Public Choice

DOI 10.1007/s11127-014-0160-8

BOOK REVIEW

Wolfgang Kasper, Manfred E. Streit and Peter

J. Boettke: Institutional economics: property,
competition, and policies, 2nd ed
Edward Elgar Publishing, Inc., Northampton, MA, 2012,
xxii + 578 pp., USD 220.00 (cloth)

G. P. Manish

Ó Springer Science+Business Media New York 2014

Any system of division of labor necessarily involves social cooperation; each individual, in
order to satisfy his own wants, must first cater to the needs of others. Thanks to the
increased productivity that results from the specialization of labor, engaging in such a
process of cooperation has the potential to significantly improve the living standards of the
participants. However, while such a process is more productive, it is not one that is
automatic; it only operates under certain conditions. Indeed, men would stop interacting
with others to satisfy their needs if there was widespread predatory and opportunistic
behavior. What incentive, for instance, would a producer have to embark on a process of
production if he faced a high probability that his employees will renege on their contracts
or that miscreants will destroy his factory? Social cooperation, in other words, requires
anti-social behavior to be stifled; it requires a certain amount of predictability in the actions
of individuals.
Moreover, successful social cooperation requires a solution of the fundamental eco-
nomic problem: ensuring that the available supply of scarce means is allocated to serve the
highest valued ends. The various factors of production must be combined to yield a
production structure that caters to those needs that consumers rank highest; no resource
should be assigned to the satisfaction of a lower-ranked end while one that is ranked higher
remains unsatisfied. Stated differently, producers must coordinate their actions to best
satisfy the prevailing consumer preferences. Any successful attempt at such coordination,
however, faces the endemic hurdle of imperfect knowledge. The various participants in the
division of labor are not blessed with omniscience; they lack the necessary knowledge that
would enable them to make the best use of the resources they possess.
Mired in the imaginary world of long run equilibrium, mainstream neoclassical eco-
nomics is oblivious to these obstacles that stand in the way of successful social cooper-
ation. Its arid mathematical models, engaged in an in-depth analysis of a world where the
economic problem has already been successfully resolved, simply assume away the
problems that any economy faces in achieving an optimal coordination of means and ends.

G. P. Manish (&)
Sorrell College of Business, Troy University, 137R, Bibb Graves Hall, Troy, AL 36082, USA
e-mail: [email protected]

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In Institutional Economics: Property, Competition, and Policies, Professors Kasper, Streit,

and Boettke provide a refreshing alternative to this prevailing neoclassical economic
paradigm. The authors, in their model of the economy, do not focus solely on the end state
of long run equilibrium. Instead, drawing inspiration from the works of F. A. Hayek and
Israel Kirzner, they emphasize the process by which the economic problem is solved; the
process by which, the underlying data remaining unchanged, the interactions of the various
individual participants ultimately yields an optimal allocation of resources.
The emphasis on the process of economic coordination leads the authors to focus on the
conditions under which the obstacles to coordination are overcome. As the title of the book
suggests, they find the key to overcoming these obstacles in the institutional structure of
the economy. Putting in place the correct ‘‘man-made rules which constrain people’s
(possibly arbitrary and opportunistic) behavior in human interaction’’ (p. 32), or the
‘‘formal and informal ‘rules of the game’’’ (p. 32), is vital to ensure optimal resource
allocation.
To better explain the crucial role played by institutions, the authors devote part I of the
book to developing the conceptual foundations underlying their view of the economic
process. Particularly noteworthy in this section of the book is their treatment of the micro-
foundations of imperfect information. Human beings, the authors correctly note, never
possess complete knowledge of the data underlying any given situation. Instead, in a world
that involves inter-personal action and where the actions of others necessarily affects the
outcomes of each individual’s choices, they do not know ‘‘important details about their
potential exchange partners’’ and the types of resources they possess (pp. 48–49) resulting
in ‘‘sideways uncertainty’’ (p. 48). Moreover, they are also ignorant of conditions in the
future that could affect the outcome of their actions, an ignorance that results in ‘‘future
uncertainty’’ and a need ‘‘to make guesses about the future to act’’ (p. 48).
Any allocation of resources that emerges from individuals making choices under such
conditions, it goes without saying, must be sub-optimal in nature. Mistakes are bound to be
made, with resources inefficiently assigned to serve the wrong ends. Any improvement in
this allocation can only be achieved by individuals engaging in a search for this missing
knowledge; a process that, to borrow the oft-repeated expression of the former United
States Secretary of Defense Donald Rumsfeld, involves a search for ‘‘unknown unknowns’’
(p. 60). Indeed, when new knowledge is discovered, ‘‘the discoverer is totally surprised’’
(p. 50), for he did not know that this piece of knowledge actually existed. It follows that
while this quest for the discovery of knowledge is costly in terms of time and resources, it
does not offer any certain or predictable benefits. Individuals cannot engage in a rational
cost-benefit analysis to determine when they have acquired the optimal amount of infor-
mation. Instead they must make a subjective and uncertain judgment that they possess
sufficient information to make a decision. Thus, while acquiring new knowledge can
improve the efficiency of resource allocation, it can never result in a perfectly rational
allocation of resource given the endemic uncertainty that surrounds human action. Mis-
takes and erroneous decisions can never be eliminated.
In part II the authors apply these concepts and find that a market-based economy, or a
system of division of labor characterized by well-enforced private property rights, provides
an institutional structure that fosters successful social cooperation. The norms of private
property, in addition to controlling predatory and opportunistic behavior, also create an
incentive structure that compels market participants to constantly strive to improve the
prevailing allocation of resources. The rivalry of buyers and sellers in any market forces
them to reduce their ignorance of prevailing and future market conditions while deciding

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how to utilize the resources in their possession; the need to compete incentivizes them to
incur the costs of the discovery of knowledge despite the unknown returns.
Moreover, once knowledge is discovered and utilized in a certain market, prices serve to
disseminate it across the length and breadth of the economy, enabling participants in other
markets to make their resource allocations more efficient. And last but not least, the market
possesses an inherent system of error correction through profit and loss. The feedback
provided by profits and losses ensures an allocation of resources that minimizes mistakes
and erroneous decisions. Thus, while the market economy does not ensure a completely
rational allocation of resources, it generates the best possible outcome given the realities of
human ignorance.
In addition to providing a robust defense of a private property order, the authors also
develop the conceptual foundations required to analyze the fascinating questions of how
institutions emerge and how they evolve over time. They delineate a detailed typology of
institutions, distinguishing between internal institutions, or ‘‘rules that evolve within a
group in the light of experience,’’ and external institutions that are ‘‘designed externally’’
and ‘‘imposed on the community from above by political action’’ (p. 108). Moreover, they
also note that while the former, for the most part, are enforced without formal sanctions
and thus constitute informal institutions, the latter, requiring a formal enforcement
mechanism, can be termed formal institutions. On the basis of this typology the authors
distinguish between two types of social orders. An institutional structure composed pri-
marily of internal institutions would constitute a spontaneous order, wherein the actions of
individuals are ‘‘ordered indirectly or in a spontaneous, voluntary way because the various
agents obey shared institutions’’ (p. 152). In contrast, a rule system comprised largely of
external institutions gives rise to a planned order in which an ‘‘outside authority plans and
implements an order by instructions or directives to achieve a joint purpose’’ (p. 152).
While acknowledging the key role that external institutions play in facilitating social
cooperation, especially by way of state-provided justice and maintenance of the rule of
law, the authors stress the vital role that internal institutions play in ensuring a robust and
thriving private property order. Indeed, they argue that essential external institutions, such
as the rule of law, can never be foisted on pre-existing internal institutions that are hostile
to the norms essential for respecting and enforcing private property rights. It follows that
the imposition of alien external institutions via revolutions necessarily ends in failure and
social chaos, as was the case in both the erstwhile Soviet Union and in Nazi Germany (p.
431). Instead, there is an inherent inertia, an unavoidable path dependency that charac-
terizes institutional change (p. 437). Recognition of the key role played by internal
institutions also helps explain why some societies, such as post-communist China, have
been able to successfully evolve toward a market-based system, whereas other nations, like
those in Eastern Europe, have struggled with the transition from socialism to capitalism
(pp. 457–482).
All in all, Institutional Economics provides a robust and enlightening defense of a
market-based system of the division of labor that depends on a clearly defined and well-
enforced system of private property rights. It is primarily designed to be a textbook and
would be ideal for instructors who wish to introduce students to the subject of institutional
economics. At the same time, the book is also a worthwhile and informative read for all
those seeking to explore questions regarding the economic consequences of different
institutional structures and the rules that govern the evolution of institutions; questions that
largely remain unaddressed by neoclassical economics.

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