The Competitiveness of Nations in a Global Knowledge-Based Economy

John R. Commons *

Institutional Economics

American Economic Review, 26 (1)

Mar. 1936, 237-249.

I am attempting in this paper to give only a theory of institutional economics as derived from the decisions of the Supreme Court of the United States.  It is a venture in pure economics, distinguished from its practical applications.  The latter belong to individual cases.  I have endeavored to make practical applications at other times, in drafting legislative bills, or administering state laws, with the idea of bringing them within the Court’s institutional meaning of reasonable value.  Such practical application must be made by a state legislature, or the Congress, or an executive in enacting or administering a law.  Also, a business corporation, a farmers’ co-operative, or a labor union must make a practical application in carrying out a policy which the Supreme Court may perhaps not declare unconstitutional.  For I think that whatever the Court thinks is reasonable it also decides is constitutional.

Economic science has not, to my knowledge, incorporated within itself a theory of reasonable value.  It separates ethics, public welfare, or national public interest as a postscript, different from economic theory.  But a theory of reasonable value, which shall include these postscripts, has become obligatory, in America at least, if the practical application of economic science is to be made to fit the Constitution.  I shall not here consider these applications except as data from which to derive the theory.

The economic theories of the past hundred and sixty years were started, in the year 1776, with Jeremy Bentham’s repudiation of Blackstone.  Thereafter economists went off on theories of happiness, but courts and lawyers continued on the theory of the common law of England and America.

A primary difference between the two is that the common law is built on conflicts of interest between plaintiffs and defendants, but with the sovereign, in the person of a judge, deciding, in each case as it arises, what is reasonable between the two, both in their conflicting private interests and in the public interest for which the sovereign is responsible.

But the happiness theory started with an assumed harmony of interests.  It could be none other than individualistic and cosmopolitan without any nationalistic public interest.  Only an individual can feel pain and pleasure.  Bentham consistently treated all individuals as a world census of population and not as national organized societies, wherein the pleasure of one is often the pain of others.  Stating it in technical economic terms, Bentham started, as one may derive from what Mitchell names his “felicific calculus,” 1  with the simplified assumption of an individual seeking his own maximum net

* University of Wisconsin

1. Cf. W. C. Mitchell, “Bentham’s Felicific Calculus,” Political Science Quarterly, XXXIII, 161 (1918).


income of happiness by seeking the maximum gross income of pleasure and reducing to a minimum his gross outgo of pain.  The spread between the two was the net pleasure of happiness for the individual, but regardless, obviously, of the pains, pleasures, or happiness of other individuals.

This happiness economy was readily converted, as Bentham did, into a money economy.  The individual seeks his maximum net income of money by maximizing his gross income of money and reducing to a minimum his gross outgo of money, regardless, by analogy to net pleasure, of the effect on others arising from the fact that his maximum gross sales income is the maximum amount of money that he can obtain from others as buyers, and that his minimum gross outgo of money is the smallest amount of money he is forced to pay to sellers.  The spread between the two is a maximum profit or minimum loss economy, 2 regardless of the consequences to others.

Finally, when Bentham’s individual becomes the collective owners of a corporation, acting as a unit, the same maximum net money income is sought for the owners as a whole, regardless of the effects on buyers of the maximum prices paid by them for products and services, or the effects on sellers of the minimum prices paid to them for materials and labor.

Since corporations are falsely treated as individuals, I name these theories maximum net-income economics instead of individualistic economics.  This is a technical phrasing of the net-income maxim, “buy in the cheapest market and sell in the dearest market”; to which, in its simplified assumption, should be added, “without consideration of methods or effects on others.”

I am speaking of the working hypothesis of pure self-interest, from Bentham to marginal utility.  It is a maximum net-income economics.  In recent years the theory has incorporated certain institutional factors, like patents, trade names, trade marks, goodwill, under such names as “imperfect competition,” “monopolistic competition,” “competitive monopoly.” 3 Yet

2. I know that this assumption of disregard of others, in obtaining the maximum net income, will be denied by economists as involved in their theories, and that they place a natural limit on net incomes by the law of supply and demand.  Yet I think they quite properly follow Adam Smith who wrote, “I have never known much good done by those who affected to trade for the public good.  It is an affectation, indeed, not very common among merchants, and very few words need be employed in dissuading them from it.”  Smith and followers rested their case on the public interest in increase of wealth to be derived from individual initiative.  But economic history shows that at times too much wealth is produced by individual initiative and at other times too little wealth is produced.  This is because the law of supply and demand has a double meaning, the traditional meaning of producing and consuming material products and the institutional meaning of selling and buying rights of ownership.  There are thus two laws of supply and demand - the consumers’ law and the business law.  The business men buy in order to sell and they buy and sell over and over again far more often or far less often the given rights of ownership than there are products produced and delivered.  But the consumer buys only once, and he buys once only as much as he wants to consume.  It is a difference both in kind and in velocity.  The first is a speculative law of supply and demand.  It rests on the legal tradition that his profits are his own - why can he not do what he wants to do with his profits regardless of the effects on others of cycles of over-speculation and under-speculation.  The second is a producers’ and consumers’ law of supply and demand suited to precapitalistic or home economics.

3. Cf. Edw. Chamberlin, The Theory of Monopolistic Competition (1933) Joan Robinson, The Economics of Imperfect Competition (1933) and references there cited.


even with these added evolutionary complexities the theory continues to be a maximum net-income economics, regardless of others.  Its characteristic problem is that of the optimum size of an individual establishment for obtaining the maximum net income of money.

But these new factors thus introduced bring to the front two additional points of view; namely, the effect on other persons and the public purpose involved.  These two aspects are combined by the Court in the meaning of reasonable value.

While a patent right may augment the net income of its owner by means of the monopolistic privilege which it affords, yet for three hundred years in England and America this augmentation has been justified, for a limited period of time, as differing from other sovereign monopolies in that it is granted only for new inventions or discoveries, and thereby fulfills the public purpose of inducing individuals to augment the national wealth while endeavoring to augment their private net incomes.

And while the goodwill of a competitive business is perhaps its most valuable modern asset towards augmenting its net income, in that it lifts its owner above the level of the free competition of traditional economics, yet it differs from other monopolies in that it exists only as long as its owner fulfills the public purpose of rendering to others what they willingly agree are reasonable services at reasonable prices.  The Supreme Court has definitely decided that a monopolistic corporation, like a gas company, shall not be permitted to set up a goodwill value as a justification for charging its monopolistic prices. 4  The goodwill of a business or profession is indeed the most perfect competition known to the law.  It is founded, however, on the three economic conditions, not of pleasure, pain, or maximum net income, but of equal opportunity, equality of bargaining power, and public purpose.  Thus understood, goodwill is the high point of fair competition and reasonable value in the public interest, contrasted with the economics of free competition and maximum net income for private interests, regardless of others and regardless of public interest.

Goodwill is, further, the meeting point of pure institutional economics and pure net-income economics.  It has two sides.  On the net-income side it augments the private net income beyond that of competitors.  On the institutional side it is the reasonable ethical relation towards other buyers and sellers, who are also members of the same national economy.

When the courts reduce their standard of goodwill and reasonable value to its simplest assumption, which they derive from the common law, it rests on the maxim of a willing buyer and a willing seller.  In technical

4. Wilcox v. Cons. Gas Co., 212 U.S. 19, 42 (1909).  See also lower Courts 81 Fed. 20 (1897) and 157 Fed. 849 (1907).  Comment by Commons, Legal Foundations of Capitalism, p. 191 (1924).  It must be noted, of course, that economic goodwill is not a sentiment of affection; it is an objective economic quantity which can be bought and sold, and whose value is reasonable.  Goodwill is often used as a camouflage, and even the Supreme Court has confused it with debt. (Hitchman Coal Co. v. Mitchell, 225 U.S. 229 [1917); Commons, Institutional Economics, p. 668 [1934).)


language this rests on the fact that the gross income of money acquired by a seller is the identical gross outgo of money given up by a buyer in a single transaction, since it is merely a transfer of ownership; whereas, in net-income economics, the net income is the spread between maximum gross income of money and minimum gross outgo of money of one party who is a buyer in one transaction and a seller in another transaction.  There can arise no question of reasonableness in maximum-net-income economics.  It is only a question of economic power. 5 But the institutional economics of willingness takes into account the ethical use of economic power in a single transaction where the gross income acquired by one is a transfer of ownership of the identical gross outgo alienated by another.  While the one may be named the maximum net-income economics of one person in two transactions the other is the gross-income-outgo economics of two persons in one transaction.

If I trace the beginning of maximum net-income economics to Jeremy Bentham in 1776, I find the beginning of goodwill economics in the year 1620, when the judges of the highest courts of England distinguished a free trade from a restraint of trade between a buyer and a seller. 6  The goodwill concept is literally the willing-buyer-willing-seller concept.  It was arrived at both negatively and positively.  Negatively, a free trade was an agreement between a seller and a buyer, neither of whom, from the standpoint of public welfare, was restrained by the other or by the state.  By removing all economic coercion, all duress of violence, and all psychological misrepresentation from either party to a transaction, through the decisions of the common-law courts, and leaving only honest persuasion, the resulting transaction between the two was free, equal, and willing in the reciprocity of alienating and acquiring the two ownerships.  These were the ownership of money on the one side and the ownership of materials or services as valued by that money on the other side.  But the positive assertion of what was thus negatively arrived at was that of a willing buyer and a willing seller.  This formula has thus become for three centuries the simplified economic assumption of the English and American common law. 7

5. Maximum net income, in modern economics, is maximum net profits.  Statistically it is found in the income tax reports of the Internal Revenue Department.  On margin for profits, that is, net income of profits, see Commons, Institutional Economics, pp. 526ff. (1934).

6. Jolyffe v. Brode, Cro. Jac. 596 (1620).  Also reported in Nov 98, 2 Rolle 201, W. Jones 13.  Commons, Legal Foundations of Capitalism, p. 263.  This case was one where the seller of a carpenter shop agreed to refrain from competition with the buyer.  The decision sanctioned what afterwards became known as a going-concern value, considerably in excess of the value of the physical plant.  On the merger of common law and equity, see H. Lévy-Ullman, The English Legal Tradition (tr. 1935).

7. The formula of gross-income-gross-outgo applies to both selling and buying transactions.  In a selling transaction the gross money income of the seller of his product or services is the identical gross money outgo of the buyer, because he merely transfers the ownership of the identical money to the seller.  Reciprocally, in the same transaction, the money value of the seller’s output of products or services, whose ownership is transferred [by the seller, is the identical money value, at the time, of the gross income of products or services whose ownership is acquired by the buyer.

But the seller has also, in a preceding transaction, been a buyer of the materials and labor, which he then converts into his own products or services which he afterwards sells.  Hence the same formula of gross-outgo-gross-income applies, but inversely, to his previous buying transaction.

This meticulous twofold formula would usually be taken as an elaboration of the obvious and a superficial and commonplace notion of money as both a medium of exchange and a measure of value.  But there are certain observations in institutional economics that follow from this obvious fact.

The so-called “exchange” of money, materials or services is not an exchange of physical products or material services, as assumed by the classical and hedonistic economists.  It is two transfers of two ownerships.  The physical delivery occurs after the ownership is transferred.  Hence the term “transaction” is appropriate instead of “exchange.”  A transaction means the negotiations culminating in two transfers of ownership.  But ownership and its alienation are created solely by the institution of sovereignty.

Likewise, the money used as a medium of exchange and measure of value is solely a legal tender creation by sovereignty.  This has been expounded recently in the gold clause decisions.  If credit is used instead of money, it also is the legal creation of debt.  The price, or money value, therefore, paid by a buyer, is not, as assumed by traditional economics, a price paid for materials, or services, or labor, but is a price paid for ownership of the materials, services, or labor.  The price is a valid price only because the state protects the new owner as it did the former owner.  The legal test of validity is the Court’s determination of willingness of each at the time of the transaction.

Again the precise time of transfer of ownership is of importance in the measurement of value.  This is because two debts are created by the transaction at a point of time - a debt of payment and a debt of performance.  These debts are equivalent to the value willingly agreed upon in the transaction.  The debt of payment is released by a payment of legal money.  The debt of performance is released by physical delivery of the materials, services, or labor, as measured by other legal units.  It was this physical delivery of materials that became the subject matter of the traditional exchange-value.  But it is ownership delivery that is the subject matter of institutional economics.  The two were identified on account of the double meaning of a commodity, which is a physical thing which is owned.

After the date of the transaction when the two ownerships of money and commodities have been transferred by operation of law, there may be greater or less changes of values in the hands of new owners, commuted mainly as risk and interest.  But at the precise date of the transaction the value of the gross outgo or gross income of materials, services, or labor are, by agreement, by contract or by debt, identical with the amount of money paid or received.

This is true, no matter how high or low, how oppressive or onerous, how coercive or intimidating, how fair or discriminatory, is the monetary price, nor how large or small is the quantity of money, materials, services, or labor power, whose ownership is alienated by one and acquired by the other.

For these reasons I do not think that institutional economics, defined as collective action in control of individual action, is contrary to the so-called pure economics of the past, which is individual action without collective control.  It is a continuation of pure economics into a higher degree of complexity by incorporating the reasonable value of willingness into the already expanding maximum net-income economics of exchange value.  Reasonable value is an upper and lower limit of exchange value placed there by the American Supreme Court.  Net income economics, indeed, places upper and lower limits of net income by the so-called law of supply and demand.  But institutional economics places another upper and lower limit by the law of reasonable value.

HHC: [bracketed] displayed on page 241 of original.


Hence the only standard that can be used by the courts in eliminating these unfair practices and restraints from the double transfer of ownership is the standard of a willing buyer and a willing seller, who, by the very terms thus used, are free from all of these inequalities and injustices.  The nearest approach, where the standard is almost perfectly reached, is in the economic quantity known as the goodwill of a going business.  Goodwill is the realized institutional economics of the willing buyer and seller.


Yet the highly valuable goodwill of a business has not, until recently, found a place in the traditional net-income economics.  I take it the reason is that pure economics has been based on man’s relation to nature instead of man’s relation to man.  This physical relation furnished a materialistic foundation for labor costs of production and for diminishing utility of consumers’ physical goods.  But goodwill is purely an institutional value, that is, so-called “intangible value,” of man’s equitable relations with other men.  Its value may far exceed the cost of production or may fall far below the cost of production of physical things.  And its value has no immediate relation to the satisfaction of wants.  Its value is derived solely from the willingness of owners, without coercion, duress, or misrepresentation, to alienate to each other their rights of ownership.  This is the simplified hypothesis of institutional economics.

Yet I do not overlook the important contributions to economic theory in the past, whether orthodox or heterodox.  I correlate them with institutional economics.  The classical and communistic economists used as their measure of value the man-hour of labor.  This is evidently, since the incoming of scientific management, the engineering economics of efficiency.  The Austrian and hedonistic economists, deriving from Bentham, used as the measure of value the diminishing marginal utility of consumption goods.  This is evidently the home economics recently introduced in the college curriculum.

But institutional economics is the field of the public interest in private ownership, which shows itself behavioristically in buying and selling, borrowing and lending, hiring and firing, leasing and renting.  The private interests become the field of intangible yet quantitative and measurable rights, duties, liberties, and exposures to the liberties of others.  These are various aspects of rights of ownership.  What we buy and sell is not material things and services but ownership of materials and services.  The correlation of engineering economics, home economics, and institutional economics makes up the whole of the science of political economics.

The only net-income economist, as far as I know, who took the trouble to examine these institutional factors and then consciously to exclude them from his pure economics of man’s relation to physical nature, was Böhm-Bawerk, in 1883.  Others excluded them by taking them for granted without investigation.  He excluded them explicitly under the names of “rights” and “relations.” 8  On examination of what he meant by these terms I find that he meant all kinds of ownership, and he limited his pure economics to the physical and psychological process of producing and consuming material things.  But if his pure economic man should go along the street picking up groceries, clothing, and shoes according to their marginal utility to him, he would go to jail.  He must first negotiate with an owner to whom

8. Eugen v. Böhm-Bawerk, Rechte und Verhältnisse (1883).


the policemen, courts, and constitution have given the right to withhold from him what he wants but does not own, until that owner willingly consents to sell his ownership.  This is his exposure to the liberty of owners, and this keeping out of jail is a part of what I mean by institutional economics.

The legal right to withhold is therefore the ultimate basis of all the imperfect or monopolistic competition that has begun to creep into the pure net-income economics of marginal utility.  It may be named institutional scarcity superimposed upon the psychological scarcity of diminishing utility.

This simplified assumption of willing buyer and seller might well be taken as the starting point of all economic theory, instead of starting with self-interest.  It is the ethics of economics.  For goodwill is not only customers’ goodwill, it is bankers’ and investors’ goodwill; it is the goodwill of laborers and sellers of materials, the goodwill of landlords and tenants, even the goodwill between competitors, in so far as may be deemed by the Court not inconsistent with the public interest.  In short, these varieties of goodwill, from the side of net income, are the valuable expectations that other economic classes will willingly, and therefore without duress, coercion, or misrepresentation, repeat in the future their mutually beneficial transactions.

The right to withhold is also the economic foundation of reasonable value.  It came up, in its modern variety of economic coercion, with the growth of large-scale industry and the mass bargaining power of thousands of stockholders acting collectively as one person under the legality of corporation finance.  This collective action is not, in fact, monopoly in the historic meaning of monopoly; it is merely the historic meaning of private property itself, but operating on the grand collective scale of associated property owners withholding from others what they want until they agree to pay or work for it.  When industry reached the stage of public utility legislation, as it did fifty years ago, an essential part of this legislation was that of depriving owners of a portion of their right to withhold services by commanding them to render service on the terms specified by the Supreme Court as reasonable for both sides of the bargain.

In other cases where monopoly was not recognized, and therefore the Supreme Court did not permit compulsory service or price fixing, the principle of a willing buyer and willing seller led to the law of fair competition as against the free competition of traditional economics.  Economic goodwill is the law of fair competition.

But it was in the case of so-called public utility corporations that the modern version of reasonable value began to creep into exchange value.  The basic principle of a willing buyer and seller was being violated by the emergence of large-scale corporations.  The legislatures, under the limitations deemed reasonable by the Supreme Court, endeavored to set upper limits


of price and lower limits of service within a range that the Court might deem not incompatible with the ideal of a willing buyer and a willing seller.

This principle might be named the ideal of the common law, just as maximizing net income is the ideal of individualistic economics.  In either case, one or the other is the most simplified assumption of its own pure economics, and might therefore be named the first principle of the science.  But in the practical application of the science to specific cases these simplified assumptions are necessarily modified by consideration of what is practicable or impracticable under all the complex circumstances of that case at that time.  In such a particular case the goal, or first principle, sought to be reached by the practical man, whether of maximum net income by the individualist or of willing seller and buyer by the Court, becomes the practicable or realistic application of the abstract science to the great complexity of favorable and unfavorable circumstances in that specific case.  This, in the decisions of a Court, is the meaning of reasonable value.  It is reasonable because it is the nearest practicable approach which the Court, in a specified dispute up for decision, thinks it can make towards the idealistic assumption of a willing buyer and willing seller.

Reasonable value, as I define it in following the Supreme Court, is not any individual’s opinion of what is reasonable.  This is the usual objection raised against a theory of reasonable value.  There are as many individual opinions of reasonableness as there are individuals, just as there are as many opinions of what is pleasurable or painful as there are individuals.  Reasonable value is the Court’s decision of what is reasonable as between plaintiff and defendant.  It is objective, measurable in money, and compulsory.

Neither is the individual permitted to say that he was unwilling.  In case of dispute, the Court alone, if only to prevent anarchy, says whether he was willing or not.  He must adjust his will, if he can, to the Court’s will. 9

So, also, individual opinions regarding the Court’s decision itself of reasonable value, and even majority and minority opinions within the Court, have as many differences as there are individuals.  But the Court’s decision must be obeyed, by the use of physical force, if necessary.

Hence it is not opinions or theories that must be obeyed; it is decisions, which take the form of compulsory orders, that must be obeyed.  Individual members of the Court may write out their own different opinions.  But these are justifications or criminations.  They are feelings, not acts.  They are even

9. The Court, in laying down the rule for ascertaining reasonable value in a particular case, states, in effect, that all conflicting theories of value must be given consideration and that to each theory must be given its “due weight”; that is, a reasonable value of the theory itself in its relation to all other theories of value, according to the facts and public purposes in that case.  (Smythe v. Ames, 169 U.S. 466, 1898.)  This is because these conflicting theories of value are really partisan theories set up by conflicting economic interests, each interest seeking for itself the maximum net income at the expense of other interests and of the public interest as a whole.


not necessary except as concessions to outside opinion.  It is the decision that counts, and the decision is a fiat of sovereignty.  The fiat is arrived at, in this country, by a constitutional process of majority rule within the Court.  Under other constitutions it may be arrived at by a dictator exercising the judicial function by appointing and removing the judges at will.  It need not then be justified and cannot be criminated without free speech.  In such cases it is arbitrary fiat, not reasonable fiat.

But reasonable value, in the United States, is what the constituted Court decides is reasonable, by mere fiat, not what individuals think is reasonable.  There have been decisions of the Court which I personally think were unreasonable, even dictatorial and capricious. 10  Such decisions I attribute to upbringing of members of the Court in the maximum net-income economics of corporation finance.  But nevertheless I and the American people must obey the decision while it lasts. 11  It is not a matter of subjective or individual opinion; it is the constitutional structure of the American judicial system that decides.

This is because the United States differs from other nations in that its sovereignty is split in two directions: the legislative, executive, and judicial

10. Cf. Robert L. Hale, ‘What Is a Confiscatory Rate?”, Colonial Law Review, xxxv, 1046, 1052 (1935); Edw. S. Corwin, The Twilight of the Supreme Court (1934).

11. There is an evolutionary principle within the Anglo-American common-law idea of willingness corresponding to the evolution of sovereignty from the time of William the Conqueror.  The idea started in warlike and feudal times when only the wills of martial heroes were deemed worth while; then was extended to unwarlike merchants in the law of the market overt; then to serfs and peasants; then to the most timid of people, for whom not only actual violence or trial by battle, but even the merest subjective apprehensions of inferiority created fear which deprived them of their freedom of will.  (Galusha v. Sherman, 105 Wis. 263, 1900.)  Then towards the end of the nineteenth century this simplified formula of a free will was extended to the relations between employers and employees, on the economic assumption that employers, being owners of property, were in a stronger economic position than propertyless laborers, such that laborers were deprived by fear of unemployment of their freedom of will in bargaining.  (Rolden v. Hardy, 169 U.S. 366, 1898.)  Further variations were partly allowed where women and children were deemed economically unequal to the superior managers, merchants, lawyers, or employers; so that the agreements which they made respecting the price of labor were not contracts between willing buyers and willing sellers.  Many other complexities arise with the incoming of large-scale production, collective action, and the cycles of prosperity and depression; and these also are among the variabilities that must be taken into account in the evolutionary application of the basic principle of the willing buyer and willing seller.

A recent writer (O. Lange, in The Review of Economic Studies, June, 1935) holds that economic theory does not have within itself a principle of evolution, and must follow Karl Marx in a theory of historical materialism in order to derive a theory of economic evolution.  But I reduce Marx to a theory of efficiency measured by man hours as an essential part of economic theory, although usually measured by dollars.  And I find economic evolution in the changes in custom, the changes in citizenship, the changes in sovereignty, as well as in technological changes.  Lange includes, in his meaning of technique, changes in “organization,” which, with me are changes in institutions.  The evolutionary principle in the common law comes under Darwin’s artificial selection, not his natural selection.  It is artificial selection by judges.

This evolutionary principle is possible because lawful economics is itself highly variable though founded, in Anglo-American common law, on the willing-buyer-seller assumption.  Not only does it have the variabilities of corporeal, incorporeal, and intangible property, and the variabilities of reasonable and unreasonable values, but also the revolutionary variabilities of communism, fascism, nazism and the gold clause decisions.


branches, in the one direction, and the federal and state branches, in the other direction.  Yet since the year 1890 12 the Supreme Court has held that, while in many matters the states are sovereign, yet in the one matter of economic valuations and activities the Supreme Court of the United States is sovereign over both the states and the executive and legislative branches of the federal government.  In railway valuations, for example, the Court has deprived the states of their sovereignty.  But even where the Court asserts state sovereignty, as in the NIRA decision, the economic acts of state sovereignty are subordinated to national sovereignty under the dominion of the Supreme Court of the United States.  Any federal or state official may be brought before the Supreme Court as defendant, on petition of a private citizen or corporation as plaintiff, in a dispute over economic valuations or economic transactions.  Consequently executive and legislative sovereignty, whether federal or state, in the field of economics, are subject to the national judicial sovereignty.  The Court thereby becomes, in economics, a superior branch of both the federal and the state legislatures, differing mainly in its procedure.

This should be named a nationalistic theory of economics, instead of individualistic, cosmopolitan, or communistic.  It parallels the trend toward nationalism the world over during the past fifty years, especially since the World War.  This nationalistic theory of value, under the sovereignty in America of the Supreme Court, I describe as an institutional theory of economics.  In order to correlate it with the maximum net-income economics of the past one hundred and sixty years, I name an institution collective action in control of individual action.  It may be unorganized collective action, which is the meaning of custom, or organized collective action like that of a corporation, a co-operative, a trade union, or the state itself.  If organized, it necessarily acts through executive, legislative, and judicial organs, whether combined or separated.  There are other meanings of institutions, as I know, but I find that this meaning of collective action fits the facts of my experience.

The supreme organized collective action is the monopoly of physical force by taking violence out of private hands.  This is sovereignty.  There are subordinate forms of organized collective action, sanctioned by the physical force of sovereignty but authorized, in the case of business corporations, to use the economic sanctions of scarcity, or, in the case of churches or clubs, to use the merely moral sanctions of collective opinion.  These subordinate forms are delegated forms, since they are created, permitted, regulated, dissolved, or prohibited by the supreme institution, sovereignty.

I date the modern recognition by the state of these delegated forms of economic collective action from the time of the general corporation laws beginning in the decade of the 1850’s, and I consider this period to be

12. C. M. & St. P. Ry. Co. v. Minnesota, 134 U.S. 418 (1890).


the beginning of modern capitalism.  These corporation laws endowed individuals with a new universal right, the right of collective action, previously outlawed as conspiracy, and not previously granted as universal but granted only as a monopolistic special privilege by a special act of the legislature.  This new universal right of collective action was evidently called for by the incoming of modern widespread markets and corporation financing.  Today, it is estimated, nearly 90 per cent of manufactured products in this country are produced by corporations. 13  In agriculture there is authorized by the state an amazing extension of co-operative associations controlling more or less certain economic activities of individual farmers.  The extent of judicial authorization of trade unions in their control of individuals is well known.  Even the individual banking business is more or less controlled by the collective action of the member banks of the Federal Reserve system, subject to the Supreme Court.

With the incoming of these collective controls the older individualistic economics becomes obsolete or, rather, subordinated to institutional economics.  The free trade individual of Adam Smith and Jeremy Bentham disappears in exactly what they denounced; namely, protective tariffs, state subsidies, corporations, unions, co-operatives - all in restraint of individual free trade. 14

13. By the National Industrial Conference Board, report on Federal Corporation Income Tax, Vol. I, pp. 23, 126 (1928).

14. A fiction is introduced by personifying corporations as individuals and giving to them not only the economic rights, liberties, and responsibilities previously attributed to individuals, but also the additional sovereign rights and liberties of collective action, limited liability, and so-called immortality.  They are not individuals - they are organized collective action in control of individuals.  This personification of collective action ends in the inequality of treating as equals a concerted thousand or hundred thousand stockholders and bankers, acting together as a single person, in dealings with wage earners or farmers or other buyers or sellers, who act separately in their naked individualism of Smith, Bentham, Ricardo, the Austrian economists, the Declaration of Independence.

The statement of this fiction is found in the case of Santa Clara County v. So. Pac. R.R. Co., 118 U.S. 394, 396 (1886).  The Court said, “One of the points made and discussed at length in the brief of counsel for defendants in error was: Corporations are persons within the meaning of the 14th Amendment.”  Chief Justice Waite said: “The Court does not wish to hear argument on the question whether the provision in the 14th Amendment forbidding a State to deny to any person… equal protection of the laws applies to corporations.  We are all of opinion that it does.”  See E. S. Corbin, Twilight of the Supreme Court, 205 (1934).  When the state of Wisconsin started, in 1907, to regulate public utilities it required all of them to take out corporate charters.  Many individuals and partnerships convert themselves into corporations for other than technological reasons.

All economic theories distinguish between activity and the objects created by that activity.  A familiar instance is “production” and “product.”  So with institutional economics.  The distinction can be fixed by the terms “institution” and “institute.”  The institution is collective action in control of individual action.  The institutes are the products of that control.  What are usually named institutions are more accurately named institutes.  The institutes are the rights, duties, liberties, even the exposures to the liberty of others, as well as the long economic list of credits, debts, property, goodwill, legal tender, corporations, and so on.  Even the individual of economic theory is not the natural individual of biology and psychology; he is that artificial bundle of institutes known as a legal person, or citizen.  He is made such by sovereignty which grants to him the rights and liberties to buy and sell, borrow and lend, hire and hire out, work and not work, on his own free will.  [Merely as an individual of classical and hedonistic theory he is a factor of production and consumption like a cow or slave.  Economic theory should make him a citizen, or member of the institution under whose rules he acts.

This distinction between institutions and institutes will, perhaps, account for a criticism of my Institutional Economics, by P. F. Brissenden in The Nation, June 26, 1935.  Brissenden says that the book “is full of theories of value, transactions, and ‘going concerns’ but almost empty of institutions.”  The explanation, I take it, is that he overlooks my definition of institution as “collective action in control of individual action” which I had named a going concern.  But the values, transactions, rights, duties, debts, corporation assets, and liabilities, working rules, and so on, expressed quantitatively by measurement in terms of legal tender, are what I should have distinguished as the various institutes created and enforced by the institutions.  Justinian’s institutes were drawn up by lawyers selected by him, but it was Justinian himself, at the head of the institution of sovereignty, who proclaimed and enforced them.  Economists who reject institutional economics have always been using institutes.  It will be seen also that I do not use the word institution as interchangeable with sociology.  I mean legal and legalized institutions.]

HHC: [bracketed] displayed on page 248 of original.


If we reduce organized collective action to its simplest possible formula, we have three parties to the transaction; namely, a plaintiff, a defendant, and a judge.  This is indeed the simplest formula of sovereignty itself. 15  A similar formula applies to all subordinate organizations.  The three parties are clearly separated in commercial arbitration, labor arbitration, and by means of the discipline committee of a stock exchange or a produce exchange.  But the judicial function is more or less merged with the executive and legislative functions in a corporation or a dictatorship.

This judicial sovereignty over economic affairs in the United States derives from the “due process” clause of the federal Constitution.  No person shall be deprived of life, liberty, or property by either an executive or a legislature or a lower court or a state or federal government without due process of law, as determined by the Supreme Court.  The meaning of due process, however, has been changed by the Court within the past fifty years.  Originally the term, as stated by Corwin, 16 “meant simply the modes of procedure which were due at the common law… Today,” continues Corwin, “due process means reasonable law and reasonable procedure, that is to say, what the Supreme Court finds to be reasonable in some or other sense of that extremely elastic term.”

It is from this later meaning of due process of law that the economic term “reasonable value” finds its place in American economics.  Reasonable value is welfare economics as conceived by the Supreme Court.

For these reasons there is in American economics a written Constitution and an unwritten constitution.  The written Constitution was written in 1787 and in succeeding amendments.  The unwritten constitution was written piecemeal by the Supreme Court in deciding conflicts of interest between plaintiffs and defendants.  We live under this unwritten constitution; we do not even know what the written Constitution means until the Supreme Court

15. Cf. Hans Kelsen, Allgemeine Staatslehre (1925).

16. Edw. S. Corwin, The Constitution and What it Means To-Day, 105 (4th ed., 1930); Commons, Legal Foundations of Capitalism, pp. 333ff. (1924); see especially majority and minority opinions in Hurtado v. California, 110 U.S. 516 (1884).


decides a case.  When we investigate reasonable value we are investigating the unwritten constitution.  When we investigate the evolution of reasonable value we are investigating the Court’s changes in meanings of such fundamental economic terms as property, liberty, person, money, due process.  Each change in meaning is a judicial amendment to the Constitution. 17

Thus, while the early economists, from Thomas Aquinas to John Locke, Adam Smith and David Ricardo, culminating awkwardly in Karl Marx, eliminated money and prices but made labor cost the measure of value, the institutional economics of the common law and the Supreme Court makes legal tender money and the free will of buyers and sellers the measure and standard of reasonable value.

17. This is the predicament in teaching the Constitution to children in the public schools and in meeting the repeated demand that we “go back to the Constitution.”  We cannot go back to the written Constitution.  We go back to the unwritten constitution.  In the case of the institutional economics of reasonable value we go back to the common-law assumption, and its later evolution, of a willing buyer and a willing seller.  This is the simplified economic assumption of the unwritten constitution.  There are other sources of the unwritten constitution, but I am speaking here of economic valuations by public authorities which the Supreme Court has said are a judicial question.  See W. B. Munro, The Makers of the Unwritten Constitution (1930) ; C. E. Merriam, The Written Constitution and the Unwritten Attitude (1931); R. L. Mott, Due Process of Law (1926); E. S. Corwin, The Constitution and What It Means To-Day (4th ed., 1930).

The gold clause decisions were a revolutionary change in the unwritten constitution as previously decided in the legal tender cases.  They changed the meanings of “obligation of contracts” and of value, by transferring from creditors to debtors millions of dollars which had been willingly agreed upon at the time when the debts were contracted.  But similar judicial revolutions have occurred in the meanings of other words in the unwritten constitution.  See Commons, Legal Foundations of Capitalism and Institutional Economics on the Court’s changes in the constitutional meanings of property, liberty, person, and due process of law.

It is upon the ground of the primary assumption of willing buyer and willing seller in the unwritten constitution that I argue for a mandate of Congress for a reasonable stabilization of prices as far as practicable by the Federal Reserve system.  The gold clause decisions are an evolution from the legal tender cases.  They leave no fixed weight of gold as the measure of value.  They assert the validity of legal tender paper throughout the nation as fulfilling the constitutional obligations of contract.  The stabilization of legal tender prices is the stabilization of creditor-debtor relations.  If such a law were enacted by Congress its constitutionality, as construed by the Court, would be a further evolution of the unwritten constitution.

This bears on the debated point of judge-made law.  The judges do not actually make law.  They decide particular disputes.  Then it is expected that they will decide similar disputes in a similar way, and so, what is the use of bringing up the same point again?  This is not so much the way in which law is made as it is the way in which custom is made.  A description of the evolution of custom, in Anglo-American law, is the change in habits due to change in expectations of what the courts will do in deciding conflicts of interest.  This is more appropriately named judge-made custom instead of judge-made law.  In America, this evolution of judge-made custom in economic affairs is the growth of the unwritten economic constitution.