The other co-winner, Elinor Ostrom was not even in the betting market as she is a political scientist by profession. If someone placed a bet on them, he or she would be a rich man by now.

I guess no one has ever made a fortune from betting on it. Cornell’s Kaushik Basu once said that he was tipping his mentor Amartya Sen to win the prize for five years in a row. When Sen did win it in 1998, he had given up betting.

In the 1990s, almost everyone predicted that Paul Krugman would win the prize, but just when everybody stopped thinking Krugman would ever win at all, the committee awarded him the prize in 2008.

The common theme of Ostrom and Williamson’s work is economic governance – basically, how economic agents cooperate and coordinate their actions without the presence of the market and market prices.

In traditional economic theory, the market will solve the problem of coordinating actions of individuals with different interests. Market price serves as the guide to aligning individual incentives.

However, not all transactions can and do take place in the market. Sometimes the transaction cost is too high so the benefit from market exchange exceeds the cost. An obvious example is the interactions among family members.

There is no market for my wife and daughter’s smiles, or for my time entertaining them. (Note: This doesn’t mean that there is no self-interest or exchanges in our family; they just don’t happen within the market.)

Another classical example is common property resources, like green pastures, lakes or water wells. Since no one privately owns them, the market will fail to assign the appropriate “price”.

This will lead to excessive consumption and rapid degradation of the environment, the so-called “tragedy of commons”.

The classical solution is to assign the property rights to the resource, either to individuals or the government, which will manage it as public property.

But Ostrom showed that common property does not always lead to the tragedy of commons. In many empirical cases, common property has been well-managed.

Users, in such cases the local community, can both create and enforce rules that prevent overexploitation. These local institutions can work better than the imposed private-ownership or government regulation.

However, this is not a generic conclusion. In some settings, privatization or government regulation may be preferable. The lesson is that we need to better understand how micro and mezzo institutions work.

Oliver Williamson’s work, on the other hand, focused more on firms. His work helped us to understand why there are large firms. The reason is because in larger firms, resource allocation and conflict resolution is cheaper (just like what happens in a family or a common resource).

For example, a firm’s executives will decide how revenues should be distributed among employees or across units.

The firm can set an internal price for transactions among units as opposed to price negotiation with other firms. At the same time, Williamson’s general framework implies that there is a limit for large firms. Large companies exist because they are efficient.

But when the cost of establishing hierarchies gets bigger, or alternatively the cost of engaging in external transaction gets smaller, then there will be less need to be big.

This explained why in the ‘70s firms tended to be big. But in the era of information, the market has become more efficient so the cost of obtaining production inputs externally is as cheap as obtaining internal output. Hence we see the trend of downsizing and outsourcing.

Ostrom and Williamson’s works show us the market is one type of institution in which transaction among agents may take place. There are other institutions that support the market, and in some cases, provide alternatives to it.

Their contribution is to help us understand that different contexts and institutional setting require different types of governance.

In many cases, markets may be missing or may fail to work properly. In such cases, local institutions may still enable agents to coordinate their actions in an efficient way.

Transplanting the market may not be an optimal solution because this local institution may have a better mechanism to reduce transaction costs.

Nevertheless, although the market fails or is missing, government intervention is not always the answer. Different problems require different answers, like Ostrom and Williamson works have shown.

This is not a new thing, of course. Economists have long acknowledged the market has its limitations.

A number of earlier Nobel prizes have been awarded to works on how the market fails; others on how institutions do matter in economic transactions.

Those are, of course, in addition to other awards that show why in many cases the market does work well. Hence, unlike unfair accusations that economists tend to dogmatically believe in the market, there is a greater degree of heterodoxy within economics in how the market is viewed.

The current global situation has put economic science and the profession under the spotlight more than ever. Many people see the current crisis as not just an economic crisis, but also as a crisis of economics as a discipline. Does the Nobel Committee want to send a message by awarding the prize to the two scholars?

If any, here’s one message I can think of: Yes, the market has problems. But we are still unsure what the alternative to the current system is. In the meantime, let’s not vote the market out.

But instead, take a closer look on what happens outside of the market, and see how they can help us understand the problems better.

 The writer is a Ph.D. student in Economics at the University of Melbourne, Australia.

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