Friday, October 23, 2009

Nobel Lessons

Written by my husband and a colleague, this article below is running in The Washington Examiner.
Conservative critics who disparaged the Nobel Prizes following the awarding of the Peace Prize to President Obama should think again. On November 12, the Royal Swedish Academy of Sciences awarded the economics Nobel jointly to Elinor Ostrom and Oliver Williamson for their advancement of the field of “economic governance.” The governance they analyze is actually governance without government, which could also be described as “voluntary self-regulation”—something American conservatives should celebrate.

Here's why. In traditional economic theory, the market allows resources to be allocated optimally by coordinating the actions of self-interested individuals through the power of price signals. However, there are circumstances in which some other mechanism or institution is needed, either because the transaction costs of determining a price are too high, or because the good in question is freely available—insofar as it is not owned by anyone—but nevertheless finite—as in, for example, fishing stocks. For many politicians, especially left-leaning ones, the solution is government regulation or ownership. Ostrom and Williamson, however, have explained how other forms of non-market governance have worked so well for centuries.

Oliver Williamson argues that when a transaction is very complicated and difficult to pin down in a contract, a company may be better off undertaking it internally. This is why companies often expand through mergers and acquisitions rather than outsource particular tasks. Williamson’s work has contributed to the recent welcome decline in antitrust intervention in the case of vertical mergers. Large companies, frequently maligned as rapacious by the left, expand to cut costs, not to impose monopoly prices on hapless consumers. Top-down government mandates that get in the way of such expansions make things worse for companies, their customers, and their employees.

Elinor Ostrom also has analyzed resources not regulated by market-transactions: those that are “unowned” or held in common, such as pastures, drinking wells, lumber, wild game, and fishing stocks. According to the theory known as the “tragedy of the commons,” the absence of property rights over such finite resources results in depletion or environmental degradation. The traditional solution has been to confer private property rights on individuals—such as in the English Enclosure Movement—or to impose government regulations.

But Ostrom argues that this is not necessarily the case. In situations in which the people who use a resource interact on a regular basis, credible retaliation makes cooperation possible. Ostrom cites numerous instances in which such “self-regulation,” via formal or informal agreements among private parties, has prevented the depletion of a resource held in common. She argues that government intervention often disrupts these institutions without providing an adequate or beneficial alternative, to the detriment of the stakeholders who are affected.

A similar logic helps explain how institutions ranging from voluntary associations to the family operate without price signals or top-down state control: If the agents in question regularly interact with each other, and the transactions cost for setting a price is high, then other forms of governance will naturally arise. Hayek’s concept of “spontaneous order” comes to mind.

Politicians’ pretense of knowledge and failure to understand the ability and willingness of stakeholders to cooperate help to account for the proliferation of damaging regulations across the economy. For example, logging restrictions are unnecessary, because loggers have an inherent incentive to avoid depleting their resources. In fact, the total forest area in temperate countries actually increased between 1980 and 1990, thanks to the use of efficient forest planting methods and improved agricultural productivity.

Yet even so, as The Economist reports, “an entire industry seems to have sprung up to identify ‘new commons’ or to claim as commons things not always seen that way.” For instance, recent and ongoing attempts by governments to regulate greenhouse gases (GHGs) threaten to increase energy prices without any palpable benefit for consumers. Under the current European emissions trading regime, designed to cut emissions, total GHGs produced within Europe have actually risen even as energy costs have skyrocketed. The cap-and-trade bill now under consideration in the Senate would have a similar effect for American consumers.

With the economic crisis pressing heavily on voters’ minds, conservative politicians need to highlight the significant economic costs of state regulations and the additional costs that would be imposed by new environment and health care initiatives. And they might even find a good word to say for the Nobel prizes in the process.

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