What are institutions?

The leaders of modern institutional theory include Douglass North, W.Richard Scott, Elinor Ostrom, and Walter Powell.

Over the past fifty years, there has been an entire generation of sociologists, economists, and political scientists who have contributed to this emerging field of institutional theory, with goals to explain economic history, compare economic and political systems, improve governance of the commons, etc, including hundreds of case studies, articles, and books.

As we dig in here, first, it is important to set forth the goal of this blog post: the goal is to provide a blockchain builder who has not studied institutional theory a helicopter view of the past fifty years of insights in this field, including those insights that were foundational in the work of both Douglass North and Elinor Ostrom, both of whom won Nobel prizes for their work in this field, in 1993 and 2009 respectively.

Second, as a point of definitional clarity, we need to flag that a red brick building or a particular large organization such as the World Bank or IMF is not an institution per se, at least not in the definitional sense of the term as it has been employed by leading social scientists and institutional theorists, nor is that how we want to define it here within the Humanity 3.0 blog.

For our purposes:

1. Institutions are systematized ideals, which emerge spontaneously out of interactions of two or more people, and which become operating rules serving as constraints on future behavior within the group.
2. There are two primary classes of institutions: formal institutions (e.g. rules, laws) and informal institutions (e.g. norms, protocols, traditions).
3. When people fail to follow formal institutions, they are punished (e.g. jail or fines). When people fail to follow informal institutions, they are socially-sanctioned by the group that created the institution (e.g. shunned, ostracized, or banished).
4. Overall, institutions play an important function for the human species in reducing chaos, creating certainty and order, and enabling efficiency in human interactions.

“Institutions are systematized ideals, which emerge spontaneously out of interactions of two or more people, and which become operating rules serving as constraints on future behavior”.

Better Future

Now lets dive into a big long string of examples. The best way to understand a new conceptual idea is to consider lots of examples, and to build up to the concept out of the details:

1. An example of a formal institution is the Securities Act of 1933, a U.S. law the prohibits selling of certain kinds of unregistered securities, which was passed by the U.S. Congress and is enforced by the SEC, with specific penalties for people who violate the Act.
2. Contract law and enforcement of contract law by the courts is a formal institution on which the American and British systems are based. The American Constitution is a set of formal institutions on which the United States was founded.
3. The fact that rulings of the courts are enforced by the police within the U.S. system means that formal institutions have ‘sharp teeth’ in the sense that there are real consequences that come w/ failing to abide by the institution.
4. In places where formal institutions are not actively enforced, they tend not to be followed consistently. For example, in Indonesia they have laws making it illegal to fish with dynamite, but they are not enforced and there are still many fisherman who fish with dynamite.
5. Failing to follow informal institutions does also have real consequences, although these consequences tend to be softer and more difficult to observe or quantify, as they are informal and not codified in a legal code anywhere.
6. An example of an informal institution is goose-stepping within a marching column of soldiers in an infantry platoon. If you fall out of line, you may be yelled at by the commanding officer, told to drop and do 50 pushups, or be put on dish duty. While there is not a specific, formal penalty or enforcement process, there are consequences for a soldier who falls out of line.
7. Another example of an informal institution is the Internet protocol, if you do not configure your computer to follow the technical standards of the protocol you cannot participate in serving-up files or retrieving files from peers in the network. The consequence of not following the protocol exactly to the letter of the protocol is being excluded from the group of billions of people globally who are engaging in the act of efficiently swapping files and sharing content with one another.
8. Another example of an institution, with both formal and informal elements, is marriage. There is the formal institution, which is effectively a contract between two willing partners witnessed by friends and family in a group setting to remain faithful to one another until death do us part. Then there is also the informal element, which is the mutual agreement between the partners of all of the daily operating rules for the household. For example, morning and bedtime routines, cleanliness standards, time spent with family versus friends, holidays to be celebrated, responsibility to take out the trash, etc. If one partner is unfaithful, or if they break too many of the daily operating rules too many times, then that partner could be at risk of being banished from the marriage, i.e. a request for divorce.
9. Generally, the larger the group of participants who follow an informal institution, the greater the costs for one individual of deviating and not following it, thus, following the institution tends to be the maximally efficient course of action for each individual in a social system. This is why standards setting exercises are so powerful if they catch on at global scale, and why standards become such a force for efficiency in the economy. This is why Peter Schiff has a losing argument against Bitcoin at this point; he is like the only guy driving against the direction of the traffic.
10. As a different kind of example, there are two types of protests in Washington D.C., there are violent insurrections w/ guns and shootings that do not follow the established institution to register and run a peaceful protest. And, there are peaceful protests that are registered with authorities, follow curfew, have police stationed at the street corners, and are orchestrated in a way that allows the organizers to make some kind of political statement without the activity scaring anyone or becoming crazy or violent. The latter type of march follows the established institution of a peaceful protest, which is a regularized and institutionalized behavior, whereas the former is truly political action or anarchy.
11. When formal and informal institutions are present, we develop standardized or routinized behaviors within groups of people at various breadths and scales in society, which results in normalization of economic, political, and social behaviors, and generally a peaceful societal order emerges (e.g. Manhattan) as compared to continuous violent crime and terror attacks (e.g. Mogadishu).
12. Institutions emerge endogenously out of repeated interactions amongst humans within social groups, and once patterns of behavior are established, these new institutions act exogenously as constraints on future human behavior within the group. For example, a stamp collecting club with 10 members can create a rule to not be late for weekly meetings with punishment of needing to stand on one’s head for five minutes, and then in future rounds of interaction within the group all of the new-joiners are subject to standing on their head if they are late, even if they weren’t present in the group at the time the institution was created.
13. Institutions are built on a foundation of cultural knowledge and shared beliefs. Shared beliefs are either consciously-held (explicit) or unconsciously-held (tacit), and it is shared beliefs that enable groups to establish formal and informal institutions (they are a kind of pre-requisite). Some institutional theorists (e.g. W. Richard Scott) go so far as to label shared beliefs as ‘cultural-cognitive institutions’ and mental models, cognitive templates, and so forth are viewed as the most basic of institutions regularizing behavior within our brains, but, I tend not to go that far definitionally, and prefer to just think of shared beliefs, well, as… shared beliefs.
14. Within any human-society, the space of acceptable behaviors is enabled, supported, and constrained by a matrix of institutions, which in turn creates a matrix of sanctions (i.e. penalties) and incentives (i.e. rewards) that determines the equilibrium of behaviors that we see repeated within that society or group.
15. Through the lens of institutional theory, the World Bank can be thought of as a whole collection or bundle of formal and informal institutions, including human resources policies, lending rules, penalties for countries who default on loans, and governance arrangements to admit new member nations. If a newcomer lacks familiarity with all of these complex institutions that have evolved over many decades, it would indeed be quite difficult for that newcomer to enter into the organization and make sense of all of the behaviors that they observe going on there inside of the four walls. (i.e. A lack of shared beliefs about all of the historical decisions within the institution makes it difficult for a newcomer to behave correctly and not to accidentally fall out of line).
16. Generally, a person who doesn’t follow a formal institution is thought to be a criminal, renegade, or rebel; a person who doesn’t follow an informal institution is considered a bumbling idiot or someone who just isn’t from here; and a person who operates with beliefs outside of the generally held cognitively-and-culturally embraced set of beliefs is considered to be crazy or insane.
17. The U.S. Tax Code is another example of a formal institution, with a set of prescriptive penalties and incentives for economic actors within the economy, which reinforces certain kinds of economic activities (e.g. tabulating expenses, making gift donations). The U.S Congress bears ultimate responsibility for creating the tax code, which is enforced by the IRS, and which sets the equilibrium of economic activity that emerges within the U.S. economy (for example, frequency of registrations of not-for-profit orgs, annual levels of charitable giving, as well as attempts to create off-shore entities in Panama and Bermuda. All of these behaviors and many more are driven by the tax code!)
18. Institutions also tend to reflect shared moral or religious beliefs held within a group. For example, there are studies connecting the ‘protestant ethic’ to the emergence of the ‘institutions of the American system’, and, connecting the organizations of cult leaders such as David Koresh (Branch Davidian Cult) or Jim Jones (the People’s Temple) to their core beliefs, as whacky as those may have been. Most likely current members of Jehovah’s Witness or Church of Scientology do not see rules they are following as whacky, but time will tell how these sets of institutions are ultimately judged.
19. For the most parts, religions can be deconstructed into mostly informal institutions established on top of shared beliefs about the origins of planet earth, the human race, and supernatural phenomenon, which, for the most part are non-observable phenomenon, but, that newcomers who join the religious group must embrace, accept, and repeat wholeheartedly.
20. Each human group evolves its own set of institutions developed endogenously within the group via repeated human interactions over time, and there have been wildly differing sets of institutional arrangements that have emerged across various groups, cultures, organizations, and societies within the human species over space and time.
21. Cultural and organizational anthropologists are generally experts in identifying, mapping, and describing institutions, as well as the culturally-embraced patterns of behavior that emerge within a particular set of institutional arrangements.
22. Most non-social scientists are well aware of the existence and role of formal institutions, but they are generally much less aware of the existence and importance of informal institutions in maintaining order, or the critically-important function of shared beliefs in underpinning the creation and perceived acceptance of institutions within groups of people. (If you are a fish born in water, and you’ve happily lived your entire life in the comfort of water, you may not even recognize what water is until you’re lifted out of the fishbowl.)
23. People who have traveled to a few dozen countries tend to be far better at recognizing the role (and danger of accidentally tripping over) informal institutions, and the awareness of informal institutions when they visit far-flung corners of the earth can make it easier to recognize them at home.

Now, with this background on institutional theory in place, in future posts we can discuss how we can go about building new kinds of informal institutional arrangements accessible via dApps, on top of Decentralized State Machine networks, with protocols written in smart contracts functioning to provide informal constraints on behavior for members of the network, and establishing a whole new class of informal institutions that can create regularity, consistency, and order in human behavior at societal and even global scale – without the need for violence that came as a consequence of our heavy reliance on formal institutional arrangements in the 19th and 20th Centuries with the nation-state model!

Appendix

Here are a few more advanced topics, for those readers interested in some of the deeper insights from institutional theory:

1. While it is difficult to judge one set of cultural institutions as being better or worse (e.g. social norms about wearing a certain national dress at Christmas time), it is possible to compare and contrast economic institutions on various metrics (e.g. GDP/capita, GINI coefficient), and in that regard, the collection of institutions making up the American political and economic system seems to be the most productive in terms of wealth creation in history, however it, also contributes to extremes in inequality.
2. An interesting question studied by institutional theorists, “Why do most schools and hospitals in America basically look and run in the same way, with the same organizational structures?” The answer to this question given by institutional theorists is that there is a matrix of formal and informal institutions that have evolved within American cultural, legal, tax, religious, scientific, and social societal systems, etc. which leads to a certain socially-legitimate and economically-efficient model of the school and the hospital becoming widely-adopted across the country. This idea is referred to as “structural isomorphism” or the “the iron cage” (see Woodie Powell’s work).
3. Informal institutions can be highly persistent within ethnic groups and over time, and can outlive formal institutional overlays if those overlays are viewed as illegitimate or unnecessary within the group. For example, after the fall of the Soviet Union, there were efforts to put in place Western institutions such as democracies and rule of law, however, these efforts were ultimately overwhelmed by deeper sets of informal institutions that were active and alive within the society, which can be traced back more than 100 years to ethnic traditions, and which ultimately have persisted longer then either the communist or the democratic formal institutions overlaid circa 1919 and 1991 respectively.
4. Well-meaning human beings tend to love copying institutions, and carrying them from one human group context to another human group context, with varying degrees of success. For example, many efforts by the World Bank to ‘plop and drop’ Western institutions into various developing countries have mixed track records, and in some cases, horrible track records. For example, there are court buildings in the city center of many developing countries, but the behaviors and institutions that we observe to be present in the rule of law systems in Britain and America did not emerge in these court houses at all. Instead, usage of the court buildings has been adapted to follow local homegrown Humanity 1.0 institutions (e.g. mafia-like justice).
5. As an example of success, the Japanese studied and copied major sets of institutions comprising the library, military, and police from the German, American, and British systems during the mid-20th Century when they were threatened by ‘black ships’ pulling into their ports, and reported considerable success in copying and transplanting activities into the Japanese context. (See Eleanor Westney’s classic, ‘Imitation and Innovation’).
6. Based on a personal lifetime traveling to 100+ countries and observing many attempts to copy and transplant institutions, I have concluded that when a group of people are determined to change and evolve themselves from the inside, and the new institutional arrangements that are copied are enacted and enforced endogenously from within their group, from within their own heart and soul so to speak, then institutions from ‘the outside’ can indeed be copied in a sustainable way. This is in contrast to the Soviet example and the World Bank example, where a small group of opportunists tried to overlay ideas and structures from outside the local set of shared beliefs and informal institutions, without the level of endogenous support and shared belief needed to make the transplant a success.

Alright, so, thats quite a long list! Overall it is thirty three points to bring the layperson blockchain builder up to speed with the core tenets of institutional theory, basically, a semester-length college course in one post. If you read this far, and if you were able to think about each of the points in your own mind and really grasp the concepts and examples in your own brain, you now have enough knowledge to be dangerous with institutional theory.

This should be sufficient examples and background on the topic that you can become an intentional institutional entrepreneur and start to build informal institutions out in the world on top of blockchain technology!