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Who were given the 2016 Nobel prize in Economics and why? How does their work acquire significance for inclusive economic growth?

  Oct 18, 2016

Who were given the 2016 Nobel prize in Economics and why? How does their work acquire significance for inclusive economic growth?

2016 Nobel prize in economics has been awarded to UK-born Oliver Hart and Bengt Holmström of Finland for their work on contract theory, which has covered a range of issues from public-private partnerships to executive pay.

As it announced the prize, the Royal Swedish Academy of Sciences described the pair’s work as key to the understanding of the real-life contracts and institutions that hold together modern economies.

Their research was praised for shedding light on how contracts help people deal with conflicting interests in areas such as insurance and employment. They were also recognised for helping with the design of better contracts, “thereby shaping better institutions in society”.

The award is for the  work that had helped lay a foundation for designing policies and institutions in areas from bankruptcy legislation to political constitutions.

Society’s many contractual relationships include those between shareholders and top executive management, an insurance company and car owners, or a public authority and its suppliers. As such relationships typically entail conflicts of interest, contracts must be properly designed to ensure that the parties take mutually beneficial decisions.

“This year’s laureates have developed contract theory, a comprehensive framework for analysing many diverse issues in contractual design, like performance-based pay for top executives, deductibles and co-pays in insurance, and the privatisation of public-sector activities.”

Hart’s research work has included a damning assessment of America’s private prisons. He showed that the pressure to cut costs was too great, leading to an unacceptable drop in quality. At the core is the issue of “incomplete contracts” – the fact that contracts are not detailed enough to cover every small point.

Holmström is known for pioneering research into executive pay. His work on employment contracts has considered a range of professions from teaching to management and whether they should be paid fixed salaries or work on the basis of performance-related pay.

Their analysis of the contractual relationship between individuals has enhanced our understanding of the inner functioning of modern firms, corporations and organisations.