Introduction

Abstract

1. WHAT IS NEW INSTITUTIONAL ECONOMICS? New institutional economics (NIE) studies institutions and how institutions interact with organizational arrangements. Institutions are the written and unwritten rules, norms and constraints that humans devise to reduce uncertainty and control their environment. These include (i) written rules and agreements that govern contractual relations and corporate governance, (ii) constitutions, laws and rules that govern politics, government, finance, and society more broadly, and (iii) unwritten codes of conduct, norms of behavior, and beliefs. Organizational arrangements are the different modes of governance that agents implement to support production and exchange. These include (i) markets, firms, and the various combinations of forms that economic actors develop to facilitate transactions and (ii) contractual agreements that provide a framework for organizing activities, as well as (iii) the behavioral traits that underlie the arrangements chosen. In studying institutions and their interaction with specific arrangements, new institutionalists have become increasingly concerned with mental models and other aspects of cognition that determine how humans interpret reality, which in turn shape the institutional environment they build (North 1990, p. 3-6; Williamson 2000). New institutional economics abandons the standard neoclassical assumptions that individuals have perfect information and unbounded rationality and that transactions are costless and instantaneous. NIE assumes instead that individuals have incomplete information and limited mental capacity and because of this they face uncertainty about unforeseen events and outcomes and incur transaction costs to acquire information. To reduce risk and transaction costs humans create institutions, writing and enforcing constitutions, laws, contracts and regulations-so-called formal institutions-and structuring and inculcating norms of conduct, beliefs and habits of thought and behavior-or informal institutions. They develop modes of organization embedded in these settings that provide different incentives that vary in their capacity to motivate agents. For new institutionalists the performance of a market economy depends upon the formal and informal institutions and modes of organization that facilitate private transactions and cooperative behavior. NIE focuses on how such institutions C. Menard and M. M. Shirley (eds.), Handbook of New Institutional Economics, M M´1 M´1-18. C C 2005 Springer. Printed in the Netherlands.