The Economic Institutions of Capitalism Essay


This study is based on the belief that economic organization is shaped by transaction cost economizing decisions. It sets out the basic principles of transaction cost economics, applies the basic arguments to economic institutions, and develops public policy implications. Any issue that arises, or can be recast as a matter of contracting, is usefully examined in terms of transaction costs. Transaction cost economics maintains that governance of contractual relations is mainly achieved through institutions of private ordering instead of legal centralism. This approach is based on behavioral assumptions of bounded rationalism and opportunism, which reflect actual human nature.

These assumptions underlie the problem of economic organization: to create contract and governance structures that economize on bounded rationality while safeguarding transactions against the hazards of opportunism. The book first summarizes the transaction cost economics approach to the study of economic organization. It develops the underlying behavioral assumptions and the types of transactions; alternative approaches to the world of contracts are presented. Assuming that firms are best regarded as a governance structure, a comparative institutional approach to the governance of contractual relations is set out. The evidence, theory, and policy of vertical integration are discussed, on the basis that the decision to integrate is paradigmatic to transaction cost analysis. The incentives and bureaucratic limits of internal organization are presented, including the dilemma of why a large firm can’t do everything a collection of small firms can do.

The economics of organization in presented in terms of transaction costs, showing that hierarchy also serves efficiency and permits a variety of predictions about the organization of work. Efficient labor organization is explored; on the assumption that an authority relation prevails between workers and managers, what governance structure supports will be made in response to various types of job attributes are discussed, and implications for union organization are developed. Considering antitrust ramifications of transaction cost economics, the book summarizes transaction cost issues that arise in the context of contracting, merger, and strategic behavior, and challenges earlier antitrust preoccupation with monopoly.


The Economic System of Socialism

Socialism—defined as a centrally planned economy in which the government controls all means of production—was the tragic failure of the twentieth century. Born of a commitment to remedy the economic and moral defects of capitalism, it has far surpassed capitalism in both economic malfunction and moral cruelty. Yet the idea and the ideal of socialism linger on. Whether socialism in some form will eventually return as a major organizing force in human affairs is unknown, but no one can accurately appraise its prospects who has not taken into account the dramatic story of its rise and fall.

The Birth of Socialist Planning

It is often thought that the idea of socialism derives from the work of Karl Marx. In fact, Marx wrote only a few pages about socialism, as either a moral or a practical blueprint for society. The true architect of a socialist order was Lenin, who first faced the practical difficulties of organizing an economic system without the driving incentives of profit seeking or the self-generating constraints of competition. Lenin began from the long-standing delusion that economic organization would become less complex once the profit drive and the market mechanism had been dispensed with—”as self-evident,” he wrote, as “the extraordinarily simple operations of watching, recording, and issuing receipts, within the reach of anybody who can read and write and knows the first four rules of arithmetic.”

In fact, economic life pursued under these first four rules rapidly became so disorganized that within four years of the 1917 revolution, Soviet production had fallen to 14 percent of its prerevolutionary level. By 1921 Lenin was forced to institute the New Economic Policy (NEP), a partial return to the market incentives of capitalism. This brief mixture of socialism and capitalism came to an end in 1927 after Stalin instituted the process of forced collectivization that was to mobilize Russian resources for its leap into industrial power. The system that evolved under Stalin and his successors took the form of a pyramid of command. At its apex was Gosplan, the highest state planning agency, which established such general directives for the economy as the target rate of growth and the allocation of effort between military and civilian outputs, between heavy and light industry, and among various regions.

Gosplan transmitted the general directives to successive ministries of industrial and regional planning, whose technical advisers broke down the overall national plan into directives assigned to particular factories, industrial power centers, collective farms, and so on. These thousands of individual subplans were finally scrutinized by the factory managers and engineers who would eventually have to implement them. Thereafter, the blueprint for production reascended the pyramid, together with the suggestions, emendations, and pleas of those who had seen it. Ultimately, a completed plan would be reached by negotiation, voted on by the Supreme Soviet, and passed into law.

Thus, the final plan resembled an immense order book, specifying the nuts and bolts, steel girders, grain outputs, tractors, cotton, cardboard, and coal that, in their entirety, constituted the national output. In theory such an order book should enable planners to reconstitute a working economy each year—provided, of course, that the nuts fitted the bolts; the girders were of the right dimensions; the grain output was properly stored; the tractors were operable; and the cotton, cardboard, and coal were of the kinds needed for their manifold uses. But there was a vast and widening gap between theory and practice.

Problems Emerge

The gap did not appear immediately. In retrospect, we can see that the task facing Lenin and Stalin in the early years was not so much economic as quasi military—mobilizing a peasantry into a workforce to build roads and rail lines, dams and electric grids, steel complexes and tractor factories. This was a formidable assignment, but far less formidable than what would confront socialism fifty years later, when the task was not so much to create enormous undertakings as to create relatively self-contained ones, and to fit all the outputs into a dovetailing whole. Through the 1960s the Soviet economy continued to report strong overall growth—roughly twice that of the United States—but observers began to spot signs of impending trouble. One was the difficulty of specifying outputs in terms that would maximize the well-being of everyone in the economy, not merely the bonuses earned by individual factory managers for “overfulfilling” their assigned objectives.

The problem was that the plan specified outputs in physical terms. One consequence was that managers maximized yardages or tonnages of output, not its quality. A famous cartoon in the satirical magazine Krokodil showed a factory manager proudly displaying his record output, a single gigantic nail suspended from a crane. As the economic flow became increasingly clogged and clotted, production took the form of “stormings” at the end of each quarter or year, when every resource was pressed into use to meet preassigned targets. The same rigid system soon produced expediters, or tolkachi, to arrange shipments to harassed managers who needed unplanned—and therefore unobtainable—inputs to achieve their production goals. Worse, lacking the right to buy their own supplies or to hire or fire their own workers, factories set up fabricating shops, then commissaries, and finally their own worker housing to maintain control over their own small bailiwicks.

It is not surprising that this increasingly Byzantine system began to create serious dysfunctions beneath the overall statistics of growth. During the 1960s the Soviet Union became the first industrial country in history to suffer a prolonged peacetime fall in average life expectancy, a symptom of its disastrous misallocation of resources. Military research facilities could get whatever they needed, but hospitals were low on the priority list. By the 1970s the figures clearly indicated a slowing of overall production. By the 1980s the Soviet Union officially acknowledged a near end to growth that was, in reality, an unofficial decline. In 1987 the first official law embodying perestroika—restructuring—was put into effect. President Mikhail Gorbachev announced his intention to revamp the economy from top to bottom by introducing the market, reestablishing private ownership, and opening the system to free economic interchange with the West. Seventy years of socialist rise had come to an end.

Socialist Planning in Western Eyes

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Understanding of the difficulties of central planning was slow to emerge. In the mid-1930s, while the Russian industrialization drive was at full tilt, few raised their voices about its problems. Among those few were ludwig von mises, an articulate and exceedingly argumentative free-market economist, and friedrich hayek, of much more contemplative temperament, later to be awarded a Nobel Prize for his work in monetary theory. Together, Mises and Hayek launched an attack on the feasibility of socialism that seemed at the time unconvincing in its argument as to the functional problems of a planned economy. Mises in particular contended that a socialist system was impossible because there was no way for the planners to acquire the information (see Information and Prices)—”produce this, not that”—needed for a coherent economy. This information, Hayek emphasized, emerged spontaneously in a market system from the rise and fall of prices.

A planning system was bound to fail precisely because it lacked such a signaling mechanism. The Mises-Hayek argument met its most formidable counterargument in two brilliant articles by Oskar Lange, a young economist who would become Poland’s first ambassador to the United States after World War II. Lange set out to show that the planners would, in fact, have precisely the same information as that which guided a market economy. The information would be revealed as inventories of goods rose and fell, signaling either that supply was greater than demand or demand was greater than supply. Thus, as planners watched inventory levels, they were also learning which of their administered (i.e., state-dictated) prices were too high and which too low. It only remained, therefore, to adjust prices so that supply and demand balanced, exactly as in the marketplace.

Lange’s answer was so simple and clear that many believed the Mises-Hayek argument had been demolished. In fact, we now know that their argument was all too prescient. Ironically, though, Mises and Hayek were right for a reason they did not foresee as clearly as Lange himself. “The real danger of socialism,” Lange wrote, in italics, “is that of a bureaucratization of economic life.” But he took away the force of the remark by adding, without italics, “Unfortunately, we do not see how the same or even greater danger can be averted under monopolistic capitalism” (Lange and Taylor 1938, pp. 109–110). The effects of the “bureaucratization of economic life” are dramatically related in The Turning Point, a scathing attack on the realities of socialist economic planning by two Soviet economists, Nikolai Smelev and Vladimir Popov, that gives examples of the planning process in actual operation.

In 1982, to stimulate the production of gloves from moleskins, the Soviet government raised the price it was willing to pay for moleskins from twenty to fifty kopecks per pelt. Smelev and Popov noted: State purchases increased, and now all the distribution centers are filled with these pelts. Industry is unable to use them all, and they often rot in warehouses before they can be processed. The Ministry of Light Industry has already requested Goskomtsen [the State Committee on Prices] twice to lower prices, but “the question has not been decided” yet. This is not surprising. Its members are too busy to decide. They have no time: besides setting prices on these pelts, they have to keep track of another 24 million prices. And how can they possibly know how much to lower the price today, so they won’t have to raise it tomorrow? This story speaks volumes about the problem of a centrally planned system.

The crucial missing element is not so much “information,” as Mises and Hayek argued, as it is the motivation to act on information. After all, the inventories of moleskins did tell the planners that their production was at first too low and then too high. What was missing was the willingness—better yet, the necessity—to respond to the signals of changing inventories. A capitalist firm responds to changing prices because failure to do so will cause it to lose money. A socialist ministry ignores changing inventories because bureaucrats learn that doing something is more likely to get them in trouble than doing nothing, unless doing nothing results in absolute disaster. In the late 1980s, absolute economic disaster arrived in the Soviet Union and its Eastern former satellites, and those countries are still trying to construct some form of economic structure that will no longer display the deadly inertia and indifference that have come to be the hallmarks of socialism.

It is too early to predict whether these efforts will succeed. The main obstacle to real perestroika is the impossibility of creating a working market system without a firm basis of private ownership, and it is clear that the creation of such a basis encounters the opposition of the former state bureaucracy and the hostility of ordinary people who have long been trained to be suspicious of the pursuit of wealth. In the face of such uncertainties, all predictions are foolhardy save one: no quick or easy transition from socialism to some form of nonsocialism is possible. Transformations of such magnitude are historic convulsions, not mere changes in policy. Their completion must be measured in decades or generations, not years.


The Economy System of Mixed Economy

A mixed economy has many of the characteristics of market, command and traditional economies. The United States is a mixed economy because its Constitution protects many of the characteristics of a market economy, including ownership of private property, limitations on government interference, and promoting innovation. However, the Constitution also encourages the government to promote the general welfare. This allows many aspects of a command economy, where needed. In addition, many American traditions still guide economic policy. A mixed economy seeks to have all the advantages of a market, command and traditional economy with little of the disadvantages. Therefore, most mixed economies have three of the six characteristics of the market economy: private property, pricing and individual self-interest. Mixed economies also have a command economy in certain areas. Most allow government to have a command role in areas that safeguard the people and the market itself. This usually includes the military, international trade, and national transportation.

An increased governmental role depends on the priorities of the people. Many mixed economies also allow centralized planning and even government ownership of key industries, such as aerospace, energy production and even banking. Some mixed economies encourage the government to centrally manage health care, welfare, and retirement programs. In addition, most mixed economies follow traditions that have been so ingrained that they may not even be aware of it. For example, many mixed economies still fund and give some power to royalty or emperors. Most of the world’s major economies are now mixed economies. It would be difficult to avoid, thanks to globalization.

A country’s people are best served through international trade — oil from Saudi Arabia, consumer products from China, and food from the U.S. As soon as businesses within a country are allowed or even encouraged to export, the government must give up some control to free market forces. Second, the global economy is primarily free-market based. There is very little government control, although some regulations and agreements have been put into place. However, there is no world government today that has the power to override a country’s sovereignty and create a global command economy. URL:

The Economy System of Islamic Economics

The way of defining Islamic Economics is to qualify the term modern or conventional economics with Islam. Islam is a religion from Allah SWT through prophet Muhammad SAW to mankind which means the total way of Man kind’s life, that is what ever man does or is going to do must be abided by the Islamic norms and values as well as laws and other rules and regulations(shariah). And conventional economics has best been defined by robbins as science which studies human behaviour as a relationship between ends and scarce means which have an alternative uses. Based on the definitions of the two concepts above, many scholars defined Islamic economics according to their understanding of the concepts. The following are the various definition of Islamic economics from different scholars: 1)Ahmad (1981) defined Islamic economics as a study of human behaviour in their attempts to satisfy needs from the abundant resources whose ultimate aim is to maximise benefit of self and society both in this world and the hereafter. 2)Akram(1983) sees Islamic economics as aims at the study human falah achieved by organising the resources of earth on the basis of cooperation and participation.

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3)Hasnuzzaman(1984) defined Islamic economics as the knowledge and application of injunctions and rules of shariah that prevent injustice in the acquisition and disposal of material resources in order to provide satisfaction to human beings and enable them to perform their obligations to Allah and the society. 4)Mannan (1986) defines as studies of a social science in the economic problems of people to fill with the values of Islam. 5)S.M Ghazali Wafa et al (2002) defines as all human activities to use the sources which follow the law to perform their obligations to Allah. Observing the above definitions Islamic economics is the some part of conventional economics plus morals, norms and values of Islam, it covers a lot of micro and macro concepts of conventional economics like ownerships, rights to produce or create, what to produce, how to produce and for whom to produce, others include equity, returns on investments, development projects, stability in the value of money, broad base economic well being with full employment, optimum rate of economic growth, joint ventures, fiscaland monetary policies, etc .

However Islamic economics ejected injustice, enforced the prohibition of interest (riba), hoarding etc. And also promote the determination of the level of individual liberty, recognition the right of property, controlling the economic inequality within the natural limits, maintaining the equality of social life, and social security. It however prohibits the wider circulation of wealth, and recognizes social and individual welfare. In conclusion, Islamic economics is designed for economy to contribute richly on the achievement of the major socio-economic goals of the society. Prof. Tariq is very talented and eloquent lecturer, in this lecture he pinpoint the following:

1.Muslims are of full of potentials

2.Universality in time and space in Islam

3.Changes and faithful

4.Things we shouldn’t confused:

a)Relationship between text and context

b)Difference between principles and models

c)Rules and ways

d)Rules and meaning.

5.Difference between adaptation and transformation vision beyond reality.

6.Dealing with rejection and projection

7.Thinking of what to produce and how to produce of halal goods to match the competition with western products.

The above are the lessons we learnt from the lecture, therefore those points are what I am going use and see how Islamic economics can be developed. Firstly, the muslims are of full potentials this so because muslims economics thinkers and economist tried and developed the Islamic economics concept and its now a discipline accepted worldwide, so the other muslim economist should start striving and explore their potentials in developing Islamic economics worldwide. Secondly universality in time and space in Islam, this means mind should be active to make changes in diversity, that is Islamic economic thinkers should have active mind and develop as many theories and models as they can in the time of the their life and places they are living , their universality of Islam should be use to manage diversities, manage changeable dimensions and new challenges with the view of developing Islamic economics.

Thirdly those things that we shouldn’t confused in the improvement of Islamic economics development is text and context should be clearly differentiated ,that is the context in the text of Quran, hadith and fiqh are vividly understood before applying it into the economic theory or model. The difference between principles and models should be understood by Islamic economics ulamas, where principles are universal in nature and models are historical in nature we shouldn’t confused those in developing anything in Islamic economics.

The next is the rules and ways, in Islam rules are in Quran and Sunnah (shariah) then the interpretation of ulamas on some concept and issues that are not clearly interpreted in the Quran and hadith and ways are how those rules are being followed with a light of vision, those must be considered and improvement in Islamic economics will be achieved. The last one is different between rules and meanings, dealing with rules will come to a point where rules forget the meanings so this must be taken into consideration for improvement of Islamic economics.

Fourthly is the difference between adaptation and transformation that is transformation is the visionary change beyond reality in a society and adaptation is transferring the idea of other society into the society, Islamic economics should be a transformation of conventional economics not adaptation. Lastly is the thinking of what to produce and how to produce of consumable goods(halal) to match the competition with western products, professionals in Islamic economics should continue with the introduction of products which will substitute haram goods and services that muslims are always consuming , this will tremendously improve Islamic economics development.

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