diversification 061103 - economy and society

327 Uris HallCornell UniversityIthaca, NY 14853-7601

Department of Sociology

CSES Working Paper Series

Paper # 47

Victor Nee

"The New Institutionalisms

in Economics and Sociology"

2005

3 The New Institutionalismsin Economics and SociologyVictor Nee

The focus on institutions as a foundational con-cept in the social sciences has given rise to a varietyof new institutionalist approaches. Not since thebehavioral revolution of the 1950s has there beenso much interest in a cross-disciplinary concept,one that offers a common theme for exchange anddebate. The writings of Ronald Coase, DouglassNorth, and Oliver Williamson on the endogenousemergence and evolution of economic institutionshave inspired a broadly based movement in econom-ics. In sociology, neoinstitutionalists—principallyJohn Meyer, Richard Scott, Paul DiMaggio, andWalter Powell—have redirected the study of or-ganizations by analyzing how institutional envi-ronment and cultural beliefs shape their behavior.In a parallel shift of analytic attention, economicsociologists—Peter Evans, Neil Fligstein, RichardSwedberg, and myself—argue for a new focus toexplain how institutions interact with social net-works and norms to shape and direct economic ac-tion. The common starting point of these ap-proaches is the claim that institutions matter andthat understanding institutions and institutionalchange is a core agenda for the social sciences.

This chapter does not seek comprehensivenessin its coverage of the new institutionalisms in thesocial sciences.1 Instead I focus selectively on thenew institutionalisms in economics and sociologyas a means to lay out core features of a new insti-tutional economic sociology, which brings backinto the research agenda a crucial focus on ex-plaining the workings of shared beliefs, norms, andinstitutions in economic life. My aim is to integratea focus on social relations and institutions into amodern sociological approach to the study of eco-nomic behavior by highlighting the mechanismsthat regulate the manner in which formal elementsof institutional structures in combination with in-formal social organization of networks and normsfacilitate, motivate, and govern economic action.2

Thus both distal and proximate causal mechanismsare addressed and incorporated into a comparative

institutional analysis of economic life. This entailsrevisiting Weber’s ([1904–5] 2002; [1922] 1968)view that rationality is motivated and guided by sys-tems of shared beliefs (religious and cultural), cus-tom, norms, and institutions. A conceptual frame-work underscoring such context-bound rationalityserves as the foundation for examining the emer-gence, persistence, and transformation of institu-tional structures.

NEW INSTITUTIONAL ECONOMICS

In the view of new economic institutionalists, theold institutionalism offered penetrating and in-sightful descriptions of economic institutions (Ve-blen 1909 [1899], 1934; Mitchell 1937; Com-mons 1934, 1957), but ultimately failed in the bidto shape the direction of modern economics. In-stead, it remained a dissident movement withineconomics, which, Coase (1984, 230) quipped,produced a “mass of descriptive material waitingfor a theory, or a fire.” With the limitations of theold economic institutionalism in mind, he notedthat “what distinguishes the modern institutionaleconomists is not that they speak about institutions. . . but that they use standard economic theory toanalyze the working of these institutions and todiscover the part they plan in the operations of theeconomy.” Kenneth Arrow (1987, 734) offers asimilar assessment in his answer to his rhetoricalquestion, “Why did the older institutionalist schoolfail so miserably, though it contained such able an-alysts as Thorstein Veblen, J. R. Commons, and W. C. Mitchell?” The new institutional economicshas been influential, he thinks, not because it offers“new answers to the traditional questions of eco-nomics—resource allocation and the degree of uti-lization,” but because it uses economic theory toanswer “new questions, why economic institutionsemerged the way they did and not otherwise.”

Without question new economic institutionalists

have sought to differentiate themselves from theold institutional economics by adapting, ratherthan rejecting, as did the earlier institutionalists,neoclassical economic theory. First, Coase’s theoryof transaction cost corrected an important omis-sion in neoclassical economics, and shows thatPigou was wrong in arguing that taxation and reg-ulation are the only effective way to deal with neg-ative externalities.3 His use of transaction cost rea-soning is not essentially different from Stigler’sadding information costs to correct neoclassicaltheory. Second, the idea that human agency is “in-tendedly rational, but limitedly so” (Simon 1957,xxiv) can be incorporated into a “thick” view of ra-tional choice as context-bound; as Posner (1993,80) points out, “rationality is not omniscience.”4

Third, through concepts like “asset specificity” and“opportunism,” Williamson extended microeco-nomic reasoning to understudied topics in eco-nomics such as vertical integration, corporate gov-ernance, and long-term contracts to show thattransaction cost economizing can generate predic-tions about the organizational boundaries andgovernance structures of firms competing for sur-vival and profit in a competitive environment.Fourth, North’s account of institutional changeviews organizations as rational actors in pursuingmarginal gains stemming from changes in relativeprices.

The differences between the old and new insti-tutionalisms may have been overstated, however(Rutherford 1994).5 The old economic institu-tionalists were not as lacking in theory as Coase’squip suggests. Veblen’s concept of cumulative cau-sation is consistent with modern ideas about ex-planation and path dependence. Mitchell (1927),who founded the National Bureau of EconomicResearch (NBER), was not a dust-bowl empiricist,but espoused the idea of research driven by mid-dle-range theory. Both old and new economic in-stitutionalisms argue that the mathematical formal-ism of neoclassical economics has contributed littleto understanding real-world economic behavior.Both espouse a realist orientation, which, as Coase(1984, 230) writes, seeks to study economic be-havior “within the constraints imposed by realinstitutions.”6

Figure 1 provides a schematic view of the causalmodel posited by the new institutional economics,as adapted by Williamson (1994, 80) from RichardScott. In this model, the institutional environmentis shaped by the rules of the game (see North1981). The downward arrow indicates that if shiftsin the broad parameters of the institutional

environment—property rights, legal change, andnorms—result in altering the relative prices forfirms, this induces changes in governance struc-tures or efforts by the firm to lobby government.The model includes a purposive actor whose be-havioral attributes—“self-interest seeking withguile”—lie behind many of the transaction coststhat governance structures are designed to address.

The Place of Transaction Cost Reasoning

The core concept of the new institutional eco-nomics is transaction cost—the cost of negotiat-ing, securing, and completing transactions in amarket economy. In Coase’s (1988, 15) view, neo-classical economics “is incapable of handling manyof the problems to which it purports to give an-swers” because it assumes a world of zero transac-tion cost in which institutions are superfluous toeconomic analysis:

In order to carry out a market transaction it is neces-sary to discover who it is that one wishes to deal with,to inform people that one wishes to deal and on whatterms, to conduct negotiations leading up to a bar-gain, to draw up the contract, to undertake the in-spection needed to make sure that the terms of thecontract are being observed, and so on. These opera-tions are often extremely costly, sufficiently costly atany rate to prevent many transactions that would becarried out in a world in which the pricing systemworked without cost. (Coase 1960, 15)

Hence in contrast to the world of zero transactioncosts assumed in neoclassical economics, transac-tion cost reasoning provides a method enablingeconomists to “study the world that exists.”

In “The Nature of the Firm” (1937) Coase ap-plied transaction cost reasoning to explain the en-

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InstitutionalEnvironment

StrategicShift Parameters

Behavioral Attributes EndogenousPreferences

Governance

Individual

Figure 1. A model of new institutional economics

dogenous existence of the firm in a competitivemarket economy. If market transactions were cost-less, Coase argued, then there would not be suffi-cient motivation for entrepreneurs to operatefirms. But, in fact, all solutions to the problem ofmeasuring the performance of agents and enforc-ing contracts are costly. Information asymmetryand uncertainty are found in all institutional envi-ronments; hence the same agency problems foundin markets also apply to the firm. The distinguish-ing characteristic of the firm is the suspension ofthe price mechanism. The entrepreneur has thepower and authority within the limits set by theemployment contract to direct workers from onepart of the firm to another. Thus “firms willemerge to organize what would otherwise be mar-ket transactions whenever their costs are less thanthe costs of carrying out the transactions throughthe market” (1988, 7). In other words, the reasonfor the firm’s existence is that the “operation of amarket costs something,” and the firm saves onthis cost.

The new institutional economics includes a di-verse group of economists with important differ-ences and ongoing debates.7 I focus here on threedistinctive approaches—pioneered by Williamson,North, and Greif—that are of interest to a newinstitutional economic sociology. The unifyingtheme of all three is the proposition that social in-stitutions matter to economic actors because theyshape the structure of incentives.

Williamson builds on Coase’s insight that infor-mation asymmetry and uncertainty make crediblecommitment to agreements difficult to secure, in-tegrating this insight with other literatures.8 Hissynthesis emphasizes that corporate governance isprincipally concerned with addressing the problemof opportunism and reducing the risk of malfea-sance in agents’ performance.9 By examining thecomparative costs of planning, adapting, and mon-itoring agents’ performance, Williamson derivestestable predictions about alternative governancestructures. His prediction turns on three types ofasset specificity—site, physical, and human—thatfirms encounter. Because firms compete in Dar-winian-like selection in markets to survive and re-main profitable (Hayek 1945), they are under con-tinuous pressure to adapt by economizing ontransaction costs. Hence, where asset specificity isgreater, principals and agents “will make specialefforts to design” a governance structure with“good continuity properties” to reinforce incen-tives for credible commitments to agreements. Bycontrast, if “assets are nonspecific, markets enjoy

advantages in both production cost and gover-nance cost respects” Williamson (1981, 558).10

Williamson’s contribution has been to build atheory-driven research program in which core hy-potheses derived from Coase have been empirical-ly verified.

A second research program stimulated byCoase’s seminal essays emphasizes the importanceof property rights in shaping the incentive struc-ture (Cheung 1970, 1974; North and Thomas1973; Alchian and Demsetz 1973; North 1981).Cheung showed that in a neoclassical world ofzero transaction costs, private property rights canbe dropped without negating the Coase theorem,an insight that North extended to develop a newinstitutionalist property rights approach to explaineconomic performance. Because transaction costsmake up a significant part of the cost of productionand exchange, North reasoned that alternative in-stitutional arrangements can make the differencebetween economic growth, stagnation, or decline.The first of the new institutionalists to explicitlydisavow the efficiency assumption of the function-alist theory of institutions (Schotter 1981), Northasserts that because incentives are structured in in-stitutional arrangements, perverse incentives aboundand give rise to property rights that discourage in-novation and private entrepreneurship. It is fre-quently profitable and more rewarding for politicalactors to devise institutions that redistributewealth, which can dampen incentives for innova-tion and private enterprise.

North’s approach is state-centered in that it fo-cuses analytic attention on the role of the state indevising the underlying structure of propertyrights in society.11 In his view, the central task in ex-plaining economic growth is to specify the eventsand conditions that provide incentives for politicalactors to establish formal institutional arrange-ments supporting efficient property rights.12 In therise of the West, this entailed the dilution of statecontrol over resources and the emergence of someform of political pluralism.13

Conceived as “humanly devised constraints thatstructure political, economic and social interac-tions,” institutions in North’s view (1991, 97)consist of formal rules like constitutions, laws, andproperty rights and also informal elements such as“sanctions, taboos, customs, traditions and codesof conduct.” Although he was among the first topoint to the informal elements of institutions,North has consistently emphasized the “funda-mental rules of the game” or the basic groundrules provided by constitutions and law. These are

New Institutionalisms 51

the rules that govern political actors and shape thestructure of property rights that define and specifythe rules for competition and cooperation in mar-kets. The importance of formal rules is amplified inmodern market economies, where, North argues,the growth of long-distance trade, specialization,and division of labor contributes to agency prob-lems and contract negotiation and enforcementproblems. Though interpersonal ties, social norms,and sanctions such as ostracism are very importantelements of institutional arrangements, they arenot sufficient in themselves to enforce crediblecommitments to agreements, because “in the ab-sence of effective impersonal contracting the gainsfrom defections are great enough to forestall thedevelopment of complex exchange” in moderneconomies (North 1991, 100).

North’s theory of institutional change appliesstandard marginalist theory in its emphasis onchanging relative prices. His economic history ofthe rise of the West showed that institutionalchange “comes from a change in the relative bar-gaining power of rulers versus constituents (orrulers versus rulers), and, broadly speaking, changesarise because of major, persistent changes in rela-tive prices” (1984, 260). Changes in relative pricesare in turn often driven by demographic change,change in the stock of knowledge, and change inmilitary technology. The dynamics of institutionalchange in North’s theory stem from a continuousinteraction between institutions and organizationswithin the context of competition over scarce re-sources. Because institutions are self-reinforcing,vested interests in the existing stock of institutionsreinforce path dependence in efforts to revise therules. Institutional innovations will come fromstates rather than constituents because states gen-erally do not have a free-rider problem (exceptsometimes in international affairs), whereas indi-viduals and organizational actors are limited intheir capacity to implement large-scale changesdue to the problem of free riding.14 Entrepreneursare the agents of change, and organizations are theplayers who respond to changes in relative prices,which include changes in the ratio of factor prices,changes in the cost of information, and changes intechnology. Organizations are agents of changewhen they lobby the state to initiate institutionalinnovations that enable economic actors to surviveand profit from changes in relative price.15

Critical of North’s approach, Greif (forthcom-ing) argues that its focus on formal rules and statepower does not illuminate why economic actorsfollow some rules but not others. Although North

acknowledges the role of ideology, cultural beliefs,norms, and conventions, Greif contends that hisapproach to institutional analysis does not providean appropriate framework to study how actors areendogenously motivated to follow rules not en-forced by the state. North relegates beliefs andnorms to a black box of informal constraints, andis unable to show how informal rules and their en-forcement combine with formal rules to enable,motivate, and guide economic behavior. Greif’sown approach, applying game theory to examinehow cultural beliefs shape the principal-agent rela-tionship, giving rise to and sustaining distinct eco-nomic institutions, is discussed below, in the sec-tion on the sociological turn in new institutionaleconomics.

A COUNTERPERSPECTIVE FROM ECONOMICSOCIOLOGY

In his influential article “Economic Action andSocial Structure” (1985) Granovetter points outthat “Actors do not behave or decide as atoms out-side a social context, nor do they adhere slavishlyto a script written for them by the particular inter-section of social categories that they happen to oc-cupy. Their attempts at purposive action are in-stead embedded in concrete, ongoing systems ofsocial relations” (487). He proffers the view that“social relations, rather than institutional arrange-ments or generalized morality [e.g. shared beliefsand norms], are mainly responsible for the pro-duction of trust in economic life” (491). He criti-cizes Williamson’s use of transaction cost reason-ing in explaining the boundaries of firms for whathe views as unrealistic assumptions of under- andoversocialized conceptions of human action, “bothhav[ing] in common a conception of action anddecision carried out by atomized actors” (485).Williamson’s “state of nature” view of markets,Granovetter contends, is devoid of reference to thehistory of concrete relationships and networkstructures, failing to take into account “the extentto which concrete personal relations and the obli-gations inherent in them discourage malfeasance,quite apart from institutional arrangements” (489).Williamson’s Hobbesian conception of hierarchicalauthority is also on shaky ground, given the extentto which congealed social networks in firms struc-ture power relations; hence, “Williamson vastlyoverestimates the efficacy of hierarchical power(‘fiat,’ in his terminology) within organizations”(499).

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Granovetter thus contributed the seminal themeof embeddedness to the revitalization of the socio-logical study of economic life. Asserting that evenwhen economics tries to take into account socialfactors, its conception of human action remainsdeeply flawed, since both the under- and over-socialized versions commonly found in economicanalysis assume atomized actors, Granovetter’s ar-gument tended to frame this revitalization of eco-nomic sociology in terms of a disciplinary-basedcompetition with economics. In contrast to trans-action cost economics’ emphasis on hierarchies insolving the problem of trust, economic sociolo-gists guided by the embeddedness approach “paycareful and systematic attention to the actual pat-terns of personal relations by which economictransactions are carried out” (504). The focus onconcrete interpersonal ties is likely to show “thatboth order and disorder, honesty and malfeasancehave more to do with structures of such relationsthan they do with organizational form” (502–3).Interpersonal ties play a crucial role in both mar-kets and firms in securing trust and serving as aconduit for useful information.16

We must note, however, that interpersonal tiesentail costs, whether in avoiding and resolvingconflict, or in the accumulation of obligations. In-deed, social relations can be very costly when con-flict, disorder, opportunism, and malfeasance eruptin networks. Transaction cost analysis suggests thatentrepreneurs will take such costs into account inconsidering alternative forms of economic organi-zation, including network-based quasi firms. De-spite the contrast in focus, the transaction cost andthe embeddedness approaches appear to agree thatfirms generally prefer social contexts where negoti-ating agreements is less problematic and costly. Inessence, the embeddedness approach differs fromtransaction cost economics in its emphasis on in-formal solutions to address the problem of trust, asopposed to formal institutional arrangements. Notsurprisingly therefore, Williamson’s (1994, 85) re-sponse to Granovetter’s essay was, “Transactioncost economics and embeddedness reasoning areevidently complementary in many respects.”

While Granovetter’s embeddedness approachlaid the basis for the revitalization of the sociolog-ical study of economic life, his sole emphasis on thenature of interpersonal ties and the structure ofnetworks contributed to a narrowing of the scopeof economic sociology from the broader insti-tutional canvass pioneered by its founders. Thecausal imagery of the embeddedness approach,positing variation in the underlying structure of

concrete social relationships to explain the work-ings of markets and firms, relies on a conceptualframework that limits economic sociology’s ex-planatory power to proximate causes.17 Moreover,the approach requires the construction of a taxon-omy of structural contexts as a necessary step tobecome sufficiently abstract to generate a powerfulanalytical framework.18 By contrast, the classicalsources of economic sociology in the writings ofWeber, Schumpeter, and Polanyi outlined analyti-cal approaches that pointed to a broad institution-al canvass of distal and deeper causal forces.

Another limitation is the absence of a clear spec-ification of mechanisms that explain why econom-ic actors sometimes decouple from ongoingnetworks to pursue economic interests. If, as Gran-ovetter asserts, a dense network of personal tiesdoes more than institutional arrangements to se-cure trust and useful information crucial for com-plex transactions, then why do economic actorsroutinely decouple from interpersonal ties to trans-act in market exchanges? A defining feature of anadvanced twenty-first-century market economy asan institutional order is its capacity to enable eco-nomic agents to switch virtually seamlessly be-tween transactions within close-knit networks andwith strangers. In sum, the social relations ratherthan institutions orientation of this embeddednessapproach introduced an element of indeterminacyin the new economic sociology, especially in thecontext of a global market economy where the vol-ume of cross-national transactions has increasedthrough innovations in information technologyenabling complex transactions between strangers(Kuwabara, forthcoming).

THE SOCIOLOGICAL TURN IN NEWINSTITUTIONAL ECONOMICS

Central among sociology’s concerns from itsorigins as a social science has been the goal of ex-plaining institutions, as exemplified in Max Weber’sand Émile Durkheim’s seminal works on the sub-ject. It is not surprising, therefore, that there hasbeen something of a “sociological turn” in eco-nomics, motivated by difficulties in explaining in-stitutions and institutional change within theframework of economic theory (Furubotn andRichter 1993). If a sociological turn is in progress,how is it manifested in the recent work of new in-stitutional economists? To what extent has eco-nomic sociology influenced their thinking?

In his article “The New Institutional Econom-


ics: Taking Stock, Looking Ahead,” Williamson(2000, 595) confesses that “we are still very igno-rant about institutions” despite the progress madeover the past quarter-century. “Chief among thecauses of ignorance is that institutions are verycomplex. . . . pluralism is what holds promise forovercoming our ignorance.” Williamson’s multi-level causal model of the economy outlines “fourlevels of social analysis” in which the higher levelimposes constraints on the lower level. “The toplevel,” he writes, “is the social embeddedness level.This is where the norms, customs, mores, tradi-tions, etc. are located. . . . North poses the query,‘What is it about informal constraints that givesthem such a pervasive influence upon the long-runcharacter of economies?’ (1991, 111). North doesnot have an answer to that perplexing question,nor do I.” This embeddedness level influences thelower three levels: level 2, institutional environ-ment; level 3, governance; level 4, resource alloca-tion and employment.19 Hence it is important toidentify and explicate “the mechanisms throughwhich informal institutions arise and are main-tained” (596). Thus the embeddedness perspectivenow is in the process of being incorporated intothe new institutional economics. But Williamsonacknowledges that though level 1 shapes the pa-rameters of what economists study, it “is taken asgiven by most institutional economists.”

A sociological turn is apparent in the influenceof Weber, Marx, Polanyi, and Parsons on North’sconception of institutions as elaborated in Struc-ture and Change in Economic History (1981).More recently, in response to confronting the dif-ficulties of implementing institutional change as aneconomic advisor to reformers in the transitioneconomies of Eastern Europe, North acknowl-edges a greater interest in understanding the infor-mal elements of institutions embedded in social re-lations. Devising new formal rules to institutemarket economies in Eastern Europe and the for-mer Soviet Union has had only limited success; thishas pointed to the intractable nature of socialarrangements embedded in interpersonal ties, cul-tural beliefs, norms, and old regime institutionalarrangements studied by economic sociologists.20

Clearly, “Formal rules are an important part of theinstitutional framework but only a part. To workeffectively they must be complemented by infor-mal constraints (conventions, norms of behavior)that supplement them and reduce enforcementcosts. If the formal rules and informal constraintsare inconsistent with each other the resulting ten-sion is going to induce political instability. But we

know very little about how informal normsevolve” (North 1993, 20).

A sociological turn is further evident in new the-orizing on the importance of cognitive mecha-nisms. Because beliefs and norms are unobserv-able, Greif argues, integrating social variables hasbeen hampered by the fact that any behavior canbe explained by ad hoc assertions about the beliefsand norms that motivate it. The integration of so-cial variables in a manner consistent with econom-ic methodology requires an analytical frameworkthat can reconcile two seemingly contradictoryviews of institutions: the view of institutions com-mon in economics as constraints created by indi-viduals and the structural view of institutions as so-cial facts external to the individuals common insociology. Organizational new institutionalists focuson diffusion of rules, scripts, and models (Meyerand Rowan 1977), whereas some new institution-al economists offer game theoretic models of en-dogenous motivation stemming from systems ofshared beliefs and norms (Greif [1994] 1998).21

Although game theory does not offer a theory ofinstitutions, Greif argues that it does offer an ap-propriate analytical framework to incorporate soci-ological variables into economic analysis of insti-tutions. It does not provide a theory of theconstraints defining the parameters of strategic in-teraction, but it offers deep insights on the dy-namics of choice within constraints. It provides atheory of social behavior in which actors’ optimalcourse of behavior depends on the behavior andexpected behavior (cultural beliefs and socialnorms) of others.22 It also incorporates a realisticview of the social world in which information isasymmetric and actors are interdependent and mo-tivated to act in a particular manner. It offers amethod to examine how strategic interactions giverise to and sustain self-enforcing institutions. Greif([1994] 1998) has extended its application to thecomparative institutional analysis of economic be-havior using cases studies drawn from medievalEuropean and Mediterranean economic history.He models the recurrent strategic social interac-tions that sustain institutions in equilibrium.23

Overall, economists interested in studying socialinstitutions have found that the more they come tounderstand the workings of institutions as endoge-nous to social processes in society, the more theirwork must address questions that lead them toturn to sociology for answers. New institution-al economists apparently agree that advances inunderstanding institutions requires integratingsociological variables—shared beliefs, norms, and

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social relationships—to understand motivation tofollow rules.

NEW INSTITUTIONALISM IN ECONOMICSOCIOLOGY

In 1898 Émile Durkheim founded the Année so-ciologique, establishing modern sociology as a dis-cipline dedicated to the comparative study of in-stitutions. Since then, Durkheim’s conception ofinstitutions as systems of shared beliefs, norms,and collective sentiments has persisted to shape thesociological approach to their study. Max Webersimilarly pioneered the interpretive study of socie-tal institutions through his comparative analysis ofcultural beliefs, economy, and polity. Reinterpret-ing the classics of European sociology, Talcott Par-sons later synthesized the institutionalist ideasassociated with Durkheim, Weber, Pareto, andTönnies into a structural-functionalist frameworkfor modern sociology. He too conceived of insti-tutions as organized systems of cultural beliefs,norms, and values common to most individuals ina society, systems giving rise to socially structuredinterests that organize incentives for individuals.His outline of a theory of institutions adumbratedthe idea of choice within institutional constraints.Parsons’s Economy and Society (1956), coauthoredwith Neil Smelser, established economic sociologyas a subfield in American sociology. Like Parsons,Robert K. Merton viewed institutions as structuresof opportunity, shaping the interests and strategicaction of individuals.

The new sociological institutionalism reformu-lates the earlier European and American institu-tionalist approaches in sociology through the lensof a different generation of American sociologists.Sociological new institutionalism has been closelyidentified with the perspective on organizationalanalysis pioneered by Meyer and Rowan (1977)and many other organizational theorists of theStanford “legitimacy” school, and canonized in awidely used anthology, The New Institutionalismin Organizational Analysis, edited by Powell andDiMaggio (1991). DiMaggio and Powell (1983)introduce into neoinstitutional theory the influ-ence of Max Weber’s and Herbert Simon’s ideas,evident in their treatment of how organizationalfields emerge and then constrain the action ofagents under conditions of uncertainty. The ele-ments of a new institutional economic sociology Ilay out below include ideas and insights from thisorganizational research program, which are inte-

grated into a framework of sociological researchthat examines context-bound rationality shaped bycustom, networks, norms, cultural beliefs, and in-stitution arrangements, as in The New Institution-alism in Sociology, edited by Brinton and Nee(1998). The new institutional economic sociologybuilds on the pioneering work of Barnard ([1938]1964), Homans (1950), and Blau (1955), analyz-ing the manner in which interpersonal ties in firmsand markets interact with formal institutionalarrangements (Nee and Ingram 1998).

For a new institutional economic sociology tomake advances in explaining the role of institutionsand institutional change, it is important to have adefinition of institutions appropriate for analysisfrom the sociological perspective that emphasizesthe causal effect of social structures. Institutionsare not simply the formal and informal constraintsthat specify the structure of incentives, as definedby North (1981), or discrete institutional elements—beliefs, norms, organizations, and communities—of a social system (Greif, forthcoming), but funda-mentally they involve actors, whether individualsor organizations, who pursue real interests in con-crete institutional structures. An institution in thisview is defined as a dominant system of interrelatedinformal and formal elements—custom, shared be-liefs, conventions, norms, and rules—which actorsorient their actions to when they pursue their inter-ests. In this view, institutions are social structuresthat provide a conduit for collective action by fa-cilitating and organizing the interests of actors andenforcing principal-agent relationships. It followsfrom this interest-related definition that institu-tional change involves not simply remaking theformal rules, but fundamentally requires the re-alignment of interests, norms, and power.24

As economic sociology moves beyond the earli-er perspective on embeddedness, the challenge isto specify and explicate the social mechanisms de-termining the relationship between the informalsocial organization of close-knit groups and theformal rules of institutional structures monitoredand enforced by organizations and states. The newinstitutional economics has contributed to explain-ing the emergence and maintenance of formalinstitutional arrangements that shape economicbehavior. However, as North (1993, 12) acknowl-edges, economics has largely “ignored the infor-mal constraints of conventions and norms of be-havior.” Economists pose probing questions aboutthe social dimensions of economic life as they en-counter the limits of economic analysis of institu-tions (North 1991; Williamson 2000). Their ques-


tions address the manner in which informal socialorganization and formal rules combine to shape theperformance of organizations and economies.With recent advances in application of game theo-ry, economists recently have begun to incorporateinformal institutional elements into their models of economic performance (Greif, forthcoming).While economic sociologists may not have all theanswers, clearly in cross-disciplinary researchaimed at explaining the capacity of social institu-tions to facilitate, motivate, and govern economicbehavior, sociology’s comparative advantage is toaddress questions that focus on the social mecha-nisms that shape economic behavior. As Smelserand Swedberg point out, “the concept of embed-dedness remains in need of greater theoreticalspecification” (1994, 18).

Figure 2 provides a schematic representation ofthe multilevel causal model for the new institu-tionalism in economic sociology, which is relatedto, but different from, the new institutionalistmodels proposed by Williamson (1994). The insti-tutional environment—the formal regulatory rulesmonitored and enforced by the state that governproperty rights, markets, and firms—imposes con-straints on firms through market mechanisms andstate regulation, thus shaping the incentives struc-ture. The institutional mechanisms operating atthis level are distal, as opposed to the proximatenetwork mechanisms at the micro- and meso-levelsof individuals and their interpersonal ties. Institu-tional mechanisms encompass the deeper causesbecause they shape the incentive structure for or-ganizations and individuals, and thereby the con-texts in which proximate mechanisms operate. Theinstitutional-level mechanisms posited by econo-mists and sociologists, despite differences in be-havioral assumptions and conceptual language, arenot as far apart as is commonly perceived. New in-stitutional economists emphasize incentives struc-tured by the monitoring and enforcement of for-mal rules, a mechanism widely accepted by bothpolitical economy and sociology. The new institu-tionalism in economic sociology specifies the man-ner in which the norms of close-knit groups inter-act with formal rules in the realization of interests.The variety of market mechanisms schematicallyrepresented in the downward arrow from the insti-tutional environment to the organizations includesthose embedded in labor markets, capital markets,raw material markets, and so on. Surprisingly per-haps, economists generally do not focus on mar-kets as such, but just assume their existence in theneoclassical view of perfect competition in markets

underlying the supply-demand curve. The institu-tional framework encompasses formal rules of theinstitutional environment and informal rules em-bedded in ongoing social relations, which interactto shape economic behavior.

Organizations through collective action lobbyfor changes in the formal rules to make them incloser accord with their interests. Industry-basedassociations and professional lobbyists act as agentsrepresenting their interests. Groups of organiza-tions are arrayed in an organizational field. Theproduction market is a close-knit network of firmsin an industrial sector arrayed in a status hierarchyof perceived quality.25 In White’s (2001) model ofthe production market, firms compete and maneu-ver for advantage and status with peer firms in a market niche. They are guided by the signals they read from the operations of their peers. Incompetitive markets, pressures on firms stemming from Darwinian selection processes necessitate aninterest-related logic of strategic action, differing inemphasis from the legitimacy-centered orientationof nonprofit organizations—public schools, muse-ums, day-care centers—which are dependent onstate and federal government and philanthropy forresources. Legitimacy is also important for enter-prises, as manifest in firms’ investments in pro-moting brand-name recognition, reputation forreliability and quality service or product, and com-pliance with federal and state laws, but legitimacy-seeking is driven mainly by the firm’s interest in itssurvival and profitability in competitive markets.For nonprofit organizations, especially, legitimacyis essential social capital, increasing the chances foroptimizing access to scarce resources. In both for-profit firms and nonprofit organizations, legitima-cy can be viewed as a condition of fitness that en-ables them to enhance their survival chances andsecure advantages in economic and political mar-

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Collective Action

Monitoring; Enforcement

Market Mechanism;State Regulation

Compliance;Decoupling

Incentives;EndogenousPreferences

InstitutionalFramework

Production Market/Organizational Field

Organizations:Firm/Nonprofit

Social Groups

Individual

Figure 2. A model for the new institutionalism ineconomic sociology

kets. Processes of conformity with the rules of thegame and cultural beliefs in organizational fields—isomorphism—motivate and guide organizations,endogenously giving rise to increasing homogene-ity within an organizational field (DiMaggio andPowell 1983).26

The social mechanisms facilitating, motivating,and governing the action of organizations in orga-nizational fields or production markets are not dis-similar from those influencing strategic action ofindividuals in close-knit groups. Mechanisms ofconformity in close-knit groups have coercive, nor-mative, and mimetic aspects (Homans [1961]1974). Actors are motivated by interests and prefer-ences, often formed and sustained within suchgroups. Rationality is context-bound and embed-ded in interpersonal ties. Individual interests andpreferences are enfolded in “welfare-maximizing”norms, which, depending on the incentives struc-tured in the institutional environment, reinforcecompliance to formal rules through self-monitoringor give rise to decoupling arising from oppositionnorms (as discussed below).

Informal Institutional Elements

The bottom box of our causal model overlapswith the earlier embeddedness concept, which ar-gues that the nature and structure of social rela-tionships have more to do with governing eco-nomic behavior than do institutional arrangementsand organizational form. Specifically, Granovetter(1985, 490) refers to the “role of concrete per-sonal relations and structures (or ‘networks’) ofsuch relations in generating trust and discouragingmalfeasance,” which he attributes to the humanpreference for transacting with individuals knownto be trustworthy and for abstention from oppor-tunism. But what explains motivation for trust-worthiness and abstention from opportunism inongoing social relationships? Why is trustworthi-ness found more commonly in ongoing social rela-tionships than in transactions between strangers?

The answer is found in specifying the mecha-nisms intrinsic to social relationships that developand maintain cooperative behavior within close-knit groups, enabling actors to engage in collectiveaction to achieve group ends. These mechanismsare rewards and punishment in social exchange andtheir use in the enforcement of social norms—shared beliefs and statements about expected be-havior.27 Social exchange theorists have explicatedthe mechanisms involved, empirically in Blau’s(1955) classic study of social exchange and net-

works in a federal bureaucracy, The Dynamics ofBureaucracy, and theoretically in the network ex-change literature pioneered by Homans ([1961]1974), Emerson (1962), and Blau (1964). Nu-merous studies in natural settings and in laborato-ry experiments confirm the efficacy of social re-wards and punishment in facilitating, motivating,and governing trustworthy behavior and absten-tion from opportunism with respect to the normsof the group.28 Enforcement of norms within close-knit groups occurs spontaneously in the course ofsocial interaction among members through the ex-change of social rewards (i.e., esteem and status)for behavior that conforms to the group’s norms,and punishment (i.e., disapproval and ostracism)for violating them. As Homans ([1961] 1974, 76)perspicaciously points out: “The great bulk of con-trols over social behavior are not external but builtinto the relationship themselves.” Frequency of in-teraction, a characteristic feature of close-knit net-works, lowers the cost of monitoring members ofthe group, assuming they are in close enough con-tact with one another that information aboutmembers’ conduct is common knowledge. Axel-rod (1984) effectively simulated the operation ofnetwork mechanisms in his tit-for-tat model,showing that reward and punishment in repeatedexchanges—when actors take into account theweight of the future, as in ongoing relationships—motivate cooperative behavior. In sum, trustwor-thiness and reliability as forms of cooperative be-havior arise from rational action responding tosocial rewards and punishment in networks orclose-knit groups.

In his detailed account of the interactions in thework group he studied made up of a supervisor, 16agents, and one clerk, Blau (1955) provides a rareillustration of how self-interested action of individ-uals endogenously produces the informal social or-ganization of a close-knit work group. In the workgroup Blau studied, agents consulted fellow agentsabout the appropriate legal rules that applied totheir case, rather than bring their questions to theattention of the supervisor who evaluated theirwork. Blau observed that the informal interactionsbetween agents involved a social exchange similar inlogic to a decentralized market exchange:

A consultation can be considered an exchange of val-ues; both participants gain something, and both haveto pay a price. The questioning agent is enabled toperform better than he could otherwise have done,without exposing his difficulties to the supervisor. Byasking for advice, he implicitly pays his respect to the


superior proficiency of his colleague. This acknowl-edgement of inferiority is the cost of receiving assis-tance. The consultant gains prestige, in return forwhich he is willing to devote some time to the con-sultation and permit it to disrupt his own work. Thefollowing remark of an agent illustrates this: “I likegiving advice. It’s flattering, I suppose, if you feel thatthe others come to you for advice.” (Quoted inHomans 1974, 343)

Blau found that the more competent the agent,the more contacts she had with other agents, andthe higher the esteem in which she was held. A fewagents who were perceived as competent but whodiscouraged others from consulting them weredisliked and had fewer contacts. These findingshighlight the importance of social rewards andsanctions (e.g., esteem and disapproval) in the nor-mative regulation of informal social organization.Routine social exchanges, such as the one de-scribed by Blau, comprise the informal social or-ganization that emerges and sustains the perfor-mance of formal organizations (Nee and Ingram1998).

Norms are the informal rules that facilitate, mo-tivate, and govern joint action of members ofclose-knit groups. They arise from the problem-solving activity of individuals as rule-of-thumbguidelines for expected behavior. Throughout his-tory, norms have coordinated group action to im-prove the chances for success—the attainment ofrewards—through cooperation. As statements ofshared beliefs about expected behavior, normsevolved together with language, as in the normsuttered by early hunting parties to coordinate ac-tion during the course of the expedition. Normsprobably evolved through trial and error, with suc-cess the arbiter of why a particular norm persists inequilibrium across generations and diffuses to dif-ferent groups.29 Members of close-knit groups co-operate in enforcing norms because not only theirinterests are linked to the group’s success, but theiridentity as well (White 1992).

The Relationship between Informal and FormalInstitutional Elements

In uncovering the social norms of Shasta Coun-ty, a sparsely settled rural county of northern Cali-fornia, where local ranchers and suburbanites main-tain ongoing multiplex relationships, Ellickson“was struck that they seemed consistently utilitari-an”; from which he inferred that “members of a close-knit group develop and maintain norms

whose content serves to maximize the aggregatewelfare that members obtain in their workadayaffairs with one another” (1991, 167).30 Norms co-ordinating individuals’ activities, as in the conven-tion of arriving in a timely fashion at an agreed-upon social engagement, are not difficult to explainsince it is easy to show that self-interested individu-als share a common interest in complying with thisconvention. But the prisoner’s dilemma norm ismore difficult to explain since self-interested indi-viduals derive a greater payoff for opportunism in aprisoner’s dilemma game. What makes this game sointeresting is that this type of dilemma is such acommon feature of social and economic life. It isthe prisoner’s dilemma aspects of human interac-tion that give rise to opportunism in contractualagreements and in ongoing social relationships. Toa degree, all social exchange resembles the prison-er’s dilemma game insofar as there is always a temp-tation not to reciprocate a good turn provided by afriend or acquaintance (Hardin 1988). The prison-er’s dilemma norm involves higher costs of moni-toring and enforcement than coordination normsbecause it is always in the self-interest of individu-als to free ride or defect. Hence, prisoner’s dilem-ma norms must be welfare-maximizing in terms ofthe Kaldor-Hicks criterion in order to create suffi-cient rewards to individuals to overcome the temp-tation to do so (Ellickson 1991, 171; Posner 1986,11–15).31

The nature of the relationship between informalsocial groups and formal organizations can sub-stantially affect the cost of monitoring and enforce-ment of formal rules in institutional and organi-zational environments. The norms of close-knitgroups can contribute to the realization of the or-ganization’s goal if the interests embedded in wel-fare-maximizing norms are, broadly speaking, con-gruous with the incentives embedded in the formalrules. This condition is met when members ofclose-knit groups or networks perceive that theirpreferences and interests are aligned with the or-ganization’s capacity to survive and profit. It isstrengthened when members of networks identifywith the organization’s goals. This gives rise to en-dogenous motivation in networks to enforce formalrules, which substantially lowers the cost for orga-nizations to monitor and enforce through formalsanctioning mechanisms, providing the necessaryand sufficient conditions for high-level group per-formance in line with formal organizational goals.However, close coupling between informal and for-mal rules does not necessarily give rise to efficiencyand high organizational performance. Indeed, pop-

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ulation ecologists argue that the environment se-lects adaptive organizational forms independent ofthe collective will and effort of individuals actingwithin the organization (Hannan and Freeman1989). For example, many high-technology firmsrenowned for the high morale and commitment ofmanagement and employees to achieve corporategoals have fallen by the wayside.

In contrast, when the formal rules are at oddswith the interests and identity of individuals inclose-knit groups, the welfare-maximizing hypoth-esis predicts the rise of opposition norms that fa-cilitate, motivate, and govern the action of individ-uals in those groups. Opposition norms enablenetworks to coordinate action to resist either pas-sively, through slowdown or noncompliance, oractively, in manifest defiance of formal rules andthe authority of organizational leaders. This leadsto increase in the cost of monitoring and enforcingformal rules as the incidence of opportunism andmalfeasance increases. There is also a higher levelof uncertainty and information asymmetry asmembers of close-knit networks collectively with-hold information that might lead to discovery ofopportunism and malfeasance. When group per-formance facilitated, motivated, and governed byopposition norms reaches a tipping point, the nec-essary and sufficient conditions for demoralizationand oppositional movements at the organizationaland institutional levels are met. The incentives anddisincentives emanating from the institutional en-vironment, in combination with interests, needs,and preferences of individuals, influence whethernorms and networks give rise to a close coupling ofinformal and formal rules, or decoupling throughopposition norms.32

In the new institutional economic sociologypurposive action by corporate actors and individu-als (usually in close-knit networks) cannot be un-derstood apart from the institutional frameworkwithin which incentives—including legitimacy—are structured.

Despite differences in local and regional historyand culture, the laws and regulations monitoredand enforced by the federal government apply toall regions of the United States, with very few ex-ceptions. Variations in locality and region maylimit the effectiveness of monitoring and enforce-ment, but they do not give rise to different under-lying rules. Not only is the constitutional frame-work invariant, but federal rules aim to extend thepower of the central state uniformly. As North’s(1981) theory emphasizes, the state is the sover-eign actor specifying the framework of rules that

governs competition and cooperation in a society.The state has the power to enact and enforce lawsand initiate institutional innovations to secure anduphold public goods and respond to changing rel-ative prices (Stiglitz 1989).

Laws, like norms, are statements of expected be-havior, ideas framed with moral and ethical au-thority backed by state power. Whether as ideolo-gy or as cultural beliefs, they define the parametersof legitimate behavior to which organizations andindividuals adapt. In keeping with disciplinarytraditions, economists emphasize the costs of op-posing the coercive forces of the state, and organi-zational sociologists emphasize the value of legiti-macy gained through compliance with the state’srules. But in actuality, whether the price of non-compliance is perceived as costs imposed by finesand penalties or as a loss of legitimacy is moot sinceboth are costly to the firm.

The institutional mechanisms of monitoring andenforcement operate directly on firms and non-profit organizations through the costs of penaltiesand withholding of federal grants and contracts,but also have indirect effects. The increase in costsof discrimination—loss of legitimacy and financialpenalty—following institutional changes duringthe civil rights era decisively opened Americanmainstream organizations to formerly excludedethnic and racial groups (Alba and Nee 2003). Thecivil rights movement and the legislative changesenacted by Congress created a normative environ-ment in which legitimacy was conditioned on fairgovernance through formal protections of theprinciple of equality of rights (Edelman 1990,1992). Equal employment opportunity law (EEO)defined broad parameters and guidelines of legiti-mate organizational practices with respect to mi-norities and women. Because the civil rights lawshave weak enforcement features and are ambigu-ously stated, organizations construct the meaningof compliance “in a manner that is minimally dis-ruptive of the status quo” (Edelman 1992, 1535).This enables organizations to gain legitimacy andhence resources through the appearance of abidingby civil rights legislation. However, “once in place,EEO/AA [affirmative action] structures may pro-duce or bolster internal constituencies that help toinstitutionalize EEO/AA goals” (1569). The civilrights laws may have their largest impact indirectlythrough professionals who generate “ideologies ofrationality” or cultural beliefs about how organiza-tions should respond to the law. Not only do high-profile landmark court cases (e.g., Texaco, Coca-Cola)33 impose direct costs through penalties and


loss of legitimacy to specific firms, but a more far-reaching effect of these court decisions, along withlegal advice about what organizations can do to in-sulate themselves from costly litigation, is to gen-erate cultural beliefs about the rationality of self-monitored compliance with antidiscriminatory laws.This is manifested in the diffusion of EEO-specified grievance procedures in organizations(Edelman, Uggen, and Erlanger 1999). Thus ide-ologies of rationality and cultural beliefs havecombined with the incentives and disincentives ofthe institutional environment, mediated by stateregulation and market mechanism. This is consis-tent with the causal model in figure 2, suggestingthat mechanisms of isomorphism align with thestructure of incentives stemming from formal rulesof the institutional environment.34

ILLUSTRATIVE STUDIES IN NEW INSTITUTIONALECONOMIC SOCIOLOGY

The causal model in the new institutional eco-nomic sociology integrates a micro-foundationbased on an account of the rational pursuit of in-terests, influenced by social relations and norms,with the idea that each economy has an institu-tional framework. As figure 2 indicates, causal mech-anisms operate in both directions, from macro tomicro and micro to macro levels of analysis. Themultilevel causal model moves beyond the earlierembeddedness perspective toward a social relationsand institutions approach to explanation of theemergence, persistence, and transformation of eco-nomic institutions and behavior. As a conceptualframework, the new institutionalism in economicsociology offers an open architecture for generat-ing theories at the middle range extending the so-ciological approach to understanding economicbehavior. The central challenge in new institution-al economic sociology is to specify and explicatethe nature of the relationships between elements atdifferent levels of the multilevel causal model toexplain how informal social organizations interactwith large institutional structures. Here are four il-lustrations of such use of a multilevel causal model.

Weberian Model of Economic Growth

Evans and Rauch (1999) specify a three-levelcausal model to examine the effect of Weberianstate structures on economic growth in developingeconomies. They argue that the characteristic fea-ture of the institutional framework of the develop-

ment state, as opposed to the predatory state, isthe presence of relatively well developed bureau-cratic forms of public administration. As Weber ar-gued in his theory of bureaucracy, the introductionof merit-based recruitment offering predictable ca-reer ladders established the basis for long-termcommitments to bureaucratic service. Whether inthe Meiji bureaucracy in Japan or in late-develop-ing industrial economies like China, the develop-ment of modern bureaucratic capacity at the serviceof reform politicians was critical to government’sability to monitor and enforce rules oriented to-ward promoting economic development. At thelevel of individual action, close-knit groups of elitebureaucrats share norms and goals shaped by mer-itocratic rules for recruitment and promotion,which reduces the attractiveness of corruption.This Weberian model provides an alternative toShleifer and Vishny’s (1994, 1023) “grabbinghand of the state” model that conflates bureaucratsand politicians, showing that politicians invariably“try to influence firms to pursue political objec-tives” inconsistent with the objective of economicgrowth. In the Weberian model, bureaucrats aredistinct from politicians insofar as they are vestedwith long-term careers governed by meritocraticrules of recruitment and promotion. Norms,shared belief in meritocratic service, and nationaldevelopment goals not only reduce the temptationof corruption but over time give rise to compe-tence and credibility of commitment to civil ser-vice dedicated to the public good. The result is in-creased organizational capacity of the state, whichin turn enables and motivates reform-mindedrulers to increase revenues through economicgrowth rather than predation.

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OrganizationalLevel

IndividualLevel

(Time Span)years of development

Bureaucratic forms of

administrative apparatus

Meritocratic recruitment and predictable career ladder with long-term

rewards

Shared norms and goals and reduced attractiveness

of corruption among individual bureaucrats

Greater economic

growth in a country

A more successful and competent bureaucracy and

increased organizational ability to reach its long-term goals

Figure 3. Evans and Rauch’s model on the effects ofWeberian state structure on economic growth

A Dynamic Game-Theoretic Model ofDeinstitutionalization

A multilevel causal model provides analyticleverage in understanding the emergence of mar-ket economies in postsocialist China, Eastern Eu-rope, and the former Soviet Union. When Westerneconomists traveled to Eastern Europe and theformer Soviet Union to advise reformers at theonset of market reforms, their advice consistentlyemphasized big-bang approaches to instituting amarket economy by designing sweeping changes inthe formal rules governing property rights andmarkets. They assumed that formal rules—that is,constitution, civil law, and other regulations—instituted by administrative fiat would establish amodern capitalist economy (Sachs 1995). Such ef-forts at capitalism by design overlooked the reali-ties of power and interests vested in the ruins ofCommunism.35 By contrast, the incremental re-form approach taken by reformers in China al-lowed economic actors to base their choices of in-stitutions on trial and error that balanced speedwith a credible record of success. This more evolu-tionary approach to market transition soon gaverise to the most dynamic economy in the world. InChina, institutional change was driven not somuch by top-down changes in the formal rules,but by bottom-up realignment of interests andpower as new organizational forms, private prop-erty rights, and market institutions evolved in aneconomy shifting away from central state controlover economic activity to market-driven firm per-formance.36 Changes in formal rules governing theemerging market economy tended to follow ex postchanges in the informal business practices, andwere therefore more in keeping with the real inter-ests of political and economic actors.37 As in theformer Soviet Union, however, efforts to reformstate-owned enterprises through formal rule changesin China also proved largely ineffectual because, inpart, ex ante changes in formal rules often rancounter to the vested interests and conflictingsources of legitimacy of the Communist Party or-ganization entrenched in state-owned firms.

Nee and Lian’s dynamic game theory model(1994) of declining ideological and political com-mitment helps to explain deinstitutionalization ofthe Communist Party in departures from centralplanning in transition economies. The technologicaland military gap that grew during the Cold War be-tween the advanced market economies and state so-cialist countries precipitated reform efforts by Com-munist elites to narrow the gap through innovations

that sought to incorporate in the institutionalframework of central planning increased reliance onthe market mechanism. But at the individual level ofparty bureaucrats and officials, the growth of eco-nomic and political markets increased the payofffor opportunism and malfeasance, which in turnsparked within close-knit groups of party membersa group-based social dynamic leading to decliningideological and political commitment to the Com-munist Party. This is demonstrated in a tippingpoint model wherein opportunism and malfeasanceamong party members, initially small, eventuallyreaches a critical mass. The reform leaders in theparty attempt to address the problem through cam-paigns aimed at punishing malfeasance. Over time,however, declining commitment reaches a criticaltipping point, precipitating demoralization and col-lapse of the Communist Party as an effective rulingorganization. This in turn paves the way for deinsti-tutionalization of the party and far-reaching changein political institutions, including political revolu-tion, in reforming state socialism. This game-theoretic model provides an explanation for de-clining organizational performance, highlightingthe embedded nature of ideological commitmentamong party members and specifying the social dynamics that produce the tidal shift from commit-ment to the party’s rules and goals to widespreadopportunism and defection. The model linkschange in the incentive structure of the institutionalenvironment—from redistribution to market—tothe emergence in close-knit party networks of beliefin opportunism as the expected behavior, presently,in a ruling party founded on an ideology opposedto such behavior. This sociological explanation forthe rapid and relatively nonviolent collapse ofCommunist polities in Eastern Europe and the



OrganizationalLevel

IndividualLevel

(Time Span)years of market transition

A rapidly growing technological and economic gap between

state socialist economies and the advanced market economies

Communist reformers’ initiation of economic

reform in state socialist economies

Increasing opportunism and declining commitment

to the Communist Party among agents of the state

Regime change in reforming

state socialism

Deterioration and collapse of the Communist Party as

an effective political organization

Figure 4. Nee and Lian’s dynamic model of declin-ing political commitment in state socialism

former Soviet Union is an alternative to standardeconomic and political interpretations (Aslund1995; Beissinger 2002). In China and Vietnam,where Communist parties still retain power, themodel predicts a cumulative decline of ideologicaland organizatonal commitment to the party.

A Signaling Model of the Market Mechanism

White’s (2001) theory of production marketsportrays them as social structures constructed byproducers in response to uncertainty arising up-stream and downstream in particular market nich-es. When a new market niche emerges, new and es-tablished firms gear up production as they enterthe market. Inevitably they must make investmentand production decisions in a state of uncertaintywith respect to upstream suppliers and down-stream buyers. Applying Spence’s (1974) signalingtheory and Burt’s (1992) model of rational actionin networks, White argues that firms watch for cuesand clues emitted by rival firms, as each firm adaptsproducts for the market niche.

Thus the social construction of a market com-prised of producers in a niche stems from the at-tempts by firms to interpret and use informationfrom signals emitted by peers, as they maneuverand compete for position in the production mar-ket. Firms watch each other, and use signals fromother firms to guide their choices and action. Theysearch for their identity through the signals fromcompetitor firms about the quality of their prod-ucts or services. A firm’s reputation for quality iscrucial to its survival. Through mutual signaling ofperceived quality, firms order themselves in a peck-ing order—their market profile—in the niche. Inthe production market firms may form strategicalliances to strengthen ties or decouple from spe-cific ties with member firms to disengage fromdependencies. The outcome over time is an insti-tutional framework of stable industrial sectorscomprised of networks of firms. White’s modelspecifies and explicates a market mechanism arisingendogenously from producers signaling each otherin the production market. The identity of memberfirms in that market is framed by its roles andnorms. White proffers a sociological view of mar-kets as social structures in which producers act asthe interface between upstream suppliers anddownstream buyers—an alternative model of mar-kets as a social institution, differing from the neo-classical economic assumption of perfect competi-tion in markets.

A Study of Close Coupling between InformalNorms and Formal Organizational Goals

In a classic ethnography of shop-floor worknorms and the emergence of institutionalized rulesof advanced capitalism, Burawoy (1979) integratesinsights from the Marxist theory of the firm withthe context-bound utilitarian view of rational ac-tion of managers and employees in a large indus-trial firm. His organizational analysis shows thatthe emergence of internal labor markets and theshift of management styles to the image of an in-ternal state grew out of the firm’s strategy of adap-tation to competition arising from global markets.Introducing these characteristic institutional fea-tures of advanced capitalist firms induced a rise ofindividualism among employees competing in in-ternal labor markets for advancement and promo-tion. Self-organized activity among employees alsoincreased. Burawoy maintains that the informalgames and norms of close-knit shop-floor workgroups led to norm-based consent between em-ployees and managers supporting the goals ofmanagement. The informal employee consent in

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OrganizationalLevel

IndividualLevel

(Time Span)years of market expansion

Emergent market with upstream suppliers and

downstream buyers

Firms, new and established, gear up

production as they enter the market

Economic actors in firms signal perceptions of

quality in industry

Stable industrial

sector

Market profile of firms arrayed

hierarchically in a production market

Figure 5. White’s model of production markets


OrganizationalLevel

IndividualLevel

(Time Span)years of transition to monopoly capitalism

As large industrial firms adapt to global markets,

they shift from competitive to monopoly capitalism

Industrial firms develop internal labor markets and

consolidate management in the image of an internal state

Rise of individualism among employees as they compete and participate in

internal labor markets; expansion in self-organized informal games and activities

Monopoly capitalism with

industrial peace and high productivity

Norms that tacitly support the goals of management; close coupling of informal

and formal rules

Figure 6. Burawoy’s model of shop-floor worknorms and monopoly capitalism

turn gave rise to the institutional environment ofadvanced capitalism characterized by industrialpeace and high productivity.

SUMMARY COMPARISON

Overall, the new institutionalisms in economicsand sociology are unified around the view thatneoclassical economics is limited by its unrealisticbehavioral assumption of individual utility maxi-mization, its conception of homo economicus, andits unrealistic assumption of zero transaction costs,as if institutions, social relations, and cultural be-liefs were superfluous to understanding economic

and organizational life. Notwithstanding this sharedviewpoint, these institutionalist approaches shouldbe viewed as distinct but related research programswith overlapping assumptions and shared con-cepts. Table 1 offers a summary comparison be-tween them.

Durkheim’s methodological holism has had apowerful influence on institutional theory in orga-nizational analysis, as has its origins in studies ofnonprofit organizations. This is evident in its be-havioral assumption emphasizing nonrational ac-tion molded by codified and legitimated beliefs,scripts, myths, rituals, and rationalized stories. Inthe foundation essay by Meyer and Rowan (1977),there is little mention of the pressures imposed on


Table 1. The New Institutionalisms in Sociology and Economics

NewInstitutionalism in New Institutionalist

Organizational Economic New InstitutionalAnalysis Sociology Economics

Behavioral Emphasis on Rationality is “Intendedly rational,assumption nonrational action context bound; but limitedly so”;

oriented to cultural actors motivated by information asymmetrybeliefs constitutive interests, usually and uncertainty giveof the institutional shaped by shared rise to hazards accruingenvironment beliefs, norms, and to opportunism

network tiesActors Professionals serve Organizations are Organizations and

as the agents of actors; individuals individuals are actorsinstitutionalization articulate interests

within organizationsand networks

Definition of Rationalized myths Interrelated system Humanly constructedinstitution and routines, of institutional constraints—the

conformity to elements—informal formal and informalwhich confirms and formal— rules that structurelegitimacy facilitating, incentives; discrete

motivating, and governance structuresgoverning social as contracting unitsand economic action

Macro-level State regulation, State regulation, States seek revenuemechanisms coercive and market mechanism, maximization;

normative collective action transaction costisomorphism economizing by firms

Micro-level Action oriented Interest-driven Self-interestedmechanisms to mimicking, action within principal/agents;

conformity, and organizations calculating hazardsdecoupling and networks of opportunism

Sources Durkheim, Weber, Weber, Marx, Smith, Knight,Berger and Polanyi, Homans Commons, CoaseLuckmann

organizations by the motive to survive and profitin competitive markets. Rather, the organization’spractical action and strategy are principally moti-vated by concern for securing and maintaining le-gitimacy. Organizational neoinstitutionalists tendto reject utilitarian conceptions of purposive actionto embrace what they perceive as a cultural turn insocial theory. The behavioral assumption empha-sizing the nonrational cultural basis of social actionintegrates Durkheim’s conception of institutions associal molds with insights from ethnomethodolo-gy (Garfinkel 1967; Cicourel 1974; Giddens 1979)and social theorists who are leading the culturalturn in sociology (Goffman 1967; Berger andLuckmann 1967; Douglas 1986; Bourdieu [1972]1977; Swidler 1986). Notwithstanding, DiMaggioand Powell (1983) incorporate bounded rationali-ty in their conception of organizational actors, andhence their seminal essay provides a useful bridgelinking new institutional economic sociology withorganizational theory.

At the other end of the continuum, new insti-tutional economics explicitly assumes boundedrationality: individuals intend to be utility maxi-mizing, but are limitedly so, due to uncertainty, in-formation asymmetry, and imperfect cognitiveability. Its basic underlying view of human agency—“self-interest seeking with guile”—is, despite Pos-ner’s (1993) remarks to the contrary, distinct fromand not readily incorporated into the neoclassicalview of homo economicus, who is wholly rational,having complete information and perfect compu-tational skills.

New institutional economic sociology stands atthe center, between the economists’ assumption ofbounded rationality and the cultural turn in orga-nizational sociology. Despite differences in em-phasis, its conception of organizational action iscomplementary with core arguments advanced byDiMaggio and Powell (1983) on interest-driven as-pects of isomorphic adaptation by organizations totheir institutional environment. Despite similaritiesin emphasis, it differs from economics in buildingon “a broader formulation of rational choice”(Granovetter 1985, 506), in which rationality isviewed as context-bound—often decisively influ-enced by shared beliefs and norms monitored andenforced by mechanisms arising from social inter-actions in close-knit networks and groups. Thus ra-tional action in economic life is facilitated, motivat-ed, and governed by shared beliefs, social relations,norms, and institutions—a view that is inconsistentwith neoclassical economics’ assumption of anatomistic, utility-maximizing homo economicus.

Although transaction cost economics assumesindividual opportunistic actors, its unit of analy-sis—economic transactions—is operationalized atthe organizational and institutional levels. Individ-ual-level action is seldom a focus of analytic atten-tion. Economists unproblematically extend theirconception of individual-level action to corporateactors in a conceptual framework that views insti-tutions as the rules of the game and organizationsas the players. North’s (1990) theory of institu-tional change turns on the assumption that organi-zations respond efficiently, even when gradually, asrational actors to changing relative prices, mountingcollective action to pressure for changes in the for-mal rules of the game that enable them to adapt tothe new price structure. North’s theory of institu-tional change, however, overlooks the powerful in-ertial forces within organizations stemming frompast investments in stable formal rules, informalsocial organization, and opposition norms (Stinch-combe 1965).

Organizational new institutionalists emphasizeprofessionals as actors driven by concern for legit-imacy in their relationship to particular organiza-tional fields and to the broader institutional envi-ronment. Rules, scripts, myths, stories, and menusprovide the rationalized guidelines for strategicand practical action. But as in transaction cost eco-nomics, individual-level action is implicit in neoin-stitutional organizational theory, and is uncom-monly a focus of empirical attention, except byreference to the role of professionals as occu-pational groups. Neoinstitutional theory shifts at-tention away from informal social structures andprocesses inside the organization, emphasized byold institutionalists like Barnard, Selznick, andBlau, to focus on actors at the levels of the organi-zational field and the institutional environment.The actors that matter are external to the organi-zation, in professional associations and legitimacy-monitoring agencies.

In accord with the embeddedness perspective’semphasis on proximate causes embedded in net-works, new institutional economic sociologistsoften focus on individual-level actors, whether en-trepreneurs or employees. Agency and the pursuitof interests are facilitated, motivated, and gov-erned by social relations, shared beliefs, norms,and institutions. Established organizations oftenappear inert, from this perspective, because theyface powerful inertial forces; instead new orga-nizational forms generate the pressures for insti-tutional change (Ingram 1998). In this respecteconomic sociologists agree with organizational

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sociologists that rational action by organizationalactors is problematic, not only because it is difficultto measure, but because unintended consequencesof individual-level rational action and path depen-dence at the institutional level greatly complicatematters at the organizational level.

As DiMaggio and Powell (1991) point out,there are many more definitions of institutionsthan there are new institutionalisms in the socialsciences, because scholars have been casual in de-fining them. Despite the profusion of definitions,there is an underlying consensus about this matterin economic and sociological new institution-alisms. Organizational new institutionalists con-ceive of institutions as systems of rationalizedmyths and routines, conformity to which conferslegitimacy upon organizations. While their con-ceptual language may differ, the underlying themeof institutions as rule-governed social construc-tions is consistent with new institutionalist eco-nomics and economic sociology, which share simi-lar definitions of institutions as dominant systemsof interrelated formal and informal rules that facil-itate, motivate, and govern social and economicbehavior. Economic sociology differs from eco-nomics, however, in the view that institutions arenot simply the formal and informal constraints thatspecify incentives and disincentives, as in North(1981), but fundamentally encompass socially con-structed arenas in which actors identify and pursueinterests. Although economists acknowledge theimportance of informal social organization, theiranalysis emphasizes the role of the state in enforc-ing formal rules. Economic sociologists emphasizethe norms produced and maintained in close-knitgroups that comprise the informal social organiza-tion in firms. As they see it, ongoing interpersonalties and networks are crucial to understanding thenature of the relationship between informal socialorganization and formal rules.

New institutionalists in economics and sociolo-gy concur that regulatory rules monitored and en-forced by the state and statelike organizations framethe underlying social structure of the institutionalenvironment. Formal rules are important in eco-nomic analysis insofar as they define the incentivestructure for organizations and firms, as in therules governing property rights. Economists em-phasize the monitoring and enforcement of formalrules by the state as the crucial macro-level mech-anism. They simply assume markets and insteadfocus explanatory attention on changes in the rela-tionship between the economic and political actors(e.g., North and Weingast 1989). Organizational

analysts, in turn, highlight organizations’ quest forlegitimacy as the motor that drives conformity toinstitutionalized rules and practices through coer-cive, normative, and mimetic mechanisms. Themechanisms of isomorphism operate within the or-ganizational field, promoting increasing homo-geneity among organizations. New institutionaleconomic sociology once again occupies the cen-ter, drawing on insights on the role of the state inimplementing institutional innovations and on le-gitimacy as a motivating interest of organizations.Economic sociologists borrow insights from orga-nizational research on the importance of isomor-phism as a macro-level causal mechanism, but theirfocus on firms and entrepreneurs as opposed tononprofit organizations (i.e., public schools, localgovernment, museums, hospitals) imparts greaterattention to specifying and explicating how marketmechanisms and state regulation shape the wayeconomic actors compete for survival and profits.38

With respect to specification of micro-levelmechanisms, organizational sociologists emphasizeorganizational action oriented to mimicking, con-formity, and decoupling. New institutional eco-nomists build on a modified version of the maxi-mizing assumption of neoclassical economics. Theintegration of information asymmetry and uncer-tainty confers a greater level of realism on bound-ed rationality. New institutional economic soci-ology conceives of micro-level mechanisms asstemming from the interest-driven action of indi-viduals influenced by ongoing social relations,shared beliefs, norms, and institutions.

The sources of the new institutionalisms in eco-nomics and sociology are diverse, reflecting differ-ences in emphasis, behavioral assumptions, andcore organizing concepts. Economic new insti-tutionalists extend the Smithian classical traditionof economic reasoning through the writings ofCoase, Knight, Commons, North, and William-son, but they also borrow key insights from Weber,Marx, and Polanyi in their understanding of insti-tutions and institutional change. In organizationalanalysis, institutional theorists extend Durkheim’sview of institutions as “social facts” that mold so-cial behavior and Weber’s view of the importanceof cultural beliefs in motivating social and eco-nomic action. New institutionalists in economicsociology extend insights from Weber’s method-ological individualism and pioneering work incomparative institutional analysis focusing on sys-tems of shared beliefs, law, bureaucracy, markets,and the state; from Marx’s theory of capitalist eco-nomic institutions, which anticipated the concept


of transaction costs in analyzing the nature of therelationship between capitalists and workers; andfrom Polanyi’s concept of social embeddednessand analysis of the institutional mechanisms givingrise to and maintaining modern market economies.They also draw on insights from economics, espe-cially following the recent sociological turn in eco-nomics that has increased the areas of overlappingconcerns.

CONCLUSION

Sociological analysis of the nature of the rela-tionships between networks, norms, and large in-stitutional structures in economic life is at an earlystage. As economic sociology refines and deepensits explanation of the nature of these relationships,it will necessarily draw on a variety of method-ological and theoretical tools. Insights from cogni-tive science, behavioral economics, game theory,and computer simulation of the emergence, diffu-sion, and transformation of norms and beliefs cancontribute to deepening understanding of themicro-macro links (Marsh 2002). These methodscan also contribute to understanding the stabilityof customs, conventions, norms, and beliefs.

Central to the research agenda of a new institu-tional approach is to bring comparative institu-tional analysis back into economic sociology. Muchof this work to date has involved qualitative histor-ical analysis of one or two case studies. While suchwork has led to advances in understanding the re-lationship between institutions and economic be-havior, the use of quantitative methods movingbeyond case studies to engage systematic cross-national firm-level studies can specify and explicatehow variable features of the institutional environ-ment affect firms’ behavior in the global economy.Comparative institutional analysis of firm-centricdata on sources of perceived costs in the institu-tional environment offers a promising approach tothe measurement of transaction costs. Thoughtransaction cost is the core theoretical concept ofnew institutional economics, economists have yetto measure this concept in a manner useful for em-pirical analysis.39 As it refers to the costs stemmingfrom uncertainty and information asymmetry em-bedded in social relations (e.g., the principal-agentrelationship), it is a concept of significant interestto sociologists as well. The development of stan-dardized indexes of transaction costs arising from avariety of institutional sources (i.e., propertyrights, uncertainty, transparency of rules, resource

dependence, bureaucracy, government regulation,state predation) using firm-centric data opens theway for a more differentiated account of how theinstitutional environment influences economic be-havior.40 Economic sociologists, for example, canfruitfully extend the ecological reasoning of orga-nizational sociology to examine discrete patterns ininstitutional environments that support distinct or-ganizational forms. For example, what features ofthe institutional environment—“institutional ecolo-gy”—support modern public-owned corporationsas opposed to the traditional family-owned firms inthe global economy?

The idea of path dependence, imported intoeconomics from the physical sciences, has deep-ened social science understanding of institutionalchange (Nelson and Winter 1982; David 1986;Arthur 1988). Path dependence refers to the lock-in effects stemming from initial conditions on sub-sequent development and change in the institu-tional environment. Economic historians haveused the idea productively to explain the stabilityof institutions and the persistence of institutionalarrangements that may later be inefficient for eco-nomic actors, given changes in relative prices(North 1990; Greif [1994] 1998). Hamilton andFeenstra (1998, 173) show that the idea of pathdependence is adumbrated in Weber’s theory ofeconomic rationalization, which maintains that“entrepreneurial strategy is necessarily embeddedin an array of existing economic interactions andorganizations.” Further research is needed to deep-en understanding of path-dependent institutionalchange and especially of the relationship betweenthe persistence of informal institutional elementsand change in formal rules (Nee and Cao 1999). Itis the stability of informal institutional elements—customs, networks, norms, cultural beliefs—thatdisproportionately accounts for path dependencein institutional arrangements.

Just as economists find it useful to incorporatethe idea of embeddedness in their models of theeconomy, so economic sociology can benefit fromintegrating economic ideas that are complementa-ry to the modern sociological approach. Econom-ic exchange is a specialized form of social exchange(Homans 1974, 68); hence the mechanisms facili-tating, motivating, and governing social processesextend to economic behavior. Cross-disciplinarytrade with economics has been useful to sociologyin the past, as evident in the extensive borrowingfrom economics by the founders of modern sociol-ogy, and in the influence of imported ideas such as human capital, social capital, and path depen-

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dence. New institutional economic sociology iswell positioned to benefit from, and contribute to,intellectual trade with economists, especially inlight of their turn to sociology for understandingabout the social dimension of economic life.

NOTES

I am very appreciative of the careful reading of an earlierdraft, and excellent comments generously provided byRachel Davis, Paul DiMaggio, Oliver Williamson, Paul In-gram, Sonja Opper, Rudolf Richter, Richard Swedberg, andBrett de Bary. Thanks to Wubiao Zhou and Suzanne Wrightfor their research assistance.

1. Recent reviews provide overviews of the new institu-tionalisms in economics (Eggertsson 1990; Williamson1994; Furubotn and Richter 1997), in organizational analy-sis (DiMaggio and Powell 1991; Ingram and Clay 2000), inrational choice political science (Ordeshook 1990; Weingast2003), and in historical institutionalism (Thelen and Stein-mo 1992; Hall and Taylor 1996; Pierson and Skocpol2003). Scott (2001) offers a useful conceptual inventory ofadvances in organizational new institutionalism.

2. See Granovetter 1992 for an application of a socialconstructionist approach to the study of economic institu-tions. Granovetter offers an interpretive account of institu-tions amenable to historical studies of institutions and insti-tutional change.

3. Coase believes nonetheless that state intervention canbe effective, but not always or automatically.

4. Furubotn and Richter (1997) show, however, thatbounded rationality cannot be incorporated in neoclassicaleconomics as such.

5. A thoughtful review of the old economic institutional-ism by Hodgson (1998) argues that habitual behavior wasthe starting point of its institutional analysis. The old insti-tutional economist examined patterns and regularities ofhuman behavior—habits—as the basis for the approach tomacroeconomic systems. It was not that the old institution-alists failed to generate important findings, but they weredisplaced by the rise of mathematical economics. See alsoYonay 1998 for an examination of the conflict between theold institutionalists and neoclassical economists.

6. Stinchcombe (1997) in fact views Coase’s “The Natureof the Firm” (1937) as an important contribution to the oldeconomic institutionalism’s core research agenda, identify-ing the institutional elements making possible the competi-tive structure of capitalism. According to Stinchcombe,Coase’s analysis of the nature of firm boundaries comple-ments Commons’s work on the noncontractual basis of thecontracts that constitute the firm. Williamson (1981,549–50) explicitly acknowledges his own intellectual debt toCommons (1934), who “recognized that there were a vari-ety of governance structures with which to mediate the ex-change of goods or services between technologically separa-ble entities. Assessing the capacities of different structures toharmonize relations between parties and recognizing thatnew structures arose in the service of these harmonizingpurposes were central to the study of institutional econom-ics as he conceived it.”

7. Significant early writings of the new institutional econ-omists influenced by Coase’s classic essays include Alchian1950; Alchian and Demsetz 1972, 1973; Cheung 1970,

1974; Davis and North 1971; Demsetz 1967, 1968, 1983;North and Thomas 1973; Barzel 1982, 1989; Williamson1975, 1985; and Ostrom 1990. In a recent review, William-son (2000) includes six Nobel laureates among key figuresin the new institutional economics: Kenneth Arrow, Fried-rich Hayek, Gunnar Myrdal, Herbert Simon, Ronald Coase,and Douglass North. The founding of the International So-ciety for New Institutional Economics by Coase, North, andWilliamson in 1996 has provided an annual forum for newwork, much of it empirical, and has greatly expanded thescope of research addressed by new institutional economists.

8. Specifically, Williamson makes use of the contract lawliterature and the organization literatures of Barnard([1938] 1964) and especially the Carnegie school (Simon1957; March and Simon 1958, Cyert and March 1963).

9. “Problems of contracting are greatly complicated byeconomic agents who make ‘false or empty, that is, self-disbelieved threats or promises’ (Goffman 1959, p. 105),cut corners for undisclosed personal advantage, cover uptracks, and the like” (Williamson 1981, 554).

10. Transaction cost economics concurs with populationecology’s core assumption that competition in a marketeconomy is the driving mechanism of adaptive fitness of or-ganizational forms (Hannan and Freeman 1989) and offersa firm-level answer to their question, “Why are there somany kinds of organizations?” Its predictions have beenconfirmed in empirical tests (Joskow 1988; Shelanski andKlein 1995; Masten 1993).

11. Because the essence of property rights is the right toexclude, North (1981) reasoned that the state, which has acomparative advantage in violence, plays a key role in spec-ifying and enforcing property rights. North’s theory of thestate is neoclassical insofar as it assumes that rulers seek tomaximize revenue through an exchange of protection andjustice for revenue from constituents. Although the rulerhas an interest in devising property rights to maximize staterevenues, the existence of rivals capable of providing thesame services constrains the state. Because the free-riderproblem limits the ability of constituents to carry out soci-ety-wide institutional change, the state, which as a monop-olist does not face a free-rider problem, is the source of in-stitutional innovations.

12. Campbell and Lindberg (1990) analyze how a weakstate structure like the United States derives enormouspower through its control of formal rules governing proper-ty rights.

13. North and Weingast (1989) argue that in the Englishcase, the key events and conditions stemmed from the erup-tion of the tension between ruler and constituent that gaverise to institutions limiting the capacity of the state to ex-propriate resources from producers, and hence the neededincentives to fuel economic growth through innovation andprivate enterprise.

14. Libecap (1994) integrates public choice theory withnew institutional economics to develop a property rights ap-proach to institutional change that takes into account polit-ical and economic interests.

15. For example, the demise of China’s planned economyled to a change in the structure of industrial production andan increase in labor demand (changing relative prices). Thestate’s response was to liberalize rules on internal migrationand household registration in rural areas.

16. A second prong of Granovetter’s critique was to pointto the limitations of the functionalist claim that institutionsand generalized morality are solutions to problems in eco-nomic life, a claim that “fails the elementary tests of a sound


functional explanation laid down by Robert Merton in1947” (1985, 488–89). In orienting economic sociology tostudy the effect of interpersonal ties and network structureson economic performance, Granovetter is well aware of aslippery slope leading to functionalism within a social rela-tions approach. It is not uncommon in the embeddednessliterature, for example, to uncover arguments positing theadvantages of networks as (1) solving efficiently the problemof trust, (2) providing ready access to fine-grained, timely,and reliable information, and (3) allowing collective prob-lem solving by entrepreneurs. This leads to his methodolog-ical emphasis on the need for economic sociology to studythe history of concrete interpersonal relations.

Because “enormous trust and enormous malfeasance mayfollow from personal relations” (492), Granovetter argues itis impossible to determine ex ante whether reliance oninterpersonal ties will cement trust or give rise to opportu-nities for malfeasance ex post. It is necessary therefore toexamine through historical case studies how specific inter-personal ties and network structures evolve (McGuire,Granovetter, and Schwartz 1993). To succeed in its compe-tition with new institutional economics, the embeddednessapproach needs to demonstrate that interpersonal ties havemore to do with shaping economic behavior and perfor-mance in markets and hierarchies than do organizationalforms. Along these lines, Granovetter has proposed a rivalhypothesis to transaction cost economics, which asserts thatvariation in the structure and nature of interpersonal ties ex-plains vertical integration of firms: “we should expect pres-sures towards vertical integration in a market where trans-acting firms lack a network of personal relations thatconnects them or where such a network eventuates in con-flict, disorder, opportunism, or malfeasance. On the otherhand, where a stable network of relations mediates complextransactions and generates standards of behavior betweenfirms, such pressures should be absent” (1985, 503).

17. As Richard Miller (1987) points out, proximate caus-es are often shallow when contrasted with the deep determi-native causes identified with large structures and processes.

18. Here I use virtually verbatim a comment provided byPaul DiMaggio.

19. Williamson’s multilevel model in which a higher levelconstrains the lower level differs from the multilevel modelI propose in figure 2 for new institutional economic sociol-ogy, where each level is in mutual dependence with theother. As Paul DiMaggio has pointed out to me in a personalcommunication, the latter approach offers a “co-evolution-ary model, with phenomena at different levels mutually con-stituting contexts within which each evolves.”

20. See Rona-Tas 1994; Eyal, Szelényi, and Townsley1998.

21. New institutional organizational analysis representsmore diversity in viewpoints on agency than is often ac-knowledged. For example, DiMaggio, Powell, and Scott dif-fer with Meyer and Rowan in their interest in taking into ac-count agency—actors who share beliefs and norms; hencethe former are closer to the position articulated by Greifthan to the structuralism of Meyer and Rowan.

22. Its use is restricted to analyzing social interactions inequilibrium, a situation in which each player’s behavior isoptimal given the perceived and expected behavior of othersin the game.

23. In his influential study of the Maghrebi and Genoesetraders in late medieval economic history, Greif ([1994] 1998)demonstrated the use of game theory to explicate the mannerin which social variables such as beliefs, norms, and networksmotivate economic action. Both groups of traders relied on

community-based social institutions to solve principal-agent is-sues: the problem of negotiating and securing contracts exante and ensuring their compliance ex post given asymmetricinformation, partial contracting, and uncertainty. Genoesetraders guided by individualist cultural beliefs constructed for-mal institutional structures that enabled them to employnonkin agents. The Maghrebi traders were collectivist in theircultural beliefs and relied on ethnically bounded institutionalarrangements to organize long-distance trade. Greif points outthat although the historical record does not allow a test of rel-ative efficiency between the two trading systems, the Maghre-bis eventually disappeared from the Mediterranean world,whereas Genoese traders flourished in late medieval Europe.Greif ([1994] 1998, 96–97) observes that “it is intriguing thatthe Maghribis’ societal organization resembles that of con-temporary developing countries, whereas the Genoese societalorganization resembles the developed West, suggesting thatthe individualistic system may have been more efficient in thelong run. . . . To the extent that the division of labor is a nec-essary condition for long-run sustained economic growth, for-mal enforcement institutions that support anonymous ex-change facilitate economic development.”

24. Development of an interest-related approach to com-parative institutional analysis is being pursued by Nee andSwedberg at the Center for the Study of Economy and So-ciety at Cornell University (see www.economyandsociety.org). The views expressed by Scott and Meyer (1983) arecomplementary to an interest-related approach to institu-tional analysis.

25. Clearly, organizational field and production marketsare overlapping and redundant concepts with respect to for-profit firms. Mechanisms of conformity to group norms andbeliefs about expected behavior operate in all close-knitgroups, whether of firms or individuals. Given the emphasison for-profit firms in economic sociology, production mar-ket, as opposed to organizational field, is the more usefulconcept.

26. An early focus on nonprofit organizations may ac-count for why organizational sociologists specify legitimacy-seeking as the driving mechanism of organizational behavior.DiMaggio and Powell (1983) specify three mechanisms—coercive, normative, and mimetic—promoting isomorphismin organizational fields. They integrate their mechanisms ofisomorphism with resource dependence theory to specifyhypotheses predicting the extent of isomorphism at the or-ganization and field levels. Coercive isomorphism integratesresource dependence theory into organizational analysis;normative isomorphism specifies how professional associa-tions influence organizational behavior under conditions ofuncertainty; and mimetic isomorphism, as DiMaggio writesin a personal communication, “is about how . . . intendedlyrational actors, facing uncertainty under high stakes, satisficeby identifying successful peers and making reasonable butincorrect attributions about the causes of their success.”

27. Social ties and norms do not themselves constitutemechanisms insofar as they are concepts referring to elementsof social structure—the relationship connecting two or moreactors and the informal rules governing the relationship.

28. See Roethlisberg and Dickson 1939; Whyte 1943;Festinger, Schachter, and Back 1950; Schachter et al. 1951;Jennings 1950; Seashore 1954; Bott 1957; Riley and Cohn1958; Walker and Heyns 1962; Cook et al. 1983; Ellickson1991; Petersen 1992; Kollock 1994; Lawler and Yoon1996.

29. Shibutani (1978) provides detailed observationsabout the emergence and maintenance of norms of a close-knit group of Japanese American soldiers in a military base,

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documenting norm emergence as a product of collectiveproblem-solving as members of the group socially constructa definition of the situation and course of action that opti-mizes their welfare.

30. Ellickson’s analysis of conflict arising from damage toproperty caused by trespassing cattle showed that the resi-dents of Shasta County commonly resorted to informalnorms of cooperation to settle disputes. Ellickson reportsthat ranchers and residents have only a vague grasp of theformal litigation procedures involved in resolving disputesover trespassing. Moreover, litigation is viewed as a costlyway to settle property disputes, both financially and with re-spect to long-standing relationships in a close-knit commu-nity. Ellickson’s narrative of the incidents of disputes be-tween ranchers and suburbanites shows that despite theircultural differences, a common identity as residents of Shas-ta County sustains a live-and-let-live philosophy that enablesparties to practice mutual restraint. As long as accounts bal-anced along multiple dimensions of interpersonal relations,parties in disputes settled informally:

The landowners who were interviewed clearly regard their re-straint in seeking monetary relief as a mark of virtue. Whenasked why they did not pursue meritorious legal claims arisingfrom trespass or fence-finance disputes, various landownersreplied: “I’m not that kind of guy”; “I don’t believe in it”; “Idon’t like to create a stink”; “I try to get along.” Thelandowners who attempted to provide a rationale for this for-bearance all implied the same one, a long-term reciprocity ofadvantage. Ann Kershaw: “The only one that makes money[when you litigate] is the lawyer.” Al Levitt: “I figure it willbalance out in the long run.” Pete Schultz: “I hope they’ll dothe same for me.” Phil Ritchie: “My family believes in ‘liveand let live.’” (1991, 61)

31. Ellickson’s specification of welfare-maximization isnot Pareto-superior insofar as its criterion focuses on thequestion, do most people derive a net benefit from thenorm? According to the prisoner’s dilemma game, T >R > P > S, where T is the temptation to defect, R is the re-ward for mutual cooperation, P is punishment for mutualdefection, and S is the sucker’s payoff. The condition for theprisoner’s dilemma norm to be in equilibrium is that thetotal payoff for cooperation, after deducting the cost ofmonitoring and enforcement (C), must be greater than thepayoff for defection (T) and the sucker’s payoff (S) : 2R −C > T + S (Nee and Ingram 1998).

32. Nee and Ingram (1998) specify how informal normsemerge and interact with formal institutional elements, per-mitting predictions about organizational and economic per-formance that can be empirically tested.

33. For example, in 1997 the landmark federal discrimi-nation case against Texaco imposed a costly settlement of$175 million to minority employees, and the publicity aris-ing from the case also damaged the firm’s reputation. Texa-co was compelled to carry out extensive organizationalchanges in personnel policy and practices in making crediblecommitment to eliminating racial discrimination to avoidfurther fines and restore its legitimacy. The federal discrimi-nation case against Coca-Cola was resolved at a cost of $192million to the firm. Coca-Cola’s management, moreover,agreed to ongoing external monitoring of its progress ineliminating bias in all aspects of the firm’s operation. As withthe public response to the landmark Texaco discriminationcase, both damage to Coca-Cola’s brand name and the fi-nancial and organizational penalties of the settlement hadthe effect of reinforcing other firms’ belief in self-monitoringfor compliance with EEO/AA guidelines.

34. In their study of the history of personnel practices in279 firms in California, Virginia, and New Jersey—localitieswith different institutional contexts— Sutton and Dobbin(1996) confirm an endogenous motivation of personnelprofessionals and affirmative action officers to developstrategies for compliance with EEO guidelines. Federal ac-tivism through expanded legal and political pressures onfirms increased the rate of adoption of legalization withinthe firm of due-process governance. In general, the diffusionof legalized governance structures demonstrating compli-ance with EEO/AA guidelines shows time-trends corre-sponding to ups and downs of federal EEO/AA enforce-ment activities. Firms that contracted with the federalgovernment were more likely to file annual EEO reports todemonstrate good faith in compliance with federal guide-lines. Organizations closer to the public domain more read-ily complied with federal EEO/AA rules and guidelines.Significantly, findings by Sutton et al. “suggest that legaliza-tion is not aimed inward, toward specific employee demandsor organizational requirements, but outward at the shiftingconcerns of regulators and courts” (1994, 996). In a follow-up study using a different data set of 154 for-profit firms,Sutton and Dobbin (1996) confirm the close coupling ofstate regulation of formal rules and the normative pressureson management from human resource professionals insidethe firm to institute proactive governance strategies (i.e.,formal lawlike rules governing grievance procedures and in-ternal labor markets to protect equality of rights) in order tocomply with federal EEO/AA guidelines.

35. For analyses of how institutional change by adminis-trative design and formal rule change faltered in Eastern Eu-rope and Russia, see Stark 1996; Gray and Hendley 1997;Hellman 1997; Varese 2001.

36. For analyses by economic sociologists of realignmentof power and interests favoring economic actors in markettransitions and institutional change in China, see Walder1995; Nee 1996; Cao 2001; Guthrie 1999; Keister 2000.

37. See Shirk 1993; Naughton 1995; and Opper, Wong,and Hu 2002 for analyses of how economic and political ac-tors benefited from institutional change.

38. Economic sociologists whose work examines the ef-fect of markets include Saxenian (1994); Swedberg (1994);Abolafia (1996); Uzzi (1997); Guillén (2001); White(2001); Baron and Hannan (forthcoming); Freeman (forth-coming); and Davis and Marquis (forthcoming). Those ex-amining the effect of both market and state regulation oneconomic actors include Nee (1992, 1996, 2000); Nee,Sanders, and Sernau (1994); Walder (1995); Fligstein (1996,2001); and Guthrie (1999).

39. North and Wallis (1986) estimated the size of thetransaction sector of the American economy; however, theiraggregate data is not useful for empirical analysis.

40. Firm-centric data, rather than aggregate national-leveldata, is needed to measure transaction costs, which are thecosts to firms of negotiating, securing, and completing eco-nomic transactions. The problem with national-level aggre-gate data is that it does not measure the effect of variation ininstitutional conditions on the firm and entrepreneur.

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