Institutional economists have raised some very specific objections to the dominant conventional theory; and while it is not necessary to analyze in minute detail all the well-known aspects of this critique, it will be useful to review some of the exceptions taken by representative institutionalists to certain methodological procedures of conventional economics, if for no other reason than to make clear the distinct perspective and mode of thought which have guided them from the beginning. These exceptions will illustrate clearly and fundamentally how institutionalism conceives the task of economic analysis in a radically different manner than the traditional, pure theory of valuation, value, and price.
Starting with a brief outline of the evolution of the theory of value from its classical origins, we shall illustrate our thesis by brief references to the institutional critique, with particular emphasis on those elements of the critique that demonstrate the alternative perspective of the institutional approach. Both Adam Smith and David Hume made deliberate use of inherited concepts of natural order and natural law to show that the system of private enterprise, or "natural liberty," was not only theoretically conceivable and practically workable, but at the same time morally superior and more efficient in the use of given resources to the preceding mercantile system. Not only did this system tend to regulate itself, it also produced terms of exchange that possessed many, if not all, of the characteristics of a "just price," as the term was conceived and propagated by medieval thinkers; it guided labor, resources, and capital into the occupations and lines of production which corresponded to the wishes and preferences of the consumer. The labor theory of value, together with the hypothesis of maximizing behavior -- both major and central hypotheses of classical political economy -- asserted that market prices would gravitate around natural prices of goods and services at their normal level, or the level at which they covered their costs of production. Prices and wages could thus be considered just and equitable, and as such did not need to be controlled. If the labor theory of value, understood as an equilibrium, seemed to guarantee the theory of distribution, the maintenance of some form of macroeconomic balance or equilibrium was shown to be guaranteed by the principle of the conservation of purchasing power, which both Adam Smith and Jean-Baptiste Say considered self-evident.
The classical theory of Smith and his successors borrowed the equilibrium concept from mechanics and supplemented its notion of natural order, natural liberty, and natural law with an increasing dependence on the quantitative, utilitarian psychology of Jeremy Bentham as a basis for its explanation of human behavior, and particularly of economic behavior. By measuring and aggregating all input and output magnitudes in terms of prices (at equilibrium levels), and by identifying the social output as the sum total of these values at market prices, the theory and system supposedly provided their own quantitative yardsticks for measuring the performance and growth of the economy over time. The economy was also said to produce the greatest sum of pleasure possible to the greatest number of people, by allowing every individual economic unit to choose goods, occupations, and investment outlets according to its own preferences. Thus, what began as an exercise in objective analysis ended in a system of normative and political conclusions, formulated without apparent or explicit value premises. This unprecedented achievement, unparalleled in any other discipline, is the outcome of a specific procedure. By first defining the scope of the analysis and postulating specific behavior patterns, the position of equilibrium is endowed with characteristics that give it the appearance of an objective optimum. Used in this fashion, the concept of equilibrium lends itself to a superficially convincing defense of the laissez-faire system of natural liberty. Philosophers, aware of the presupposition of classical and neoclassical analysis, have shown the logical limitations and weaknesses of the concept of natural order and natural law; they have demonstrated that such doctrines have been used repeatedly to support open and hidden valuations of the greatest variety and mutual incompatibility and shown that the ideology does not exist that cannot be defended by an appeal to the laws of nature.
Institutional economists have developed their own analysis of the philosophical premises of classical and neoclassical economic theory into a thorough critique of their preconceptions. Veblen criticized the non-causal teleological character of the analysis in contrast to the viewpoint of modem science, and Gunnar Myrdal showed that conventional equilibrium analysis has continued a long tradition of normative (political) thinking while professing a commitment to a positive (value-free) and objective account of the natural world. In fact, both radical and conservative economists have been inclined to shape and use their economic analysis to support their political objectives and perform the logically untenable feat of arriving at normative political conclusions without explicit political premises. The political objectives of classical and neoclassical economists were those of anti-mercantilism, anti-regulation, and non-intervention. Theoretical economists appealed to natural order and natural law, based on a theory of man later reinforced by the utilitarian calculus. Aided also by the analogy to mechanics and stable equilibrium (i.e., under static conditions where no new “forces" produced changes in motion), they have developed a system of conclusions that make economic and political processes appear to work towards common goals and a maximization of "social welfare." Levels of equilibrium are so defined that processes of production and distribution, under the impulse of the forces of self-interest, tend automatically and in a self-correcting manner towards a socially desirable and optimal outcome. What was initially introduced as a simplifying assumption for the abstract representation of reality for purely analytical purposes is thus subtly converted into the idealized norm of a perfectly competitive market, providing direct criteria for economic policies without further diagnosis of the specific situation, and without explicit normative or moral value premises. This logically untenable feat of arriving at political conclusions without political premises is, however, achieved with the aid of logical fallacies, the norms and teleology derived from pre-analytical visions and ideologies have forced upon economics specious concepts, definitions, and assumptions. Thus, normative and ideological elements have shaped the concepts, language, distinctions, and modes of thinking of conventional economics. Institutional economics has made major contributions to identifying these fallacies, and in doing so has produced both a critique of conventional economic theory and a clear picture of the modern character of institutionalism itself, as a distinct approach to economic analysis. The most notable points of the institutional critique are the fallacies of the utilitarian foundations of economic theory, the fallacy of the doctrine of the sovereignty of the consumer, and the fallacy of the means-ends dichotomy.