Elinor Ostrom on the Market, the State, and the Third Sector

The remarkable achievements of the Nobel Prize-winning economist

When economists show that market arrangements fail, they usually make the simple recommendation that “the” state should take care of these problems. Elinor Ostrom has demonstrated empirically that “the” state may not be “the” solution. Her work argues for the wisdom of institutional diversity, looking to individuals to solve problems rather than relying on top down, one-size-fits-all solutions. The conventional wisdom assumes that natural resources and environmental problems should be solved in a centralized—and if possible, global—manner. Through innovative analysis in the field, in the experimental laboratory, and in theory, Ostrom’s work has show that creative solutions to problems such as the depletion of common pool resources exist outside of the sphere of national governments. Hence today’s announcement that she had received the 2009 Nobel Memorial Prize in Economic Sciences.

But there is more to Elinor Ostrom’s work. In fact, one may say that, together with Vincent Ostrom, she has mounted a remarkable challenge to the mainstream views in economics and political science. As she described it herself, her work is a systematic attempt to transcend the basic dichotomy of modern political economy.

On the one hand, there is the tradition defined by Adam Smith's theory of social order. Smith and his intellectual descendants focused on the pattern of order and the positive consequences emerging out of the independent actions of individuals pursuing their own interests within a given system of rules. That was the “spontaneous order” tradition where the study of markets—the competition among producers and consumers of pure private goods leading to a better allocation of resources—occupied a preeminent place.

On the other hand, there is the tradition rooted in Thomas Hobbes’ theory of social order. From that perspective, individual actors pursuing their own interests and trying to maximize their welfare lead inevitably to chaos and conflict. From that is derived the necessity of a single center of power imposing order. In Hobbes’ view, social order is the creation of the unique “Leviathan,” which wields the monopoly power to make and enforce law. Self-organized and independent individuals thus have nothing to do with making order. Most modern theories of “The State" have their origins in Hobbes’ vision of Leviathan.

In Ostrom’s view, the theorists in both traditions managed to keep not only the theories of market and state alienated from each other, they also managed to keep the basic visions of the two separated. Smith's concept of market order was considered applicable for all private goods while Hobbes's conception of the single center of power and decision applied for all collective goods. But what if the domains of modern political-economic life could not be understood or organized by relying only on the concepts of markets or states? What if we need "a richer set of policy formulations" than just "the" market or "the" state? Answering that challenge is probably the best way to see Ostrom’s work on governance and common pool resources: It’s an empirically-based contribution to a larger and bolder attempt to build an alternative to the basic dichotomy of modern political economy, an effort to find an alternative to the conceptions derived from Smith and Hobbes.

“The presence of order in the world,” Ostrom writes, “is largely dependent upon the theories used to understand the world. We are not limited, however, to only the conceptions of order derived from the work of Smith and Hobbes.” We need a theory that “offers an alternative that can be used to analyze and prescribe a variety of institutional arrangements to match the extensive variety of collective goods in the world.” In response to that need, Ostrom has explored a new domain of the complex institutional reality of social life—the rich institutional arrangements that are neither states nor markets. These are for-profit or not-for-profit entities that produce collective goods for “collective consumption units.” Examples of such “consumption units” abound. They are small and large, multi-purpose or just focused on one good or service: suburban municipalities, neighborhood organizations, condominiums, churches, voluntary associations, or informal entities like those solving the common-pool resources dilemmas studied and documented by Ostrom around the world. Yet, once the functional principle behind them was the identified, the very diverse forms could be understood as part of a broader pattern, and the logic of the institutional process involved could be revealed with relative ease. They could be seen as a “third sector” related to but different from both “the state” and “the market”.

And thus Ostrom’s study of governance is not only a source of inspiration, it is also a challenge to libertarians. In study after study, she has shown that the principles of individual freedom, responsibility, entrepreneurial creativity, and resourcefulness apply not only to the production and distribution of private goods, they also apply to a large institutional domain outside the market order. This “third sector,” which is “neither state nor market,” may in fact be as important a battleground for the preservation of a free and prosperous social order as the market itself.

Paul Dragos Aligica is a Senior Research Fellow at the Mercatus Center. He is the co-author (with Peter Boettke) of Challenging Institutional Analysis and Development: The Bloomington School (Routlege, 2009). He studied with Elinor Ostrom at Indiana University, Bloomington. This column first appeared at Reason.com.