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This article is from the In-Depth Report The 2009 Nobel Prizes

Economics Nobel Highlights How Social Relationships Explain Certain Economic Activities

Elinor Ostrom and Oliver E. Williamson win the prize for their analyses of cooperation and conflict in economic governance
nobel-shared resource-water-irrigation



STOCKPHOTO/IGOR KARON

Two Americans won the 2009 economics prize in memory of Alfred Nobel: Elinor Ostrom of Indiana University "for her analysis of economic governance, especially the commons," the prize committee announced today, and Oliver E. Williamson of the University of California, Berkeley, "for his analysis of economic governance, especially the boundaries of the firm." Ostrom becomes the first woman ever to win this economics prize.

Both researchers went beyond traditional economics thinking, which relies on analyses of market prices. Instead, they examined the relationships among interdependent people and other entities to draw conclusions about economic governance.

Ostrom's honored work focused on shared resources, such as fish stocks, water for irrigation and grazing land. Conventional economics suggests that, to prevent overuse and degradation of these common resources, central government control or privatization is necessary. Otherwise, the "tragedy of the commons" can occur, in which self-interested parties act selfishly and end up destroying a limited resource—a typical example is that of shepherds taking their flocks to a single public grassland, quickly denuding that land to the detriment of all.

But such tragedies do not always happen; in many empirical studies starting in the 1960s, Ostrom found that common property can be surprisingly well-managed, because users often establish rules to mitigate damage.

One example is the grasslands that extend into Russia, China and Mongolia. For centuries, nomads have used the land for their herds, moving them on a seasonal basis, and in Mongolia, the area has remained suitable for grazing. Meanwhile, in Russia and China, collectivization led to permanent settlements that degraded the land. In an attempt to reverse the damage, China reversed gears and let households own the land, to no avail.

Ostrom found several similar examples around the world, including the use of groundwater in some parts of California.

Williamson's work examined helps to explain why large firms exist at all, instead of individual buyers and sellers. In particular, he studied economic activity within a firm in the context of conflict resolution.

He found that large hierarchies form when contracts between buyers and sellers are complex or nonstandard and when the parties are mutually dependent. If a coal-burning power plant has several choices in buying coal from many nearby mines, it can easily avoid contract disputes with its nearest coal supplier by reaching out to alternative mines.

Things change if the distance, and hence the costs, of the alternatives grows. Then, the mutual dependence of the plant and the nearest mine increases. Williamson discovered that in such cases, the terms of the contracts become more complex and longer, and that it becomes likely that both the plant and the mine become vertically integrated within a single entity. One study concluded that a coal-burning plant located next to coal mine is about six times as likely to be fully integrated than any other coal plant.

Williamson's theory works in other industries, too, and economists have found it useful in analyzing many kinds of incomplete contracts, ranging from unspoken agreements between family members to financial terms between entrepreneurs and investors.

 

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