Recognizing Governance and Institutional Puzzles

Efficiency is not an ideal to strive for, but a constraint that shapes how economists should interpret observed behavior. When agents are assumed to be maximizers—doing the best they can under their given constraints—any apparent inefficiency in an equilibrium is not a signal of suboptimality, but rather of a flaw in the model. Deadweight loss, for example, in a single-price monopoly, is not an objective failure, but the result of ignoring real-world constraints like the inability to price discriminate. Once we take seriously the idea that observed behaviors persist because they are locally optimal given constraints, we are compelled to treat puzzling or costly institutions not as failures to be corrected, but as puzzles to be explained. This is the foundation of institutional economics. Instead of viewing costly practices like dueling as irrational or immoral, economists should seek the hidden logic that sustains them—such as their role in signaling credibility or resolving information asymmetries. The introduction of transaction costs into economic reasoning has been pivotal in uncovering such hidden rationalities. Declaring behaviors “inefficient” prematurely halts analysis and enforces the economist’s model as the benchmark, rather than real-world constraints. True understanding requires bracketing moral judgment and focusing on the structures, incentives, and constraints that make seemingly irrational practices persist. Efficiency, therefore, should not be a normative benchmark for policy, but a methodological guideline reminding us that persistent behaviors—no matter how strange—must make sense under some set of constraints.

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