Tuesday, October 13, 2009

The Economics Nobel Prize 2009 and Governance

This year’s Nobel Prize has been awarded to Professors Elinor Ostrom and Oliver Williamson for their work in the area of “economic governance”. The significance of this year’s award is its recognition of transaction economics despite its decline due to the financial crisis.

Of relevance to our discussion is Williamson’s work, which has triggered academic thought in the area of law and economics, with reference to firms and associations, and more particularly companies. Williamson’s work provides economic insights into the functioning of companies and enables appropriate their regulation. To that extent, the theory has a bearing on principles of corporate governance. As Professor Bainbridge notes, while reviewing one of Williamson’s works:

Transaction cost economics focuses on institutions, in contrast to neoclassical economics' focus on individuals, providing simple models that help us understand how institutions function and how they will respond to regulation. We can analogize transaction costs to friction: they are dead weight losses that reduce efficiency. They make transactions more costly and less likely to occur. Among the most important sources of transaction costs is the limited cognitive power of human decisionmakers. Unlike the Chicago School of law and economics, which posits the traditional concept of rational choice, Williamson asserts that rationality is bounded. Put another way, he assumes that economic actors seek to maximize their expected utility, but also that the limitations of human cognition often result in decisions that fail to maximize utility. Decisionmakers inherently have limited memories, computational skills, and other mental tools, which in turn limit their ability to gather and process information. As he demonstrates, this phenomenon, known as bounded rationality, has pervasive implications for understanding how institutions work.

Accordingly, Williamson's approach provides an analytical framework that is useful not only to economists, but also to lawyers and policymakers. Among other subjects, Williamson tackles such subjects as vertical integration, corporate governance, and industrial organization.
This award has given rise to euphoria in the law and economics academy. See Truth on the Market, The Conglomerate and The Volokh Conspiracy. It comes after similar recognition of another law and economics scholar, Ronald Coase, who was awarded the Nobel Prize for Economics in 1991.

Update: Dhiraj Nayyar has an interesting analysis of the Prize in the Financial Express.

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