Oliver Williamson and Elinor Ostrom Awarded Nobel in Economics

I would not have predicted this (links to other comments are given below):

Two Americans Share Nobel in Economics, by Louis Uchitelle, NY Times: In a departure from prevailing economic theory, the Nobel Memorial Prize in Economic Science was awarded Monday to two social scientists for their work in demonstrating that business people, including competitors, often develop implicit relationships that supplement and resolve problems that arise from free-market competition.

The prize committee cited Elinor Ostrom of Indiana University “for her analysis of economic governance, especially the commons,” and Oliver E. Williamson of the University of California, Berkeley, “for his analysis of economic governance, especially the boundaries of the firm.”

Ms. Ostrom becomes the first woman to win the prize for economics. Her background is in political science, not economics.

“It is part of the merging of the social sciences,” Robert Shiller, an economist at Yale, said of Monday’s awards. “Economics has been too isolated and these awards today are a sign of the greater enlightenment going around. We were too stuck on efficient markets and it was derailing our thinking.” ...

The committee, in effect, said that theory was too simplistic and ignored the unstated relationships and behaviors that develop among companies that are competitors but find ways to resolve common problems. “Both scholars have greatly enhanced our understanding of non-market institutions” other than government, the committee said.

“Basically there is a common understanding that develops even among competitors when they are dealing with each other,” Mr. Shiller said, adding “when people make business contact, even competitors, they can’t anticipate everything, so an element of trust comes in.”

That is what the Nobel committee recognized, he said, in citing Mr. Williamson and Ms. Ostrom.

In its announcement, the committee said Ms. Ostrom “has challenged the conventional wisdom that common property is poorly managed and should be either regulated by central authorities or privatized. Based on numerous studies of user-managed fish stocks, pastures, woods, lakes, and groundwater basins, Ostrom concludes that the outcomes are, more often than not, better than predicted by standard theories.”

Mr. Williamson’s research, the committee said, found that “when market competition is limited, firms are better suited for conflict resolution than markets.” ...

See also: Paul Krugman, Marginal Revolution 1, Marginal Revolution 2, Arnold Kling, Real Time Economics, Justin Fox, Cheap Talk, Lynne Kiesling 1, Lynne Kiesling 2, Steven Levitt, Crooked Timber, Ed Glaeser, Michael Mandel.

Update: Steven Levitt:

When I was a graduate student at MIT back in the early 1990’s, there was a Nobel Prize betting pool every year. Three years in a row, Oliver Williamson was my choice. At the time, his research was viewed as a hip, iconoclastic contribution to economics — something that was talked about by economists, but that students were not actually trying to emulate (and probably would have been actively discouraged from had they tried to do so). What’s interesting is that in the ensuing 15 years, it seems to me that economists have talked less and less about Williamson’s research, at least in the circles in which I run. I suspect most assistant professors of economics have barely heard of him. Yet I suspect the older generation of economists will applaud this choice.

The reaction of the economics community to Elinor Ostrom’s prize will likely be quite different. The reason? If you had done a poll of academic economists yesterday and asked who Elinor Ostrom was, or what she worked on, I doubt that more than one in five economists could have given you an answer. I personally would have failed the test. I had to look her up on Wikipedia, and even after reading the entry, I have no recollection of ever seeing or hearing her name mentioned by an economist. She is a political scientist, both by training and her career — one of the most decorated political scientists around. So the fact I have never heard of her reflects badly on me, and it also highlights just how substantial the boundaries between social science disciplines remain.

So the short answer is that the economics profession is going to hate the prize going to Ostrom even more than Republicans hated the Peace prize going to Obama. Economists want this to be an economists’ prize (after all, economists are self-interested). This award demonstrates, in a way that no previous prize has, that the prize is moving toward a Nobel in Social Science, not a Nobel in economics.

I don’t mean to imply this is necessarily a bad thing — economists certainly do not have a monopoly on talent within the social sciences — just that it will be unpopular among my peers.

Update: Henry at Crooked Timber:

To amplify what Kieran has just said – political scientists are going to be very, very happy today. ...[T]his is ... a very interesting statement of what the Nobel committee see as important in economics.

Lin’s work focuses on the empirical analysis of collective goods problems – how it is that people can come up with their own solutions to problems of the commons if they are given enough room to do so. Her landmark book, Governing the Commons, provides an empirical rejoinder to the pessimism of Garret Hardin and others about the tragedy of the commons – it documents how people can and do solve these problems in e.g the management of water resources, forestry, pasturage and fishing rights. She and her colleagues gather large sets of data on the conditions under which people are or are not able to solve these problems, and the kinds of rules that they come up with in order to solve them.

This is, as Kieran suggests, a vote in favor of detailed, working-from-the-ground-up, empirical work, which doesn’t rely on sharply contoured theoretical simplifications and flashy statistical techniques so much as the accumulation of good data, which reflects the messiness of the real social institutions from which it is gathered. ...

One plausible characterization of her life’s work is that it is about demonstrating the empirical weaknesses of a ‘cute’ economic model (the Tragedy of the Commons) that assumed a role in policy discussions far out of proportion to its actual explanatory power, and replacing it with a set of explanations that are nowhere near as neat, but are far more true to the real world. ...

It is also a vote in favor of supplementing quantitative work with qualitative understanding – Lin spends a lot of time (albeit less than she used to) in the field, soaking up practical knowledge which informs her work in striking ways. She is hands-on in a way that very few economists, political scientists or sociologists are. It is also interesting to note that the Nobel committee pays specific attention to the political implications of her work.

Elinor Ostrom has challenged the conventional wisdom that common property is poorly managed and should be either regulated by central authorities or privatized. Based on numerous studies of user-managed fish stocks, pastures, woods, lakes, and groundwater basins, Ostrom concludes that the outcomes are, more often than not, better than predicted by standard theories.

This reflects what she and her husband Vincent refer to as “polyarchy,” a normative approach to governance which stresses the degree to which higher levels of government should not crowd out self-organization at lower levels. Her work implies that both pure marketization and top-down government control can have badly adverse consequences for resource management, because they rob individuals of the capacity to govern themselves, and because they both lead to the depletion of important forms of local collective knowledge. Alex Tabarrok is right to see something Hayekian in Ostrom’s arguments – but it is Hayek against Hayek. Ostrom stresses repeatedly that even the best functioning markets are undergirded by an array of collective institutions which order people’s market interactions, and that in the absence of such rules, self interested behaviour will have highly adverse consequences. ...

I’m delighted that it was Lin. A Good Outcome.

Update: Jeff at Cheap Talk:

Oliver Williamson

This prize is long overdue.  The theory of the firm is one of the big ideas in economics and as far as I can tell the Nobel committee was right to trace it back to Williamson.

A firm is a container for a bunch of highly idiosyncratic, repeated, informal transactions.  A great thought experiment is to wonder why these transactions are not conducted through a market, making the firm dissolve away.  Instead of giant firms building and selling cars, why aren’t there a bunch of tiny firms each doing a tiny part with all of their interaction governed by the market or by contract?  There are three main reasons why.

First, its costly to use the market.  If the chassis firm is going to be buying axles from the axle firm all the time, it would save transaction costs by just integrating.  Then it can “procure” axles with a memo.

Second, the contracts would be impossibly complicated and unwieldy.  Imagine writing a complete blueprint for the car, breaking it down into individual instructions for every actor who is supposed to contribute, laying out the timing when each party is supposed to arrive and do his part, describing payments as a function of the performance of each interdependent action, etc.  That is probably already impossible, but imagine you could do that.  Now suppose that a supply shock requires you to use different materials for the chassis.  This would require a coordinated change in many parts of the car, to keep structural integrity, balance, etc.  The entire volume of contracts would have to be re-written.

The third reason is the one that adds richness to the theory of the firm.  Most of the transactions that occur within firms require parties to make investments that only make sense within the context of that specific firm.  The party making the investment has little or no option to recover the value of the investment outside the firm.  When the chassis firm contracts with the firm building auto bodies, it writes down minute specifications that must be met.  The bodies produced could not be sold to any other chassis maker.  The firm building auto bodies must invest in the machinery that can make these specific bodies.  Once sunk that investment has no value outside of the specific relationship with the chassis firm.

The reason this adds richness to the theory is that it explains which transactions must be encompassed within firms.  Transactions that require relation-specific investments would be crippled if conducted across firm boundaries.  Once the die is cast for building these specific auto bodies, the chassis firm has no reason to pay a price that compensates for the sunk cost because there is no outside option.  This hold-up problem implies that the auto body firm has poor incentives to make the investment in the first place, unless it integrates with the chassis firm and becomes a claimaint to the profits of the integrated firm.