Elinor Ostrom And Oliver Williamsom: Nobel Prizewinners In Economics

by Pejman Yousefzadeh on October 13, 2009

An excellent choice, and one that takes the bad taste left by the awarding of the Peace Prize out of one’s mouth. I note that Paul Krugman’s reaction, while properly laudatory, does not reveal the fact that Williamson’s and Ostrom’s work is in many ways, antithetical to Krugman’s views on the role of government.

Consider first Williamson’s work, which is summarized by David Henderson:

. . . Drawing on 1991 Nobel laureate Ronald Coase’s work on why firms exist, Mr. Williamson showed that these voluntary institutions exist to solve problems that arms-length market transactions have trouble solving.

Take, for example, a coal mine that depends on a railroad line to ship its coal. Before the mine owner develops the mine, he wants to be assured that the railroad owner won’t charge him a monopoly price. Before the potential railroad owner builds the spur, he wants to be sure that the coal mine owner, his only customer, won’t try to skin him by paying a price below the amount that would compensate him for the high fixed cost of the railroad. Solution: vertically integrate. Have the railroad owner also be the mine owner and you solve the problem.

Prior to Mr. Williamson’s work, many legal scholars and economists had seen vertical integration as a way to acquire market power. This argument made little sense, as antitrust scholars Robert Bork and the late Ward Bowman pointed out, because it’s hard to multiply market power using vertical integration. As the Nobel committee noted, Mr. Williamson’s work led to less concern that vertical integration enhances market power and this has caused judges and antitrust officials to be less hostile to vertical integration.

Although the Nobel committee did not highlight Mr. Williamson’s classic 1968 article, “Economies as an Antitrust Defense,” I will. Mr. Williamson showed that horizontal mergers of companies in the same industry—even those that increase market power and even those where the increase in market power leads to a higher price—can create efficiency. The reason is that if mergers reduce costs, the reduction in costs can create more gains for the economy than the losses to consumers from the higher price.

And then, there is Ostrom’s work. Again, quoting Henderson:

. . . Most economists are familiar with the late Garrett Hardin’s classic article, “The Tragedy of the Commons.” His idea was that when no one owns a resource, it is overused because no one can control its usage and each person has an incentive to use it before others do. This insight has helped us understand much human behavior and has led people to advocate either having the resource privately owned or having it controlled by government.

Not so fast, said Ms. Ostrom. Examining dozens of case studies, she found cases of communal ownership that worked—that is, that didn’t lead to the tragic outcomes envisioned by Hardin—as well as ones that didn’t. Were there systematic differences? Yes, and interestingly the ones that worked did have a kind of property rights system, just not private ownership.

Based on her work, Ms. Ostrom proposed several rules for managing common-pool resources, which the Nobel committee highlights. Among them are that rules should clearly define who gets what, good conflict resolution methods should be in place, people’s duty to maintain the resource should be proportional to their benefits, monitoring and punishing is done by the users or someone accountable to the users, and users are allowed to participate in setting and modifying the rules. Notice the absence of top-down government solutions. In her work on development economics, Ms. Ostrom concludes that top-down solutions don’t help poor countries. Are you listening, World Bank?

Alex Tabarrok reinforces Henderson’s analysis of Williamson’s work, and also gives an excellent summary of Ostrom’s work, in which he says that

For Ostrom it’s not the tragedy of the commons but the opportunity of the commons. Not only can a commons be well-governed but the rules which help to provide efficiency in resource use are also those that foster community and engagement. A formally government protected forest, for example, will fail to protect if the local users do not regard the rules as legitimate. In Hayekian terms legislation is not the same as law. 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.

Ilya Somin, states the following:

Ostrom’s theories are often seen as an alternative to traditional libertarian thought, which emphasizes the importance of private property and markets. However, it actually fits well with libertarianism defined more broadly as advocacy of the superiority of private sector institutions over government. In some respects, Ostrom’s norm-based approach to dealing with tragedies of the commons is actually less dependent on government than the more traditional libertarian approach of relying on exclusive private property rights. The latter, after all, often depend on enforcement by government. Even where private property rights exist, it is often easier and cheaper to solve some collective action problems by norms rather than relying on the law. And, obviously, Ostrom’s emphasis on the importance of local knowledge is similar to the earlier work of libertarian theorist F.A. Hayek.

And finally, Paul Dragos Aligica (great name) specifies the policy challenges that attend Ostrom’s work and findings:

“The presence of order in the world,” Ostrom writes, “is largely dependent upon the theories used to understand the world. We are not limited, however, to only the conceptions of order derived from the work of Smith and Hobbes.” We need a theory that “offers an alternative that can be used to analyze and prescribe a variety of institutional arrangements to match the extensive variety of collective goods in the world.” In response to that need, Ostrom has explored a new domain of the complex institutional reality of social life—the rich institutional arrangements that are neither states nor markets. These are for-profit or not-for-profit entities that produce collective goods for “collective consumption units.” Examples of such “consumption units” abound. They are small and large, multi-purpose or just focused on one good or service: suburban municipalities, neighborhood organizations, condominiums, churches, voluntary associations, or informal entities like those solving the common-pool resources dilemmas studied and documented by Ostrom around the world. Yet, once the functional principle behind them was the identified, the very diverse forms could be understood as part of a broader pattern, and the logic of the institutional process involved could be revealed with relative ease. They could be seen as a “third sector” related to but different from both “the state” and “the market”.

And thus Ostrom’s study of governance is not only a source of inspiration, it is also a challenge to libertarians. In study after study, she has shown that the principles of individual freedom, responsibility, entrepreneurial creativity, and resourcefulness apply not only to the production and distribution of private goods, they also apply to a large institutional domain outside the market order. This “third sector,” which is “neither state nor market,” may in fact be as important a battleground for the preservation of a free and prosperous social order as the market itself.

Twelve years ago, Virginia Postrel wrote that “honoring Williamson and Ostrom is coincidentally quite a negative comment on the current rage for technocratic planning.” Indeed, awarding the Nobel Prize appears to be a dramatic repudiation to the kind of big government control of economic institutions that people like Paul Krugman regularly call for.

Funny that Krugman didn’t mention this fact in his post.

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