Michael Spence, chairman of the Commission on Growth and Development, 2001 Nobel laureate for economics and a senior fellow at Stanford's Hoover Institution explains the contribution of this year's Nobel laureates adding that Markets aren't everything.
The Nobel Prize this year recognizes two distinguished scholars, Elinor Ostrom and Oliver Williamson, one a political scientist and the other an economist. The press has noted that Professor Ostrom is the first woman to receive the prize in economic sciences. This is to be celebrated, as is the likelihood that we can anticipate many more to follow in the years to come. Women in many subfields of economics are now among the intellectual leaders and innovators.
The common theme underlying the prize this year is that markets do not solve all problems of resource allocation and incentives well or even at all. That is not a new idea. What is important is that people and societies find ways through organizational structures and arrangements, political and other institutions, values, incentives and recognition, and the careful management of information, to solve these problems. Professors Ostrom and Williamson have led the development of this increasingly important part of economics. In reading their work, you are impressed that economics is not really fundamentally about markets, but about resource allocation and distribution problems. Markets appear because they operate effectively to handle a subset of these resource allocation challenges. Alternative creative institutional arrangements have been devised and refined over time to deal with those that markets handle imperfectly.
Sometimes those institutional arrangements include "creating" markets as has been done with some effluents that affect air quality. But often this approach is impossible or impractical because of monitoring and other costs.
The deeper insight that these scholars have helped us to come to understand is that there are many circumstances in which non-cooperative outcomes (nash equilibria) are deficient or sub-optimal, and that a good part of economic and social progress lies in the creative design of institutions whose purpose is to cause these non-cooperative equilibria to come closer to socially and economically efficient and fair results.
Climate change is a commons problem on a global scale with the added complication that collective action is designed not directly to produce results (in the sense of temperature reduction), but rather to acquire tail insurance by shifting the probability distributions against outcomes that are highly destructive but not certain to occur. Though some are not convinced this is a problem worth acting on, a majority globally recognize that there are risks to be taken seriously. This may be the most complex commons problem we have yet faced. We are in the midst of shifting values with respect to energy efficiency and clean technology. The challenge is to design institutions, mechanisms and incentives that move us in the right direction.
But many would argue that the most challenging problems are those associated with knowledge and information. Here Professor Ostrom and Williamson have had a major impact on our understanding.
Knowledge is, for the most part, the shared (read commons) intangible asset on which growth, development and prosperity is based. Though there are proprietary market add-ons designed to create or enhance incentives for innovation, the broad corpus is augmented, shared and transmitted through an extraordinarily complex and evolving set of institutional arrangements that include educational institutions, firms, multinational organizations, and governments. It has long been known that knowledge is an "unusual" economic commodity, in that if you have it and you give or transmit it or even sell it to me, then we both have it. The costs of creating the knowledge are a lot higher than the costs of sharing it. If it is priced efficiently to cause the sharing to occur, the incentives to produce it may be damaged, and vice versa.
Solutions have combined the inculcation of values, trust, incentives, partial use of market mechanisms, institutions and public sector investments. It is a work in progress as new challenges arise, but also an extraordinary success story.
George Akerlof received the Nobel Economics Prize for his analysis of how markets perform when there are asymmetric informational gaps and private information that is not easy to share. His persuasive short answer was "quite badly" with great insight as to why. One could leave it there. But of course, as this years Nobel Prize winners have taught us, institutions including business firms are created in part to solve these resource-allocation problems where markets fail. They do this by changing the informational and incentive structures that plague market performance. Professor Williamson has been at the forefront of understanding these processes, in asking what part of resource allocation is done within the firm and when is the process turned over to the market, or as the Nobel Prize Committee put it, what determines the boundary between the firm and the market.
The prizes this year can be celebrated in recognizing two highly original scholars and in so doing, highlighting the important parts of economics, political science and political economy that they have done so much to build.
Update: Paul Romer's praise
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