According to Douglass North (1990), "institutions are the rules of the game in a society or, more formally, are the humanly devised constraints that shape human interaction" (p. 3). It is well established that institutions generate subsequent incentives for various choices. As North firmly states, "institutions structure incentives in human exchange, whether political, social, or economic" (p. 3). In other words, "institutions define and limit the set of choices of individuals " (p. 4).
It follows from the above that if the institutional structure of a given social order changes or evolves, the inhabitants face a different institutional-benefit/cost structure, resulting in a new incentive environment. These changes tender new opportunities and vulnerabilities: Choices deemed acceptable before the change are now unacceptable; choices that were previously out of the question are now desirable. In the new incentive environment, previous choices are obsolete. To prosper, future choices must differ from those of the past. People must rethink their previously settled way of thinking about the world and relating to others.
I consider an institutional structure change to be any change in the scope or the absolute number of the functional institutions of a social order. By "functional" I mean those institutions that actually constrain people's behavior. Functional institutions may be either formal laws that are backed by state coercion or informal rules or norms that are not, but in either case, to be functional, they must be enforceable and enforced.
In any social order, there are different levels of institutions to which people must conform. In tribal societies, there are different rules for interactions between those of different tribes, generations, genders, and kinship. In modern societies, the state has its various subdivisions with its corresponding laws. More locally, people are constrained by the parochial norms of functional communities to which they belong. Using "functional" in the same sense as above, a functional community generates norms of conduct and sanctions those who do not conform to them. In modern society, people are constrained first and foremost by the laws of the state. There are times when laws and norms come into conflict, and instances when people choose to go to jail rather than break parochial norms: the Mafioso that refuses to "squeal" on his family; the "pro-lifer" that refuses to vacate the area when so instructed by police. However, in larger society these are exceptions rather than the rule. Most people, however grudgingly, adjust their behavior to the existing laws so they can get on with their lives. Perpetual law-breaking is simply too costly. Even the Mafia must take laws into account when calculating the relative cost of their various endeavors.
There are also times, as Benson (2002) has shown, when parochial norms become the law of the land through a long process of legitimization, internalization, and finally legalization. On a smaller scale, Selznick (1943; 1948) explains how informal structures in an organization lead to changes in official policy. However, these views do not alter the fact that in the short term people must abide by the laws of the land, whatever their origin, or pay huge costs. Although both formal and informal institutions can be functional, formal institutions are primary in the sense that parochial norms are constrained by the larger, formal institutional structure in which they occur. Parochial norms cannot deviate far from the laws of the land without imposing huge costs on their adherents. Furthermore, some writers (Shearmur and Klein, 1997; Taylor, 1982; Ellul, 1965; Gellner, 1988) argue that the state actually destroys parochial norms.
In light of these views, that parochial norms are constrained by formal institutions and that formal institutions of the state tend to replace parochial norms, I consider formal institutions as primary and, therefore, consider a change in institutional structure to be a change, either an increase or decrease, in the scope or the absolute number of formal institutions of a social order. If a social order increases the scope or the absolute number of laws beyond those that secure property rights, it moves itself away from the minimum institutions end of the institutional continuum and toward the maximum institution end.
A change in the formal institutional structure of a social order is realized by its inhabitants as a change in the security of private property rights. If people were in a Hobbesian state of nature, then the formulation of formal laws to protect life and property would increase property-rights security. Once property rights are secure within practical limits, what role is left for additional laws? They can only mandate that people must do something with their property that they would prefer not to do or that they must refrain from doing something that they would prefer to do. In other words, there is an inverse relationship between the implementation of new laws and private property rights security. Once private property rights are secure, adding new laws reduces property rights security. We see, then, that along our institutional continuum, property rights become increasingly less secure as a social order moves toward the maximum-institutions end of the continuum, i.e., as a social order increases the scope or absolute number of laws.
Because of the relation between property rights and people's freedom to associate with others, a change in the formal institutional structure of a social order is also realized by its inhabitants as a change in the amount of free association in which they are allowed to engage. Free association does not exist in the absence of formal law. In tribal cultures, for example, tribal norms and traditions are primary and govern intratribal interactions. Intertribal interaction is minimal because of extensive transactions costs. Free association only exists when a social order embraces private property rights that are protected by formal law. Now people are free to interact with whom they please, and they posses the "don't play" option, a term adopted from Tullock (1997, 25), if they are not treated by others as they feel they should be. As the scope or the absolute number of laws increases beyond those necessary to secure private property rights, people's freedom to associate becomes increasingly constrained. Laws that prevent people from exchanging goods and services that they would prefer to exchange or from engaging in interactions that they would prefer to engage in reduce free association. We can see now that along our institutional continuum, not only do property rights become increasingly less secure as a social order moves toward the maximum-institutions end of the of the continuum, but free association increasingly becomes more constrained as well.
So far, our continuum model looks as shown in Figure 1. The extremes of this institutional continuum are each well-known models of society for which there are huge literatures. From here on I call them by their appropriate names: "private property order" and "bureau."
FIGURE 1: Basic Model
The private property order model springs from classical liberal writers such as John Locke, Adam Smith, Edmund Burke, Frederic Bastiat, Alexis de Tocqueville, Lord Acton, and more recently, Ludwig von Mises, Friedrich Hayek, and Henry Hazlitt. According to classical liberalism, the private property order is a society in which human relations are ordered by spontaneous processes that are the result of people's actions within limited areas of concern and responsibility. These limited areas are identified and delineated by private property rights and are protected from trespass by the state. The state is constrained by the Rule of Law, which assures that government is bound in all its actions by fixed rules.
The bureau model was first developed by Max Weber (1958) and has since been qualified by a legion of other writers including Ludwig von Mises (1983), Anthony Downs (1964), Francis Rourke (1984), and Philip Selznick (1943; 1948). Presenting a composite view of the above writers, the bureau is both an economy that lacks market prices and a social structure fraught with incentives and opportunities for deception. The incentives for deception spring from the bureau's internal tension between the formal structure and the informal structure. When the formal structure -- a la Weber, a hierarchy of graded authority with fixed jurisdictional areas, where management is based on written documents, expert training, and general rules -- does not meet the social and personal needs of the bureau's occupants, the informal structure, ala Selznick, works to undermine the official structure and implement more user-friendly policies.
I use the term "bureau" rather than the more common "bureaucracy" because it engenders a clearer mental image of the model that I am constructing and, hence, more readily facilitates analysis. Weber (1958, p. 196) calls a fixed jurisdictional area an "office," hence, the imagery. We only need imagine a small office that contains three people and a file cabinet. The file cabinet contains official documents that specify that person A is the superordinate, that persons B and C are subordinates, what all are officially to do, and how they are to do it. In such a context, it is easy to visualize the formal structure, various informal structures, and the tensions between them. We can see person A consulting the official file and then issuing orders to B and C. We can see persons B and C becoming uncomfortable with the arduous task and conspiring to alter the officially decreed output level, thereby gaining discretionary time and resources. A bureau is transformed into a bureaucracy when persons A, B and C's functions are carried out by "offices" rather than individuals. Now we have offices commanding and reporting to offices. A bureau might be thought of as a fractal of bureaucracy, having similar internal relations but on a miniature scale.
The private property order and the bureau form an institutional continuum with voluntary association on one end and coercion on the other. In economic terms, this translates to no central planning vs. total central planning. This distinction, explained by Friedrich Hayek (1984, p. 366) as that between "spontaneous order" and "organization," rests on the absence or presence of common purpose. A spontaneous order has no common purpose. Its members are free to pursue their own purposes within their limited areas of concern, which are delineated by property rights. In contrast, an organization has a common purpose, an overall design, and a central authority that commands individuals to adjust their actions to meet the requirements of an overall design.
According to Hayek (1948, p. 4), these two opposed forms of social order are the practical outcomes of two opposed strains of individualism. The British school, known as the "anti-rationalists" due to its emphasis on nonrational, spontaneous processes, is the philosophical foundation for the private property order. The Cartesian school or "rationalists" view of individualism with its emphasis on design and man's perfect or perfectible rationality is the philosophical basis for the bureau. Figure 2 incorporates the views of the above writers. To become more familiar with these models and to make them more useful for analysis, let us go inside them and look around a bit.
FIGURE 2: Expanded Model
The private property order and the bureau models can be used to model both society at large and sub-groups with in society. For example, the society of pre-progressive-era American society was predominantly that of a private property order, i.e., society was, for the most part, spontaneously formed with no common purpose, along the lines of free association. Within American society then and now, one can identify sub-groups, some of which exhibit spontaneous order and others that are consciously designed. The former are commonly called "communities," or less commonly, "organic communities" as the literature often refers to them. (e.g. Tonnies, 1957). Communities are spontaneously ordered along the lines of free association. They are, therefore, fractals of the larger private property order society of which they are apart, i.e., they have the same social order but on a smaller scale.
Consciously designed sub-groups in the private property order are called "organizations." Organizations are designed around a specific purpose such as earning a profit, advancing a political agenda, implementing the functions of the state, fulfilling members' spiritual needs, etc. Organizations are sub-groups with internal social orders different than that of the private property order society of which they are a part. They are discrete instances of the bureau model occurring, in varying degrees of formality, within the larger private-property order society. Because of free association, organizations can choose their members according to established standards and can reject "undesirables," thereby conferring what Shearmur and Klein (1997, p. 37) call "seals of approval" on their members. Churches, service and fraternal organization, chambers of commerce, professional associations, and youth groups all confer seals of approval on their members.
Because formal law protects free association in the private property order, inhabitants have the "don't play" option at all levels, i.e., they are able to exit communities, organizations and even society at large. This places severe constraints on these groups' power to influence individuals and each other. In regard to for-profit organizations, the "don't play" option manifests itself in managers firing subordinates that do not contribute to profits, and in consumers and investors withholding their patronage from firms that make unacceptable products or conduct business in an unacceptable manner. People who exercise the "don't play" option with regard to nonprofit organizations don't support them either socially or financially.
A bureau society has many of the characteristics of the former Soviet Union. It is hierarchically structured with fixed jurisdictional areas where management is based on written documents, expert training, and specific rules. Spontaneous order is replaced with total planning, and total planning precludes free association. Without free association, inhabitants lack the "don't play" option, i.e., they may not exit society nor the organizations to which they are assigned. Nor can they withhold financial support from organizations with which they are displeased. All human interaction is specified by decree and is aimed at the joint attainment of a common purpose as set forth by the supreme authority. The bureau has many formal sub-groups, all of which are organizational fractals of the bureau society itself. They are hierarchically structured nonprofit organizations charged with the attainment of various aspects of the supreme authorities plan. They cannot confer seals of approval in the same sense as in the private property order because membership is at the pleasure of the supreme authority.
Spontaneously ordered communities ordered by free association also exist within the bureau model, but only in its informal structure. Association that occurs in these communities is illegal since it is not specified by law and must therefore be done surreptitiously. Such association amounts to stealing time and resources from the supreme authority. It diverts resources intended for the advancement of the supreme authority's purpose toward the fulfillment of the personal and social needs of the model's inhabitants. These underground associations move goods and services to where the inhabitants want them rather than where the law specifies.
In both types of society, then, there exist communities and organizations. In the private property order, both communities and organizations are legal, and because of free association, members may exit them or society at large if they do not meet their needs. In the bureau, there are legal organizations and illegal communities. Members may exit communities but not organizations since they are specified by law.