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The Theory Of Real Win

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Talk about dark horses. British betting  firm Ladbrokes offered 2-to-1 odds on Eugene Fama of the University of Chicago winning this year's Nobel Prize in economics — which is not really a Nobel Prize but ‘The Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel' — for his work on the efficient market hypothesis. A close second on Ladbrokes' list was Paul Romer of Stanford University for his work on how technological change impacts economic growth. At 6-to-1 odds, there were Robert Barro from Harvard University, a neoclassical macroeconomist, Ernst Fehr from the University of Zurich (for neuro-economics or how the brain responds to economic decisions) and a frequent collaborator of Fama's, Kenneth French of Dartmouth.

The winners, Elinor Ostrom and Oliver Williamson were a complete surprise. Ostrom is not even an economist: she is professor of political science and public and environmental affairs at Indiana University. Williamson is professor of economics at the University of California at Berkeley. It is perhaps the first time that the prize has been awarded to people whose work is interdisciplinary. Williamson's research covers organisation structures like corporations, and includes the law.

Ladbrokes was not the only agency to bet on who would  win the prize. A Harvard University prediction pool began in 1982. Thomson Reuters, the news agency, also makes predictions. There are others, too. But markets and finance are out of favour this year: though most pools picked economists with a penchant for markets.

First Lady Of Economics: Elinor Ostrom (AP)The two winners have worked extensively on ‘the economics of governance' (the title of a 2005 paper by Williamson); their work revolves around the role of institutions in economics. Ostrom's work suggests that given the right institutions, the provision of public goods can be managed from the bottom-up for shared prosperity. Markets organise production and consumption efficiently, but only when supported by networks and communities. Media organisations have reported on her work in Kodepalli village in Andhra Pradesh and, similarly, in villages in Nepal. Williamson had earlier won the HC Recktenwald Prize in Economics, Germany's premier prize which is awarded every two year, in 2004 for his work on transaction cost theory and institutional economics. (Other winners of that prize include Paul Krugman, Joseph Stiglitz — both Nobel Prize winners — and Paul Romer). Much of his work focuses on transactions that are not covered by detailed contracts and legal rules.

Contrary to trends in economics that another Nobel winner Ronald Coase said "bears little relation to what happens in the real world", Ostrom observed how communities were doing things differently. In opposition to the assumptions of rationality, perfect information, etc., which are central to economic theory, her research looked at new assumptions that could better explain real world results.

As the Bank of Sweden said in its announcement, Ostrom "challenged the idea that common property is poorly managed and should be either regulated by central authorities or privatized". Ostrom, they said, used studies of user-managed fish stocks, pastures, woods, lakes and groundwater basins, to demonstrate that the results are "more often than not, better than predicted by standard theories". She proposed the idea of "polycentric governance", an approach that emphasises the degree to which higher levels of government should not crowd out self-organisation at lower levels.

Perhaps the best kudos for the award were given by Paul Romer, himself a future Nobel Prize contender: "Bravo to the political scientist who showed that she was a better economist than the economic imperialists who can't tell the difference between assuming and understanding". Perhaps the interdisciplinary approach may just be what economics needs.

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(This story was published in Businessworld Issue Dated 26-10-2009)