Ideas, crisis, and institutional change

By Abdel-Jaouad Ouarraki

Blyth argues that Ideologies and ideas in general are important drivers of institutional change. He poses several hypotheses of which the first one is that “In periods of economic crisis, ideas (not institutions) reduce uncertainty”. Blyth argues that in periods of crisis, the existing institutions no longer provide for the right incentives to act in the interests of the actors, as crises are generally unexpected and the sources of crises unknown. Therefore, in times of crisis, Blyth argues, “agents cannot take institutions “off the shelf” to reduce uncertainty, as institutional supply would be random at best, and at worst impossible”. This is where ideas come in as they provide for a framework that makes it possible to interpret the situation at hand, as these ideas explain how the economy supposedly works and therefore provide for a basis on which to act upon.

The financial crisis of 2008 is a textbook example of a crisis that was anticipated by few, and properly understood by arguably even less people. To make sense of the financial crisis two narratives emerged. On the one hand, we have the “socialists” arguing that the banks were given free space to gamble and hence stricter regulations imposed by governments are the institutional solution to the crisis in the long term. On the other hand we have the “capitalists” who argue that the crisis is caused by “profligate governments” that bought votes with welfare spending.

Hence, one side argues for increased government regulations, while the other side argues for less government involvement in the economy. The two ideologies make a different assessment of the same crisis and the institutions that would emerge from either one of these assessments are radically different. Nonetheless, both of these narratives reduce the uncertainty of what to do as the existing institutions simply did not provide for the right incentives to prevent the financial crisis from happening.