Formal institutions play a central role in many spheres of life and are consequential in both economic activity and public policy. Despite the early example of John R. Commons, formal institutions have received limited explicit treatment in the original institutional economics literature. Few articles today in the Journal of Economic Issues treat formal institutions; few authors of books or edited volumes treat formal institutions. Exceptions to this rule tend to briefly note differences between formal and informal and quickly move on to other topics (e.g., Gordon 1980).
Apart from original institutionalists, other economists recognize the salience of formal institutions and give them explicit treatment; for instance, Douglass North (1990) includes an entire chapter on formal institutions in Institutions, Institutional Change, and Economic Performance. However, these treatments are consonant with rational choice assumptions of human behavior or variants thereof, such as the new institutional economics (Vandenberg 2002). The purpose of the present paper is to articulate a framework for formal institutions which proceeds from assumptions compatible with the original institutional economics.
Institutions serve to constrain and guide human behavior. More particularly, institutions are systems of established and embedded social rules that structure social interactions (Hodgson 2001). (1) Both formal and informal institutions share this property. Informal institutions include such things as norms, conventions, customs, and traditions; formal institutions include such things as laws, religious organizations, stock markets, and universities. Formality is a somewhat elusive concept with a variety of meanings and interpretations. The Oxford English Dictionary (2d ed.) gives twenty-three senses of the adjective formal, one of which (#5) seems to best apply to the present case:
Done or made with the forms recognized as ensuring validity; explicit and definite, as opposed to what is matter of tacit understanding. Following this, formal institutions are institutions characterized by purposeful attention to validity as well as explicitness with respect to rules and consequences. These characteristics are expressed in a number of tangible ways, such as charters, proclamations, bylaws, symbols, and a variety of ceremonial displays and rituals.
However familiar and tangible, these and other characteristics fail to represent the essence of the distinction between formal and informal. Instead, they are best viewed as the accoutrements of formality, albeit highly useful ones. The basis of fundamental differences between formal and informal institutions lies in the concentration of control over the institution. Informal institutions are embodied in and across group members, with a substantial degree of egalitarianism. Each member is somewhat of a personal authority, and each may exercise some measure of latitude to interpret the institution, to encourage conformity, and to punish violations. On the other hand, formal institutions are much less egalitarian: authority rests with a specially designated subgroup. Formal institutions are administered by a central authority. Thus the essential difference is a difference in locus and type of control. A formal institution is one in which control of the institution has been expropriated by, or otherwise vested in, an elite. This type of institutional control involves the power of the few to set rules which will direct the behavior of the many, as well as the power to interpret and enforce the rules. By contrast an informal institution is one in which control is distributed among group members, although some individuals will usually have more influence than others. This type of institutional control is communal and emergent rather than an exercise of power.
Maintenance of control in formal institutions occasions the use of tangible characteristics such as explicitness of rules and attention to forms which ensure validity, viz., the charters, symbols, and rituals. It is chiefly variations in these outward characteristics that distinguish one formal institution from another, although the degree of consolidation of central control is also variable. While locus and type of control is the chief distinguishing factor between formal and informal, there is no hard and fast boundary between the two categories. Indeed there is a zone of intersection between the two which may result from instances of incomplete consolidation of control or intermittent attainment of control. A special case of this intersection--the case of transformation of an informal institution into a formal one--is discussed below.
Institutions are created by humans, so some assumptions about humans are necessary at the start. Much behavior is understood to be directed by habits and norms; however, the present analysis is also interested in the formation of formal institutions. Consequently, the analysis is concerned with two types of human behavior, represented by the observation "Man is as much a rule-following animal as a purpose-seeking one" (Hayek 1973, 11). Rule making is the purpose of formalizers, and subsequent rule following is their objective. The devising of these rules is an instance of purpose-seeking behavior. As Marc Tool noted, individuals are both conditioned by culture and are conditioners of culture (1979, 52). That is, institutions are understood to be created by individuals (Hodgson 2000); they are not uncaused causes.
Such an undertaking requires cognitive engagement on the part of the rule maker. This revolves foresight or anticipation of a desired goal and an appraisal of means to achieve this end. Thought processes of the strictly means-ends rationality type (self-interest seeking) or of the value-rationality type (group-interest seeking) are needed. Both forms of thinking about institutions involve a planning type of rationality, in essence, an institutional rationality (Redmond 2004). On the part of rule followers, a cognitive appraisal of new rules and a considered response to them precedes an eventual pattern of habitual response. That is, both rule makers and rule followers engage in institutional rationality.
Mode of Illustration
One difficulty in discussing an entire category of institutions is the problem of illustration. Formal institutions are of an immense variety. In order to provide a sense of focus in the following discussion, illustrative examples will be drawn primarily from one area, the law. Law appears to be a suitable exemplar of formal institution for several reasons. First, its explicit aim is the basic institutional effect, to constrain and guide behavior. Second, it fits the OED definition of formality well. Third, it is among the oldest known formal institutions, arising at the dawn of civilization (Bogucki 1999; Roth 1968). Despite the focus on law for illustrative purposes, however, the aim of the paper is to develop an analysis which is applicable to formal institutions generally. (2)
Within the realm of legal studies, there are numerous explanatory perspectives and theories. One of the most prominent in recent years is based on rational choice assumptions (Grey 1998; Posner 1980). More fruitful from an institutional point of view are perspectives which emphasize the social context and the pragmatic aims of law. To this end, many examples will be drawn from writings of Max Weber and Oliver Wendell Holmes, Jr. Weber is of particular interest here because Economy and Society ( 1978) contains a sociological analysis of law (Trubek 1994). Further, Weber was keenly attuned to the problem of historical specificity (Hodgson 2001), and the present paper seeks to avoid a historically narrow view of formal institutions. Holmes is of interest because The Common Law ( 1963) is informed by pragmatic philosophy and the present paper takes a pragmatic approach. That is, formal institutions are viewed as human devisings with practical purposes.
Analysis of Formal Institutions
In order to analyze stability and change, an analytical framework is needed. Moreover, there is a potentially large number of avenues by which to approach the analysis of formal institutions. The approach adopted here is based on the notion that key insights into an institution can be developed from an understanding of the historical process under which it was formed (Berger and Luckmann 1966). Thus the framework developed below is premised on the idea that processes of stability and change are connected with processes of initiation (Tool 1979, 164). In other words, conditions of origination affect the subsequent course of institutional stasis or dynamism. Four aspects of the genesis of formal institutions set them apart from informal institutions: (a) the general purpose, (b) negotiation, (c) explicitness in formulation and dissemination of rules, and (d) prior consideration of mechanisms of compliance, or ensurance. These features are common to most formal institutions and are not typical of informal institutions.
Formal institutions are marked by highly varied objectives, which are often both the expressed purpose and the actual result of the institution. However, a general approach to formal institutions requires that some common ground be found other than their varied objectives. In this regard, Weber's usage of terminology is instructive and reflects his sociological approach to the law ( 1978). Specifically, Weber employed two terms interchangeably, law and legal norm. A law, then, is a formalized norm.
In general, what is formalized (i.e., controlled) in a formal institution is a norm. Informal norms, even well established ones, are not automatically and invariably followed by all group members. In other words, conformance is uncertain. It is this uncertainty or, more precisely, the desire to do something about it which is central to...