Institutional economics going mainstream

(Note: Read the first and last paragraphs only if you have a sense of humor.)

Elinor Ostrom and Oliver Williamson won this year's Sveriges Riksbank Prize in Economic Sciences in memory of Alfred Nobel for their significant contributions in the field of institutional economics. I am especially delighted by the recognition of the value of Dr. Williamson's work on governance structures, as I did my own dissertation research in that area. Perhaps I will soon get some cash from the Royal Swedish Academy of Sciences for showing potential and as an encouragement to complete my book on economic divergence. And I don't mind sharing.

In the assessment of John Nye, one of the most brilliant young members of the International Society for New Institutional Economics and a future Nobel laureate if I have ever met one, Williamson is responsible for promoting "Ronald Coase's insights into the economics of the firm by making the theory of transactions costs a central part of the literature in mainstream economics." Williamson draws our attention to certain cases that challenge the puristic neoclassical models of market competition and increases our appreciation for the role of specific institutional frameworks (rules) in channeling investment.

Dr. Ostrom's work presents an even bigger challenge to some of the former orthodoxies in economics education and in our understanding of economic behavior. Most economics students learn their stuff through abstract mathematical models, assuming a level of technology and formal rules, ignoring societal norms of proper behavior. As a result they grow up to develop theories and give policy advice that fail to jump-start the economies throughout the Third World. Justifiably, the prominent growth-theorist Paul Romer notes that Ostrom's most valuable contribution is in making "the rules that humans follow the object of scientific inquiry."

I am very optimistic for the future of our field and the ideas of liberty for, as John Nye points out, this year's Nobel winners "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." Finally, to make it easy for the Swedes to select the next Nobel winner, here is what institutional economics has helped me discover so far: The Industrial Revolution started in England, spread to the United States, and gave the West its amazing prosperity as a result of the growth-enhancing rules legitimized by pro-capitalist social attitudes embedded in decentralized structures. But if economists presume to be wise enough to advise the poor how to catch up with us, they should try to be very flexible and do so on a case-by-case basis after a careful historical investigation of the local institutional constraints.