Methodological Individualism

276 The new institutional economicsinstitutions are treated both as endogenous and exogenous variables. It is myimpression, though, that economists differ in their reaction to this fact. For some,exogenous institutions are a problem, since they violate the requirement of strictmethodological individualism. This attitude is common, if not ubiquitous, in theeconomic theories of the family and the firm. For others, such as OliverWilliamson and James Buchanan, exogenous social institutions are not aproblem, but rather a solution to many problems in economics. It might beargued, however, that no theory of social organisation can be entirely free fromexogenous social institutions. If we believe, for instance, that no social organisationis likely to emerge in an environment totally free from social rules, it followsthat all theories of social organisation, will include at least one type of socialinstitution among its exogenous variables, or conditions, namely social rules.Social rulesThere are many kinds of social rules, from the informal codes of etiquette, ormanners, to the formal rules of written law. Economists are, for obvious reasons,most interested in those rules that regulate market transactions, viz., the closelyrelated laws of property and contract. But not exclusively. There is also a moregeneral theory of ‘law and economics’ and a theory of the most fundamental ofall laws: the constitution.Property rightsThe neo-institutional theory of property rights started with Armen A. Alchian’sarticle ‘Some Economics of Property Rights’ (1961), which was an attempt toanalyse and compare different types of property rights. This project wascontinued by Harold Demsetz (1964; 1966; 1969), who followed Coase in criticisingwelfare economics for seeing all negative externalities as a loss of welfarethat should be remedied. The mistake of this ‘nirvana approach’ is to comparethe existing market economy with an ideal that does not exist and could notexist. A more reasonable approach would be to compare different existing institutionalarrangements, with different property rights and different transactioncosts.The dominating concern in these early contributions to the theory of propertyrights is to compare different institutional arrangements with respect to theireffects. This is institutional individualism and, as such, wanting from the perspectiveof the more orthodox methodological individualism, prevailing in Chicagoat that time. Milton Friedman, who was one of the dominating figures inChicago at that time, expresses this view in the following manner: ‘On ourapproach these [institutional conditions] too, are to be regarded as resultants ofan economic equilibrating process, not as physical data’ (Friedman, 1956: 13).In line with this view, there is the early attempt by Demsetz (1967), to explainalso the emergence of property rights. Demsetz’s thesis is that ‘property rightsdevelop to internalize externalities when the gains of internalization become