Tuesday, October 13, 2009

Nobel Looks Outside Markets Economics Prize Goes to Americans Who Studied Shared Resources, Corporate Decisions

American economists Elinor Ostrom and Oliver Williamson, who study the way economic decisions are made outside markets, were awarded the Nobel Prize in economics Monday.

Ms. Ostrom, who teaches at Indiana University in Bloomington, Ind., is the first woman to win the economics prize, which had been awarded to 62 men since its launch in 1969. The judges cited her analysis of what happens when natural resources are shared commonly.

Mr. Williamson, who teaches at the University of California, Berkeley, was cited for explaining why some decisions are made more efficiently inside corporations rather than at arm's length in markets.

Within the economics profession, neither was seen as a likely choice for the award, officially the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel. Ms. Ostrom's doctorate is in political science, though she considers herself a political economist. Ms. Ostrom, 76 years old, said that when the phone rang at 6:30 a.m. Monday, she thought it might be a telemarketer. Mr. Williamson's work, meanwhile, has been highly influential on fields outside of economics. The 77-year-old has been described as the economist most cited by noneconomists.

Both have highlighted areas where standard approaches of economics are inadequate at explaining what actually occurs. "They both pay incredible attention to what happens in the real world," said Wharton School economist Witold Henisz, a former student of Mr. Williamson's.

Ms. Ostrom's work challenged the view that when people share a finite resource, they will end up destroying it -- what is known as the tragedy of the commons. That view argues that resources that are important for the common good need to be highly regulated or privatized.

As a graduate student in the early 1960s at the University of California, Los Angeles, Ms. Ostrom researched the way water was being managed in Southern California. Groundwater levels were falling, and saltwater was seeping into the system. But rather than collapsing into a tragedy of the commons, communities and water producers hashed out a solution. That led her to explore situations throughout the world where resources were commonly held, and she found that people often developed institutions, networks and other ways of interacting that solved problems.

Economists had largely ignored the importance of such networks, said Yale University environmental economist Matthew Kotchen, in part, because they couldn't come up with elegant models to describe them.

When it comes to large-scale problems such as climate change, where there are few existing relationships on which to build, solutions are less likely to come from the ground up, Ms. Ostrom said. "But that doesn't mean we should just wait until the international agreement comes through," she said. Instead, governments should encourage and aid people where they are trying to solve the problem, such as finding ways to make it easier for them to use solar energy or to bicycle to work.

Mr. Williamson's work stems from time he spent in the late 1960s working in the Department of Justice's Antitrust Division, and noticing that experts there paid scant attention to the internal economic workings of companies. "The way economists used to think of the firm was as a black box that transfers inputs into outputs, and they didn't look inside," Mr. Williamson explained in an interview.

[Leading Institutions chart]

He found that many economic decisions that standard theory said would be more efficiently left to the marketplace were actually better left within a firm. "Competitive markets work relatively well because buyers and sellers can turn to other trading partners in case of dissent," the Nobel judges said. "But when market competition is limited, firms are better suited for conflict resolution than markets."

Economist Steve Tadelis at the University of California, Berkeley's Haas School of Business, who has worked with Mr. Williamson, cited the 787 Dreamliner being developed by Boeing Co. as an example of how firms can be more efficient than the marketplace. Boeing, which previously designed and built planes in-house, outsourced much of the Dreamliner's manufacturing. But because it had less control over its supply line, Boeing couldn't adapt as quickly and flexibly to the changes and problems that invariably arose within a project as complex as the Dreamliner. Boeing has since taken much of the Dreamliner's production back in-house.

Mr. Williamson's work is driven by two key ideas. The first is that a contractual agreement can never be complete; there are always contingencies that haven't been accounted for. The other is that people act opportunistically within the gray area of contracts to make sure they benefit the most, and that can lead to problems.

One problem that has arisen during the financial crisis, the Wharton School's Mr. Henisz said, is that many credit-market contracts were written without regard for the possibility that so many loans could fail, and then market participants further snarled markets by haggling over contract terms with one another.

The economics prize, founded by the Swedish central bank, is the only one of six Nobel prizes not created by the 1896 will of industrialist Alfred Nobel. The two will share a prize of 10 million kronor ($1.4 million).

(from wsj.com, October 13, 2009)

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