2008 Nobel Laureate Paul Krugman famously said, “most work in macroeconomics in the past 30 years has been useless at best and harmful at worst.” Who am I to argue with that?

The definition of a classic is that most people have heard of the book, but very few have actually read it. The same must be true of the work of most Nobel Laureates — we are aware that they must be famous, but not sure what they are really famous for. I have read the work of Oliver Williamson, the 2009 joint Laureate in Economics, because I studied the theory of firm carefully in trying to understand why corporate governance. However, I confess that until the recent announcement, Nobel Laureate Elinor Ostrom was not on my radar screen.

I commend her award, as she truly has contributed significantly towards our understanding of collective human behavior. Professional economists, like scientists, are tribal in behavior, because they hold onto their theories and beliefs religiously against all comers. The free market orthodoxy has proven very hard to dislodge, because discrepancies found in real life are either “pooh-poohed” or dismissed as defective scholarship. But this current crisis of massive financial market failure has shaken the economics profession to its roots.

The foundation of free market economics stems from the Scottish Moral Philosopher Adam Smith's assertion that the pursuit of individual selfishness can lead to public good. To free market believers, if government gets out of the way, individual freedom to do selfish things would create the greatest prosperity. This is exactly what Wall Street has preached and practiced, leading to the greatest crash since the 1930s.

In 1968, ecologist Garrett Hardin wrote an influential essay called “The Tragedy of the Commons” that challenged the Smith assertion. He demonstrated how the selfish behavior of individual farmers created overgrazing of the common fields and therefore destroyed the public good and the environment. We have observed how wanton destruction of forests for short-term gain has denuded our ecological heritage and led eventually to global warming. Hardin's paper stirred up a storm that eventually gave Elinor Ostrom her Nobel Prize.

Basically, there were two conventional solutions to stop the Tragedy of the Commons. One was the imposition of the State to enforce rules to stop encroachment of the public good; the other was privatization of the commons. The free market school favored privatization, but as experience has shown, privatization has tended to become “privatization,” in the sense that some privileged few has gained from the privatization exercise. The late political scientist Mancur Olson became famous for his assertion that even the “stationary bandit,” the strongest of the contenders for power, can protect the public interest because he has the most to benefit from the public good.

Elinor Ostrom is not only the first woman to win the Nobel Prize in Economics, but also a political scientist, meaning an outsider is storming the economics profession. Moreover, she is not a pure theoretician, but a behavioral and empirical analyst, pointing out that there is plenty of evidence in history and real life that collective action problems (such as the Tragedy of the Commons) are not solved by more government or privatization, but through self-governance, meaning that the altruistic behavior of individuals can lead to protection of the common good. Many communities have solved collective problems through the public spirited individuals, civil society and non-governmental organizations (NGOs).

Ostrom argues that what makes society work together are the core relationships of reciprocity, reputation and trust. She identifies reciprocity as a class of strategies for human behavior or games between individuals, the most famous being tit-for-tat. Reciprocity is necessary to drive human behavior towards norms of trust and reputation. If the other side cooperates, you can cooperate to achieve common good. If the other side does not cooperate, most societies can enforce some kind of punishment, such as naming, shaming and isolation.

Most people use reciprocity to acquire a reputation by doing short-term action that has costs, but creates long-term net benefits. Trust is the valuable asset that creates social cohesion. Without trust, societies break up because people vote with their feet. The tragedy of the commons occurs because individuals do not trust each other and therefore elect to do their own thing selfishly.

In order to break these collection action traps, Ostrom emphasizes the importance of communications and also civic education. If our school textbooks praise self-interest, are we surprised that our financial industry has greedy Gordon Geckos and Bernie Madoffs?

Ostrom also suggests that the role of the state has to change, because she felt that “national governments are too small to govern the global commons and too big to handle smaller scale problems.” She argues for governments to work with civil society, giving them enough space and support to handle the small problems that government bureaucracies cannot handle efficiently. In other words, she argues against the simplistic view that world problems are solved only by governments or private enterprise. There is a major role for citizen participation for the public good.

Traditionally, Asian society sees governance as divided between the state and the family. The rise of the corporate world created governance between the state, the firm (private enterprise) and the family. Today, there is a new class of civil society, in which citizens want to work with each other to look after their common interest, such as environmental protection, education, public health or social welfare. There is increasing awareness that governments cannot solve all problems, and bureaucracies can often be the problem, not the solution of our social ills.

Thanks to Ostrom, we are reminded that governments need to work with civil society to create social cohesion. Most bureaucracies around the world are not equipped to think or function like that. But that is the way of the future.

Andrew Sheng is Adjunct Professor at Tsinghua University, Beijing and University of Malaya. He was formerly the Chairman of the Securities and Futures Commission, Hong Kong.