By Randall Holcombe • Wednesday October 14, 2009 1:08 PM PST •
With so much press coverage of the Nobel Peace Prize, the Nobel Prize in economics has not been discussed much. I am an economist, but I’m not really complaining. The other prizes haven’t received much press coverage either, and most people don’t have that much interest in economics anyway. (That’s not to say they’re not interested in the economy; they are just not interested in economics.)
The Prize went to Oliver Williamson and Elinor Ostrom for their analysis of the institutions of governance — as opposed to government. Williamson has focused his work on the organization of firms, whereas Ostrom’s work has been focused on governing common resources, such as fisheries, oil fields, and irrigation systems. Both Williamson and Ostrom show how individuals can devise solutions to resource allocation problems without having government impose them.
Ostrom’s work has significant implications for public policy because she looks at cases where most economists would argue that government solutions are needed to prevent an inefficient use of resources. She shows that not only are individuals able to work collectively to efficiently allocate resources, but that they do a better job of governance when they devise and enforce mechanisms for use of collective resources than when they have governance structures imposed on them.
Both Williamson and Ostrom take an institutional approach to understanding resource allocation, which means focusing on the arrangements people devise and use in their economic interactions. This contrasts with what might be referred to as a technological approach to economics (Williamson has used that term) where an economy is modeled as a system of equations that can be solved to find equilibrium outcomes.
From a public policy standpoint a technological approach to economics tends to lead economists to view the economy as if it is that system of equations, to look for ways that the mathematical structure of the model might be modified to yield better results, and then to imagine that there is a way to change the real-world economy in the same way. It is a short step to then say that the government can impose the same policies in the real world as the economist can impose on the mathematical model.
The institutional approach recognizes that there are potential solutions to economic problems that nobody may have thought of yet, and that any inefficiency is also an opportunity for entrepreneurial individuals to devise a better way of doing things. In a market economy the entrepreneurs benefit, but so does everybody else. If the government protects and enforces property rights, Williamson and Ostrom show that the creativity of individuals will produce a superior allocation of economic resources by allowing market mechanisms to work rather than by imposing rules from above. I will again emphasize the importance of Ostrom’s work, because she has shown this in cases where there is typically a presumption that a government-imposed solution is necessary.
The institutional approach taken by Williamson and Ostrom is much more market-friendly, and freedom-friendly, than the technological approach to economic analysis, which is one of the reasons I am delighted that their work has been recognized this way. They are not the first Nobel Laureates who have emphasized institutions. James Buchanan, Douglass North, and Ronald Coase also fit this description, but when real-world policy issues turn on whether we should rely more on markets or government planning, it is nice to see the Nobel Committee recognize the importance of this type of work.
While academic economics is probably of limited interest to most policymakers and elected officials, John Maynard Keynes famously said, “the ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. ... I am sure that the power of vested interests is vastly exaggerated compared with the gradual encroachment of ideas.” If so, the recognition by the Nobel Committee of Williamson’s and Ostrom’s work is a step in the right direction for freedom.