Tuesday, October 13, 2009

Another Nobel With Policy Implications

Caption: A photographic comparison of irrigation systems in Nepal. On the left is a farmer-maintained system made from locally available materials. On the right is a government-built irrigation ditch. Despite appearances, the farmer-maintained irrigation systems often perform better than the government-built systems.

Image credit: Reduced size screenshot of Science Magazine article by Cujo359

This is a Nobel Prize that I can get behind:

Two American economists, Elinor Ostrom and Oliver Williamson, who study economic governance and the way decisions are made outside the markets, were awarded Monday with the Nobel Prize in economics.

Ms. Ostrom, who teaches at Indiana University in Bloomington, Ind., is the first woman to win the prize, which previously had been awarded to 62 men since it was launched in 1969.

The judges cited Ms. Ostrom's "analysis of economic governance, especially the commons," the way in which natural resources are managed as shared resources.

Ostrom, Williamson Win Nobel Prize for Economics

Interpreting what the work Ostrom did to earn the prize seems to be a subjective thing. Here's how the Wall Street Journal article defines it:

Her work challenged the view that when people share a finite resource, they'll end up destroying it. Such "a tragedy of the commons" argues that resources that are important for the common good need to be highly regulated, or privatized.

It's an area of research that she said was relevant to questions about global warming, and suggests that decisions by individuals can help solve the problem even as governments work to reach an international agreement.

"Based on numerous studies of user-managed fish stocks, pastures, woods, lakes, and groundwater basins, [Ms.] Ostrom concludes that the outcomes are, more often than not, better than predicted by standard theories," the Nobel judges noted.

That's because over time, people often develop institutions, social networks and ways of interacting that solves the problem. Lobstermen in Maine, for example, have come to informally regulate, and restrict entry to, the areas where they work. Where these "lobster gangs" are prevalent, there are more lobsters.

Ostrom, Williamson Win Nobel Prize for Economics

They'd probably take the position that this means government regulation isn't necessary. My view is that in that case, government having either not known enough or having failed to act, the affected individuals cooperated to form what amounted to regulation. Sometimes that can work, but as the WSJ article goes on to point out, it's a method that has its limits:

On a larger scale, these social networks don't always work as well, notes Yale University environmental economist Matthew Kotchen -- there are fewer lobsters, for example, further away from Maine harbors. What's important, he says, is that Ms. Ostrom's work points out the importance of the networks that many economists had ignored, in part, because they couldn't come up with elegant models to describe how they worked.

"Just because you don't know how to model them doesn't' mean you can ignore them," he said.

Ostrom, Williamson Win Nobel Prize for Economics

At that point, something like a government, it seems to me, needs to be the arbiter. Even professional organizations such as the Bar Association have limited abilities. Determining those limits is one of the things that this work should help us do, somewhere down the line.

As Dr. Ostrom's work has shown, however, government or other external regulation can sometimes be less efficient than self-regulation mechanisms. The illustration that leads this article is from a paper she wrote called "Revisiting The Commons: Local Lessons, Global Challenges". Toward the end of the article, it mentions irrigation systems used in Nepal. The caption for the figure reads:

The farmer-managed irrigation systems of Nepal are examples of well-managed CPRs that rely on strong, locally crafted rules as well as evolved norms. Because the rules and norms that make an irrigation system operate well are not visible to external observers, efforts by well-meaning donors to replace primitive, farmer-constructed systems with newly constructed, government-owned systems have reduced rather than improved performance. Government-owned systems are built with concrete and steel headworks, in contrast to the simple mud, stone, and trees used by the farmers. However, the cropping intensity achieved by farmer-managed systems is significantly higher than on government systems[.]

Revisiting The Commons: Local Lessons, Global Challenges

As an engineer, I understand that there are plenty of things that can go wrong when replacing a working system with a newly designed one. There are several steps to engineering such a system. To start with, requirements have to be defined. This requires understanding the problem to be solved, and the environment in which it must be solved. Then a design must be created. A design defines how a thing will built. It can be wrong for many reasons, which usually revolve around an incomplete understanding of the requirements defined earlier, the environment it is to be constructed in, or the technology to be used. It may also be affected by lack of sufficient funding, or arbitrary requirements that have nothing to do with the usefulness of the project. One such requirement, in Iraq, was Saddam Hussein's demand that the Mosul Dam be built on land that was water permeable. This doomed the dam from the outset.

Many of these things have contributed to the failure of the government systems to work as well as the farmer-maintained irrigation systems (FMIS). A brief survey of literature on the subject would seem to confirm this, but other factors come into play as well. A general observation from the United Nations Food and Agriculture Organization (FAO):

Since time immemorial, farmer-managed irrigation systems have played a major role in the irrigated agriculture of Nepal. Before 1951, there were only three state-run or agency-managed irrigation systems in the country (Ansari, 1995). The planned irrigation development in the country, with the establishment of a state agency (the present Department of Irrigation), began only after 1951. At first, a lot of interventions were made in the farmer-managed irrigation systems under the banner of modernization and some new irrigation schemes were taken up. The mode of intervention was to take over the selected irrigation systems from farmers' management and treat them as new schemes, thus keeping farmers completely aloof. All of the capital cost was borne by the agency and segregation occurred between the farmers and the agency. Original farmer-managed irrigation systems became the agency-managed irrigation systems. Even after the planned involvement of the state in irrigation development, the irrigation development status is still led by farmer-managed irrigation systems (Table 2). Another reality is that the present irrigated area is merely 30 percent of the total irrigable area.

The farmer-managed irrigation systems were built, operated and maintained by the farmers themselves with little or no help from state or outside agencies. They contribute substantially to the agricultural production of the country, have been managed well and, in general, give better yields. Usually, their infrastructure is simple and lacks provision for water control and management. In other words, they run on the tradition of self-help. The agency-managed irrigation systems, on the other hand, in spite of their recurrently increasing operation and maintenance costs, have not improved their performance. When they were taken over by the state, the old irrigation systems were thought to have much potential for increased performance, as they were rudimentary, lacked permanent structures, were susceptible to damage during floods and to silt problems and had high water losses. In consequence, farmers had to contribute much labour and resources to run these systems. This led the government to rethink its irrigation strategy. By the mid-1980s the government became aware of the importance and strengths of the farmer-managed irrigation systems for the country's agriculture. There was also recognition of the scope for improving the systems through their rehabilitation and the extension of irrigated area, which would be possible by minimizing water losses and improving management efficiency.

Modernization Of Farmer-Managed Irrigation Systems In Nepal: Process And Learning

The government at first took over working FMISs and made them less efficient, while disenfranchising the people who had been maintaining the old systems well. They later started to realize their mistake.

The difference is sometimes stark, as this article from the Journal of Developments in Sustainable Agriculture relates (it also mentions Dr. Ostrom's work rather prominently):

Intervention by government agencies to improve FMIS has also run into difficulties. Ostrom pointed out that these difficulties often arise because irrigation agencies fail to recognize the institutional aspect of irrigation systems and focus only on improving physical capital. To emphasize her point, Ostrom cited the experience of the USAID-funded Chiregad Irrigation Project in Dang, as reported by Hilton. A new irrigation system with permanent headworks and cement-lined canals was constructed in an area that was previously irrigated by five FMIS. Making no effort to understand how the pre-existing water associations were organized, [Nepal Department of Irrigation (DOI)] appointed a new user committee that failed to include any of the water managers of the five FMIS. The outcome of this intervention was that only three of the five maujas (villages) received water consistently. Prior to the intervention, all five maujas used to receive adequate water. The effort to improve agricultural productivity through investments in physical capital alone thus resulted in reduction of the service area, unreliable water delivery, a non-functional [water user association (WUA)], and a weakened older WUA. Institutional structures stand on social capital developed over many years of learning through shared experiences and are as real as physical capital. Their neglect, as we see in this example, not only resulted in weakening of farmer organizations but also led to adverse outcomes.

Self-Governance in Farmer-Managed Irrigation Systems in Nepal

The requirements definition of the irrigation projects had some problems, but the bigger problem appears to be that the projects did not fit well with existing community organizations that had been doing this job for some time. These organizations were either left out of the maintenance of the new ditches, or couldn't run them as efficiently as they ran their old ditch systems as this 1994 report from Hokkaido University notes:

The following recommendations are made for future construction or rehabilitation of such small scale irrigation systems. Selection of schemes should be based on strict economic and technical evaluations after receiving request from the beneficiaries. Interventions for the rehabilitation or improvement of the farmer's traditional schemes should be limited only in the needy areas not in the whole system after receiving requests from the farmers. Once a scheme is selected, or if possible even prior to making a request for a scheme, a water users group should be formed from the real beneficiaries only. If there is a need to move away from the traditional technology, short term training should be provided to members of the users group and the people employed by them. Such training programs would basically relate to exposing the participants to new ways of doing things, which are totally within their own capability both in terms of management and resources.

Farmer-Managed And Government-Managed Irrigation Systems In Nepal

In defense of the people who were attempting to make these improvements, there were some other barriers to progress that they needed to work with. The Hokkaido University report compared an FMIS with a government-maintained irrigation system (GMIS) nearby. It notes this about the difference in the populations in the two irrigation project areas:

The education level is much higher in FMIS than GMIS in which no female is educated. Total literacy rate is 65 per cent in FMIS and 22 per cent in GMIS. Most of the uneducated people represent Kumales who are unprivileged group in the society. The main occupation in both systems is agriculture. Secondary occupations are service, trade and caste based profession.

Farmer-Managed And Government-Managed Irrigation Systems In Nepal

If Dr. Ostrom's work only provides principles for recognizing these issues and dealing with them before they turn into expensive failures, her work will be well worth the Nobel.

Paul Krugman, meanwhile, has some observations about what this means to the science of economics:

The way to think about this prize is that it’s an award for institutional economics, or maybe more specifically New Institutional Economics.

Neoclassical economics basically assumes that the units of economic decision-making are a given, and focuses on how they interact in markets. It’s not much good at explaining the creation of these units — at explaining, in particular, why some activities are carried out by large corporations, while others aren’t. That’s obviously an interesting question, and in many cases an important one. For example, in my own home field of international trade, the basic models don’t assign any particular role to multinational corporations; how do we get them into the story, and what difference do they make?

An Institutional Economics Prize

He goes on to note that this form of economics fell into disfavor after the Great Depression, because it could not offer any useful answers to that catastrophe.

Wikipedia has this to say about institutional economics:

Institutional economics, known by some as institutionalist political economy, focuses on understanding the role of human-made institutions in shaping economic behaviour. The institutional economists were typically critical of US American social, financial and business institutions. What is now called new institutional economics, is a very different creature politically, but still focuses on the role of institutions in reducing transaction costs. Heterodox institutional economics emphasizes a broader study of institutions and views markets as a result of the complex interaction of these various institutions (e.g. individuals, firms, states, social norms). Law and economics has been a major theme since the publication of the Legal Foundations of Capitalism by John R. Commons in 1924. Behavioral economics is another hallmark of institutional economics based on what is known about psychology and cognitive science, rather than simple assumptions of economic behavior.

Wikipedia: Institutional Economics

It also has an entry for behavioral eoconomics, the study of how human psychology affects economics. This area is a relatively recent addition to the field, with the first notable works appearing in the 1960s. I'm not sure if this is what Prof. Krugman meant by "institutional" economics, but it's certainly a related field, and until recently an under-appreciated one.

Meanwhile, orgtheory.net, which concerns itself with organization theory, has a slightly different take on all this:

Here’s the kicker (and what makes it sociological): She finds that coordination happens through self-organization and local (very local) governance. There is a meso level — between the individual and the grand institutional structures of society — that is big enough to bite off a significant chunk of population, but not so big so as to transcend the interpersonal. The only way that self-organizing can really overcome collective action problems, in her view, is to go small. It is like a fractal theory of economics: to build a stable, strong macro economy, you need to reproduce the structures of society over and over and in smaller and smaller scale down to the smallest units possible.

In other words, Ostrom discovered organization, through the back door of economics as it were.

Of course she did. How could she have avoided it? Like all great empiricists, Ostrom has never been satisfied with numbers and formulas as a means of understanding the world. She is interested in water management, so she goes to Nepal to study water use. She is interested in fisheries, so she goes to Maine to talk to fishermen. She is interested in sanctioning behavior, so she runs a lab experiment. And what one finds when one does that is that organizations are the fundamental units of society. Her work is as influenced by the stories and observations of the ways people self-organize as it is by any one theory. It is in the productive dialogue between observation and theory that her insights emerge.

Of Cows And Collective Action, Ostrom Wins A Nobel

Some economists would argue that individual people are the fundamental unit of society, as I suppose would politicians. Nevertheless, how people organize, and why they do or do not, is a very fundamental aspect of economics and politics. As we have seen with oil cartels and the National Rifle Association, organizations can have an influence out of all proportion to their numbers.

I think it's telling that Krugman admits being unfamiliar with Ostrom's work. This is an area that most economists have tended to ignore. My personal stereotype of economists, particularly the "free market" variety, as seeing the entire world as individual widget makers, salesmen, and buyers, is sometimes sadly close to the truth. People do things in all sorts of ways that aren't easy to describe mathematically, and yet have a profound effect on how markets work. The tragedy of the commons is an attempt to express one such way in terms of how people could choose to use a limited resource.

To me, that's what makes this an interesting award. Not only does it seem to represent a move away from Freidmanesqe "free market" economics, but it also represents the increasing attention paid to the ways humans actually make economic decisions and economic policy. Recent events would suggest that the more we know of these things, the better we can make those policies.

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