Arrow's Analysis of Social Institutions: Entering the Marketplace with Giving Hands?

Frame 10. "Entering the Marketplace with Giving Hands"
You go to the marketplace barefoot, unadorned
Smeared with mud, covered with dust, smiling.
Using no supernatural power
You bring the withered trees to bloom.

The Ox-Herding Pictures (trans. in Levering and Stryk 2000)

The apparent inconsistency between "giving hands" and behavior normally expected in the marketplace is suggestive of the tensions underlying Arrow's effort to establish an economic role for social institutions. At times, Arrow's (1963: 947) analysis appears to be equal parts economics and mysticism: "I propose here the view that, when the market fails to achieve an optimum state, society will, to some extent at least, recognize the gap, and nonmarket social institutions will arise attempting to bridge it." "I am arguing here that in some circumstances other social institutions will step into the optimality gap, and that the medical-care industry, with its variety of special institutions, some ancient, some modern, exemplifies this tendency." In The Ox-Herding Pictures, the seeker is able to enter the marketplace with giving hands in the tenth and final frame of the story only after a long and arduous journey. ¹ The seeker must first search for, capture, tame, and train the ox, where the ox and ox-herding are Buddhist metaphors for gaining control over one's own mind. One should expect unvarnished social institutions to be at least as stubborn as the untrained ox. Social institutions may well be able to serve Arrow's ultimate economic role, but such giving hands cannot be taken for granted. Such an outcome is more likely to be the result of a process of careful planning and constant struggle. Moreover, in taming the ox, the ox-herder is also changed, raising questions about the effects that Arrow's efforts to rationalize a role for social institutions may have on our understanding of economics itself.

This essay examines Arrow's treatment of social institutions and its implications for policy making. The first section looks at what his 1963 article has to say about social institutions and its specific treatment of the nonmarket roles of licensing, subsidies for medical education, and professional norms. The second section examines the policy-making implications of Arrow's optimality-gap-filling conjecture. From such a perspective, Arrow's thesis is evocative, but substantially underdeveloped. This section explores the difficulties of trying to herd social institutions, both within the domain of welfare economics and in a realm where the composition of "markets" and the metric of welfare economics are themselves contestable. The final section argues why setting workable boundaries between market and nonmarket institutions matters and tentatively explores implications that Arrow's insights may have for some contemporary health policy problems.

Arrow's Analysis of Social Institutions

Institutions as Economic Data

One can discern two important insights about social institutions in Arrow's 1963 article: an admonition to economists to take social institutions more seriously and an ambitious conjecture about the possible optimality-gap-filling role of certain nonmarket institutions. In wrestling with the complexities of the second and more controversial proposition, the inherent wisdom of the first should not be overlooked. At a basic level, Arrow issued a wake-up call to economists that social institutions matter and that nonmarket institutions may have important economic content. In his introductory discussion of economic methodology, Arrow contends that "institutional organization and the observable mores of the medical profession" should be included as "data to be used in assessing the competitiveness of the medical care market" (944). This is an important insight that, outside the realm of new institutional economics, has been substantially overlooked by the profession (Williamson 2000).

The Role of Institutions in Arrow's Economic Theory

The call to consider social institutions as economic data highlights the fact that Arrow's analysis...