Why All Policy Analysis Needs Institutional Economics, and Why This Economics Needs to Admit Unequally Rational Individuals and Comprehend Economic Change
Abstract: Today’s economists increasingly agree that an economy’s performance importantly depends on its institutions (though in not always well-defined meaning). If this is the case, the knowledge of this dependence is doubly important for the policy analysis that seeks a remedy for an underperforming economy: the institutions may contain the causes of the underperformance, which the analysis needs to identify; and institutional change may be a necessary ingredient of the remedy, the effects of which the analysis needs to assess. This paper has two main objectives, indicated by its title: (1) to show that this is indeed the case, and that policy analysis therefore needs help from certain parts of Institutional Economics (IE); (2) that IE, to effectively help and not mislead policy analysis, needs to be extended by certain parts of certain “heterodox” fields, divided into Behavioral-Informational economics, and Evolutionary-Developmental economics. The paper interconnects all the needed parts into a consistent conceptual model, able to help policy analysis deal more reliably with a broader range of important policy issue, and avoid proving optimal in theory policies that grossly fail in practice. Its usefulness is illustrated by new contributions to four old policy issues: the economic sustainability of socialism; the social efficiency of selective industrial policies; the social efficiency of large, transaction-costs saving firms; and the regulations of the financial sector, including the financial transaction tax.