21512 Chap.10 Neo-Institutional Theory: Formal and Informal Rules
Neo-Institutional Theory: Formal and Informal Rules
The second school of institutional theory comes from applied economics. Neo-institutional theory, or new institutional economics, is associated with Douglass North, who asked why some countries are rich while so many are poor and pointed to institutional voids, under-developed institutional environments in poorer countries.
North defined institutions as humanly devised constraints that structure human interaction, and the lecture explains that a firm's strategic choices are shaped, to a large degree, by the limits and rewards set by its formal and informal institutional environment.
The chapter separates formal institutions, written and legally enforceable, from informal ones, uncodified and enforced socially, and shows each in a constraining and an enabling role.
It treats culture as the key informal institution, compares North's two categories with Scott's three pillars, and works through the traps students fall into when classifying professional codes and mixing the two vocabularies.
What this chapter covers
- 01
North and new institutional economics
- 02
Institutional voids and economic development
- 03
Formal institutions: laws, policies, regulations
- 04
Informal institutions: culture, norms, values, beliefs
- 05
Constraining and enabling roles
- 06
Reducing uncertainty: the rules of the game
- 07
Comparing North's and Scott's schools
Worked example · free
Find the enabling and constraining rules for an export decision
- 1The free trade agreement is a formal institution in an enabling role: a written, enforceable rule that lowers the cost of entry.
- 1Product registration is a formal institution in a constraining role: a regulation that delays entry and adds compliance cost.
- 1A preference for local brands is an informal institution in a constraining role: a social norm the brand must overcome.
- 1Fast-moving online communities are an informal institution in an enabling role: a consumer practice that favours new products.
Key terms
- Neo-institutional theory
- The applied economics school of institutional theory, also called new institutional economics.
- Institutional voids
- Gaps in a country's institutional environment that leave people and businesses without reliable rules.
- Formal institution
- A written, legally enforceable rule such as a law, policy, ordinance or regulation.
- Informal institution
- An uncodified rule such as a cultural norm, value or belief, enforced socially rather than legally.
Neo-Institutional Theory: Formal and Informal Rules FAQ
How do formal and informal institutions differ?
Formal institutions are written rules of a society, such as government policies, laws, ordinances and regulations, and breaking them carries legal or judicial penalties. Informal institutions are uncodified, such as culture, norms, values and beliefs, and breaking them brings social costs like exclusion, ostracism or stigma rather than a court case.
What did Douglass North mean by institutional voids?
North asked why some countries are rich while many are poor. Part of his answer is that poorer countries suffer from institutional voids: their institutional environment for people and businesses is under-developed compared with advanced economies, so rules are weaker, uncertainty is higher and firms find it harder to plan, invest and trade.
How does this school differ from Scott's institutional theory?
Scott's sociological school sorts institutions into regulatory, normative and cognitive pillars and stresses legitimacy. North's economic school uses two categories, formal and informal, and stresses constraints, incentives and uncertainty in strategic choice. The lecture calls them very similar, and both treat institutions as the rules of the game for organisations.
Why is culture treated as an informal institution?
Culture is uncodified: it lives in shared knowledge, beliefs, morals, customs and meanings rather than in written law, and it is enforced socially. The lecture quotes Tylor, Schwartz and Hofstede to show how it shapes what a society accepts, which in turn constrains or enables what a firm can sell and how it operates.
Assessment move
Draw the two-by-two of formal and informal against constraining and enabling, and fill every cell with an example from an industry you know. Practise the enforcement test on three tricky cases, such as a professional code, an industry standard and a tax incentive. Decide early which institutional school you would use for Assessment 2, and keep its vocabulary consistent throughout.
Test yourself by explaining the same case through both institutional schools, then decide which one gives the clearer argument for your folio.
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