A Theory of Institutional Change in Capitalist Societies

“You cannot step into the same river twice; nothing endures but change”’   Heraclitus (535 BC)

In the study of democratic capitalism one is confronted with the challenge of explaining how institutions change and evolve over time. Previously, a large shock or an event (such as the French revolution or the oil crisis in the 1970’s) was used to explain periods of stability and change. But, much like the study of biology, scholars recognised that gradual and incremental changes can often lead to transformative social change that goes unnoticed, and can only be analysed ex post. This change takes place in-time; therefore time itself becomes an important variable in explaining social phenomena. Given technological developments over the past 20 years – time has become increasingly compressed and social change more complex. The macro-institutional change that occurred in the political economies ofEurope, from the late 1980’s, for example, is increasingly described as a shift from ‘Keynesianism to Neoliberalism’. The institutional process and explanatory factors that enabled this change to take place, however, is deeply contested.

The focus on institutions is central to the study of comparative political economy and economic sociology for empirical reasons i.e. it enables us to explain variation – why Italian politics is different to Dutch politics, why wage bargaining leads to egalitarian outcomes in Denmark but not Ireland. Institutions include wage setting, electoral and welfare systems, corporate governance, industrial sectors and political parties. At its most basic, an institution is a ‘rule’ or a ‘norm’ that imposes constraints and opportunities on actors. In the study of comparative capitalism, institutions are often conceptualised as beneficial constraints upon the greedy pursuit of self-interested actors (i.e. labour market regulations exist as a counter-force to the power of capital. It is a beneficial constraint for social cohesion). Institutions also overcome problems of collective action. All actors (trade unions, employers, government) in an economy want full employment; institutions enable them to coordinate their strategies into a shared public pursuit of this goal. Different institutional regimes, therefore, explain capitalist diversity. The study of national incomes policies in the 1970’s was central to this research program. But, if capitalist institutions are increasingly converging on the same market conforming function (let’s call it neoliberalism) does this mean that varieties of capitalism (the replacement theory of neo-corporatism) no longer exist?

In most western capitalist economies ‘neoliberalism’ was not imposed via shock therapy as occurred in central and Eastern Europe. It was a gradual process of political liberalization, in response to a given set of environmental factors; capital mobility, globalisation, EMU, financialisation, technological change, shifts in structure of the family and labour market (Streeck and Thelen, 2005). The causal process is complex but most agree that the de-regulation of capital markets had the most significant impact on the strategic capacity of domestic actors, particularly the state, to pursue non-neoliberal modes of adjustment. Keynesian democratic institutions that imposed ‘beneficial constraints’ on capital were gradually liberalized with unforeseen consequences.  Political and business actors gradually morphed institutions (that previously existed for different functions) to enact market conforming rules and regulations in the interest of capital accumulation; to ensure economic and employment growth (think about European wage setting systems, during the 1950s-1970s, these were previously used to compress income differentials. From the 1990′s they evolved into a means to ensure wage restraint and competitiveness).

The shift toward a market conforming paradigm, or neoliberalism, did not come from above but from below. In social science terms, it was a gradual endogenous development that took expression in different ways, at different times and in different places. Thus, whilst we know, intuitively, that there has been a paradigm shift toward market conforming rules in all areas of public policy, we still lack the analytic tools to test and explain how this transformative change took place. This is because we do not have a fully fleshed out theory to explain institutional change (Thelen, 2010). Powerful business interests did not just turn up to parliament one day and take power; it was a much more gradual process of quiet politics (Culpepper, 2010). InEurope, the institutionalisation of the single market, and then the single currency, changed the rules of the game for all capitalist actors, but this did not lead to the construction of new institutions. Old rules were morphed, ignored, transformed or layered on to pre-existing ones.

To explain institutional change and stability in complex and heterogeneous societies is no easy task. There have been three main schools of thought that attempt to do this: historical institutionalism, rational choice institutionalism and sociological institutionalism (Hall & Taylor, 1996). Historical institutionalists focus on how institutions, such as centralised wage bargaining, emerge and set in place a series of lock in effects to create a path dependent mode of behavior for actors. Path dependence is broken by exogenous shocks or critical junctures. The problem with this analytic framework is that it provides an insufficient account of the actors who underpin and constitute institutions. Rational choice institutionalists, on the other hand, give priority to agency but in timeless game-theoretic terms. Institutions are considered the outcome of rational calculation by intentional actors to ensure system equilibrium. The problem with this analytic framework is that it is apolitical and ignores the importance of culture, power and history. Institutions are more than a series of nested games to ensure equilibrium. Capitalism, as argued by Streeck (2009) is a social order not a rational-efficient system. Sociological institutionalists recognize this. Their frame of reference is focused on the role of norms and codes of appropriateness in governing and constituting behavior. The problem with this analysis is that it is prone to tautological hypothesis, and does not provide a sufficient account of rational or purposive action. Institutions become indistinguishable from culture – which is hard to measure and define.

This essay proposes a fourth approach to explaining and understanding the processes of actor-centered institutional change in capitalist societies: power-distributional. This builds upon the work of Thelen and Mahoney (2010) but differs in three respects. Institutions in political economy have to be considered first and foremost as capitalist. Thus, as argued by Streeck (2010), we need to bring capitalism back in to the study of institutional and social change. Secondly, institutions have to be analysed according to how they are used by the coalition of actors that underpin them. If we are to explain change we must examine the purposive action of agents, and the coalitions they form (individuals, groups, associations), not market transactions. Thirdly, capitalist institutions are inherently unstable because powerful actors have the capacity to exit, challenge and confront existing norms. Therefore, a change in institutionalised power relations and its impact upon the underlying political coalition explains the process of capitalist change. When applied to the incremental but transformative shift towards neoliberalism – it is the decline in the effective power of labour that provides the most powerful explanation. Thus, contrary to the most influential theory in the study of comparative political economy; varieties of capitalism (Hall and Soskice, 2002), a power-distributional approach locates the driving force of change to be capitalist firms operating in the absence of a labour constraint. The interest of corporate business is central to explaining capitalist diversity but not in rational equilibrium terms. Capitalism is a social order and the variety it takes is a reflection on the institutional strength and weakness of its counter-power: labour.

Capitalist institutions both condition and are framed by the strategic preferences of the actors who underpin them. Whilst one cannot assume the fixed preference of actors, a priori, we can reasonably expect that employers, trade unions and political parties in government will have different perspectives and preferences on fiscal, labour market, social and macro-economic policy. Corporatist institutions, in particular, are political legacies of concrete historical struggles that try to strike a strategic compromise between different interests. They attempt to mediate between state and civil society for two purposes: economic performance and democratic legitimacy. But, they are only sustained to the extent that they generate a distributional return to the actors. Institutions, in this regard, are a resource for actors to pursue and recognize their strategic interests.  In my PhD, for example, I ask why the Irish state, employers and trade unions pursued a strategy of ‘social partnership’ and the conditions that enabled the state to exit the process in response to the Eurozone crisis. The empirical conclusion is that elite networks constructed around the Prime Ministers office ensured compliance. This access to cabinet government, in addition to a political exchange premised on low incomes taxes, sustained the distributional coalition. But, the decline in the effective labour power of trade unions, and the voluntarist structure of collective bargaining, meant that it was ultimately dependent on the preference of employers and the state.

Taking for granted that capitalism is unstable, conflicted and contested (i.e. the opposite of a rational choice equilibrium model); actors will pursue their strategies within a given set of broader institutional constraints. In capitalist societies, employer strategies are conditioned by institutions of the labour market (particularly the structure of collective bargaining) not because of the institution per se but because of the extent to which it increases or decreases the power resources available to the actors to engage with one another as ‘social partners’. If capital-employers can totally ignore labour, they will. But, this is rarely, if ever, the case. All of the main functional actors in a capitalist economy – state (represented by government/political parties), trade union and employers have a shared interest in managing and directing fiscal, wage, social and labour market policy. When a compromise is reached on these issues and embedded over time – it is generally referred to as ‘corporatism’. Ireland is the archetype example of liberal market corporatism in the neoliberal era. The lesson to be learnt from the Irish case is that state corporatism and centralised wage agreements, as a mechanism to ensure social order, can occur in the absence of a social democratic exchange. Furthermore, it emerged as a mechanism for the state to legitimise fiscal adjustment. But, over time, it began to serve very different purposes.

A power-distributional approach to institutions is particularly useful in explaining the process of change in industrial relations and corporatist political democracy, as it takes historical continuity and strategic action seriously.  The main institutions of the labour market that increase or decrease the effective power of labour include; the legal and institutional framework of wage setting (i.e. is it voluntary or legally enshrined), trade union density, collective bargaining coverage (inclusive or exclusive), the formal involvement in formulation of public policies and parliamentary strength of leftist parties. The social action strategies available to actors, thus, are embedded in the institutions of country specific industrial relations regimes. Therefore, it is the institutions that impact upon the effective power of labour to act as a constraint on capital that one should look to when trying to explaining change in a capitalist society. The change we can observe over the past twenty years has been to weaken labour, increase income inequality, and replace direct with indirect taxes – all in the interest of generating a specific regime of capitalist accumulation. One can easily come to this conclusion (empirically) without having to argue whether it is a good or bad thing (normative). Most economists will celebrate the removal of collective labour constraint and a return to market forces. Most critical-Marxists will lambast trade unions for entering into any compromise with the system. Economic sociologists, whilst generally sympathetic to labour, simply point out that the strategic relationship between actors and institutions is central to explaining capitalist change – i.e. this can take place via the market, corporatist-associations or state imposed rules and regulations. It does not rule out, a priori, like neoclassical economists and critical-Marxists, the strategic pursuit of tri-partism.

Once created, institutions are not easy to change, particularly those that have legal-constitutional guarantees. Most European collective bargaining, labour market and wage setting regimes have some form of legal protection. This explains their institutional embeddedness. Employers certainly try to bend the rules and adopt strategies to overcome these constraints – Germanybeing a particular case in point. Therefore, from a power-distributional perspective, stability is best understood as a process of compliance. Why do actors comply with the rules? Why don’t people hand back their keys to the bank when they are in negative equity? Think of this in terms of a board game. If four friends are playing scopa (Italian card game) they will generally comply with an explicit set of rules. But, if one starts to break the rules they are likely to be viewed unfavorably by others. Established rules and institutions bring actors closer together and over time they establish a set of norms, habits and procedural acceptance. If the rules are voluntary, open for contestation and not embedded in any structural sense – they will decrease the possibility of compliance. But, even in this case, actors in an established process (such as the voluntary social partnership process ofIreland) will not exit whilst there is a distributional gain to be extracted from the institutional resource. Actors invest a significant amount of political capital into creating, nurturing and complying with an institutional regime. This process of nurturing compliance is central to a process of institutionalisation.

Thelen and Mahoney (2010) define institutions (although not explicitly couched in capitalist terms) as distributional instruments laden with power implications that require constant mobilization of political support. An institution changes when there is a shift in the balance of power. If a social democratic party, in coalition with manufacturing based trade unions, is the most powerful coalition in the construction, genesis and evolution of corporatist-wage bargaining, then they are likely to condition the underlying dynamics, outcome and structure. But, because it is a capitalist institutions one must not assume stability as the default position, one must assume change and conflict as the established social order. The ability of Swedish employers to bring down centralised wage bargaining is a case in point. The general point is that change is not exogenous to a capitalist institution (such as compliance with a national wage agreement) but endogenous to the strategic action choices of the actors who choose to comply (or not) with it.

Institutions that restrict creative capital power will always be contested. This can lead to total breakdown or it can lead to an existing institutional form being crafted for new end goals, or in he case of Thatcher and Pinochet, it can be imposed by an authoritarian state. The function rather than the form of an institutional regime can change. This is precisely what has happened in most European countries with traditionally egalitarian collective bargaining structures (see Bacarro and Howell, 2011). The same occurred internally within many European social democratic and labour parties. Their form and structure has remained relatively stable but the function, policies and market ideology underpinning their political platform has been transformed. In many ways, this transformation explains the crisis underpinning social democracy acrossEurope – the party (like trade unions) still exists as actors but their institutional strategies and ideational paradigm within which they operate has changed dramatically.

When there is ambiguity in a capitalist institution business will exploit it. One only has to think of the ingenious strategies adopted by finance firms when capital mobility was de-regulated. Or, think about the creative accounting practices that MNC firms adopt to take advantage of low corporate tax regimes (transfer pricing) in Irelandand the Netherlands.  But, this exploitation of ambiguity is not unique to business; public sector unions can take advantage of the state in national wage agreements by pushing for higher wage increases, which the state has to pay for through public revenue (public sector benchmarking being a classic example). The general point is that when adopting a power-distributional approach to explaining institutional change the focus shifts from the rule or the institution to the strategy of actors in exploiting it. Capitalist markets by design (as opposed to large bureaucracies) generate more space for creative destruction (outside strict legal contracts), as a dynamic tension is built into them. For Streeck (2011), the motor of history is the attempt to resolve this internal conflict between expansionary capitalist markets and political-distributional democracy. Various types of corporatism(s) are the outcome of this strategic interaction, and their form and function conditioned by the underlying power-distributional dynamic.

Political conflict drives the politics of institutional change in capitalist societies. The coalition pattern through which takes place varies across time and space, and central to explaining capitalist diversity.  A power-distributional theory enables us to explain this complex coalition pattern underpinning institutional change, as it conceptualizes the social order of capitalism as made up of associational-collective actors with unequal power resources, not free-efficient and competitive markets in equilibrium. Societies with an institutional ecology that provides minimal effective power to labour (USA) and maximum power to corporate interests are more likely to experience higher levels of wage inequality and the direction of institutional change will be aggressively neoliberal, unless the state is autonomous enough to act in the interest of non-capitalist accumulation. Therefore, if one wants to reverse the pattern of neoliberalism, it requires an effective change agent that increases the power of labour – beyond voluntarist structures of compliance (Ireland). In the next essay I will use this power-distributional institutionalism to account for the change and diversity of corporatism(s) in the EMU, before applying it to the political-economic history of centralised wage bargainingIreland.

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