Monday, October 12, 2009

A Teachable Moment

The awarding of the Nobel Prize in economics is always a teachable moment. This year’s award is no exception. It recognizes research on “economic governance” and goes to Elinor Ostrom for her work on “the commons” and to Oliver Williamson for his work on “the boundaries of the firm.” Both Ostrom and Williamson focus on the interactions between people outside the usual market mechanisms, an important topic to teach in the first lecture or the first chapter of Principles of Economics. The Nobel Prize Committee web page provides an excellent summary of their contributions with many examples. Ronald Coase originated research on this subject and won the Nobel Price for it back in 1991. I think it is important to note how Ostrom and Williamson build on Coase’s work in different ways. What do they teach us?

Williamson’s research teaches us to recognize when transactions will take place within a firm and when they will take place in markets. He significantly extended Coase’s insights on reducing transactions costs by delineating the advantages of such within-firm interactions when mutual dependence between people is high. The predictions of his theory are testable and have been confirmed in many empirical studies.

Ostrom's research teaches us that “market failure” due to externalities or public goods of the kinds illustrated in Garrett Hardin’s famous "tragedy of the commons" example can be resolved by genuinely engaged individuals working together, and that government intervention may therefore not be needed to solve such market failures. Indeed she finds that individual arrangements frequently achieve better results than government intervention. In this way she too builds on the work of Coase.

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