Concepts of importance in the literature of the New Institutional Economics, such as transaction costs and bounded rationality, have been used to extend the standard neoclassical model of the firm, but the hybrid models created have failed to provide adequate explanations of enterprise behavior. An alternative, “neoinstitutional,” model of the firm is developed in the paper that differs from the pure neoclassical model and hybrid models in respect to both the nature of the solution it yields and the process by which it reaches a solution. The neoinstitutional firm cannot be expected to achieve either the hypothetical allocative efficiency promised by the frictionless neoclassical model, or the relatively efficient (constrained Pareto optimal) solutions predicted by the largely frictionless hybrid models. The orthodox marginal rules of neoclassicism can only be used to solve lower-level problems that appear within the firm.

The 1991 conference, like others in this series on the New Institutional Economics has been concerned fundamentally with the role institutions play in shaping economic behavior. A consistent theme advanced by the new institutionalism is that institutional arrangements matter (Furubotn and Richter [1984, 2]) and, indeed, are responsible, in large degree, for the success a system has in achieving its social objectives. In the case of East European reconstruction, the emphasis, of course, must be on the development of a new structure of institutions that will serve to accelerate economic growth and promote greater welfare for the peoples of these formerly socialist regions. Fortunately, the hopes placed in institutional change are not without foundation. There is increasing evidence from historical experience that the explanation of economic performance must be based on something more than data on resource endowments, savings rates, population densities, etc. (North [1990]). Arguably, the critical factor determining economic growth is found in the nature of a country's institutions. Given the dramatic events that have taken place in Eastern Europe during the last few years, it is not surprising that economists and other scholars in the West have shown greater interest in the theory of economic systems. One manifestation of this increased concern can be seen in the substantial flow of current writings, both popular and professional, on comparative institutional analysis and the problems of transition to market capitalism. There is great willingness on the part of Western observers to proffer advice, and this predisposition to put forward policy suggestions is not necessarily bad in itself. The experts, however, are often far removed from the scene of action and, consequently, the practical value of the advice given should not be overestimated. We all have much to learn about the process of large-scale institutional restructuring. From a scientific standpoint, it is perhaps encouraging to see that, at the general level at least, there is considerable agreement concerning the reforms that are needed to bring about productivity enhancing changes to stagnant economies. While the various policies mentioned as crucial to reform may not

Conventional theory asserts that an idealized capitalist system moves to a Pareto-optimal equilibrium. This result depends, either implicitly or explicitly, on the assumption that transaction costs are zero. When a capitalist economy operates subject to costless transactions, however, durable collusive agreements can be formed and enforced. The consequence is that atomistic competition tends to break down. Income transfers (or bribes) can be used to induce coalitions to mimic competitive behavior and improve efficiency. But such transfers, which cannot be lump-sum, distort incentives and cause departures from the technical conditions that must be met to ensure first-best Pareto efficiency.

The present conference was prompted by the belief that scholars engaged in the study of institutional or organizational economics are associated with a number of distinct schools of thought and, as a consequence, are not always in full communication with one another. In particular, there seemed to be need for a greater interchange of information between researchers concerned with abstract analytical models and those occupied with less formal theorizing. By showing interest in these different methodological approaches, however, the conference has opened the way to basic questions concerning the role of mathematics in economics. And, with respect to this matter, feelings in the profession can run high. Thus, no less a figure than Professor Buchanan has argued that, if real understanding of institutions is to be developed, there is need for a new methodological revolution that will overturn, or at least greatly diminish, the present dominant position of mathematically grounded theory. He says:

During the postwar period, state-sponsored codetermination programs have become increasingly important and, by now, are firmly established in most countries of Western Europe. Conventional wisdom suggests that this growth of reform legislation is part of a broad social movement designed to advance industrial democracy and enlarge the power of labor to influence corporate policy. Certainly, there is no doubt that significant institutional change has taken place. But since reorganization has been motivated more by political considerations than by any fundamental rethinking of the theory of the firm, questions still exist concerning the effects the new system may have on economic behavior. There are, in fact, serious doubts about the efficiency of mandatory codetermination. Various writers have suggested that the type of codetermination legislation found in Europe may force firms to adopt organizational structure that would not be selected voluntarily by wealthWhen workers finance firm-specific investments, they supply one part of the total capital stock needed by the firm for production. It is arguable, then, that worker-investors should be regarded as equity holders and be granted control and income rights in the enterprise. This article seeks to explain the property-rights structure that such a firm must possess to be efficient, and to determine the conditions under which this organizational form is likely to emerge under a voluntary contracting process. Compared to a legally mandated codetermined firm of the European type, the voluntary variant shows clear superiority; specifically, it tends to promote productivity-enhancing incentives, relatively lower transaction costs, and a more rational allocation of risk. * Special thanks go to Armen Alchian, who has provided encouragement, advice, and key ideas concerning the nature of the firm. The article was written during my residence at the Center for the Study of the New Institutional Economics, University of the Saarland, West Germany, 1985. Financial assistance was received from the Deutsche Forschungsgemeinschaft and is gratefully acknowledged.

Journal Article CODETERMINATION, PRODUCTIVITY GAINS, AND THE ECONOMICS OF THE FIRM Get access EIRIK G. FURUBOTN EIRIK G. FURUBOTN University of TexasArlington Search for other works by this author on: Oxford Academic Google Scholar Oxford Economic Papers, Volume 37, Issue 1, March 1985, Pages 22–39, https://doi.org/10.1093/oxfordjournals.oep.a041675 Published: 01 March 1985