Explaining institutional change: aspects of an innovation in the new institutional economy

The Authors

Jon-Arild Johannessen, Norwegian School of Management, Oslo, Norway

Abstract

Purpose – The purpose of the paper is to use systemic thinking to explain institutional change. The paper is conceptual, based upon conceptual generalizations.

Design/methodology/approach – The paper considers the question: how can one explain institutional changes? Explaining institutional change is demanded by several recent authors. An interpretation framework is first developed around explanations, where various perspectives on explanations are considered. Then the various perspectives are used to explain institutional change. Finally, an analytical model is developed to explain institutional changes.

Findings – The analytical model is used in order to develop a conceptual model to explain institutional changes in the economic system.

Originality/value – The paper breaks new ground in using systemic thinking to explain institutional change.

Article Type:

Conceptual paper

Keyword(s):

Systems theory; Cybernetics; Innovation.

Journal:

Kybernetes

Volume:

Number:

Year:

2008

pp:

20-35

Copyright ©

Emerald Group Publishing Limited

ISSN:

0368-492X

Introduction

The institutional legitimacy has, according to Scott (1995, p. 37), two forms, cognitive legitimacy and normative legitimacy. Cognitive legitimacy is concerned about what we take for granted, and how this has possibly been changed. Statements of the type: this is how we do it around here, represents this cognitive authority. This expresses common conceptions or common mental models, which determines the thought pattern in a total activity. To what extent an activity is cognitively closed to the outside world or more cognitively open to the outside world, says something about the ability to learn on the part of the activity. Normative legitimacy is engrained in the social pressure brought to bear directly or indirectly on its actors. It is here relevant to speak of normative openness or closeness. The more normatively closed a system is, the more self-referential the system becomes, and the less comparison with other systems in the environment takes place. Institutional factors, cognitive and normative legitimacy, can be focused around cognitive closeness/openness and normative closeness/openness.

The cognitive part can be regarded as a thought pattern and the normative part as an action pattern. Seen in this way, it is our thought and action pattern which opens versus closes institutions. This perspective gives us access to understanding and explanation of changes in institutions.

The question to be focused on in this paper is: how can we explain institutional changes? There are changes in institutions that are difficult to explain. To understand is a psychological mode, while explaining is a methodological mode. To understand is linked to involvement and absorption, while explanation is linked to the understanding of stability and change at the system level by means of historical links, e.g. the changes in relative prices due to technological changes. Stability and change at the system level can be explained by means of expectations or as pattern of expectations, e.g. the discontent due to increasing expectations. Stability and change at the individual level can be explained by means of action patterns, e.g. norms and values, ideology, cooperation versus competition.

This paper has systemic thinking as its theoretical perspective (Bunge, 1967, 1983a, b, 1985a, b, 1996, 1997, 1998, 1999). It is thus this perspective that will permeate the perspectives and explanation patterns developed in this paper.

The paper is organised in the following manner: in Part I we discuss modes of scientific explanations. In Part II we will use these explanation types to explain institutional changes. This leads up to an analytical model. In our conclusion we will develop this model as a step down in terms of abstraction level and develop a conceptual model for the economic system explaining institutional changes.

Part I: causal relations in social systems

The purpose of Part I is to develop four perspectives which we will use to explain institutional change. Explaining institutional change is demanded both by North (1996, 1997), Furubotn and Richter (1998) and Eggertson (1996).

One important concern in research on social systems, from a systemic point of view, is to reveal patterns, however unimportant they may seem, “and possibly also predict social facts” (Bunge, 1985b, p. 157). This is also emphasised by Glaser and Strauss (1967, p. 3). When revealing patterns, we try to find the phenomena causing variation in the behaviour of systems.

The systemic point of view is that patterns of social behaviour, even if they are all created by individuals or groups, are only rarely a result of momentary considerations. They develop in concert with social groups in the course of time. They are limited by laws of nature, ecological circumstances and tradition, and they are weaker when the group they regulate breaks down, even if they may be incorporated in the culture to the extent that they exist long after they have ceased to have a function.

The ultimate goal in all social science, viewed in a systemic perspective, is to find or uncover patterns conducive to explanations and predictions. But most social patterns are local, in the sense that they appear exclusively in societies of a special type. Universal and cross-cultural patterns are however to be found, along with the local ones.

Social scientists cannot overlook values, if they are to understand peoples behaviour. And we have to try to understand what values people in various social groups treasure the most. We must further analyse the consistency of the various value patterns, knowing that any value is in conflict with one or more other values. Maintaining the maxim of social science being devoid of values, we will treat people as automates. The solution is not to overlook values, but to study them scientifically.

Some sociologists, as well as economists, try to explain all social facts in terms of the rationality principle. This principle is based on the hypothesis that any person, choosing between various action patterns, will choose whatever will maximise his expected utility, i.e. the result where the value (utility) multiplied by the probability of a positive result, is greatest. There are at least three problems in connection with this principle:

It requires the liberty on the part of any actor to choose, which is a dubious supposition.
Secondly, the value (utility) and the probability involved is subjective, i.e. is difficult to check.
Thirdly, the principle is normative, not descriptive. It characterises the rational actor, not the real ones. This means that in reality the principle is irrefutable. Any error in the chosen course of action can be criticised by referring to erroneous observations on the part of the actor with regards to values (utility) and probability.

The rationality principle, interpreted as explained, would perpetuate itself and enclose itself, rendering all criticism impossible, i.e. would tend to be an almost non-scientific principle.

In social research we often encounter the question: what is the cause of X? In social systems causal relationships are more complex and at least different than in the crude physical nature. In the crude physical nature we will often, however not always, find a cause realising an effect. Such connections also exist in social systems. This will here be denoted as historical causal processes. In addition to historical causal processes there are at least three other causal processes forming the basis for the explanation of social systems. We have in Figure 1 made a typology the four causal processes.

Historical causal processes

The causal processes in most frequent use is the historical one (Hempel, 1965; Salmon, 1989, pp. 25-26). This is in Figure 1 the typology, linear-causal process at a low-causal level. Historical causal processes reflect the existence of an initial cause and a subsequent effect in the direction of time. In the physical world there are many causal flows of this type. In social systems this type of causal context is also evident, but not as pronounced as in physical systems. The following are examples of historical causal processes: conditions of growing up affect behaviour later in life, past events in an organisation affect present behaviour on the part of the employees here and now.

The question linked to historical causal process are of the type: what is the cause of X? For example, what is the cause of A's behaviour? What we should observe carefully is that this question is also asked when causal processes are not historical. If the person asking the question is ignorant of the three other types of processes, answers will most certainly be less than illuminating and at worst downright confusing. The knowledge to be derived is that we as researchers must be made aware of what causal processes exist in the social system on which we want to comment before we ask the question, the answer being frequently inherent in the very question.

Functional causal processes

Questions in connection with functional causal processes are of the type: what does X attempt to accomplish by his acts, behaviour, etc.? Functional processes are linked to an expectation mechanism (Braithwaite, 1953; Wright, 1976; Bigelow and Pargetter, 1987). While cause in historical processes is always linked to the past, expectation is linked to the future. It is for this reason we have made the typology historical and functional processes as linear. There is either a “line” from the past to a present situation (historical causal connections), or a “line” from the future (expectation) to the present situation (functional causal connections). In literature, functional causal connections are denoted as teleological, since they are linked to future goals for the person or the system (Radcliffe-Brown, 1952; Malinowski, 1954; Merton, 1957; Nagel, 1977). Examples of functional connections are: to look for someone's motive is potentially of a functional type. What motive relative to his action did per have? But here we should realise that the motive can also be linked to an historical event, i.e. an historical social mechanisms is in operation, not an expectation mechanism. If we not clarify which causal connection is in operation, explanation appearing at a subsequent level might be misleading. A more obvious example of a functional context, is questions related to future goals on the part of the system. For example: what is the professor's goal regarding student guidance? What goals is the company trying to reach? What is Knut's object of drinking? Take a closer look at the last question? The reply or the replies would provide a completely different type of insight than if it had been: what is the cause of Knut drinking? The latter question brings to mind a historical causal connection and limits solution proposals to involve search for events in the past which could prove helpful in future treatment. The first question, on the other hand, brings to mind an expectation mechanism, and a potential treatment will then be different from what it would have been, if the second question had not been asked. That both causal connections should be used in relation to the problem in question and other problems, is today seen as a foregone conclusion. But in other areas that is not necessarily the case.

Cybernetic causal processes

Circular causal models are relatively new in a research context and can be traced back to the 1940s. Cybernetics in Figure 1 is linked to feedback processes (Rosenblueth et al., 1943). Some examples would explain this. People raise their children, but children also raise their parents. The working environment affects productivity, but productivity also affects the working environment. Teachers influence their students, but students also influence their teachers. Advertising influences consumers, but consumers also influence the lay-out of advertising. The leader influences the employees, but the employees also influence the behaviour of the leader. Aggressive behaviour leads to deprecatory attitudes, enforcing aggressive behaviour. The means affect the end, but the end also affects the means, etc.

The question linked to cybernetic processes is of the following type: what sustains an act, behaviour, etc.? The answer, at a general level, is that it is the feed-back mechanism which sustains the act, behaviour, etc. At a concrete and practical level it is important to find out what this feed-back mechanism consists of. Its existence in social systems is a universally acknowledged fact (Ashby, 1961, 1970, 1981). What the researcher must do is to reveal the identity of the critical feed-back mechanisms in systems and situations which we want to make comments on.

Circular processes are characterised by feedback loops. We can distinguish between two main types of feed-back. It is the ones which have been developed to head towards a prearranged goal (negative feedback) (Nagel, 1956, 1961), and those which appear to inflate themselves, according to an accumulative principle (positive feedback) (Maruyama, 1963). A positive feedback mechanism has a tendency to destabilize social systems. The researcher must therefore disclose to what extent it is negative or positive feedback which dominates the social system subject to study. If we view the system on the basis of circular understanding, it is futile to look for one or more causes. It is how critical entities interact which becomes the interesting field of study, in order to explain the causal processes. If we in the study of a social system extracts one or more entities and denote them as cause, the entire explanation of system behaviour will take on a new meaning, compared to what it would if based on circular processes.

Pattern processes

Patterns is the most complex of the four explanation types in Figure 1. Patterns cannot be quantified for the simple reason that patterns are neither numbers, nor quantities, but are of a different and more elevated logical type than both number and quantity (Bateson, 1972, 1979). The case of mistaken identity which often occurs, is due to the fact that number and quantity form the basis for patterns, but they are not patterns. It is the disclosure of patterns which is interesting in this process, both because pattern disclosure precedes the development of social laws, but also because pattern disclosure reveals something about how the components and the complete structure of social systems relate to one another (Hanson, 1958). The question linked to this type of causal processes is: what is the pattern of which, e.g. system behaviour is part? A pattern is linked both to an historical causal process, to feed-back mechanisms, in addition to expectation mechanisms. One example might provide conducive to the understanding of patterns. If person A has a relationship to person B, a change in expectations which, e.g. person B has regarding his future position, career, etc. might cause person A to change his behaviour toward B instantly. Another example is the communication pattern of a family. If a family conflict is headed towards an emotional breaking point, the emergence of a specific pattern according to which communication will adhere, will be evident fairly soon. Firstly, the instant feedback mechanisms will be in operation, i.e. the particular behaviour (smiling, shake of head, clearing one's throat, etc.) could easily reinforce a negative pattern, in the same way as taciturnity might generate explosive behaviour. Secondly, expectations of a future happening, not necessarily related to the conflict in question, might be introduced as an argument in the conflict. Thirdly historical events, possibly dating a long time back, might easily be brought into the conflict, despite their lack of relevancy to the situation at hand. The result is that with a great degree of certainty, a positive feedback mechanism will be in operation, and the conflict will get out of control, with the subsequent well known solution mechanisms. If we, in the imagined capacity of family researcher, ask the question: what is the cause of this conflict getting out of control?, the answers are likely to display a certain inclination towards historical causal explanations, whereas entirely different mechanisms were really the ones in operation.

Pattern is the synthesis of the three other causal connections. But this is also crucial for the understanding of patterns, the synthesis possibly being different from the sum of the other three causal connections. Sometimes the synthesis can be more than the sum of the other three causal contexts. On other occasions the synthesis may be less than the sum of the other three causal connections. On some rare occasions the synthesis can equal the sum of the three other causal contexts. Patterns are, on the basis of the above discussion, a causal process qualitatively different from the other three, where the word qualitatively is the main point.

The four causal processes are not reciprocally preclusive, but have to be regarded as complementary if we are to understand and explain institutional change in social systems. All types should be used in the study of institutional change, but preferably questions adequate to each of them. Only in this way will our explanations be sufficient.

Part II: towards an analytical model to explain institutional change

The purpose of Part II is to explain institutional change with the help of the four perspectives developed in Part I of the paper.

The new institutional theory has two developmental features. One is from neo-classical economic thinking. The other school is the Austrian school, in particular Hayek (Langlois, 1989, pp. 291-294). The concept of new institutional economy, also called the new theory about organizations, was first used about Williamson (1975). After that important names in this perspective are: Coase, North, Furubotn, Richter, etc. Both Ludvik von Mises and Fredrick Hayek, both part of the Austrian school, provided basic points of view regarding the impact of institutions on performance.

In the new institutional economy the individual is in focus. It is the objective, taste, ideas, purpose, behaviour, etc. of the individual, which constitutes the basis for the new institutional economy, and as an explanatory factor for performance in social systems.

This point of view is in complete accordance with the main features of the Austrian school. Inherent in the extension of a new economy is that all systems seek to maximise their own benefit within the framework they operate in. It is further assumed that preferences on the part of individuals change over a period of time (North, 1990). A consequence of changing preferences is that expectations and mental models to be used for the purpose of self-orientation also change. Individuals are expected not to be perfect as rational actors, even if they may have intentions of being rational.

Information and communication costs (info-structure costs) will be too massive for necessary knowledge about a complex phenomenon/problem to be acquired. Therefore, the behaviour of the individual is surrounded by ambiguity. Ambiguity can be reduced by means of information, but can be clarified by means of communication. Therefore, info-structure costs will be a determining factor for interaction among people.

In a new institutional economy proprietary rights are assumed to have a major impact on performance in social systems. In the extension of proprietary rights contracts play a major part (Coleman, 1991). The political framework has a direct impact on the development of proprietary rights and the conflict system balancing the latter in the social room. The political framework also has an impact on the development of laws, rules and their interpretation, in addition to systems for the enforcement of laws and regulations.

The new institutional economy is concerned about the rules of the game (institutions and the individuals controlled by these formal and informal rules (Furubotn and Richter, 1998, p. 7). This means that there are not just historical links and the political framework which determines performance in social systems seen form a new institutional perspective, but also the organisation of stability and change in social systems.

Institutional theory, as opposed to, e.g. contingency theory, resource-based theory and transaction cost theory contribute to emphasising the cultural factor in order to understand and explain activities. Institutions can be defined as: “formal and informal rules that constrain individual behaviour and shape human interaction” (Eggertson, 1996). Informal rules can be constituted by laws, contracts, deals, etc.

Explaining institutional change: a historical perspective

As shown in Part I the historical perspective emphasize linear causal relations.

Institutional analyses also have the focus on how institutions influence performance. We study performance and change in systems from an institutional perspective, the historical context is decisive, because historical links influence the organisation and thus performance. It is this very interaction between institutions and organisation that will influence performance and changes in social systems as noted by North (1996, p. 345). Institutions are constituted by formal and informal rules. Formal rules can, e.g. be the laws and regulatory mechanisms. Informal rules can, e.g. be norms and values in a social system.

Historical links can be used to understand change processes in the economic partial system. The economic partial system does not operate in a vacuum. Its historical bindings can therefore be used to understand relations between the various partial systems constituting the fabric of a social system, i.e. economic, social, cultural, and political partial systems. This type of context has been shown by North (1968), who points out that when relative prices are changed, this is an indication of technological changes.

One of Joseph Schumpeter's argument was that economic history was the most important basis for economic understanding (Fogel, 1997). One insight into economic history is that institutional factors impact the diffusion of technology (North, 1994). Kuznets (1966) further contends that a change in norms and values promotes mobility and thus influences economic processes. The culture or basic ideology of a society has a tremendous impact on how quickly and efficiently new technology is put to use (North, 1990). North's historical “law” can be expressed as institutions influencing performance. This “law” can be used in many contexts to explain various performances between different systems. This does not mean that social systems are historically determined, but that the links of history set limits for the performance of social systems.

The most typical historical links are technological and institutional (Arthur, 1989). Systems and individuals are literally locked in and stigmatised by historical events, for better or worse. There are various conceptions regarding the importance of technological versus institutional attachments in regard to change, stability, and performance. North (1981, 1990), North and Davis (1971) and North and Thomas (1973) emphasise the importance of institutions. Institutions and technology both influence transaction costs and transformation costs, which in turn influence the performance of the system. In order to create change, then one can change each of the abovementioned elements, i.e. institutions, technology, transaction costs, transformation costs and performance.

Even if stability is a necessary condition for complex human interaction (North, 1990, p. 84), then change is a necessary condition for stability (Bateson, 1972). From an economic perspective change in relative prices is the most important social mechanisms for change everywhere (North, 1981; North and Thomas, 1973). The action rule to be extracted from this intention is the following one: in order for changes in social systems to be uncovered, changes in relative prices should be looked for. For example, relative prices of: land and work, work and technology, work and capital, technology and competence, competence and creativity, innovation and geographical location.

Changes in relative prices influence the political development, cultural development and as well as changes in the interaction system. In addition to individual actors, innovators and entrepreneurs, etc. will be strongly influenced by changes in relative prices.

Historical links are often reinforced as a result of the success or penetration of, e.g. technology influencing a system. When technology is used continuous improvements of the technology are developed, serving to link the individual more strongly to this very type of technology. The inherent force of habit attaches the technology to the user, even if other technologies could generate higher performance. Habits, learning and the use of technology in other systems cause it to have an uncontested position in relation to other competing technologies.

Explaining institutional change: a cybernetic perspective

As shown in Part I the cybernetic perspective emphasize feedback processes. We will explain institutional change by this perspective with the focus upon the two constructs: transaction costs and transformation costs.

Transaction costs are here understood as: “the costs of measuring agreements” (North, 1997, p. 9). Williamson (1996, p. 8) says that the transaction perspective is: “the combination of rational spirit, with a system perspective”.

Transformation costs can be linked to costs relative to matter/energy in and between systems (Miller, 1978). Transaction costs can be linked to information functions with Miller (1978). The assumptions behind transaction and transformation costs are limited rationality, i.e. intended rational, but limited so (Simon, 1961) and opportunism (Williamson, 1996, p. 10).

Transaction costs appear in connection with exchange of information, or information linked to the exchange process. The size of and the distribution of these costs influences the organisation of economic activities, among other things. It is not only institutions that will influence transaction costs, but also the technology surrounding the system. A transaction: “occurs when a good or service is transferred across technologically separable interface” (Williamson, 1975, p. 1). Where an activity is completed and a new starts a transaction thus takes place. This definition does not distinguish between transformation costs and transaction costs. The distinction has however been made by us, since in our opinion it creates more analytical understanding and depth of explanation in the transition from the industrial economy logic to the knowledge economy logic, and can help us explain institutional changes. For analytical reasons we will therefore distinguish between transaction costs and transformation costs in the following way: a transaction takes place when information is passed on from one information process to another information process in, or between systems, in such a way that an activity is completed and a new one starts. This transaction incurs an expense for social systems, referred to as transaction cost.

This understanding is a slight extension of Williamson's transaction theory, which makes it analytically easier to understand and explain the development of organisations and institutions in the knowledge economy. We find support for this interpretation with Miller and Vollman (1985), among others.

Already Smith (1776) in his pin example treated transactions and transformations. Adam Smith points out that it takes X number of transaction and transformations in order to complete the entire process of manufacturing a pin. In Adam Smith's example there is great similarity between transactions, transformations and the division of work internally in the company. Both transactions and transformations can be economic, political, social and cultural. Economic transactions and transformations make up just a small part of actions in social systems. In the new institutional economy it is political and economic transactions as well as transformations which are focused on. Social and cultural transactions are not so usual, but even more important viewed from a performance perspective, or a institutional change perspective.

Transaction and transformation costs can be linked to the establishment, maintenance, and change of economic, political, social and cultural activities in social systems.

Various types of transaction and transformations within the economic area are costs linked to the establishment, maintenance and change of economic operations internally in systems and between the system and the environment, e.g. expectation, incentives and market transactions.

Various types of transactions and transformations within the political field are costs linked to the establishment, maintenance and change of power internally in systems or between the system and the environment, e.g. mental models, ideology, proprietary rights and judical system.

Various types of transactions and transformations within the social field are costs linked to establishing, maintaining and changing social relations internally in systems and between the system and the environment, e.g. creativity, competence and innovation.

Various types of transactions and transformations within the cultural field are costs linked to establishing, maintaining and changing values and norms internally in systems and between the system and the environment, e.g. behaviour and values.

For Coase (1988, p. 19) the starting point for transaction cost thinking was to what extent operations should be self-sufficient in terms of functions or buy functions from the market. In this way boundaries for operations in the business could be stipulated in the following way: when transaction costs linked to carrying out operations yourself exceeds the costs of buying operations form the market, then operations should be outsourced.

In the political partial system resistance and opportunistic behaviour may ensue when transaction costs and transformation costs are changed. In the cultural partial system creative tension is released during changes in transactions and transformation costs.

In social partial systems, relational strain will be released in the event of changes in transaction costs or transformation costs. In the economic system a conflict may easily ensue when transaction and transformation costs are changed. Transaction costs and transformation costs in this way influence the organizing of social systems.

The negative social consequences of organizing, leads to what can be described as organizing costs. Transaction and transformation costs then influence both performance and organizing (Kreps, 1990).

Explaining institutional change: a functional perspective

As shown in Part I the functional perspective emphasize expectation mechanisms.

Institutions in this way will limit people's interactions, and structure their relations and thus a lot of the communication (North, 1996, p. 344). Both formal and informal rules exist due to their being accepted as a totality of the social system in which it operates. Both formal and informal rules are maintained by means of cognitive normative expectations. Cognitive expectations are not costly to change in psychological terms. They are less value-oriented. Normative expectations on the other hand are value-oriented, they are taken into consideration and influence behaviour at an unexpressed level. This is the realm of concealed influences, but with major social consequences if observed. Institutions stipulate limitations for the realms of possibility in the interaction between people. In this way institutions influence the possibilities for change and the performance of systems. If the possibility realm is changed, e.g. by changing the possibilities for relations between people, systems will change as a result of relations changing.

While institutions can be understood as the rules of the game, organisations can be seen as a relations between the players (North, 1997, p. 9). An institution can also be understood as any thought and action system, formally or informally, as framing interactions between people (North, 1990, p. 4).

Thought and action structures framing the interaction among people are linked to common norms and values, relations existing among persons, in addition to the mutual relations existing in the interactions. Thought and action structures influence the direction of competence development, which in turn will influence long-term development of social systems (North, 1990, p. 78)

Expectations can be driven by two main groups of functions: cognitive expectations and normative expectations. Cognitive factors can be, e.g. preferences linked do personal interests which can be expressed in laws and rules. Normative factors can, e.g. be group norms, culture, ideology, integrity rumour, etc.

When cognitive expectations or normative expectations are emphasised, this depends on the situation and the context. Norms can, e.g. change as a consequence of the cognitive openness on the part of the system. Therefore, the degree of normative closeness and cognitive openness is an explanatory factor explaining institutional changes.

The degree of normative closeness and cognitive openness can provide guidance on how to understand the environment, how to explain the environment, and how to act in relation to the environment. Cognitive and normative expectations are therefore important to clarify.

Expectations are changed during the course of time. It can start with marginal changes, to be followed by giant leaps. Expectations with the highest degree of durability are the normative ones, and particularly the ones integrated into one's own habits. Habits are reinforced by routines, rules, traditions and conventions.

Explaining institutional change: a pattern perspective

As shown in Part I the pattern perspective emphasize the question: what is the pattern in which the behaviour take part?

It is not in fact so that the best technology will gain ground, or that competition will always further performance or lead up to the best choice. Human habits or the pattern of habits creates a historically-based preference for some technologies and some situations. In this way our expectations are adjusted in relation to our habits. If this is correct, i.e. that our habits to some extent determines our use of technology, they will also be determining for the change of social systems. From the opposite perspective it could be argued that the more influence someone has on one's habits, the stronger is their normative power.

While rules can be changed quickly habits will be slower to change. Habits therefore, influence systems longer than new rules introduced in order exactly to change habits and norms. If norms are to be changed, intervention must be made at a higher level than rules, which here means to change habits. If relations among people are to be changed, this can be achieved by changing the rules that regulate the game. If lasting changes manifesting themselves in increased performance are wanted, then it is not the rules that should be changed but the habits that should be checked and changed.

Our thought and action structures can be maintained despite being unproductive, since our habits and historical attachments maintain and reinforce ways of being which obviously are not optimal. Historical attachments mean that the past has a decisive influence on our way of being here and now. These attachments also influence how changes in the environment are interpreted and what actions the individual actor will perform. Actions performed by the individual will also influence the development of stability and change in social systems. Historical attachments then influence us in relation to how we relate to technological changes, models used, and ideas and ideologies adopted by us, i.e. our pattern of behaviour.

Our thought and action structures are our constructs. They are invisible, but generate visible social consequences, through our pattern of behaviour. In this way they are of crucial importance in our attempt to change institutions and the performance in social systems.

Our thought and action patterns also influence the development of change processes in social systems. On the other hand social systems influence our institutions. This interactive (circular) understanding of change is important to gain insight into the reciprocal nature between institutions and social systems. How actors in social systems understand the thought and action room, also influences the maintenance and change of the corresponding social systems. How actors conceive of something depends on the social system they are part of. The various networks will interpret information about the environment differently. This is explained on the basis of historical factors, histories and narratives related in the network, and the entities stressed or toned down by the network. These mental models constitute both historical attachments and the various expectations in existence, our pattern of behaviour, and thus influencing and changing institutions.

Our mental models constitute our thought and action patterns. Mental processes are constituted, maintained and changed as a result of visions, i.e. the patterns of expectations we have for the future. Our visions are maintained and changed through complex interactions. Some of the important factors are however to what extent the pattern of expectations are fulfilled or not over a period of time. If expectations are not met over a period of time, the expectation mechanism will collapse. New expectations are established, which in turn will influence the vision and mental models, then being integrated in thought and action patterns, i.e. they are institutionalised, and constitute our pattern of behaviour.

Expectations can be regarded from two categories: normative and cognitive expectations. The first one is more difficult than the other, but both influence each other. The pattern of expectations is constituted by the subjective conception of the environment on the part of each individual. Persons then select something, thereby discarding something else in the environment, when the pattern of expectation is constituted (North, 1990, pp. 22-27). In addition to this, people's preferences over a period of time will change, which in turn will have impact on what we select and what we discard from the environment, which constitutes change.

The complexity of the environment, its pace of change, also effects change in our expectations. This comes in addition to limitations each of us has to internalise and analyse existing information.

On the basis of the discussion we will make the analytical model visible as an explanation for institutional changes being developed through this paper in Figure 2.

Conclusion

In the conclusion we will look at institutional changes in the economic partial system. We will here develop a conceptual model explaining institutional changes in the economic system (Figure 3). The conceptual model is at a lower abstraction level than an analytical model, developed in Part II of the paper.

As a superior explanation factor for the economic system we can say that expanding markets lead to increased specialisation and division of work. That will in turn influence both the cognitive and normative expectations, due, among other things, to the development of new habits, new norms, new rules and new relations. This change then brings about institutional changes, which in turn will effect a direction toward new historical attachments. Specialisation leads, among other things, to continuous changes and innovation. Productivity will increase and further division of work will continue, both in the individual system and between the individual systems. The increased division of work then leads to the development of coordination and integration. These functions indicate that a relatively larger part of the system's resources is spent on information processing, i.e. on developing the administrative apparatus. Further, specialisation and division of work pertaining to the coordination and integration function will generate a hierarchical development of systems. Both functional hierarchies and hierarchies based on symbolic distinctions are developed. These hierarchies are based on symbolic distinctions being developed. These hierarchies are then linked geographically, so that systems over a period of time will interact with each other at an increasingly higher level of structural links. In their economic consequences this leads to the development of clusters.

To handle the degree of cognitive and normative closed/open attitude, requires a focus on costs of information exchange, i.e. transaction costs, since the degree of openness versus closeness has just been linked to the boundaries of the system, and it is at the boundaries that these costs are generated. These costs increases or hinder further participation in expanding markets. Transaction costs will also influence to what extent the free market will continue to expand or not, since the alternative to the market will be other market forms. This in turn will influence the further development of specialisation and division of work.

Transaction costs are decreased among other things through innovations, both technological and organisational innovations. When transaction costs are reduced, it promotes the development of expanding markets. Innovation becomes a mechanism, which during certain historical epochs will lead to economic partial systems taking new steps towards value creation, often through creative destructions. Innovation is carried out in the economic partial system, due to the inclination to achieve an innovation price at a higher level than the monopoly price. This innovation price then leads to a systematic and strategic input of new innovations to the existing market, in order to reap the innovation profit, which is higher than the monopoly profit. The market will therefore change through the continuous use of strategically marketed innovations and lead to a continuous loss of control with regards to the equilibrium of the market. After some time entrepreneurs will fill up the market with innovations generating innovation price and move the market towards equilibrium. Owing to continuous innovation, propelled by the desire for innovation profit, the equilibrium will be disturbed and imbalance will be the normal situation in the market. The reason is quite simply the intention of continuously to reap the innovation profit of the market.

When the political system tries to prevent the development of monopolies, cartels, trust formations, then the economic system will expand to a higher level of abstraction, and introduce a strategy to achieve an innovation price, which at any time will be higher than the monopoly price. Economic institutional changes will be based on this understanding have precedence over changes in political, cultural and social institutions.

Figure 1Types of causal processes

Figure 2The analytical model for explaining institutional change

Figure 3Explaining institutional change in the economic system

References

Arthur, B. (1989), "Completing technologies, increasing returns and lock in by historical events", Economic Journal, Vol. 99 pp.116-31.