Descriptive Economists Rock Nobel Prize

This year's Nobel Prize winners for Economics made their mark describing how institutions and their governance work in the real world.

Elinor Ostrom of Indiana University showed that management of collective natural resources often works better than conventional economic theory would expect. A recent book she served as editor for discussed the need to rethink the fundamental premises of intellectual property law with a focus on concepts like the open source movement.

Oliver Williamson of Berkeley is known for his contract oriented research on how transaction costs, agency problems, imperfect information and similar frictions and drive strategies of corporate governance. One recent paper by Williamson finds common cause with Joseph Schumpeter in attaching economic importance to the way that firms are organized and governed, and complaints that strategic issues in the private contractual ordering of firms "had been ignored by neoclassical economists from 1870 to 1970."

The awards are made in a climate of massive backlash against the disciplinary program of academic macroeconomics and modern finance theory, which failed to understand the financial crisis because their models were too disconnected from the realities that drive the collapse of economic bubbles. In particular, critics argue that corporate governance created the wrong incentives for managers in big business and the investment banking world.

As Krugman explains the old status quo:

There was an old tradition of economics that focused on the origins and nature of economic institutions. This tradition was very influential before World War II.

But it proved not at all helpful during the Great Depression. My caricature version is that when the Depression hit, institutional economics, asked for advice about what to do, replied that well, it’s all very complicated, and has deep historical roots, and … Meanwhile, Keynesian economists, using very simple mathematical models, basically said “Push this button — we need more G”.

And this had a somewhat perverse effect. The rise of Keynesian economics also meant the rise of the equations guys (Samuelson in particular), and in the end the equations crowded out institutional economics even as Keynes fell into disfavor.

In the current cycle the time for the "More G" Keynesian's is passing and the time to improve our institutions so that this doesn't happen again for a long time has come. Fortunately, Nobel Peace Prize winner President Obama's own economic leanings are willing to deal with the "it's all very complicated" work that it takes to rebuild our economy on a better foundation.