ECONOMIC GOVERNANCE

Institutions are sets of rules that govern human interaction. The main purpose of many institutions is to facilitate production and exchange. Examples of institutions that affect human prosperity by enabling production and exchange include laws, business organizations and political government. Economic governance research seeks to understand the nature of such institutions in light of the underlying economic problems they handle. One important class of institutions is the legal rules and enforcement mechanisms that protect property rights and enable the trade of property, that is, the rules of the market. Another class of institutions supports production and exchange outside markets. For example, many transactions take place inside business firms. Likewise, governments frequently play a major role in funding pure public goods, such as national defense and maintenance of public spaces. Key questions are therefore: which mode of governance is best suited for what type of transaction, and to what extent can the modes of governance that we observe be explained by their relative efficiency? This year's prize is awarded to two scholars who have made major contributions to our understanding of economic governance, Elinor Ostrom and Oliver Williamson . In a series of papers and books from 1971 onwards, Oliver Williamson (1971, 1975, 1985) has argued that markets and firms should be seen as alternative governance structures, which differ in how they resolve conflicts of interest. The drawback of markets is that negotiations invite haggling and disagreement; in firms, these problems are smaller because conflicts can be resolved through the use of authority. The drawback of firms is that authority can be abused. In markets with many similar sellers and buyers, conflicts are usually tolerable since both sellers and buyers can find other trading partners in case of disagreement. One prediction of Williamson's theory is therefore that the greater their mutual dependence, the more likely people are to conduct their transactions inside the boundary of a firm. The degree of mutual dependence in turn is largely determined by the extent to which assets can be redeployed outside the relationship. For example, a coal mine and a nearby electric generating plant are more likely to be jointly incorporated the greater the distance to other mines and plants. Elinor Ostrom (1990) has challenged the conventional wisdom that common property is poorly managed and should be completely privatized or regulated by central authorities. Based on numerous studies of user-managed fish stocks, pastures, woods, lakes, and groundwater basins, Ostrom concluded that the outcomes are often better than predicted by standard theories. The perspective of these theories was too static to capture the sophisticated institutions for decision- making and rule enforcement that have emerged to handle conflicts of interest in user-managed common pools around the world. By turning to more recent theories that take dynamics into account, Ostrom found that some of the observed institutions could be well understood as equilibrium outcomes of repeated games. However, other rules and types of behavior are difficult to reconcile with this theory, at least under the common assumption that players are selfish materialists who only punish others when it is their own interest. In field studies and laboratory experiments individuals' willingness to punish defectors appears greater than predicted by such a model. These observations are important not only to the study of natural resource management, but also to the study of human cooperation more generally.download