Institution and economic life Week 10

The limitation of neoclassical economic theory

It assumes a direct connection between choice and outcome, it ignores institutions
It assumes actors have complete information, eliminate uncertainty
It overlooks imperfect processing of information by actors
It assumes that actors maximize utility and undermine the effects of cultural belief and ideology.
It assumes zero transaction cost

Transaction cost is the cost incurred in making an economic exchange, includes:
• Search information cost (cost of information)
• Bargaining cost (cost of negotiation)
• Enforcement and monitoring cost (cost of enforcement)

Production cost is the sum of transformation cost and transaction cost. Transaction cost arises from specific institutional arrangements.

Why transaction costs are so costly?

It is largely because the asymmetry of information among transacted parties. It is costly to get accurate information and determine and measure value. Sometimes, people have an interest in withholding information.

North’s Transaction cost approach suggests:

Economic theory must take into consideration of the transaction cost. There are many economic efforts and resources are devoted to measurement of attributes; warranties, guarantees, trademarks; sorting and grading. Much effort and resources involved in enforcing contract and in case of disputes arise, arbitration, mediation and litigation also increase transaction cost.

The same is also applied to relationship of the principal and agent; the employee and employer. To ensure the maximum effort from employee and agent, often, employer and principal need to monitor their performance, but the frequent measurement is very costly. There are always some degrees of trade off and uncertainties in these relationships. The greater uncertainty, the higher transaction cost.

In order to reduce the uncertainty, the new institutional economics model suggests that institutions act as a system of interrelated formal and informal elements governing social relationships within which actors pursue and fix the limits of legitimate interests. They facilitate, motivate and govern economic and social action.

Institutional constrain in regulating economic and social action acts in different levels:
• Network constrains the internal relationship between exchange parties
• Third party may also constrain the first party
• Government by law and police imposes political constraints
• Social norms and customs impose societal constraints.

Institutional change

Economists and New Institutionalists such as North (1984)thinks that institutional change is possible, which comes from a change in the relative pricing i.e. the relative bargaining power of the rules versus constituents of (rulers vs rulers). The changes in relative prices driven by demographic changes, change in stock of knowledge and change in technology, especially military. Such changes provide entrepreneurs the opportunity in making profits, so that they may lobby for institutional changes.

(you may understand why North Korea and Iran are insisting their nuclear power technology)

Organizational sociologists think, because of path dependence, it is not easy to have institutional change at all.

Path dependence here refers to the structure inertia, that organization internal changes are slower than outsider environmental changes. That is because:

1. The goals of organization are multiply, to maintain and reproduce their structure, apart from performing collective action.

2. To survive is one of top goals for organization. It must have invested considerable resources to enter into business, to ensure reliability of performance, secured by maintaining reliability in compliance to rules and regulations.

3.The organization possess relatively fixed norms, corporate culture, and rules and procedure.

The detailed illustration on structure inertia:

The limitation of adaptation perspective is that there are a number of processes that generate structure inertia. The inertial pressures arise from internal structural arrangement and environmental constrains.

Internal constrains:
1. Firm investment in plant, equipment, and specialized personnel constitutes assets that are not easily transferable.
2. Firm decision makers face information constrains.
3. Internal political constrains. When firm structure changes, political equilibria also disturbed. Management always faces the challenge between long term re-organization benefit vs., short term political resistance.
4. Firm has its own historical constrain, normative agreement provides justification to resist changes, and precludes the serious consideration of alternative responses.

External pressures:
1. legal and fiscal barriers to entry and exit from markets
2. Availability of information.
3. legitimacy constrain
4. General equilibria is hard to achieve by collective rationality.

Those above inertial pressures render adaptive perspective must be supplemented with a selection orientation.

Path dependence and structure inertia together foster a resistance to change, which is "a by-product of the ability to reproduce a structure with high fidelity: high levels of reproducibility of structure imply strong inertial pressure." (Hannan and Freeman 1989:77). Because selection pressures favor organizations with a high level inertia, successful organizations tend to be those that carry with them the strongest inertial forces.

Therefore, organization sociologists think institutional change is not easy, if it is not all impossible, the new organizational forms adapt more quickly to a changing institutional environment, at the same time, the risk is high too.

Under selection pressures, there are three isomorphic processes that shapes firms and institutional environments in term of surviving-:

1. Coercive isomorphism: political influence of the state through their legal enforcement


2. Mimetic progress: firms adapt the successful strategies which other firms have proven


3. Normative pressure: Professionalization is an important source for organizational homogeneity. Formal education and professional schools provide a common cognitive base fro cadres who run organizations.

Organizational sociologist's focus on new organizational forms is complementary to North's theory of institutional change. Changing relative prices opens new niches and opportunity structures for new organizational forms to emerge. Sociologists also focus on social movements which are often motived by ideas and cultural beliefs.

Short Definition on Economic Sociology

1. Economic Sociology is the sociological study of economic life. Social networks and institutions are the central of economic life.



2. The spirit of capitalism, essentially is rationalism. The rationalization is the process whereby an increasing number of social actions and interactions become based on consideration of efficiency and calculation, rather than motivations from custom, tradition, or emotion.
   
   The spirit of capitalism works as inner world calling, and an obligation to fulfill the will of God. In doing so, one may have certain degree of security of being saved. That inner motivations lead to a man to work hard, reject unnecessary spending, greedy (for the covet has no place in the kingdom of God) and instant gratification; to minimize the cost and increase production turnover; to book keeping in all transaction, not only to be accountable in front of men but of God; to serve customer's needs and increase marketing efforts.
   
   Weber shows that the Protestant ethic is the core element of cultural belief that gave rise to Western capitalism, not capital as Marx argued, but the spirit of capitalism mattered.


3. Embeddedness of economic action: Granovetter criticizes the assumption of atomized individuals as economic actors, instead people are embedded in networks of social relations which shape economic action and institutional outcome. Networks provide timely and reliable information and personal ties provide a basis of trust and credible commitment.



4. Social exchange: George Homens extends Adam Smith's economic exchange concept. He thinks exchanges is one of basis characteristics of human interaction and follow the utilitarian laws.



5. Social norms: implicit contracts binding members of any given society and social groups. Norms are maintained by members of society and followed to conformity. Social norms not only constrain member's behaviors but also enable and motivate collective action in networks and close-knit communities.



6. Transaction cost: refers to cost incurred in making an economic exchange. It includes cost of searching and finding information; cost of negotiation and cost of monitoring and enforcement.



7. Social capital-refers to resources grounded in durable exchanged based networks of persons. Bourdieu defines "social capital" as the sum of resources, actual or virtual, that accrue to an individuals or a group by virtue of possessing a durable network of more or less institutionalised relationships of mutual acquaintance and recognition. Network closure and structure hole are two mechanism in explaining social capital



8. Cultural capital: familiarity with and a configuration of knowledge, attitude and social skills that place one at a distinct advantage in the school setting. It includes linguistic styles, aesthetic preference and style of social interaction.



9. Firm: economists define firm as "the system of relationship which comes into existence when the direction of resources is dependent on the entrepreneur, it is the autonomous unit that maximizes on profits; firm is exist only when production cost is lower than transaction cost.";
   Economic sociologists define firm as "a congealed network." which embedded with social network.



10. Cliques refer to network ties between two or more people maintained to realize gain from cooperation. Dalton shows in his study of firm that the real power structure in the firm is organized around cliques of managers and employees. Cliques form the basic stable power in the firm. Like social norms, cliques operate through implicit contract binding the members, the implicit contracts are welfare maximizing norms for member of cliques.
    
    Cliques also have negative effects, for example, business cliques can lobby government to secure redistribution of resources to themselves; within firms, cliques of executives can collude to plunder the firm, as in Enron and Tyco, and NKF in Singapore. The horizontal clique of corporate board members can collude to reward themselves with huge compensation for CEO and top management, as reviewed in recent financial credit crunch.
    
    Under transaction cost theory, CEO makes independent decision to minimize transaction cost; under clique theory, clique will influence decision making in order to maximize their own benefits.



11. Institutions are humanly constructed constraints that structure political, economic and social interactions, are the rules of games; are a system of interrelated informal and formal elements including formal(law and legislation) and informal rules (custom, belief and convention etc. Institutions are dominant form of social orders which provide a conduit for social and collective actions by facilitating and structuring the interests of actors and enforcing principle and agent relationships.



12. Where does institution come from? Avner Greif thinks from cultural beliefs. In individualist society, impersonal, formal institutions laws in commerce and trade become well-developed overtime to resolve any conflicts arise; while in collectivist society, personal relationships and networks are often used in resolving conflicts, formal institutions are not well developed.
    



13. Entrepreneurship: an innovation in carrying out of new combination of 1) new goods and service; 2) new method of production; 3) new market;4) new raw materials; 5)new organization of industry.
    
    Entrepreneurship is an activity that involves the discovery, evaluation and exploitation of opportunities to introduce news goods and services, ways of organizing, market, raw materials and way to productions.

.

Entrepreneurship: Productive, Unproductive and Destructive

Reading on Entrepreneurship: Productive, Unproductive and Destructive
By William J Baumol 1990

Using historical analysis, Baumol suggests that entrepreneurial activities can be productive, unproductive and even destructive depends on what kind of activities took place and how did it allocate in society. He argues that policy maker can influence the allocation of entrepreneurship more effectively than it can influence its supply.

Expanding on Schumpeterian model of “Innovation” which Baumol would refer as productive entrepreneurship, he regards activities such as rent-seeking as one kind of unproductive entrepreneurship.

In Schumpeterian model, innovation which leads to entrepreneurship covers five cases: 1) introduction of a new good, or of a new quality of a good; 2) the introduction of a new method of production; 3) The opening of new market; 4) the conquest of new resource of raw materials or half manufactured goods; 5) the carrying out of the new organization for any industry, such as in monopoly position or the breaking through a monopoly position.

Baumol thinks Schumpeterian model has its limitation. For example, it does not explicitly encompass innovative acts of technology transfer that take advantage of opportunities to introduce already available technology. He suggests expanding Schumpeterian model to include such items as innovations in rent-seeking procedures, which is an unproductive entrepreneurship.

Here, we need to examine the definition of entrepreneurship. If entrepreneurs are defined to be persons who are ingenious and creative in finding ways that add to their own wealth, power, and prestige, then it is to be expected that not all of them will be good for society as a whole. Baumol argues that the exercise of entrepreneurship can sometimes be unproductive even destructive, depending on structure of payoffs in the economy- the rules of game.

He therefore provides two propositions:

1. the rules of the game that determine the relative payoffs to different entrepreneurial activities do change dramatically from time to time
2. Entrepreneurial behaviour changes direction from one economy to another in a manner that corresponds to the variation in the rule of game.

Historical evidences:

-Where the rule of games did not encourage enterprising, later the rule of games changed, there were some innovation activities for military purpose which often reduced the overall social welfare as one of destructive entrepreneurial activities:

Ancient Rome

For Romans, people in honourable position had three primary and acceptable sources of income: landholding, usury and political payments. It was however, freedmen, not honourable Romans, who were in operation of commerce and industry. The attitude towards promoting technology and productivity was not favourable. Economic effort was neither the way nor the purpose, the labour, not even labour of the entrepreneur, was not respected.

Medieval China

In China, people were more motivated to past imperial exams so that they could land a position of higher rank in bureaucracy where they could reap wealth by power therein. The others who failed would engage commerce and trading. Enterprise was not only socially encouraged and well regarded, even facing many obstacles from officials. The overall rule of games in China then was against innovation. At the same time, the state had power to confiscate all property within its power. That had become a substantial impediment to economic expansion.

The Earlier middle Ages

Military activities were the main avenues for wealth accumulation and prestige in society. The innovations were therefore mostly related on military conquest and protection, which differs vastly from the introduction of costing saving industrial process or a valued new goods and services. These types of activities would not increase but often reduce the overall social welfare.

The later Middle Ages

The revival of the towns and protection from arbitrary taxation and confiscation was well under way. Small activities such as architect and water-driven mill technology began to yield some return. It was however seen as more for release one from physical labour for spiritual devotion than any economic gains.

Fourteenth Century

The long period of war between French and England had titled to favour more than before inventions designed for military purposes. This military enterprise developed at expense of the general public.

Early rent seeking. Unproductive entrepreneurship, by using legal system for rent seeking purposes, gradually replaced military power as a prime source of wealth and power.

If entrepreneurship is the imaginative pursuit of position, with limited concern about the means used to achieve the purpose, then we can expect changes in the structure of rewards to modify the nature of the entrepreneur’s activities sometimes drastically.

The rules of game can then be a critical influence helping to determine whether entrepreneurship will be allocated predominantly to activities that are productive or unproductive and even destructive.

Baumol arrives his third proposition:- The allocation of entrepreneurship between productive and unproductive activities can have a profound effect on the innovativeness of the economy and he degree of dissemination of its technological discoveries.

As discussed above that in ancient Rome and its empire the rule did not favour productive entrepreneurship. Even though there were many invention and technology know-how, under such rules of game which encouraged the pursuit of wealth but discouraged its pursuit through the exercise of productive entrepreneurship, they did not transfer into economic development.

Similarly in ancient China, where constituted one of earliest potential revolutions in industry such as the invention of paper, compass, waterwheels, and water clocks and gunpowder, none of these led to flowing of industry. What China lacked was not mechanical skill or scientific aptitude, nor a sufficient accumulation of wealth, but scope for individual enterprise, there was no individual freedom and no security for private enterprise, no legal foundation for the rights other than those of the state, on alternative investment other than landed property, no guarantee against being penalized by arbitrary exactions from officials or against intervention by the state. Therefore free enterprise was of no ground to grow.

Since the first Industrial Revolution in 18th century, the rules of games had changed dramatically. Entrepreneurship has since reaped great rewards. However, the unproductive entrepreneurship takes many new forms, often via activities such as litigation and takeover, and tax evasion and so on.

The corporate executives devote much time and effects to litigate and countersuit, huge reward by the courts can bring prosperity to the victor and threaten the loser with insolvency. It is tempting for company to hire the top lawyers rather than engineers.

Taxes can be served to redirect entrepreneurial effort. Instead of focusing on productive activities, the corporate management engage speculative financial transaction. Baumol suggests that policy makers should carefully examine the possible direction on how the reallocation of entrepreneurial effort will serve the goal of society. For example the restriction of monopolies

Cultural beliefs and societal organizations

Reading summary on “Cultural beliefs and the organization of society: A historical and theoretical reflection on collectivist and individualist societies” by Anver Greif

In this article, Avner Greif examined the two kinds of trade groups: the Maghribi traders of the eleventh century in the Muslim world; and the Genoese traders of twelfth century of the Latin world. He sought to gain the understanding of the relations between cultural beliefs and societal organization.

It has been established by sociologist, anthropologists and economic historians that the societal organization will affect its economic performance of its society and cultural variations account for setting up and maintaining different societal organizations. The organization of society is the reflection of its cultural beliefs, (here the author emphasized the rational cultural beliefs); diverse cultural beliefs, through the strategic social interactions happened in specific social and historical context, led to differential economic behavior towards individuals, wealth distribution and different relationship between efficiency and profitability in intrasociety and intersociety economic interactions, etc.; may imply diverse social constructs.

The cultural beliefs and the rules of games (i.e. social norms) also affect the enforcement institutions; social and economic patterns of interactions also affect moral enforcement mechanisms.

	Maghribi Trade Groups Represents the Collectivist	Genoses Trade Groups Represents the Individualist
Cultural belief	In regard to hire agent, it is commonly agreed and practiced that they shall never hire dishonest agents	Agent past behavior of being dishonest had no bearing for his future employment
Agent relation and setting up	The cost of agent is high, to keep him remain honest	The cost of agent is low
Information share and investment	Invest in information and sharing information	Not invest in information, not sharing information
Social organization pattern	Horizontal social structure where a merchant hires another merchant to be his agent. Each trader served as an agent for several merchants while receiving agency services from them. Agency relations are mostly partnership and formal friendship	Vertical social structure where a merchant doesn’t hire another merchant to be his agent. Wealthy merchants rarely function as agent Agency relations are mainly based on contract which one provides capital and others provides work in form of traveling and transacting overseas.
Wealth distribution	In Horizontal structure, the poor individuals have no opportunity to capture the rent of agent.	Vertical structure provides better opportunity for upward mobility to poor individuals.
Response to social change	Segregated manner, expand their trading employing other Maghribis as agents	Integrated manner, they established agency relationship with non Genoese.
Profitability	The more efficient agency relations, the less profit for merchants	A joint economy between merchants and agents
Efficiency	Not efficient intereconomy agency relationship	Efficient intereconomy agency relationship
Collective punishment	Exist and self-enforced through in group social network; punishment reinforced by social and moral mechanisms which of a result of frequent economic interaction within a small segregated group	Do not exist and not self-enforced with low level of communication, which hinder social and moral enforcement mechanisms, to support collective action, an individualist society needs to develop formal legal and political enforcement.

In conclusion, the author was able to show cultural beliefs are sufficient to account for their diverse social organization. According to author, the collectivist systems is more efficient in supporting intraeconomy agency relation and requires less costly legal system, but it restricts efficient of intereconomy agency relation. The individualist system does not restrict efficient intereconomy relation but is less efficient in intraeconomy agency relation, it requires costly legal systems.

Greif noticed that Maghbribis’ societal organization resembles that of contemporary developing countries, whereas the Genoese societal organization resembles the developed countries. He suggested that in the long run, the individualistic system may have been more efficient.

The Social Structure of Competition

Reading for "The Social Structure of Competition" By Ronald S Burt

The market production equation of profit:

Investment x rate of return= Profit

Economists concern Investment as financial and human capital in this equation. Burt suggested that the social capital, i.e. the player’s network and the location of the player’s contacts in the social structure of arena, attributes the rate of return, which is ultimately deciding factor of profits. The social capital in one’s social structure provides the competitive advantage in getting higher rates of return on investment.

A player brings three kinds of capitals to the market, they are: 1) Finical capital; 2) Human capital; and 3) Social capital.

The distinguishing social capital

Social capital differs from financial and human capital is owned jointly by the parties of relationship. While financial and human capital concern the production capabilities, social capital concerns the transformability from the financial and human capitals into profit. Social capital therefore is the final arbiter of competitive success.

The above is especially true when facing imperfect competition and with abundant investment capital. Empirical evidence shows that people develop relations with people like themselves. The players with well structured networks will easily obtain useful and reliable information at the right timing. The truth of such information is critical when market is imperfect. That will lead to higher rates of return.

Structure holes provides information benefit

When one’s network increases, the efforts to maintain the relationship within network are also expected to increase. Burt found that it is not how many contacts, but what kind of contacts within networks matter.

Structure hole refers to a relationship of nonredundancy between two contacts. Balancing network size and diversity is a question of optimizing structure holes, for that is the key to information benefits.

In order to optimize the structure holes, one should firstly maximize the number of nonredundant contacts in the network to maximize the yield in structure holes per contact. Secondly, one should focus on primary contacts, which link to secondary contacts and save his energy to maintain the diversity of network. Burt’s argument consistent with Granovetter’s weak ties concept, however, Burt stressed that weak tie is a correlate, not a cause; structure holes is where the true cause for information benefits. Whether the weak or strong relationships are, the structure hole generates information benefits when it is a bridge over a structure holes.

Burt concluded that players with a network optimized for structural holes enjoy higher rates of return on their investments because they know more and have more rewarding information.

Structure holes provides control benefits

Besides providing information benefits, according to Burt, structural holes also give certain players an advantage in negotiating their relationship.

Taken from the work of George Simmel, the tertius gaudens is the third who benefits. The tertius strategies are being the third after two or more players after the same relationship; and being the third between players in two or more relations with conflicting demands.

The control benefits of structure holes require an active hand in distribution of information. Entrepreneur behavior is kind of tertius. Motivation is often traced to cultural beliefs and psychological need.

Structure holes provide an entrepreneurial opportunity and motivation. The non redundant relationships an entrepreneur has will provide him strategic information and opportunity.

Structure hole offers a new dimension of theory of competition

1. Competition is a matter of relationships, not player attributes. Structural holes arguments escape the traditional social science practicing in using player attributes for explanation. The causal effects are rather of the network relations. A player’s physical attributes are a correlate, not a cause of competitive success. This analysis is to cut past the spurious correlations between attributes and outcomes to reach the underlying social structural factors that cause the outcome.
2. Competition is a relation emergent, not observed. The structural holes in which competition develops are invisible relations of nonredundancy, relation visible only by their absence.
3. Competition is a process, not just result, by which the price and occurrence of transaction is decided.
4. The structure hole argument suggests that competition made imperfect by the freedom of individuals to be entrepreneurs. Competition is imperfect to the extent that any player can affect the terms of any particular relationship.

Weber’s Economic Sociology of Modern Capitalism

(lecture 2, HSS203)

Weber (1864) came to intellectual age when Marx’s work on capitalism defined the cutting edge of historical and sociological studies.

Weber’s cultural theory was influenced by his social origin in the German middle class, and his own religious root- Protestant.

Weber’s Methodology

Weber sought to develop general concepts which identified empirical processes; then to apply his concept to understand historical events, such as the rise of capitalism in the West; For Weber, sociology is a discipline dedicated to developing general concepts which can be applied to explain the particular events that historian study.

Verstehen “understanding and interpretation of meaning”

Weber believed that causality is established when a process is understood. Weber believed social scientists have advantages over nature scientists, as they themselves are participating, they can understand the social world better.

Verstehen involves knowing the subjectivity of actors; not intuition, but based on the research interviewing, field observation and reading text.

Use of Ideal type analysis

Identify the main attributes of a class of phenomena based on extensive research, distill the essence of a class of phenomena, in capitalism case, rather focusing on particular capitalists, Weber developed ideal-type of modern Calvinist entrepreneur.


Weber’s methodological individualism

Weber believed that sociology must build its theories on the basis of understanding social action at the individual level. He assumed rational action which is that actors pursue interests oriented towards utility in their economic behavior. Weber always reduces large scale of structures to the action of individuals, their action and motivation.

(Durkheim took the opposite approach; he thinks that social phenomena only can be understood in a large scale, individual’s action is decided by one’s societical contexts)

Marx’s materialism

Marx theory on emerging of capitalism thinks that economical material forces determine the political and social structures- superstructure. Industrial revolution led the changing of means of production, which also altered the relationship between bourgeois and proletariats. That class struggle finally leads to development of capitalism and the social structure and orders therein.

“The totality of these relations of production constitutes the economic structure of society, the real foundation, on which arises a legal and political superstructure and to which correspond definite forms of consciousness. The mode of production of material life conditions the general process of social, political and intellectual life. It is not the consciousness of men that determines their existence, but their social existence that determines their consciousness”

Weber disagreed with Marx’s materialism approach. Instead he sought to demonstrate that religious-cultural beliefs have an independent causal effect. He believed that ideas form interest; interest guides one’s action.

For Weber, rationalism was the essential spirit of modern capitalism. Rationalization is the process whereby an increasing number of social actions and interactions are based on considerations of efficiency or calculations rather than motivations derived from custom, tradition or emotion.

The features of capitalism society: rational calculation of profits and losses; book keeping etc.

The difference between modern and traditional capitalism:

Traditional capitalists live for substance, the economy drive was just for living, and once enough for living, the drive disappears; Modern capitalists have disciplined obligation to work as calling, to maximize profit. The link of these two, according to Weber was Protestant Reformation.

Traditional form of capitalist enterprise has the same form of capitalistic organization: the activity was of purely business like; the use of capital, turned over in the business, was indispensible; the objective of economic process, the book keeping was rational; however, it lacks of the spirit which animated the entrepreneur: the traditional manner of life; the traditional rate of profit; the amount of work; the manner of regulating the relationships with labour and the market strategy and customer services. (Ideal type of traditional capitalist firm)

Modern capitalist firms seek to engage the final customers and serve customers’ need directly; to low the cost and product maximum volume; to maximum profit as the ultimate goal.

Weber sought to show the effect of ascetic Protestantism – inner worldly orientation- extended rationalism to economy and society. Weber thinks that Western civilization decisively shaped by a methodical way of thinking, first developed by the Greeks, revived during Renaissance, though the same rationalization was developed in Asia, but was not as scientific, political, economic nor artistic form as emerged from the West.

Protestant Ethic

Weber starts with a simple observation: in countries with mixed religious composition, business leaders, skilled workers, technical workers and professional tend to be overwhelmingly Protestants.

He then proceeds to eliminate spurious correlations, such as level of cultural development. He shows that Protestants are much more heavily represented in modern firms whether in Germany or Poland, though Germany is culturally more developed than Poland.

(Cultural develop theory claims that more Protestants represented was due to the more culturally developed area or nations; however, Weber was enable to show that regardless the origin of countries, Protestants are more likely to be at top level in society, e.g., Germany and Poland,)

He rejects “inheritance theory” that differences between Protestants and Catholics predated the Reformation.

(Inheritance theory claims that the more developed economically are more favoured by natural resources and situation, in particular a majority of wealthy towns, went over to Protestantism in the sixteenth century. The results of circumstances favour the Protestants even today…Weber shows that whether economically developed or not Protestants are much more heavily represented in capitalist industries)

He finally rejects Minority Status theory which suggests ethnic and religious minorities may be driven to capitalist enterprise by society’s prejudice. Weber shows whether Protestants are in the majority or minority, they still are much more numerous than Catholics in modern capitalist enterprises in Europe.

Therefore, Weber says “Protestants have shown a special tendency to develop economic rationalism which cannot by observed to the same extend among Catholics either in the one situation or in the other. Thus the principle explanation of this difference must be sought in the permanent intrinsic character of their religious beliefs, and not only in their temporary external historical political situations.”

Weber rejects historical materialism; he thinks greed often stands in way of capitalism. Greed was present in societies that did not become capitalist. “It is not capital as Marx argued, but the spirit of capitalism that enabled Western capitalism developed.” A new type of workers saw working as calling for God, a new type of entrepreneur that saw money making as an end itself. Both are able to free themselves from traditional practices and engage in economic life with a new spirit.

Weber further rejects the idea that the spirit of capitalism is part of the rationalism of Western thought as a whole. In fact, the sense of calling in Calvinism was far from rational, but the psychological mechanism in Calvinism translated religious devotion into practical economic actions, which finally led capitalism fully developed.

Calvinism and Predestination

God’s predestination in salvation left believers in anxiety. The only way of assurance is by the way of living. The Calvinist needed to consider himself as one of chosen and good work and profits were not only the will of God but the works of God through him. It is proof of grace and sign of election. Ascetic and frugal living is desirous by God. Thus capital accumulation increases overtime. On the other hand, lazy, unwilling to work is sign of lack of grace.

In summary, the Protestant ethic is a core element of the cultural belief that gave rise to Western capitalism. In order to prove one’s worthiness of ultimate salvation, one needs to demonstrate faith through worldly action by ascetic, hard working manner with sense of calling to maximize the profit.

Men Who Manage

By Melville Dalton

By close examining the operation in Milo, Dalton discovered that, although the formal organizational authority displaces the rule and responsibility of each role of individual, it is the informal or unofficial cliques decides certain business operation to be carried out or to be resisted.

One of examples he illustrated was FWD issue. To solve the operation struggles to keep cost low on operation and maintenance level, a new system Field Work Department was introduced with all available knowledge and experienced personnels. However, such effort was eroded by masked human relationship from different cliques. FWD was designed to reduce costs, speed repair work, and prevent politics, finally was undone and officially rejected.

In this article, clique refers to a small exclusive group of person with a common interest. It often connotes a group concerned with questionable activities. Though often with negative tone, without cliques, the organization will soon be fall apart. The formation of clique is chiefly on he basis of the relation to the formal chart and the services they give to members. There are three types of cliques:

1. Vertical:
Vertical symbiotic clique: in this relation, the top office is connected to aid and protect his subordinate. Subordinate, in return, exercises the full loyalty to him. Thus, this kind of clique forms the power centers.

Vertical parasitic clique: this is a negative approach which assumes that collusive behavior is inevitable among persons with kinship ties who are in certain job relations. Parasitic is used because the exchange of services between lower and higher clique members is unequal.

2. Horizontal
Defensive clique, cutting across departments and including officers, nearly in the same rank, this clique is usually brought on by what its members regard as crises such as threatened reorganization, introduction of new method such as FWD. This clique usually is strong and only for the limited time to defeat threat.

Aggressive clique: This clique has clear goal and direction. Their action is a cross departmental drive to effect changes rather than resist them, to redefine responsibility or even directly shit it. The inter-departmental fiction subsides as the clique becomes a mutual support bloc.

3. Random, members of the random clique are not solidly in any of the more functional cliques.

Dalton argues that the cliques are indispensable and essential to both cement the organization and to accelerate action. They become the bridge between official and unofficial purposes intertwining the corporate goals and individuals and groups ends. They preserve the formalities vital for achieving organizational goals and controlling the turmoil and adjustment.

George Homans’ Social Exchange Theory

Weber’s cultural approach emphasizes the endogenous preferences. He thinks that cultural belief shapes one’s interests and preferences, which then guides one’s action and behaviours.

Granovetter argues that individuals are not atomized, but involve in social network. Social relations can affect people’s economic actions, also provides information and basis for trust and credible commitment. (Embeddedness and relational approach)

Note that sociological approaches on economical explanation:

1. Cultural approach


2. Embeddedness and relational approach


3. Social exchange approach

Homan’s social exchange approach

Exchange characterizes all human interactions. Like economic exchange, social exchange is a universal human trait, it also follows the same utilitarian laws as in economic exchanges.

Homan aimed to develop general proposition that identified social mechanisms universal to human interactions and to show how these hold empirically.

Theory of social exchange:

Social control, a stabilize behaviour, is intrinsic to social interaction. Repeated social exchange builds up stable social relationship, leads to social equilibrium. There are rewards and costs in social exchanges, like in economic exchanges, but in social exchange context, rewards and costs can be material and non-material.

Social structures emerge from human interactions, repeated exchanges are the foundation of all social organization. Power, authority and hierarchy are formed in give and take in social exchanges. Those who give more will in return receive more power and authority. “Give, thou shalt be given”. Those who receive more are more likely to be the bottom of society or subordinate positions.

In order to explain why social exchanges are repeated, Homans had the following propositions:

1. Success proposition: for all actions taken by persons, the more often a particular action is rewarded, the more likely that action will be repeated. That is to say that action that is rewarded is likely to be repeated. The shorter intervals between actions and rewards, and intermittent rewards, the more likely the repetition of actions will be.



2. Stimulus proposition: if in the past the occurrence of a particular stimulus, or set of stimuli, has been the occasion in which a person’s action has been rewarded, the more similar stimuli are to the past ones, the more likely the person is to perform the action, or some similar actions.
   
   People generalize from a specific experience and look for conditions that remind them or approximate those attached to a rewarding experience.



3. Value proposition: The more valuable to a person, the more likely for one to perform certain action. Rewards involve positive values, punishment, negative values. Unlike a hedonistic theory, which suggests that people always do to maximize the material gains, value proposition sees that rewards can be both material and nonmaterial gains.



4. Deprivation- satiation proposition: The more recent a person had received a particular reward, the less valuable any further unit of that rewards becomes for him/her.



5. Aggression approval proposition: One did not get what he expected, he can be more aggressive in behaviour, such behaviour may leads to more valuable results form him. Performing approval behaviour is more likely to be valuable for one who did not expect to receive greater rewards.



6. Rationality proposition: facing choices, one will choose that one for which, as perceived by him at the time the value V, of the result multiplied by the probability, P, of getting the result, is the greater. A=VP

Homans on social norms

Social norm is the statement of certain custom behaviour shared by the members of societies, and members are expected to follow conformity to the norm. Social norms are implicit contracts binding members of group.

Social exchange theory is a deductive theory of human interaction. There is no fundamental difference between social and economic exchanges since rewards and costs can be material or non materials. All social life is constituted and emerges from social exchanges, which is regulated by social norms.

Economic Action and Social Structure: The Problem of Embeddedness

(reading for week 3)

By Mark Grandovetter


Introduction of the problem of embeddedness

According to Granovetter, people are embedded in social relations which subsequently affect their economic behaviors and decisions.

Utilitarian tradition, including classical and neoclassical economics, assumes rational, self-interested behavior affected minimally by social relations. Therefore, the economic behavior can be freed from social relation as one of independent variables.

Majority sociologists, anthropologist, political scientists and historians are of the view that economic behavior was heavily embedded in social relations in pre-market societies but became much more autonomous with modernization. This view sees that economy as an increasingly separate, differentiated sphere in modern society, with economic transactions defined no longer by the social or kinship obligations of those transacting but by rational calculations of individual gain.

However, few economists agreed with above views, instead, they asserted that embeddedness in earlier societies was not substantially greater than the low level in modern markets. The theory of exchange suggested that since labor was the only factor of products in primitive society, goods must be exchanged in proportion to their labor costs.

Granovetter’s view differs from above two. He asserts the level of embeddedness to of economic behavior may be different but it continues to be substantial.

Over and Undersocialized conceptions in human actions in sociology and economics

Undersocialized, atomized conception of human action, represented by classical and neoclassical economists with utilitarian tradition, is that elimination of social relations from economic analysis. No impact from social structure and social relations on products, distribution or consumption. It is “idealized markets”, and self-regulating economic structures, which are politically attractive.

Oversocialized conception is to assume that people act in certain ways because to do so is of customary, or of an obligation. The social influence, on the other hand, is external and rather automatic.

The common point of both sides is a conception of action and decision carried out by atomized actors. In the undersocialized account, atomization results from narrow utilitarian pursuit of self-interest; in over socialized account, from the fact that behavioral patterns have been internalized and ongoing social relations thus have only peripheral effects on behavior. Granovetter emphasized to avoid the atomization implicit in the theoretical extremes of under or over socialized conceptions.

Embeddedness, Trust, and Malfeasance in economic life

Hobbes saw that there is nothing in the intrinsic meaning of self-interest that excludes force and fraud. Atomized actors in competitive market under self-regulated economic structures internalize normative standards of behaviors as to guarantee orderly in transaction.

In recent years, the concerns for fraud and malfeasance have risen. Granovetter saw two answers for these problems:-

The undersocialized account is found mainly in the new institutional economics. It substitutes institutional arrangement for trust, which leads to Hobbesian situation, in which any rational individual would find way to develop clever ways to “cheat”;

Other economics acknowledge the generalized morality. This conception has the over socialized characteristic of calling on a generalized and automatic response, a moral action. One may wonder how effective this morality would be if large costs were incurred.

The embeddedness argument stresses the role of concrete personal relations and structures of such relations in generating trust and discouraging malfeasance. Economists have pointed out that one incentive not to cheat is the cost of damage to one’s reputation, but this is an undersocialized conception s of reputation as a generalized commodity, a ratio of cheating to opportunities for doing so.

Standard economic analysis neglects the identity and past relations of individual transactors, but rational individuals know better relying on their knowledge of these relations.

Social relations, rather than institutional arrangement or generalized morality, are mainly responsible for the production of trust in economic life.

But social relations are not sufficient to prevent cheating and malfeasance. The reasons are:

1. The trust engendered by personal relations presents, by its very existence of opportunity for malfeasance. The more trust, the more gain in malfeasance.


2. Force and fraud are most efficiently pursued by teams, and the structure of these teams requires a level of internal trust.


3. The external of disorder resulting from force and fraud depends very much on how the net work of social relations is structured.

Disorder and malfeasance do occur when social relations are absent. This suggests that social relations perhaps in some degree inhibit malfeasance, but the level of malfeasance in a truly atomized social situation is fairly low.

The problem of markets and hierarchies

Williamson sought to know under what circumstances economic functions are performed within the boundary of hierarchical firms rather than by market process that cross these boundaries. His answer is that the organizational form observed in any situations is that which deals most efficiently with the cost of economic transactions.

For those that are uncertain in outcome, recur frequently, and require substantial transaction specific investments that cannot be easily transferred to interaction with others on different matters, are most likely to take place within hierarchically organized firms. For those that require no transaction specific investment, such as one time purchase of standard equipment, will more likely take place between firms, which is to buy from markets.

The reason for those transactions been internalized with hierarchies for two reasons: 1). Bounded rationality, which means the transactions are internalized within firm’s governance structure and control. 2) Opportunism, the rational pursuit by economic actors of their own advantage, with all means at their command, including guile and deceit. . It is more efficient to settle internally rather appeal to costly litigation institutions.

Granovetter argued that Williamson overplayed the efficacy of hierarchical power within the firm, but overlooked the role of social relations among individuals in different firms. He argued that social relations and social networks among individuals, especially on executive management levels, in different firms bring in order to economic life.

Of Coast and Cattle: Dispute Resolution Among Neighbors in Shasta County

(Reading for week 4)
By Robert C. Ellickson

This research paper presents an empirical perspective of dispute resolution among neighbors in evaluating economist Ronald Coase’s hypothetical theorem “The problem of social cost”, in which Coase suggests that when transaction costs are zero, the rule of liability will have no effect on the allocation of assets.

The author examined how the rural landowner respond to the change of trespass law, why the law is not efficient to solve such dispute and how did neighbor in Shasta county had been relatively successful to resolve disputes between landowners and ranchers.

The finding of Ellickson’s study though supports Coasean Parable that the rule of liability for animal trespass does not affect, the allocation of resource, it is however not because of low transaction costs, but on the contrary, the high transaction costs.

Ellickson suggests in this study:

1. In order to apply Coasern Theorem, one has to assume that all parties of dispute have perfect knowledge of law, however, that was not the case in reality. Shasta county residents’ knowledge to Animal trespass law Legal are insufficient, no one, he found in Shasta county had a complete working knowledge of such law.
2. Even for legal professional, their knowledge of trespass is not adequate.
3. People rely on norms rather legal rules as their basic source of entitlements
4. The control of deviants are four types:
• Self help retaliation, from gossip sanction to violent retaliation
• Reports to county authorities
• Claims for compensation informally
• Formal legal claim to recover damages. are costly to learn and enforce
5. The live-and-let-live philosophy is overwhelming among residents, firstly, they see the animal trespass as an inevitable part of their life; secondly, they expect “give and take” attitude among neighbors, the norm of good neighbors constrain them from further legal action against each other.

The study of Shasta country shows that under such conditions, residents more likely solve their dispute among themselves and ignore the formal legal rules.

He concluded that law-and-economics scholars should pay more attention to transaction cost. High cost of legal preceding and high costs to learn and enforce the law are main reasons that a rational actor applies informal norms, not law, to evaluate the propriety of human behavior. Further more, the intertwined relationship between farmers and ranchers prompt them to employ non-legal methods of dispute resolution.

Question: Is that right to say that in less developed society, people more likely rely on social norms to settle disputes, while in more developed society, on legal system>

Granovetter and Network: Embeddedness perspective

HSS 203 Lecture 3-2
Jan 22 2008

Granovetter and Network: Embeddedness perspective

Classic labour economists had long noted that people likely find their jobs through friends and relatives, which they viewed as source of inefficiency, and cause of nepotism and clientelism, i.e. mismatch between jobs and one’s qualifications.

Mark Granovetter used “embeddedness approach” to explain such phenomenon in labor market. He found that, people find their jobs most likely through “weak ties”. That is people you don’t know well may be the most useful people who help you find jobs.

Burt disagrees with such concept, instead he stresses it is not what strong or weak ties matter, but where you locate matters most. Entrepreneur, who often locates himself at structure holes, where he is able to get most information from his social network, is the one most likely to be successful.

By using the same concept, Granovetter criticizes economists for assuming atomized individuals. He argues that people are embedded in network of social relationship which shapes economic action and institutional outcome. Networks serves as conduit for timely and reliable information, people ties provide a basis for trust and credible commitment which prevents opportunism and malfeasance.

Oliver Williamson as one of founders of “new institutional economy” emphases the importance of institutional arrangement in providing information and preventing opportunism. The formal rules and contracts will secure economic agreements and contracts. Granovetter criticizes him overlooking the role of network, he thinks the relationship between people, especially top executives, helps to build trust and securing agreements and contracts.

The difference between Polanyi and Granovetter:

Though both of them emphasize the embeddedness of social relation in economic actions and behavior, Granovetter nonetheless disagrees with Polanyi’s acceptance of homo economicus and assumption of "self-regulating markets" in modern capitalism. He thinks that Polanyi overstates the extend of embeddedness in ancient market, but rather understates the embeddedness in modern market economies.

Granovetter argues that it is network rather than institutional arrangement that shapes economic behavior.

The weakness of his theoretic framework however is that it is based on case study, i.e. Chicago Edison company, and many empirical observation shows that social relations do not determine trust. It is maybe more acceptable to adapt both informal relationship and formal institutional approach.

Granovetter extended Polanyi’s view that economy is embedded in social relations to modern network analysis. Networks are ongoing social relationships which comprise the basis structural unit of society, which provide a basis for trust and credible commitment. Weak ties may serve as a conduit of timely and reliable information; structure holes offer an opportunity for entrepreneurship through broking.

Karl Polanyi’s Economic sociology

HSS203 Lecture 3-1 Jan 22 2008

Karl Polanyi’s Economic sociology

Classic and neoclassical economical view (Chicago school) on market is that:

• Market arise spontaneously from the human propensity of exchange
• All social exchange is based on the norm of reciprocity, economical exchange similarly involves reciprocity
• Voluntary agreement between buyer and seller forms the basis of all markets, both buyer and seller benefit from the exchange
• Laissez faire: that state should leave market alone because intervention distorts the beneficial effects of free markets.

Karl Polanyi disagreed with above view, he suggested:

1. Markets are meeting place for the purpose of buying and selling. Modern market represents a new institutional arrangement, only created recently.
2. Using substantivist approach, he suggested that the economy is embedded in social relations.
3. The origin of modern capital market.

Typology of institutional orders
• Reciprocity, barter, where exchange good for profits is restricted.
• Redistribution, state socialism
• Exchanging, price making market.

Polanyi argued that modern markets did not evolve naturally, they required the conscious construction of a new institutional framework. The market in fact is a political construction, not self-regulating.

In order to have the market, price-making is the first step. That faces two problems 1). Information to determine the price, such as the production cost, other seller’s price; and 2) Opportunism.

Such endeavours can only be done by state institutions. For example, before a company can be listed in the stock market, it has to comply with the government requirement in releasing relevant information. Government is also able to punish opportunism behaviour by restoring legal action. Further more, such rule and regulation is established and maintained by the state.

Therefore, market is by no means “free” or “Laissez faire” the state’s intervention is not only constant but also necessary, especially when market failure in Great Depress etc.

Neoclassical economic defines “economic” as “the most efficient use of scarce resources to achieve a given end.” In formal economic analysis, it is assumed that economic actors behave the same way in a market and non-market economy.

Karl Polanyi’s substantive definition of economy is “an institution process of interaction between man and his environment to meet material needs.”

“The human economy is embedded and enmeshed in institution”. Since market mechanism liberates greed in human nature, self-regulating market is utopian, uncheck and unrestrained greed can lead to disastrous effects to our society and environment. E.g. China with new open market economy is now facing grievous environmental problem. Market society requires an institutional order that calls for a socialist society. Society must protect itself from the ravages of market

The difference between Karl Marx and Karl Polanyi:-
o Polanyi was influenced by Marx. Like Marx, he viewed the early capitalist firm as a “satanic mill”;
o He conceived the free market as Prometheus unbound; society needs to keep market in check
o His research on the origin of capitalist markets was motivated by the search for social institutions to tame the market, in order to solve the problems caused by capitalism.
o While Marx ultimate goal was to abolish private ownership, therefore abolish market, Polanyi was to establish state regulated market mechanism i.e. welfare capitalism society.

Polanyi’s concept of embeddedness is a foundation for economic sociology. A market society is an institutional framework that supports a market economy. The modern markets are political constructions.


The substantivist position, first proposed by Karl Polanyi in his work The Great Transformation, argues that the term 'economics' has two meanings: the formal meaning refers to economics as the logic of rational action and decision-making, as rational choice between the alternative uses of limited (scarce) means. The second, substantive meaning, however, presupposes neither rational decision-making nor conditions of scarcity. It simply refers to study of how humans make a living from their social and natural environment. A society's livelihood strategy is seen as an adaptation to its environment and material conditions, a process which may or may not involve utility maximisation. The substantive meaning of 'economics' is seen in the broader sense of 'economising' or 'provisioning'. Economics is simply the way society meets their material needs

Weekly Reading- Week 1

The Protestant Ethic and the spirit of capitalism

By Max Weber

Chapter 5

In this chapter, Weber examined the ascetic Protestantism and other Christian religious belief and their impacts on economic behaviors and conducts.

From Richard Boxter’s “Christian Directory, who worked to promote practical ethic practice and moral life in Church, Weber presented the basic ideas of Protestant Ethic. Contrasted with many puritans writing, Boxter demonstrated open-minded and broad view towards wealth and acquisition.

1. Wealth is no longer viewed as all evil, rather, a stewardship with God.
2. Waster of time is the first in principle of deadliest sin. “Redeem the time” and “Time is money”.
3. Labour is viewed as religious duty for everyone. Wealth will not exempt one from working, “He who will not work shall not eat.” Labour is one of ways to prevent temptation and moral unworthiness.
4. Division of labour is seen as God’s divine calling. The perseverance of the individual in the place and within the limits which God had assigned to him was a religious duty, which gives the moral justification to division of labour.
5. The proof of one’s state of grace is shown through his conscious work in systemic and methodical manner. While Lutherans in general had uncertainty of their salvation, Protestants see the fruit of labour, increasing wealth, and systematically diligently working as the sign of God’s grace.
6. The profit-making endeavor is justified. The increasing wealth and success in business is favorable as in God’s favor and grace for God’s glory.

The Puritan idea of calling combines with ascetic conducts had directly influenced the development of a capitalistic way of life. “This worldly Protestant asceticism acted powerfully against the spontaneous enjoyment of possessions; it restricted consumption, especially of luxuries. On the other hand, it had the psychological effect of freeing the acquisition of goods from the inhibitions of traditionalistic ethics. It broke the bonds of the impulse of acquisition in that it not only legalized it, but looked upon it as directly willed by God. When the limitation of consumption is combined with this release of acquisitive activity, the inevitable practical result is obvious: accumulation of capital through ascetic compulsion to save”

Those religious movements had created a rational way of conducts which corresponded with a spirit of capitalism. In return, the believers had the assurance as elected into God’s kingdom. By which, the Christian belief, especially Protestant asceticism became a building block into the massive development of future economic social order. Though the first peak of religious enthusiasm faded away, the rational way of conducts and the characteristic of capitalism remain