Economic Institutions as Social Constructions: A Framework for AnalysisAuthor(s): Mark GranovetterSource: Acta Sociologica, Vol. 35, No. 1 (1992), pp. 3-11Published by: Sage Publications, Ltd.Stable URL: http://www.jstor.org/stable/4194749 .Accessed: 19/08/2011 15:21

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Acta Sociologica (1992) 35:3-11

Economic Institutions as Social Constructions: A Framework for

Analysis Mark Granovetter

Department of Sociology-, State University of New York at Stony Brook

Institutional economics has moved from a position, earlier in the twentieth century, of drawing eclectically on several other disciplines, to a stance of building its arguments almost entirely out of neoclassical materials. This paper argues that such a stance cannot provide a persuasive account of economic institutions, and suggests a broader foundation based on classical sociological arguments about the embeddedness of economic goals and activities in socially oriented goals and structures. Emphasis is placed on how economic activity comes to be coordinated by groups of people rather than carried out by isolated individuals. Firms in developing countries, business groups, and the origins of the electrical utility industry in the United States are posed as cases of the 'social construction of economic institutions'. It is argued that, although proper analysis of such cases involves a high level of contingency, these contingencies can be taken into account in a systematic theoretical argument, and that historicist pitfalls can be avoided. Such an argument is posed as the distinctive agenda for a new economic sociology.

Mark Granovetter, Department of Sociology, State University of New York at Stony Brook, Stony Brook, NY 11794-4356, USA.

1. Introduction: the new economic sociology

The discipline of economics has seen two strong and, at first glance, mutually incon- sistent trends over the past twenty years: a return to dominance by the pure neo- classical tradition, after a period of con- tention with competing paradigms, and an attempt by economists to greatly broaden their subject matter. This odd, simul- taneous narrowing and broadening of per- spective has resulted from the virtual demise of institutional economics in its mid- century form.

Earlier contention had resulted from the inability of the neoclassical synthesis to explain the broad institutional framework within which economic transactions take place. The resulting theoretical vacuum was filled by 'institutionalist' economics, whose explanations drew on historical, political,

?) Scandinavian Sociological Association, 1992

sociological and legal factors, with minimal use of formal economic reasoning. Such widely followed American figures as T horstein Veblen, John Commons, Wesley Clair Mitchell and John Dunlop often seemed as closely allied to other disciplines as to economics.

A broad counterattack began in the 1960s, spearheaded by Gary Becker, later joined by many of the best and brightest mathematical economists. They inventively applied rigorous neoclassical arguments to problems previously abandoned to the insti- tutionalists. The expansion of educational institutions, long considered a cultural phenomenon, was declared the outcome of rational individuals investing in their own capacities (Becker (1964), followed by a vast outpouring of literature on 'human capital'. See the critical review in Blaug (1976)). Rigid wages and long tenures in internal labor markets were attributed not to social pressures or a 'new industrial feu- dalism' (a metaphor common in 1950s labor

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economics), but to 'implicit contracts' opti- mally structured by rational employers and employees faced with otherwise difficult problems of shirking and bad faith. (See the extended discussion in Granovetter (1988)). Huge wage discrepancies between categories of workers resulted not from restrictions on entry based on differences in group power, but from optimal arrange- ments for distributing talent in society (e.g. Rosen 1982). Vertical integration occurred not because of the suppliers' 'conspiracy against the public' denounced by Adam Smith, but as an arrangement to reduce transaction costs in markets where business had become too complex to conduct between independent units (see especially Williamson (1975, 1985)).

This 'New Institutional Economics'- dis- tinguished from the old by its reliance on arguments for the economic efficiency of observed institutions - was closely allied to the 'New Economic History', which made similar claims for historical settings. Prop- erty rights, enclosures, and all manner of political and legal institutions came to be interpreted as the efficient outcome of rational individuals pursuing their self- interest (e.g. North & Thomas 1973; Ran- som & Sutch 1982). And these new inter- pretations were applied even to spheres far from economists' traditional domain, such as the family, crime, altruism and animal behavior (e.g. Becker 1976, 1981). Rep- resentative of the claims of this optimistic new school is Jack Hirshleifer's comment, in a 1985 article entitled 'The Expanding Domain of Economics', that 'economics really does constitute the universal gram- mar of social science' (p. 53).

One unifying theme of my current work is that the new economic imperialism attempts to erect an enormous super- structure on a narrow and fragile base. A more solid foundation can be constructed on the basis of three classic sociological assumptions: (1) the pursuit of economic goals is normally accompanied by that of such non-economic ones as sociability, approval, status and power; (2) economic action (like all action) is socially situated, and cannot be explained by individual motives alone; it is embedded in ongoing networks of personal relations rather than

carried out by atomized actors (for an earlier programmatic statement see Grano- vetter (1985)); (3) economic institutions (like all institutions) do not arise auto- matically in some form made inevitable by external circumstances, but are 'socially constructed' (Berger & Luckmann 1966).

The extreme version of methodological individualism that dominates much of mod- ern economics makes it difficult to recog- nize how economic action is constrained and shaped by the structures of social relations in which all real economic actors are embedded. Economists who want to reform the discipline typically attack its psychology - proposing a more realistic model of decision-making (see, e.g., Lei- benstein 1976). While the psychology in neoclassical models may well be naive, I claim that the main difficulty lies elsewhere: in the neglect of social structure. Psy- chological revisionism has a following in part because it does not require economists to give up the assumption of atomized actors making decisions in isolation from broader social influences.

Mid-century economic sociology oper- ated at the fringes of economic activity, ceding the central topics of production, dis- tribution and consumption to economists. The more recent generation of economic sociologists, who constitute what I call the 'New Economic Sociology', have looked much more at core economic institutions, and are closer to such intellectual forebears as Emile Durkheim and Max Weber - who regarded economic action as a subordinate and special case of social action - than to the accommodationist stance of mid-cen- tury sociologists. I

An important part of this focus is a socio- logical theory of the construction of econ- omic institutions. Such a theory must make dynamics central, in contrast to most neo- classical economic work on institutions which (like many branches of economics) emphasizes the comparative statics of equi- librium states. Without explicit dynamic argument, we have the irony that econom- ics, despite its devotion to methodological individualism, finds itself with no ready way to explain institutions as the outgrowth of individual action, and so falls back to accounts based on gross features of the

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environment. There are two such main accounts: culturalism and functionalism.

Culturalist accounts explain economic institutions as arising from cultural beliefs that predispose a group to the observed behavior, as in the claim that the stress in Japanese culture on 'organic' unity and hierarchical loyalty produces trouble-free industrial organization. Functionalist accounts argue backwards from the charac- teristics of institutions to the reason why they must be present. Andrew Schotter, in his Economic Theory of Social Institutions (1981) states this principle in unusually can- did (and a sociologist might add, pre-Mer- tonian) form - that to understand any social institution requires us to 'infer the evol- utionary problem that must have existed for the institution as we see it to have devel- oped. Every evolutionary economic prob- lem requires a social institution to solve it' (p. 2). This implicitly assumes a system in equilibrium, since a still-evolving insti- tution might not reveal by inspection what problem it had evolved to solve. These highly elliptical and often tautological cul- turalist and functionalist accounts become superfluous once the social construction of institutions is properly understood.

But it is not enough merely to chip away at the insufficiencies of neoclassical econ- omics. A theoretically persuasive economic sociology must also provide an attractive alternative that improves upon the explana- tory power and predictive ability of existing accounts. Though I argue repeatedly against the reductionist methodological individualism of modern economics, I have no taste for the historicist views of some of its other opponents, who suppose that every case is unique and anything can happen. I stress the contingencies associated with historical background, social structure and collective action, and the constraints imposed by already existing institutions; but my aim is still that of finding general principles, correct for all times and places. This requires that the contingencies them- selves be systematically explored and incor- porated into the theoretical structure. It also requires us to understand under what circumstances economic institutions are malleable by the forces of social structure and collective action, or 'locked in' in such a

way that these forces are mainly irrelevant. Finally, and closely related to this last issue, a sophisticated economic sociology will neither throw the valuable corpus of econ- omic reasoning out the window, nor be so seduced by it as to produce a 'rational choice' argument that loses touch with the classic sociological tradition; rather, it will seek to understand how modern economics can be integrated with a social con- structionist account of economic insti- tutions, and what the division of labor must therefore be between sociology and econ- omics.

2. Over- and undersocialized conceptions of human action

Before discussing institutions as such, I want to make some general comments on conceptions of human action. I begin by referring to Dennis Wrong's (1961) article 'The Oversocialized Conception of Man in Modem Sociology'. Wrong complained that sociologists saw people as so sensitive to the opinions of others that they auto- matically obeyed commonly held norms for behavior. This 'oversocialized' view resulted from an attempt to compensate for the neglect of social effects in (what Talcott Parsons (1937) called) the utilitarian tradition, whose view of economic action I would call 'undersocialized'. (For a fuller account of this distinction, see Granovetter (1985)). As Albert Hirschman (1982) has pointed out, in classical and neoclassical economics, traders in competitive markets are price-takers and thus interchangeable. The details of their social relations are irrel- evant.

The classical economists thus treated these relations only as a drag on perfect competition. In a famous line from The Wealth of Nations, Adam Smith denounced the use of social occasions by traders to fix prices. Implicitly he recognized that his image of competitive markets was incon- sistent with a world where economic actors knew one another personally well enough to collude. In recent years, a different tend- ency has emerged in economists' treatment of social influences: that is to take them

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seriously but in terms close to Dennis Wrong's 'overocialized' conception: e.g. James Duesenberry's (1960) quip that 'economics is all about how people make choices; sociology is all about how they don't have any choices to make', or E. H. Phelps-Brown's description of the 'soci- ologists' approach to pay determination' as assuming that people act in 'certain ways because to do so is customary, or an obli- gation, or the "natural thing to do", or right and proper, or just and fair' (1977).

This conception of 'social influences' is oversocialized because it assumes that people follow customs, habits or norms automatically and unconditionally; nearly all economists' treatment of 'norms' has this flavor, and discussions of 'conventions' also run the risk of sliding into an over- socialized treatment. But this points to an irony of great theoretical importance: the oversocialized approach has in common with the undersocialized a conception of action uninfluenced by peoples' existing social relations.

In the undersocialized account this atom- ization results from the narrow pursuit of self-interest; in the oversocialized one - which originated as a corrective to the undersocialized one - atomization results nevertheless because behavioral patterns are treated as having been internalized and thus unaffected by ongoing social relations.

This surprising convergence of under and over-socialized views helps explain why economists who try to incorporate social influences on economic action fall so easily into oversocialized arguments. Thus it is common to attribute distinctive styles of decision-making to members of different social classes, as the result either of class cultures or of each class's distinctive experi- ence in the eductional system (cf. Piore 1975; Bowles & Gintis 1982). But this con- ception of how society influences individual economic action is too mechanical: once we know someone's social class, everything else in his behavior is automatic, since he is so well socialized - I would say 'over- socialized'. Thus, I attempt in my work to thread my way between under and over- socialized views, by analyzing how behavior is embedded in concrete, ongoing systems of social relations.

3. The social construction of economic institutions

I now proceed to discuss the impact of this 'embeddedness' on the social construction of economic institutions by focusing on a problem traditionally given little attention in economic theory: how and why economic activities are carried out not by isolated individuals, but by groups that entre- preneurs get to cooperate in such larger entities as firms, industries and inter-indus- try groups. In other words, I recast the problem of economic institutions as one involving the mobilization of resources for collective action, which opens it up to a whole stream of thought in sociology and political science previously considered irrel- evant.

Following Schumpeter (1926), one may call those who coordinate the economic activity of otherwise separate individuals, 'entrepreneurs'. But the neoclassical theory of the firm ignores the entrepreneur because, as William Baumol points out, its model 'is essentially an instrument of optimality analysis of well-defined prob- lems, and it is precisely such. . . problems which need no entrepreneur for their solu- tion' (1968:67). This comment suggests that the emphasis in economic theory on the comparative analysis of equilibrium states discourages attention to entrepreneurship, which can best be thought of as involving situations where markets are out of equilibrium.2 Related to the failure to pro- vide dynamics is the tendency to abstract away from institutions on the grounds that opportunities for profit will automatically be taken; if there are institutional or other barriers to the taking of such profit, these will be breached, and since one can count on this taking place, the actual process by which it occurs is not of much theoretical interest. Correspondingly, institutions that encourage or discourage entrepreneur- ship are neglected since it is assumed that it will emerge if there are profits to be made. 3

This helps explain the remarkable fact that in the recently burgeoning economic literature on why firms exist, exemplified by Oliver Williamson's work on 'trans- action cost economics' (1975, 1985), entre-

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preneurs still make no appearance and how firms come to exist receives no attention. Instead, it is assumed that firms emerge when needed to reduce transaction costs. In the functionalist style of the New Insti- tutional Economics, this emergence is taken to be automatic.

But economic institutions do not emerge automatically in response to economic needs. Rather, they are constructed by indi- viduals whose action is both facilitated and constrained by the structure and resources available in social networks in which they are embedded. We can see this in many accounts from developing countries where firms would greatly reduce transactions costs but cannot be constructed. What are the difficulties?

Traditional development theory took a dim view of social structures where econ- omic activity was embedded in non-econ- omic obligations, supposing that this would prevent efficient operations. But where this embedding is in fact absent, and many indi- viduals appear to be rational profit max- imizers - approximating the 'under- socialized' model of human action I have described above - economic activity is often stymied by lack of the interpersonal trust required to delegate authority or resources to others (see, e.g., Dewey 1962; Geertz 1963; Davis 1973; D. Szanton 1971). But if such problems of trust are overcome, the problem forecast by traditional theories does indeed come to pass: the fledgling firm is often swamped by the claims of friends and relatives for favors and support. As one abdicated king in Bali told anthropologist Clifford Geertz, firms 'turn into relief organizations rather than businesses' (1963:123). That is, the welfare of the local community is put ahead of that of the busi- ness as such.

Certain groups, however, such as the overseas Chinese in Southeast Asia, con- sistently overcome both problems. Trust is available because the community is so close-knit that malfeasance is not only dif- ficult to conceal or execute, but often even hard to imagine. Many accounts thus indi- cate that Chinese businesses extend credit, pool capital and delegate authority without fear of default or deceit. How, then, do the businesses avoid the second problem, that

of excessive claims based on non-economic ties?

Part of the answer is that overseas Chinese are typically a small minority, and there are simply not enough of them for such claims to cause trouble. But the organ- ization of social networks also limits claims, because people belong to non-overlapping groups. Kinship is so clearcut that the num- ber of relatives with credible claims on a business is small and well-defined. People also divide into groups based on recency of immigration and on home area in China. Particular businesses are organized along such kinship and organizational lines, and it is thus sharply defined which individuals can make claims. By contrast, most non- Chinese Southeast Asian kinship patterns are more diffuse, so it is hard to limit the number of relatives with legitimate claims; and people typically belong to many over- lapping interest groups, so that if one is the core of a business, its members may still be subject to claims from fellow members of others (Geertz 1963; Dewey 1962; Davis 1973; Lim & Gosling 1983).

Briefly put, overseas Chinese social struc- ture has a pattern of coupling and dec- oupling that produces highly cohesive groups that are sharply delimited from one another; thus trust is available but non- economic claims are illegitimate beyond these group boundaries. These mechanisms of coupling and decoupling, that define the boundaries of trust and social affiliation, must become central matters for a theory of economic institutions. It would be a fair generalization to say that across such boundaries, economic actors may appear to act as if following the undersocialized model of action, and within them, as if oversocialized - following the dictates of the group. But this way of viewing the matter shows that the fundamental issue is not to get the right model of individual action, but rather to understand properly how variations in social structure create behavior that appears to follow one model or the other. The locus of explanation moves away from the isolated individual to a larger and more social frame of reference.

Following out this logic, note that the argument about Chinese firms implies that under some conditions, it is possible to use

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connections of family and friendship to dev- elop efficient firms. But one may suspect that the consequent overwhelming import- ance of trust in such firms drastically limits expansion even when it would be econ- omically rewarding. How can such a limi- tation be overcome? In many countries this occurs as the result of alliances of families into 'business groups'. This widespread phenomenon goes under many names: the old zaibatsu and their modem successors in Japan; the chaebol in Korea, the grupos economicos in Latin America, the 'twenty- two families' of Pakistan, and on and on.

Though there are analyses of such groups in particular countries and regions, we have so far no sustained analysis of the phenom- enon as a whole, and little realization that this is a central aspect of modem capitalism. The groups vary in size, structure and legal organization, and have originated in a num- ber of different ways. One dimension of variation, for example, is the extent to which these groups originated in a single family group which then extended its domain through acquisition or alliance, as in Japan and Korea, or in the coalescence of a number of strong family or other groups that began independently and later joined, as is more the case in Latin America. But whatever the origin and structure, it is com- mon for them to span a number of firms and industries, and to coordinate their investment and production decisions, often through a bank that is formed through and closely identified with the group. Such groups have a strong and sometimes dom- inating role in the economies and polities of their countries.

And despite the variations in history and structure, it is typical for such groups to be composed of participants who are, to quote one economist who has studied them, 'linked by relations of interpersonal trust, on the basis of a similar personal, ethnic or communal background' (Leff 1979:663). In some cases, tne network of personal relations that initially builds the group becomes formalized into institutional pat- terns such as holding companies as in Nica- ragua (Strachan 1979) or patterns of mutual stockholding as in Japan (Gerlach 1991). And then the shape of these institutions results more from the original structure of

personal relations than from the exigencies of the market - they are, in effect, con- gealed social networks.

Economists studying these groups in developing countries, interpret them as responses to market imperfections, arguing that they will vanish as more 'sophisticated' markets appear (e.g. Leff 1979). But when economists come upon them in advanced economies, as in Japan, Korea, France, West Germany and others, they either argue that they are vestigial and will fade - as used to be argued for Japan, though this is now increasingly implausible - or that they arise in just those economic cir- cumstances that make them efficient. The arguments for developing and developed economies alike are functionalist tauto- logies that avoid the central tasks of under- standing how such alliances can be constructed and why capitalist economies, despite their great differences, rarely con- sist of single, unrelated firms.

Just as for firms and business groups, I argue that whether and how an industry is organized is a social construction. I use the case of the electrical utility industry in the United States from 1880 to 1930.4 We want to explain why certain plausible alternatives to the private investor owned utilities now dominant in the United States did not occur: e.g. public ownership, or private generation of electric power by each home and large industrial company, which would have consigned utilities to a minor role.

We find a series of stages where the per- sonal networks of a few individuals were crucial. From 1880 to 1892, Thomas Edison mobilized his considerable personal fol- lowing, including substantial capital from the German Empire, in a bitter struggle to defeat banker J. P. Morgan's vision of an industry providing not electricity but gen- erators to homes and businesses to produce their own electricity on site - the kind of system that, in the United States, became conventional for home heating.

Edison had always preferred central sta- tions and though he was finally ousted from General Electric and the electricity industry by J. P. Morgan in 1892, the dominance of central stations was by then too entrenched for even Morgan to reverse. Note that Edi- son won this battle not because his solution

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was the technologically correct one, but rather because he was able to construct winning coalitions of key actors.

One of Edison's main assistants in this battle was his personal secretary, the Eng- lishman Samuel Insull. In 1892, Insull moved to Chicago to take over a small, new company, Chicago Edison, and brought with him a unique set of personal ties: to financiers in Chicago, New York and London, to local political leaders, and to inventors in both the United States and Britain. Many of these had been forged as the result of his long association with Edison. His combination of financial and technical expertise and political connec- tions allowed him to assemble capital, pol- itical favors and ways of operating that other utility companies had found impos- sible to implement, even though some were well aware of their potential. That is, his achievements were due to his political and entrepreneurial skills rather than to tech- nological or organizational innovations.

A close study of the way Insull organized Chicago Edison, with the help of his exten- sive connections and technical skills, shows that the structure of the entire industry derived from the initial organizational decisions in what would become the largest and most successful firm. Insull also shaped the industry by encouraging regulation by states (rather than by the federal or local governments) and by developing the hold- ing company form, that stabilized relations with local industry and with regulators. Soon, this network of firms, holding com- panies and regulators congealed. Personal networks still mattered, but only those of people central in the holding companies. By the 1920s, the institutional forms were in place, and the outcome that we now see in the industry was already visible.

4. Discussion In the case of the evolution of an industry, as for the development of firms and business groups, stable economic institutions begin as accretions of activity patterns around personal networks. Their structure reflects that of the networks, and even when those are no longer in place, the institutions take on a life of their own that limits the forms

future ones can take; they become 'locked in'.5 Thus, economic problems and tech- nology do not call forth organizational out- comes in some automatic and unconditional way. Instead, these economic conditions restrict what the possibilities are. Then, individual and collective action, channeled through existing personal networks, deter- mine which possibility actually occurs. So even in identical economic and technical conditions, outcomes may differ dra- matically if social structures are different. Where firms are, in some sense, 'called for' by market conditions, they still may not arise if no group's social structure can sus- tain them; inter-industry 'groups' may or may not arise in favorable economic con- ditions, depending on the structure of con- nections among important families; and industries may be configured in quite dif- ferent ways, depending on the shapes of the interpersonal networks of leading actors.

There is thus, in this argument, a high level of contingency in the outcomes. This resembles situations in economic dynamics that are characterized by multiple stable equilibrium points. Indeed, I believe that a social constructionist account can help make such dynamic economic models of institutions more sophisticated. These models are frustrating because there is little substantive way to resolve their under- determination. As in physical cases with multiple equilibria, you can understand which state the system has reached only by looking at its history. But the contingencies involved in this history are typically outside the economic framework, and thus seem ad hoc and unsatisfying to economists; within a sociological framework, however, they can be given systematic treatment.

Notice that such multiple equilibrium models, even if underdetermined, are far from the historicist argument that every case is unique and anything is possible. In all my cases there are only a few major possibilities. In the case of electric utilities, for example, we see, in effect, three poss- ible system equilibria - public ownership, private decentralized generation of power, or privately held utilities. What we argue is even given the constraints of the particular political, technical and economic parameters in place in late 19th century

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America, other outcomes were unlikely, but any of these three might have occurred. Individual and collective action, channeled through existing networks of personal and political relations, determined which possi- bility actually did occur.

An important part of general arguments about such matters would be to characterize those circumstances under which there indeed are multiple equilibria, and net- works of collective action may determine outcomes; part of my argument about the utilities was that later on, once the industry form was locked in, the other possibilities were foreclosed, and in those periods, less contingent theoretical accounts might have sufficed.

Also central to the project is to formulate some theoretical principles concerning social structure that will cut across all the cases and offer some explanatory power. One such general principle is that the level of network fragmentation and cohesion, or coupling and decoupling, is a major deter- minant of outcomes. That was central in the discussion of malfeasance, in the argument about the overseas Chinese and in the discussion of -business groups.

Such an argument bears also on the case of electric utilities. If Samuel Insull, for example, had been socially located in a tightly-knit network of close associates, he might well have found it impossible to con- struct the outcomes he did. Instead, he had relatively weaker ties into several insti- tutional spheres - financial, political and technical - that were decoupled from one another, and this was the reason for his success. The general principle may be that the actor whose network reaches into the largest number of relevant institutional realms will have an enormous advantage. This may be a case of what I have called the 'strength of weak ties' (1973). It relates also to the work of Norwegian anthro- pologist Fredric Barth, who considers the ability to breach traditionally closed spheres of exchange as the essence of entre- preneurship (Barth 1966).

The ultimate aim, then, is to produce a theoretical argument with a high level of contingency that nevertheless meets scien- tific standards of generality, and does not fall prey to ever-present temptations of his-

toricism. Such an agenda, I argue, is central to the vitality of the new economic soci- ology.

Acknowledgements This paper was presented at a conference spon- sored by the Centre de Recherche en Epistmo- logie Applique of the Ecole Polytechnique, on 'The Economics of Conventions', Paris, 27-28 March 1991. It draws on my book-in-progress, Society and Economy: The Social Construction of Economic Institutions, to be published by Har- vard University Press.

Received September 1991 Final version accepted December 1991

Notes I For a more detailed historical account of the

economic arguments of Durkheim & Weber, and of the interactions between economists and soci- ologists over the course of the twentieth century, see Granovetter (1990).

2 For elaborations on this theme, see Blaug (1986) and Kirzner (1973).

3 For a more detailed account of the ups and downs in the treatment of entrepreneurship by economists, see Granovetter (1991:Ch. 4). ' This section reports on collaborative work originated by Patrick McGuire and joined later by me and Michael Schwartz.

I The idea that institutions may become 'locked in' despite the possible greater efficiency of other conceivable forms is a generalization of the argument for lock-in of inefficient tech- nologies by Paul David (1986) and Brian Arthur (1989). Their line of argument parallels that in industrial organization on 'first-mover' advan- tage.

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