Elinor Ostrom and Oliver Williamson were two unlikely picks for the Nobel Prize in Economics, but their low profiles belie their impact. Like many others, I found myself scrambling to find out more about Ostrom and Williamson, so I sat down with Managerial Economics and Decision Sciences professor Bard Harstad to shed some light on these two new giants in the field.
Though Ostrom and Williamson have never worked together, they were each awarded the Nobel for their research into working relationships—Ostrom for her studies of bottom-up, informal organizations that operate outside of the marketplace, and Williamson for his work to understand when and why firms may be more efficient than the market.
The current recession has some experts questioning the role of the efficient market hypothesis, a trend that may have influenced the committee’s decision. “This year’s winners are focusing on how the market is not efficient,” Harstad told me.
That the award went to two social scientists this year also represents a small step toward broadening the economics Nobel, Harstad said. Though this is not the first time the prize has been awarded to someone outside the formal field, it is not common—it happened most recently in 2002.
Despite their status as “outsiders,” Ostrom and Williamson certainly deserve the prize. Both have strong backgrounds in economic theory, each owing a debt to Ronald Coase, the University of Chicago economist whose work addressed transaction costs, property rights, and the theory of the firm. Coase is best known for his two theorems, one of which states that well-defined property rights should be enough to produce an efficient market in the absence of transaction costs. With a smoothly functioning marketplace, buyers and sellers could negotiate with each other independently, obviating the need for such organizations like companies and governments. Yet firms and governments exist, suggesting transaction costs do play a role. But, Harstad noted, “he was very vague about what those transaction costs are.”
Williamson has helped fill many of the gaps Coase left behind. He argued that certain negotiation costs in the market necessitate firms—certain things are more easily done in house—but using the marketplace in other situations can be advantageous.
Take the example of a coal-fired power plant, Harstad said. If there is one power plant and many coal mines, it makes little sense for the plant to own one or more of the mines. Competition between the mines will keep transaction costs low, benefiting the plant. But, if there is only one plant and one mine, it would make sense for the two to integrate, decreasing the transactional costs by turning contracts into administrative decisions. Williamson’s work centers on theoretical ruminations about these sorts of complex relationships.
Ostrom, on the other hand, deals with case studies of informal arrangements, like those between livestock herders on the Mongolian steppes where grazing land is a common resource. In such arrangements, there is always a danger of one individual exploiting the resource for short-term gain at the expense of others. Coase opined that problems related to managing a common good could be solved with property rights. But Ostrom’s research, Harstad said, refutes that idea and another closely related to it—the tragedy of the commons, a concept popularized by ecologist Garrett Hardin.
“The people who own the grassland, they can find a way to solve it,” Harstad said, explaining one of Ostrom’s cases. “They can get around the tragedy of the commons even with no property rights—contradicting Coase—and even with no government. You don’t need a government, and you don’t need a market necessarily.” Ostrom’s research he said, indicates “there are other ways of solving the problem.”
One perennial theme in Ostrom’s research, Harstad said, is the idea that the people sharing a resource maintain an ongoing relationship with frequent interactions. While not all cases Ostrom has studied have successfully overcome the tragedy of the commons, a few groups did succeed, an outcome that many found surprising.
“When does it work?” Harstad reflected. “Ostrom says they succeed in avoiding the tragedy of the commons if they have a conflict resolution mechanism, if the duty in maintaining the system is proportional to the individual’s benefit—larger users should have larger responsibilities—and the monitoring and censuring should be by the users.”
“Her argument is very much a bottom up approach where individuals should find a way to solve this themselves,” Harstad said.
“A big question is then whether these ideas work not only for the small problems she’s studying, but on a global scale,” he continued. “Are those ideas still relevant if you’re talking about climate change? Is it better that you hope the countries will find some informal way of organizing or cooperating, or should you have a top down approach where we should force everyone to have the same agreement?”
By awarding the Nobel to two very different researchers, Harstad said the Nobel committee rewarded two complementary trains of thought. Williamson is primarily a theorist looking at firms, while Ostrom is an empiricist studying much more informal arrangements. Still, they both fit the profile of Nobel laureates: “Their ideas are quite deep,” Harstad said.