**3.1 Why institutions matter**

We can now argue that institutions matter in economic life when individuals need social expectations to solve specific problems like that of defining 'ends' or 'goods' in economy (that I am referring to as the problem of orientation), getting information about the situation that lies ahead, especially who are the exchange partners and what are the exchange rates (this may be called the problem of coordination), and lastly, the big questions as to whether there are any common interests and how to meet them, such as the wealth of a society, justice, social order, etc.

Within the framework of action-based institution theories we can use these three kinds of social problems, but also develop more precisely shaped models of social action in economy that has need for institutions in general. This also allows us to focus on the underlying problem in a more concise way by stating why and how particular aspects of the situation and of individual action become relevant. Hence, it is possible to define a wide range of social action problems that matter in the economic field by giving precise arguments about the underlying logic and the degree of the problem that has to be overcome in order to found social action and relations in the economic sphere.

If we start with the very simple assumption that individuals act in order to meet private interests, we can argue that with regard to the three logics of interdependency described above the general need for *orientation* is not that problematic, since every orientation is better than none. Because of this, simple common knowledge as well as cultural symbols or defined social standards or information by chance can help to act intentionally. In all of these cases, 'focal points' help by saying what action is to be expected. Furthermore, because of their positive effects, such patterns of orientation are stabilizing step by step and therefore create path-depending social solutions that are not problematic or further discussed. That is what Neo-Institutionalists have in mind when arguing that processes of institutionalization happen and create social expectations without anyone noticing.

If we start with complementary interests it is to argue that, in the easiest case, two or more actors only need to know what the other will do in order to act intentional. This case is described for example by Thomas Schelling as a pure coordination game of 'strangers' who

This can be seen as a starting point for an integrated approach that focuses and systemizes social situations which, in the sense of social expectations, make institutions advantageous

Therefore, I am arguing now on the basis of a theory of intentional actions that is more precise, in the sense that realistic theses can be formulated about the conditions as well as the functioning of main economic institutions in modern societies, when we do not start with the assumption of given or socially founded expectations on the macro level. Instead, I suggest starting with simple assumptions about individuals trying to act with regard to their own intentions in social fields and therefore dealing with the problem of social expectation. Hence, we consider the processes of establishing and maintaining institutions in economic fields by regarding individual intentions as well as capabilities on the one hand,

We can now argue that institutions matter in economic life when individuals need social expectations to solve specific problems like that of defining 'ends' or 'goods' in economy (that I am referring to as the problem of orientation), getting information about the situation that lies ahead, especially who are the exchange partners and what are the exchange rates (this may be called the problem of coordination), and lastly, the big questions as to whether there are any common interests and how to meet them, such as the wealth of a society,

Within the framework of action-based institution theories we can use these three kinds of social problems, but also develop more precisely shaped models of social action in economy that has need for institutions in general. This also allows us to focus on the underlying problem in a more concise way by stating why and how particular aspects of the situation and of individual action become relevant. Hence, it is possible to define a wide range of social action problems that matter in the economic field by giving precise arguments about the underlying logic and the degree of the problem that has to be overcome in order to

If we start with the very simple assumption that individuals act in order to meet private interests, we can argue that with regard to the three logics of interdependency described above the general need for *orientation* is not that problematic, since every orientation is better than none. Because of this, simple common knowledge as well as cultural symbols or defined social standards or information by chance can help to act intentionally. In all of these cases, 'focal points' help by saying what action is to be expected. Furthermore, because of their positive effects, such patterns of orientation are stabilizing step by step and therefore create path-depending social solutions that are not problematic or further discussed. That is what Neo-Institutionalists have in mind when arguing that processes of institutionalization

If we start with complementary interests it is to argue that, in the easiest case, two or more actors only need to know what the other will do in order to act intentional. This case is described for example by Thomas Schelling as a pure coordination game of 'strangers' who

for individual actors, but also looks for their intended and unintended consequences.

and by taking specific social constellations into account on the other.

found social action and relations in the economic sphere.

happen and create social expectations without anyone noticing.

**3. Social institutions in modern economy** 

**3.1 Why institutions matter** 

justice, social order, etc.

are to meet in New York but have not made arrangements as to where and when. Then simple common knowledge can help and can build up to institutions by used private or common knowledge; for example to meet at the most famous place in town and the usual time.

The challenge for economic sociology is to figure out situations that make social interaction or exchange useful for individuals, but cause the need for stable mutual institutions at the same time. Thus, by analyzing the structure of interests we can describe the problem and ask what sort of institution might be necessary and possible. If formal institutions guaranteed by hierarchies are to be explained, we can say that unintended by-products are to be expected caused by the conflicting interest structure between rulers and staff as well as between rulers and obedients.

But this is not the overall case when focusing on *coordination problems* – most important in modern economic life – because successful social coordination benefits from complementary interests and therefore needs only to restrict the individual's scope of action in order to gain the positive effects of specializing, labor division, or agency. Coordination is a general problem in modern societies and economies because of the socially guaranteed rights of individuals to act and the formally defined property rights (including the formal right to enter into a contract, e.g. a market or an employer-employee relationship). Ergo, we can consider the problems that come along with such social relations and look for adequate social institutions that help to stabilize them, causing intended as well as unintended social and economic effects. In this framework, the often mentioned general trust problem can now be considered more precisely either as a problem of one-spot exchange by strangers or as a long-term exchange within a group that shares social norms or as a long-term exchange within a conflict arena and therefore making opportunism and strategic action relevant. To shape typical coordination problems in the economic sphere, it is helpful to consider firstly situational aspects and add special individuals' skills (to strengthen coordination problems, it is helpful to reflect which capabilities would help but are missing, e.g. to have the right information, to have complete information, to have and reflect ends logically, and, most of all, to act rationally with regard to intentions or ends like consumer utility, profit, common interests, and so on). Coordination problems are essential in modern economic life because both market exchange as well as employer-employee relationships can be regarded as a general problem of coordination, but with a specific logic (see paragraph 3.2 and 3.3). Whereas market exchange is mostly driven by trust problems that result from incomplete information (about the others, e.g. either private consumers, firms, the state, or, above all, about the commodities), social relations within business firms are a kind of trust problem that goes along with employees acting on behalf of their employers and their employers' interests. It is not so much the exchange of goods and services that makes intra-firm relations problematic, but the wide range of conflict patterns like opportunism, agency problems, strategic action, etc. Therefore, it can be stated that such social institutions are advantageous that firstly solve the coordination problem and secondly help to frame the conflict structure. Privately-owned firms in modern economies can be viewed as an institutionalized answer to the problem of controlling and determining the actions of others. Business firms have to be explained by analyzing the incentives given in and by hierarchical structures.

Economic Sociology: Bringing Back Social Factors 89

to consider the existence of these institutions on the basis of problems of orientation,

From an institutional point of view there are three perspectives on the business firm described as a privately-owned organization producing for an anonymous market in order to make profit. The first question is: *Why* has that kind of organizational form spread so widely since the late 19th century? Secondly: *What kind of social actions* and *interdependencies*  are typical for this social setting, causing what kind of social institutions? Thirdly: How can we describe the *relationship* between *modern society* and *(large) business firms* in terms of social

The first question is well considered because of the inevitable decline of social communities (tribes, families, feudal tenures, cloisters, and guilds) as producers of scarce goods and services during the process of industrialization. Instead, centralized production in the privately-owned industry driven by pure profit-orientation increased and became the very core issue of all social sciences (Swedberg, 2003). Whereas economists and historians point out that the decline of social communities and the rise of privately-owned companies was mostly related to technical innovations, (Neo-)Marxists as well as New-Institutionalists focus on the 'transformation problem' of human labor that arises because of the two main structural elements: private property and profit-orientation. The problem is to transform the abilities of human labor into an outcome that benefits the few owners and therefore coordinates the working process and solves the agency problem by effective structures. This is the very starting point for discussing the possibility as well as the need for centralized control mechanisms by private owners within the firm as an important fact for the overall success of privately-owned firms. Furthermore it is argued that the profit-orientation drives the widening of coordination effects firstly by enlarging the business and secondly by finding more and more rational ways of coordinating a large number of skilled workers. Economists and historians showed that social coordination effects the process of establishing more complex organizational and managerial structures, as well as organizing the production on a large scale and scope (Chandler, 1962; Williamson, 1985; North, 1990).

Therefore, the formal organizational structures as well as the formation of managerial structures gained a lot of attention during the 20th century. One of the most exciting aspects discussed within sociology – especially in the sociology of work – relates to the change of *control systems.* It is stated that direct and personal forms of control lost relevance and were substituted by more technical and bureaucratic forms of control (Edwards, 1979) and lastly by new forms of self-control (Burawoy, 1979; Piore & Sabel, 1984). With this reading, sociology competes with New Economic Institutionalism that offers a strong argument for the rise of various kinds of managerial and structural forms in the 1930s in the US and in the 1950s in Europe because of information overload on the top management, which generated a need for certain kinds of institutions or for organizational change. Managers as well as hierarchies within this framework are regarded as effective mechanisms of coordination

*a. Why privately-owned and hierarchically organized (large) business firms* 

coordination, and cooperation.

action and social expectations?

*b. Social expectations within firms* 

established by the private owners.

**3.2.1 The large firm** 

In contrast to economic theory that focuses mainly on exchange and complementary interests, sociology and political theory normally focus on *common interests* and therefore coordinated collective behavior. The classic answer to this is given by Max Weber (see paragraph 2) who argued that a means-end and legally founded order creates an organization ("Verband") that provides rational collective action in all fields. But Weber's solution is based on the assumption of a given legitimacy ("Anerkennung") and is lacking an explanation on how this can be constituted as well as on how collective action in economic fields can be organized by alternative mechanisms when legitimacy fails. Whereas sociologists take common interests seriously when discussing collective actions, they do not ask for the corresponding problems that might be caused by individual interests. This is because they argue like Weber or assume that common interests enforce collective actions themselves. One of the major insights of using a rational-choice theory is that common interests do not automatically lead to collective actions, but also need social institutions to be guaranteed. This means we need to ask when and why intentional actors are able to create social institutions that allow them to solve the various problems that go along with collective action, first of all the various kinds of free-riding, but also problems of defining ends (Offe & Wiesenthal, 1980; Wiesenthal, 1993). Because free-riding is a dominant strategy when common interests are enforced by others, such expectations need to be enforced either inside the group by social mechanisms or by establishing authority and control structures – all of which are also public goods. Economic sociology can use and broaden the concept of public goods to discuss why producer or consumer associations are so rarely to be found in modern economies or what social institutions are possible and necessary to establish and maintain such associations. An economically interesting variation of this general problem is discussed by Russell Hardin and Elinor Ostrom as 'Tragedy of Commons'. Ostrom (1990) in particular showed that the economic use of scarce common goods like water or fish can be governed within small groups and informal trust-based rules and local knowledge.
