Difficult Thinking About Institutional Change III: Ostrom’s Design Principles

Lynne Kiesling

In my previous “thinking out loud” post on institutional change, I ended with this question:

Institutional change is in many ways itself a constructivist exercise. Is there a way to make the process of institutional change more organic, and thus more likely to lead to “valuable, meaningful, forward-looking, robust, evolutionarily adaptive institutional change”?

For help in thinking through this question I turned to one of the most important works about institutional change, Elinor Ostrom�s Governing the Commons. Ostrom focuses on how communities develop self-governance institutions for the mutually beneficial use of common pool resources (CPRs), particularly water and land. Ostrom’s work has shaped my thinking on these issues, as is evident in the property rights paper that I co-authored with David Haddock in 2002.

Ideas about institutions governing CPR use are highly relevant to electricity policy, but have not yet been applied. At a very fundamental level, CPRs and physical networks share crucial economic features, most notably the interdependence of both production and consumption decisions of individuals. In her CPR context Ostrom calls individuals “appropriators” because she is focusing on, for example, the appropriation of water from a shared river; in a network context let’s call those individuals agents. In both cases, appropriators and agents make decisions based on the institutional environment in which they operate, which influences their incentives and opportunity costs. Those decisions can and will affect the consumption and production of other agents, and in a dynamic sense will also affect their incentives for how much to consume and produce in the future. This is the sense in which the analysis of so-called public goods and externalities using the prisoner’s dilemma is so powerful.

Traditional arguments about how to get out of the prisoner’s dilemma in CPRs involve privatizing the commons. In electric power, this strong property rights approach is not feasible because of the network nature of the transactions and because Kirchoff’s Laws mean that the physical flow of electrons and the contract path corresponding to assigned property rights are not likely to match up. So Ostrom�s exploration of situations in which people choose to keep a CPR as a CPR but use governance institutions to get out of the prisoner’s dilemma offers some insights about what some of the features are of robust institutions.

In Chapter 3 of Governing the Commons, Ostrom distills some design principles from case study analysis of several long-enduring CPR institutions (Table 3.1, p. 90). She does not claim that these design principles are either necessary or sufficient, but that experience of robust CPR institutions suggests that these design principles increase the probability of success.

1. Clearly defined boundaries: rights to withdraw resources from the CPR must be well defined. Note that this principle relies on a very crucial distinction in both CPRs and networks: the distinction between property rights and use rights. Either by choice or physical necessity a group of agents can treat a resource as a CPR while still defining very specific, clear, transparent use rights. This principle is very important in a network context.

2. Congruence between appropriation and provision rules and local conditions. Local conditions matter, a lot. We have millennia of human history, with the most poignant and painful being the Soviet experience, showing how the top-down imposition of external institutions that do not respect or incorporate local knowledge and local conditions will make people worse off and are ultimately doomed to costly failure. This design principle gets at the core of my question by indicating that robust institutions are organic in nature; they derive from the decentralized interactions of those with strong interests and good local knowledge. Local knowledge and local conditions differ, even on an electric power network. Furthermore, some of that local knowledge is going to be tacit and difficult or impossible to communicate, reinforcing the important points of Hayek’s “The Use of Knowledge in Society”.

3. Collective-choice arrangements. Agents affected by the institutions should have opportunities to modify the institutions. Otherwise the institutions stagnate as networks evolve, and the institutions become obsolete at great cost (both financial cost and opportunity cost) to the network agents.

4. Monitoring. Monitoring is important but costly, and should be done in a way that the monitors are accountable to the network agents. In many of the CPR cases Ostrom analyzes appropriators themselves do the monitoring, although it’s important to have a third party responsible for enforcement and punishment. In a network context, where everyone’s actions are to some degree interdependent, self-monitoring arrangements should be relatively cheap, but getting the incentives right for the monitor is a challenge.

5. Graduated sanctions: punishment escalates with the severity of the violation.

6. Conflict-resolution mechanisms: these can be formal or informal, from courts to local self-administered arbitration. In different contexts different conflict resolution mechanisms will have the credibility to make their decisions stick, so this design principle also builds on the local conditions/knowledge one discussed above.

7. Minimal recognition of rights to organize: the rights of local agents to develop and arrange their own institutions are not challenged by central government authorities. This one is a toughie in a network context like electric power that occurs in multiple political jurisdictions, and with this history of 85 years of symbiotic codependency of the regulator and regulated. But it’s an important one, because this is a pressure valve that allows for the evolution of institutions and the adoption of designs that are better suited to local conditions and/or changing and unknown conditions. Government-based institutions do not typically face competition from different institutional arrangements, but that competition is crucial (and is one of the important foundations of the “laboratory of the states” defense of federalism).

8. For more complex or heterogeneous populations or resources: Nested enterprises. I interpret “nested enterprises” as analogous to the concept of federalism, with local knowledge and local institutions prevailing where appropriate but nested within an institutional structure to accommodate larger and broader interests.

These design principles can inform how we design institutions in electric power that have more organic features, and are more likely to be flexible enough to evolve beneficially in the face of unknown and changing conditions.

Please share your thoughts with me about how these design principles are relevant in electric power, and any ideas you have about implementing them.

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