source: Le Nouvel Observateur
author: Pascal Riché
translation: doxa-louise
The two new Nobel Prizes in Economics for Dummies
Oliver Hart and Bengt Holmstrom specialize in the theory of contracts. Which
allows to determine in fact when it might be better to control all oneself.
The worn out joke among economists, who know how to laugh at themselves:
'It works in practice just fine, but will it work in theory?' The 2016 prize attributed
by the Bank of Sweden, in memory of Alfred Nobel (which is improperly referred
to as the Economics Nobel Prize, and comes with a gift of some 900,000 euros)
will provide little fodder to those who find that funny.
In effet, the two economists who received it Monday, the British-American Oliver Hart
(68, Harvard), and the Finn Bengt Holmstrom(67, MIT) are only interested in what
works in practice.Or, to quote Justin Wolfers (University of Michigan), a past student
of Hart, who expressed his pleasure at the announcement on his Twitter account,
in 'a reality which is not neat' full of 'imperfections'. Last year, the prize went to an
economist at work on the incoherence within enterprise: The Frenchman Jean Tirole.
The Economy: knots of contracts
Hart and Holmstrom are being rewarded for their contribution to the theory of
contracts, a field which they partly helped form. It is a matter of exploring the
most basic relationship, but also the most important in economics: that which
binds a buyer and seller, a giver of orders and the person who carries them out,
a stock holder and a manager, etc. As explained by Olivier Sautel, specialist in
industrial economics and vice-président of Microeconometrix:
'All organizations and institutions can be understood as knots of contracts.
The theory of contracts looks at what motivates the various actors and how hierarchies
are formed.'In a contractual relationship, interests sometimes converge, sometimes
diverge; often a mixture of both. This relationship is bounded by rules and institutions
(property rights, for example) and one actor can dominate the other for various reasons.
It is in the interest of the economy that contracts be of benefit to all.
Bengt Holmstrom thus worked in the 1970s on the relationship between
stockholders and management. What is the proper remuneration of the latter to
best attain the objectives of the former. What bonuses should one offer if one wants
them to focus on the long term.
The puzzle of 'incomplete' contracts
Oliver Hart, for his part, worked in the 1980's on the problem of 'incomplete'
contracts,in the footsteps of the works of Oliver Eaton Williamson, another
Nobel winner. Virtually all contracts are incomplete in the measure that not all
possible outcome can be planned for. which opens the risk of having to renegotiate.
From this consideration of incomplete contracts comes different possibilities for
organizations.
Let us take the example of an enterprise looking for a certain supply object. If it
is simple and there is no reason to foresee change ( a plastic fixture, for example)
it is possible to elaborate with a supplier a rather complete contract: description of
the object, price indexed to the price of oil, delivery mechanisms etc. But in other
situations (for a product destined to evolve, for example),the risks in negotiation
are such that it is to the advantage of the enterprise to integrate its supply object,
to stay on top of decision-making. The more a contract is incomplete, the less
it is interesting to go to an outside supplier.
Two friends
'According to Hart, in evolving situations, hierarchical control should go to those
who possess the physical assets', explains Olivier Sautel. 'But this hardcore approach
has been questioned by many who see human capital (know-how, talent, aptitude) is
more important than physical assets: the ownership of computers or offices does not
confer any particular power on management. Bent Holmstrom has shown more
interest on this question of human capital.
Research by these two men have made possible advances in various fields: what
companies would do best to merge. Does it make sense to privatize institutions
such as schools and prisons. Their differing views have not stopped these two new
Nobels from getting along. They even wrote a book together in 1987,
The Theory of
Contracts (Cambridge University Press). 'Oliver Hart, I am so
happy to have won the prize with him, he is my best friend', happily stated
Holmstrom on Monday.
* * *
The Nobel Prize in Economics for 2015 went to Angus Deaton, USA
for is analysis of consumption, poverty and welfare.
That of 2014, to Jean Tirole, France
for his analysis of market power and regulation.
* * *
source: Libération
author: Vittorio De Filippis
translation: doxa-louise
The Economics Nobel Prize rewards the theory of contracts
The Nobel Prize in Economics - or, more accurately, the 'prize of the Central
Bank of Sweden in Economic Sciences in memory of Alfred Nobel - was given on
Monday to the British-American Oliver Hart and the Finn Bengt Holmstrom.
The first, born in 1948, got his doctorat from Princeton and teaches at Harvard.
The second, born in 1949, teaches at MIT (Massachusetts Institute of
Technology) after having obtained his doctorat from Stanford. Both were rewarded
for their work on the theory of contracts. Nothing to do (or very little) with
contracts in the legal sense of the term.
Their work is an extension (in part) of that of the Americans George Akerlof,
Michael Spence and Joseph Stiglitz, also rewarded by the Bank of Sweden
(in 2001) for their research on asymmetric information within markets. It
was a question of showing that a market will be far from efficient
when buyers and sellers have different information. The best example being
the market for used cars where the seller knows the defects of the vehicle but
the buyer does not. Thus showing the necessity of putting in place mechanisms
for greater transparency.
Hart and Holmstrom aim to go further, with the merit of having given birth to
'a fertile field of fundamental research' according to the jury. An objective that only
contracts make possible. On the face of things, the recipients seem to be doubting
the obvious. Like the reasons that could explain ( but not justify) why an enterprise
belongs to stockholders and not workers. Put differently, why the cooperative model,
which many believed would replace capitalist enterprise, lost the battle on free-market
ownership of property. When Hart and Holmstrom try to offer an answer, they realize
to what extent the enterprise is a knot of contracts favourable to the stockholder-owner
form. On the one side, workers with remuneration contracts as guaranty, and a
strong aversion to risk...On the other, holders of capital who take risks and accept
the possibility of loss, but then have a right to profit. In other words, Hart and
Holmstrom reveal to what extent property rights to residual revenue (loss as well as
profit) belong to those who bring the most important assets to the enterprise. A way
of seeing rejected by Marxists, who speak of a 'technical expression of domination'.
The theory of contracts has other concrete applications. The most evident is
relative to the phenomena related to the 'moral unforeseen'. Here is a simple enough
notion. This approach brings out proof for risky behavior when an assured knows he
is protected by a contract. Thus showing the need for more efficient contracts for
Insurance. From this work, Hart and Holmstrom have brought important contributions
to the 'theory of incentives'. Or how to make sure behaviors are more efficient
thanks to incentives of all kinds. Thus it is a matter of formulating contracts.
What is valid for Insurance is as well for Financial Markets and the Banking Sector.
As well, the works of the recipients have permitted a better understanding of the
behavior of those banks that feel that they are 'too big to fail'. They know that their
own bankruptcy would entail that of other large banks. But they also know that the
public purse will be there to put out the fire with liquidities (tax money) from taxpayers.
And here again, the necessity to find contracts that ensure virtuous behaviors.
Too bad no one applied this theory before the fall of Lehman Brothers in 2008.
And that it is still so little used, while the spectre of disaster hovers for Deutsche Bank.
