The big news in Monday's announcement of the winners of the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel, does not lie so much in who won it, Elinor Ostrom and Oliver Williamson, but in who did not win it: Eugene Fama, the University of Chicago economist most associated with "efficient markets theory."
As late as yesterday prediction markets were betting that Fama was the odds-on favorite. At U.K.'s Ladbrokes, Fama was a 2-1 favorite, while both Ostrom and Williamson were 50-1 outliers. The irony, as Barry Ritholtz notes at The Big Picture, is that efficient market theory holds that markets know best. But in Fama's case, they did not -- so clearly, he didn't deserve the award.
As has been universally noted, for an icon of the Chicago School to win the Nobel at a moment when the world's faith in the authority of financial markets is at a historic low point would have been very odd. But what can we say about the political implications of today's choice? It's a much trickier question than last year's anointment of Paul Krugman. For example, both Krugman and the libertarian oriented Alex Tabarrok, who blogs at Marginal Revolution, had positive things to say, and they rarely agree on anything.
Tabarrok, vigorously upholding Marginal Revolution's status as the-place-to-go for Nobel economic prize insta-analysis calls Ostrom (the first woman ever to win the prize) "the mother of field work in development economics:"
She has worked closely investigating water associations in Los Angeles, police departments in Indiana, and irrigation systems in Nepal. In each of these cases her work has explored how between the atomized individual and the heavy-hand of government there is a range of voluntary, collective associations that over time can evolve efficient and equitable rules for the use of common resources....
For Ostrom it's not the tragedy of the commons but the opportunity of the commons. Not only can a commons be well-governed but the rules which help to provide efficiency in resource use are also those that foster community and engagement. A formally government protected forest, for example, will fail to protect if the local users do not regard the rules as legitimate. In Hayekian terms legislation is not the same as law. Ostrom's work is about understanding how the laws of common resource governance evolve and how we may better conserve resources by making legislation that does not conflict with law.
Similarly, Williamson's research, part of which focuses on why corporations evolve into their particular forms of organization, does not resolve easily into a market is good-or-bad dichotomy, but instead appears to bring more nuance to the question of why things are the way there are.
Williamson analyzes how firms come to rely on long term contracts or vertical integration or other seemingly non-competitive solutions to enhance market productivity. Early generations of antitrust enforcers often saw these as monopolistic dealings, but scholars such as Williamson helped us understand how these are essential to the workings of the invisible hand.
Krugman explains what links Ostrom and Williamson:
The way to think about this prize is that it's an award for institutional economics, or maybe more specifically New Institutional Economics.
Neoclassical economics basically assumes that the units of economic decision-making are a given, and focuses on how they interact in markets. It's not much good at explaining the creation of these units -- at explaining, in particular, why some activities are carried out by large corporations, while others aren't. That's obviously an interesting question, and in many cases an important one. For example, in my own home field of international trade, the basic models don't assign any particular role to multinational corporations; how do we get them into the story, and what difference do they make?
...Oliver Williamson's work underlies a tremendous amount of modern economic thinking; I know it because of the attempts to model multinational corporations, almost all of which rely to some degree on his ideas. I wasn't familiar with Ostrom's work, but even a quick scan shows why she shared the prize: if the goal is to understand the creation of economic institutions, it's crucial to be aware that there is more variety in institutions, a wider range of strategies that work, than simply the binary divide between individuals and firms.
Let's hear it for moving past the binary divide! Today's Nobel Prize in economics celebrates nuance and discrimination and complexity. Yay.
UPDATE: Felix Salmon demolishes the theory that Eugene Fama's loss was "ironic."