What exactly is an “institution”?

An institution is not a building, although if you watch TV they often depict the World Bank by showing a clip of its building.  It is not exactly an organization, because there are institutions without hierarchies (for example, a Friday Night Out “with the boys” is an institution).  It is often a unique and special arrangement, as in a “Mental Institution.” But institutions are also said to be important for economic growth and development.  This is now the mantra of economists who try to explain why so much money has been spent on still-poor countries by aid agencies and international financial institutions.  The excuse is that the money was not directed to the “right” institutions.  (Could the money have been re-routed improperly, either by ineptitude or bad faith?)

So, what exactly is an institution? In 2003, I tried to answer this question, and my paper’s conclusion is as follows:

As suggested by the dictionary, institutions are important to the life of a community or society.  This characteristic of institutions stems from the nature of the goods they deal with.  Institutions are arrangements to ensure the provision of public goods, or to solve the problems associated with a natural monopoly when the good involved is either a common pool resource or a private good. Because institutions address market failure, efficient arrangements to produce and allocate private goods (i.e., the market in the sense of Adam Smith’s “invisible hand”) cannot, by definition, be institutions.

Institutions also come and go, not only because of changes in technology that affect the way goods are produced or consumed, but also because tastes change, including in the arena of moral precepts (a type of public good) that change when shared ideologies change.


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