Nobel in Economics: Prize for Practical Wisdom

The Nobel Prize in Economics to Ostrom and Williamson—who have by

their independent research taken economics beyond the traditional
analysis of market prices by establishing ‘economic governance’ as a field
of research—has come at the right time when the world is entangled in
governance issues that have not only led to the collapse of organizations
but also to worldwide contagions.

GRK Murty
Neo-classical economics textbooks proclaim that markets endowed
with private property rights and contracts are better equipped to
deliver wonders—efficiency and equity. But in the real world, as is
incidentally being experienced amid the ongoing global economic crisis,
it does not happen that way, at least always. Even the prophet of
market economy, Adam Smith, is perhaps aware of it when he said:
“Creating harmony between the pursuit of self-interest and the pursuit
of social welfare depends on the constraints on self-interest.” But the
scope for the operation of such a ‘constraint’ on man’s behavior
appears slim: for ‘Man’, as enunciated by grandsire Bhishma in The
Mahabharata, is a slave to money—arthasya purusha dasah. The
ongoing world economic crisis is, perhaps, a vindication of this
prophecy.

Fortunately, there are off-beat researchers of modern day who have

analyzed as to why the world looks the way it does—different from the
ideal world found in classical textbooks—and explained as to what
works in it. It is to two of such researchers—Elinor Ostrom of Indiana
University, Bloomington, US, and Oliver Williamson of University of
California, Berkeley, US—that the Nobel committee has awarded the
Nobel Prize in Economic Sciences for the year 2009. They share the
prize for their separate research into economic governance—the rules
by which people organize, cooperate, relate and exercise authority in
companies and economic systems—that “advanced economic
governance research from the fringe to the forefront of scientific
attention.” The committee observed that their research revealed how
economic analysis could explain most forms of social organization.

Ostrom, the first woman to win Nobel in Economics, is currently the

Arthur F Bentley Professor of Political Science, at Indiana University,
Bloomington. Her pioneering work mostly concerns the economic
governance of the common pool resources—managing common
resources such as pastures, woods, lakes, and fish stocks. Her research
“has challenged the conventional wisdom that common property is
poorly managed and should be either regulated by central authorities
or privatized,” said the Nobel economics committee. Her findings,
though sound commonsensical, are eye-openers, for they challenge
Garret Hardin’s “The Tragedy of the Commons”—a living expression of
neo-classical thinking—through their revelation that common resources
are better managed from the bottom-up by user-associations than by
the governments or the private sector. Ostrom went out to the field to
study what people and communities are doing differently, and drawing
new insights from it, proposed a new architecture of governance, which
she dubbed ‘polycentric governance’. Based on her field research,
Ostrom has prescribed new ‘design principles’ that could be used by
people, communities, and societies facing real-world problems in
managing local common pool resources: one, clearly defined
boundaries; two, adapting rules regarding the appropriation and
provision of common resources to local conditions; three, collective-
choice arrangements; four, effective monitoring by monitors who are
part of or accountable to the appropriators; five, a scale of graduated
sanctions for resource appropriators who violate community rules; six,
cheap and easy access mechanisms of conflict resolution; and seven,
recognition of the self-determination of the community by higher-level
authorities.

Her co-winner, Williamson, currently the Edgar F Kaiser Professor

Emeritus at the Haas School of Business, University of California,
Berkeley, is a pioneer in the multi-disciplinary field of transaction cost
economies and has been awarded the Nobel “for his analysis of
economic governance, especially the boundaries of the firm.”
Williamson “developed a theory where business firms served as
structures for conflict resolution”. He has argued that hierarchical
organizations, such as companies, represent alternative governance
structures, which differ in their approaches to resolving conflicts of
interest. His ‘transaction cost theory’—developed based on the
opportunistic behavior of agents who can renege on their
commitments, bounded rationality of agents and asset specificity,
where assets are only valuable in certain uses and certain economic
relationships that offer a scope for the parties transacting with each
other to engage in ‘holdup behavior’—indeed highlights the nature of
real-world market organizations. It argues that “large private
corporations exist primarily because they are efficient. They are
established because they make owners, workers, suppliers, and
customers better off than they would be under alternative institutional
arrangements.” It also clarifies that “when corporations fail to deliver
efficiency gains, their existence will be called into question,” which
means firms cannot grow infinitely either. Admitting the fact that
corporates are better equipped to handle the drawback—haggling and
disagreement—associated with markets by virtue of their authority to
‘mitigate contention’, Williamson warns that the same authority can as
well be abused. It also emphasizes the limited ability of people to make
perfectly informed decisions, besides the propensity of some to act
opportunistically. His research findings recommend that it is better to
control such behavior directly rather than through policies that restrict
the size of the corporates.
In sum, his insights help us understand better a broad range of
organizational compacts such as the choice and design of contracts,
‘information impactedness’, corporate financial structure, the function
and operation of political systems, and the size and scope of firms—the
question of a firm going for vertical integration as defined by the scope
for lowering the transaction costs; why some activities are carried out
by large corporations, while others aren’t; and why big firms come into
existence more frequently than is predicted by the neo-classical theory.

Interestingly, the Nobel award is a good thing to happen to Ostrom and

Williamson who have by their independent research taken economics
beyond the traditional analysis of market prices by establishing
‘economic governance’ as a field of research that has “greatly enhanced
our understanding of non-market institutions,” that too at a time when
the world is entangled in governance issues—failure of boards of
directors to moderate excessive compensation or bonuses that
encouraged excessive risk-taking, leading to not only the collapse of
organizations but also worldwide contagions. Thus, their research
highlights once again the need for a constant vigil over “man’s slavery
to money”, as reflected in his behavior.

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