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Economics Nobel Laureates Analyzed Economics Outside Markets

October 17, 2009

Science 16 October 2009:
Vol. 326. no. 5951, p. 347
DOI: 10.1126/science.326_347

Adrian Cho

Last year, financial markets took the worst drubbing since the Great Depression, so perhaps not surprisingly this year’s “Nobel Prize” in economics honors two researchers who studied economic behavior in other settings. Half of the 2009 Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel goes to Elinor Ostrom, a political scientist at the University of Indiana, Bloomington, for her insights into the use of shared resources. The other half of the $1.4 million prize honors Oliver Williamson, an economist at the University of California, Berkeley, for his analysis of how a company decides what to do or make for itself and what to buy from others.

“The really great thing is that this [year’s prize] recognizes that we should look at the institutions that govern economic activity, which include a lot of things that aren’t markets,” says Robert Gibbons, an economist at the Sloan School of Management at the Massachusetts Institute of Technology in Cambridge.

Figure 1

 

 

Broader vision. Williamson (left) and Ostrom studied institutions other than markets.CREDIT (LEFT TO RIGHT): UNIVERSITY OF CALIFORNIA, BERKELEY; CHRIS MEYER/INDIANA UNIVERSITY

 

[Larger version of this image]

Ostrom, 76 years old and the first woman to win the economics prize, has made her career studying how people cooperate to manage a common resource. For example, all users of a fishery can benefit by limiting their catches to prevent overfishing. But self-interest can torpedo cooperation, as each fisher can maximize profits by hauling in as much as possible. That “tragedy of the commons” seems to be an inevitable consequence of rational self-interest.

Economists had consequently believed that cooperation had to be imposed by the government or induced by market incentives. And yet, beginning with fieldwork on efforts to halt saltwater intrusion into groundwater in southern California for her doctorate in 1965, Ostrom found that some communities do share communal resources. Through case studies, theoretical analysis, and experiments, she identified seven principles that foster cooperation. “Work on the commons is almost synonymous with Ostrom,” says Simon Gächter, an economist at the University of Nottingham, U.K. “She’s a towering figure in the literature.”

Ostrom found that individuals will cooperate if, among other things, they are able to participate in governance, monitor the compliance of others, and punish cheaters. “When people have trust that others are going to reciprocate, then there can be cooperation,” she says. “When there is no trust, there is no cooperation unless people are facing the gun.”

Williamson, 77, studied how a company decides which goods and services to provide for itself and which ones it will buy—decisions that delimit the “boundary of the firm,” explains Gibbons. “At one time, Henry Ford was investing in rubber plantations in South America,” he says. “Now car companies buy tires.”

Such decisions involve a balancing of benefits and costs. Suppose a sewing machine company uses a specialized part made by only one supplier. The company could save money by making the part itself, especially if the lone supplier inflates prices. On the other hand, if the company makes things that it could buy from one of several competing suppliers, it may waste money.

Williamson’s analysis serves both as a description of how companies naturally behave and as a prescription for how to organize a company, says Francine Lafontaine, an economist at the Ross School of Business at the University of Michigan, Ann Arbor. “I don’t think there’s an economist out there who doesn’t know Williamson’s name,” she says. “There’s no question he deserves this recognition.”

Nonmarket economics may also get more recognition, researchers predict. Close alliances between megabusinesses such as Wal-Mart and their suppliers are putting a new wrinkle on the boundary of the firm, Gibbons says. And Gächter says that climate change looms as the ultimate problem—and perhaps tragedy—of the commons.

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