On the role and limit of community

If I were a newspaper journalist, writing a story on the Nobel Prize winners should not be a difficult job. Just translate and rephrase the 5-page public information prepared by the committee, which has neatly summarized the contribution of the Laureates. Unless if you had a prior ‘agenda’ in your mind; e.g. attacking mainstream economics cum economists cum global capitalism. Then you risk writing something that has no connection between the report and your conclusion.

My favorite newspaper provided a good example on how a single paragraph had successfully driven the article way out of context:

The economic collapse caused by the crisis was a blow to the Nobel Committee’s credibility. The public has seen how economic theories, which have been developed by economists and brought them previous Nobel awards, were proven ineffective, leading to the global economic catastrophe.

Surely, if the ‘reporter’ has spent some time in researching previous awards, he or she may have understood that a significant portion of the awards were given to economists who have devoted their career to show how market can fail. Moreover, although Ostrom and Williamson’s work was about non-market transaction, it is misleading to conclude that non-market transaction is a solution to the market at anytime and any place.

Remember, also, that the Nobel Prize in Economics is awarded to studies that have made significant contributions over the past two or three decades. That means, there is a 2-3 decades lag between the time the theories were developed and the Prize. During the period, many studies have followed the original works. So it doesn’t mean that this year’s Nobel marks a significant U-turn in the economic discipline.

One particular area is how communities can solve the coordination and allocation problem in the absence of working market – Ostrom’s contribution. In the past two decades, there have been a significant number of economic papers that studied this issue. I summarized some of them in this note.

In addition to that, I’d also want to point out some interesting papers written by MIT’s Ben Olken. Here he showed that higher level of ‘civic participation’ in the village is not associated with lower village corruption, contrary to the standard theory of social capital. In another paper he argued that, external monitoring (for example, audit by a government agency), is still more effective in minimizing corruption of local public expenditure compared to monitoring by community.

In this work in progress (co-authored with others), he showed that in identifying who are the poor in a community, full community-based targeting is no more dominant than the top-down approach. However, a combination of the two provides the best result. Then, in another paper, he concluded that higher level of civic participation in local political decision making has little effect on actual decisions. However, the inclusive process in itself can substantially increase satisfaction and legitimacy.

The bottom line is, while the role of community should be appreciated more and paid greater attention in economic works, we also need to understand the limit of community in solving the problem of allocation and coordination. No need to say, we should be very careful before making inferences on the relations of Ostrom’s works and the solution to the economic crisis.

Note: all Ben’s works above are using Indonesian cases.

And The Nobel was (not) given to…

Update: a typo in the 7th paragraph has been corrected. Thanks, Roby. Also, take a look of Haryo Aswicahyono's nice analogy of Williamson's work here (Facebook member only).

If you are betting on Oliver Williamson winning this year’s Nobel Prize, congratulations! According to Ladbrokes, his odd was 50/1. Elinor Ostrom was not even on the market as she is a political scientist by profession. (Don't forget also that Ostrom is the first female Laureate!).

But this is what makes the Nobel Prize in Economics interesting: there is no good predictor whatsoever on who’s going to win in a given year. You may tip someone to win it within, say x years, or win it someday. But I guess no one have ever made a good fortune in betting on the winner. Kaushik Basu once said, he was tipping his mentor Amartya Sen to win the Prize for five years in a row before he gave up. When Sen did win it in 1998, Basu did’t bet. In the 1990s, almost everyone predicted Paul Krugman will win the Prize. But just when everybody stopped thinking Krugman will win it at all, the Committee awarded him in 2008.

To be honest, I am not a follower of both works, so I won’t be a good reviewer of the decision. But the official Nobel Prize website has written a nice summary of their works (as well as a more elaborated one). What I am interested is what is the message, if any, sent by this year’s award? It’s not that the Nobel Committee has ever taken into account the recent economic situation or discourse in making their decision. However, it’s hard to disagree that the current global crisis has put economic science and profession under the spotlight more than ever. In that case, I am more interested in taking a closer look on who don’t win it.

Prior to the announcement, several names were being tipped as the strongest candidates. One name that has been constantly in the circulation for some years is Chicago’s Eugene Fama. He was referred to as the father of the ‘Efficient Market Hypothesis.’ I do think he deserves the Prize (most likely shared with Kenneth French), based on how influential his work is. But for many reasons, I can see that if he wins it this year, it will spark controversies, even bitter and harsh debates, however unfair it will be.

Another strong candidate was Ernst Fehr. He was well-known for his contributions in behavioral finance, experimental economics, even neuroeconomics – where people see how human makes economic decisions from neuroscience perspective. Fehr, and some other people that may share the Prize like Matthew Rabin, Richard Thaler or Armin Falk, has worked in a field that can somehow be a counter-argument to the efficient market argument. Bounded rationality, cognitive and emotional factors and other things make rationality assumptions are often violated. No one will doubt their significant contributions to economics. However, if the Prize goes to Fehr et al, I can see a wave of ‘I told you so’ attitudes, or even disproportionate attack against the rational agent vis-à-vis efficient market camp.

Well, I may be wrong. Those controversies may not happen at all.

Back to this year’s Prize. If there is any message from the decision, then it would be “Let’s pay more attention to other things apart from the market.” Ostrom and Williamson’s work show that many transactions happen outside of the market: within society or ‘commons’ (Ostrom’s), or firm (Williamson's). True, in many cases market fails to exist or work properly. But even in the absence of the market that is working properly, agents can still coordinate actions that is optimal, and that the government intervention is not always the answer. A closer look on what happens within the mezzo-institution will help us understand ‘what-to-do’ better.

That’s the best I can summarize. Better comments include:

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. (Michael Spence).

Issuing the award to these two economists is a welcome trend because it once again leads us to focus on the microeconomic issues that have, when aggregated, macroeconomic consequences. … The joint award to Ostrom and Williamson could be read as a needed corrective on this macroeconomic approach. The common thread that links these two authors together is their concern with mid-size institutions that face serious questions of coordination and control. (Richard Epstein).

… the Nobel selection committee … is expanding the scope of "economic sciences" into the social sciences. That is probably a good thing for several reasons. … I think the point to emphasize is that Elinor Ostrom does great economics at the same time as she does great political science. So does Dan Kahneman. The overlap between the two disciplines is great. (Thomas Schelling).

They show how firms, communities and organizations come to solve these problems absent government regulation and how the choices they make can be disrupted or worsened by bad state policy or sustained by good rules that promote stable property rights and reliable contracts. (John Nye).