important in showing the systematic ways in which international markets shape developments within societies. The study of labor markets within the world-system, for example, has been particularly fruitful in making sense of international migrations-the massive movements of people across national boundaries-that loom so large in understanding both core and peripheral societies (Portes and Walton 1981).

Wallerstein's work, however, is vulnerable to criticism because it sometimes implies that there is a single unified world market for commodities, for labor, and for capital that operates quite similarly to the markets of economic theory. Critics have suggested that Wallerstein devotes too little attention to analyzing the specific institutional structures of global markets and that his work has not given sufficient weight to the institutional variations among capitalist societies. The response to the criticism is that the homogenizing logic of a global capitalist system will work itself out over time and will ultimately eliminate much of the variety in institutional forms.

Toward the end of the 1990s, debate over this precise issue has become increasingly important. The attention of a growing number of scholars is focused on the interactions between the varieties of market institutions at the national level and the dynamics of a global capitalist system. Particularly in discussions of "globalization" (see article in this encyclopedia), scholars ask whether there are-as Wallerstein suggests-powerful structural forces operating at the global level that are systematically forcing all market societies to adopt Anglo-American economic institutions. One British scholar posed the question polemically by asking if there were a new type of Gresham's Law in which "bad capitalisms were driving out good" (Gray 1999).

One set of events that intensified interest in this question were the deep problems of the Japanese economy during the 1990s and the Asian economic crisis that began in Thailand in July of 1997 and spread to Malaysia, Indonesia, South Korea, and ultimately to Russia and Brazil. Enthusiasm for an East Asian model of capitalism was considerably dampened by the severity of Japan's long-term problems, by South Korea's overnight transition from success story to severe financial crisis, and by doubts that the model could facilitate sustainable growth in poorer countries such as Thailand and Indonesia. At the same time, the crisis heightened awareness that the institutions of global capitalism, especially the International Monetary Fund, were exerting powerful pressures on East Asian countries to align themselves more fully with Anglo-American ways of organizing their economic institutions. Most specifically, in the aftermath of the crisis, there were pressures on nations to shift from bank-centered finance to stock market-centered finance (Wade and Veneroso 1998).

Finally, the Asian crisis also drew attention to the power of what one observer has labeled the "electronic herd" (Friedman 1999)-the global network of traders in markets for bonds, equities, foreign exchange, and more exotic financial instruments. When significant numbers of these traders decide that a particular economy on any continent is being poorly managed, they have the capacity to precipitate a major financial crisis just by taking positions in the market that assume a depreciation of the value of the country's financial assets and currency (Block 1996). To be sure, this power is not yet universal; China and Vietnam have been able to insulate themselves from these pressures by maintaining controls on capital movements, and Hong Kong and Malaysia were successful in foiling the speculative strategies of the traders. Nevertheless, the power wielded by these traders is further evidence that the global market might be able to force steadily greater homogenization in economic institutions and practices across nations.

These same concerns extend to the more developed economies of Western Europe. Scholars have argued that the rapid movement of capital across national boundaries has fundamentally weakened the social democratic model as an alternative way of organizing market societies (Scharpf 1991). And others have begun to wonder aloud as to how long the German model can resist the pressures to abandon its particular institutions for organizing labor markets and capital markets (Gray 1999; Streeck 1997). Developments such as the crossborder merger between Daimler-Benz and Chrysler might portend German accommodation to the Anglo-American model.

The question of whether the global economy will increasingly converge to a single type of capitalism based on the Anglo-American model or whether there will be continuing diversity of the institutional forms of market societies is far from being resolved. The outcome will depend on economic and political developments over the next few decades. However, if there is convergence, the results are likely to be highly unstable unless there is significant progress in increasing the regulatory capacities of global economic institutions. If one starts from neoclassical economic premises, one can imagine that a self-regulating global economy with relatively weak international institutions could be viable. However, a sociological view of markets evokes deep skepticism about the stability of such a system (Polanyi [1944] 1957). Just as sustained economic activity within nations requires both embeddedness of markets to minimize guile and deceit and enforcement of blocked exchanges, so an increasingly integrated global economy has similar needs. Moreover, since globalization tends to weaken regulatory mechanisms at the national level, the need for effective enforcement at the global level becomes more acute.

The Asian economic crisis of 1997 and 1998 revealed that the International Monetary Fund lacks the resources and the capacity to contain international financial panics. Moreover, since the global economy lacks an effective "lender of last resort," a financial panic could lead to a cascade of failures by large financial institutions on an enormous scale. But even when the need to expand global economic regulation is recognized, the political obstacles to the strengthening of international financial and regulatory institutions are enormous. Most national governments are extremely reluctant to cede sovereignty to international agencies. Since the same processes of globalization that increase the need for global regulation have already eroded the powers of national governments, political leaders are reluctant to limit their own authority even further. At the same time, while the United States has thrown its political and economic weight behind the forces of globalization, domestic political opposition in the United States to strengthened international agencies continues to be formidable. Hence, it appears unlikely that the globalized economy will soon have the regulatory institutions that it needs to function effectively.

(see also: Corporate Organizations; Division of Labor; Economic Sociology; Money; Transnational Corporations)

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Fred Block