Tuesday, October 13, 2009

Return of the political economist?

By awarding the The Sveriges Riksbank Prize in Economic Sciences to Elinor Ostrom "for her analysis of economic governance, especially the commons" and to Oliver E. Williamson "for his analysis of economic governance, especially the boundaries of the firm", the Nobel Committee may have signalled the return of the political economist to the centerstage of debates on economic issues.

Apart from signalling the convergence between economics and other social sciences, there are two more interesting things, of great relevance now, about this award. One, in keeping with the tumultuous events of the recent months, the prize highlights attention on more broad-based market failures and underlines the importance of non-market institutions and arrangements in addressing such failures. Second, amidst all the euphoria surrounding outsourcing and shrinking of firms, the work of Williamson in particular, sounds a note of caution and points to the need to revisit Ronald Coase's analysis of transaction costs.

As Edward Glaeser writes in an excellent post, Prof Williamson saw the limitations, as well as the benefits, of hierarchies and organizations. His analysis focussed on market failures due to bounded rationality, asymmetric information, imperfect contracting, adverse selection, ex-post opportunism, and so on. As Glaeser writes, Prof Williamson focussed on "peer group associations and hierarchies... emphasizing information asymmetries and the difficulty of ascertaining the productivity of particular workers... argued that a simple hierarchy with workers, ground level managers and an entrepreneur was a remarkably efficient way of handling production when information was imperfect."

Ostrom’s work focuses on the commons, such as how pools of users manage natural resources as common property. As MR correctly points out, Prof Ostrom saw not the tragedy of the commons but opportunity of the commons and the relevance of social and community institutions and conventions in addressing widely prevalent market failures in many areas of sharing of common public resources - grazing, fishing, irrigation etc. It writes, "Ostrom's work is about understanding how the laws of common resource governance evolve and how we may better conserve resources by making legislation that does not conflict with law."

Prof Ostrom's work goes beyond the conventional public-private divide and focuses on how "pools of users manage natural resources as common property" and thereby overcome the market failures arising from the tragedy of the commons. There are numerous examples of traditional governance structures, where the commons users "create and enforce rules that mitigate overexploitation". As Prof Ostrom has written (and also here), "When users are genuinely engaged in decisions regarding rules affecting their use, the likelihood of them following the rules and monitoring others is much greater than when an authority simply imposes rules".

Paul Krugman sees the awards as a recognition of the New Institutional Economics. See Mark Thoma, as always, for the exhaustive links.

1 comment:

gaddeswarup said...

Elinor Ostrom's work sounds very nice and natural but I wonder about this statement "Ostrom's work is about understanding how the laws of common resource governance evolve and how we may better conserve resources by making legislation that does not conflict with law." in the Indian context. Some of the laws of common resource governance has caste elements in it(like fishing, temples etc) and these implicit understandings of the past may not be desirable or viable now.