Introduction: Schumpeter revisited on innovation

In the last decade or so a near-consensus seems to have emerged among economists that “institutions matter” in making economic performance differ across economies. However, if institutions are nothing more than codified laws, organizational entities and other such deliberately designed human devices, why cannot a badly performing economy jettison “ineffective” institutions and then emulate the “good” institutions operating in a well-performing economy? Is it simply because politicians are bad? But, if so, why do they survive? Is their persistence itself not an institution? Alternatively, is it the case that good institutions cannot be emulated because they are shaped in each economy in a path-dependent manner? Does it then follow that there cannot be “innovation” in institutions?

In order to be able to provide intelligible answers to these questions, we need first to be clear about what is meant by the term “institution.” However, there does not seem to be an unambiguous consensus among economists regarding this point. Certainly, it would be unproductive to quarrel over a semantic definition of institutions as such. Any definition would do, as long as it serves to answer a meaningful and analytical question. And one of the objectives of this chapter is to understand a mechanism of change in an “institutional” framework that may constrain or enable economic, political, and other social activities relevant to economic performance and development.

In pursuing this purpose, this chapter first introduces a static conceptualization of an institution based on a game-theoretic equilibrium notion. Some ardent students of the evolutionary approach may immediately dismiss this approach as inappropriate for an earnest study of institutional change of an inherently dynamic nature.