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This year’s Nobel Prize: A case of market failure

Ideas@TheCentre – The CIS newsletter (Sydney), 15 October 2010

This year’s Nobel prizes started promisingly enough: The literature prize was awarded to Mario Vargas Llosa, who made the defence of individual liberty the theme of his work. Then the peace prize went to jailed Chinese dissident Liu Xiabao, who has had to pay a high personal price for his decades-long fight for political freedom in the one-party state.

The Nobel Prize in economics, however, left me somewhat puzzled. To be sure, the recipients Peter Diamond, Dale Mortensen, and Christopher Pissarides are all highly respected economists. Their contributions to labour market theory have become part of textbook economics. In this sense, the prize is well deserved.

Having said that, awarding the prize to the trio also looks a bit like a safe choice. If the Nobel committee had wanted to set an exclamation mark with their decision, they could have honoured branches of economics they had hitherto neglected. For example, research into entrepreneurship is long overdue in terms of Nobel recognition, and someone like Israel M. Kirzner would have been a worthy recipient. No one has more elegantly formulated why and how entrepreneurs are the key figures in driving the competitive market economy and thus economic growth.

In another sense, too, the choice of the three labour market specialists is hardly revolutionary. Though their models are elegant, what they are actually saying is very much common sense. For example, their model shows that ‘more generous unemployment benefits give rise to higher unemployment and longer search times,’ the Nobel committee inform us in their press release. But does it surprise anyone that a life on benefits makes it less urgent to look for a job?

Even stranger, the Nobel laureates are happy to claim responsibility for labour market reforms that are widely regarded as failed. Pissarides says the ‘New Deal for Young People,’ a British government initiative aimed at getting 18- to 24-year-olds back on the job market after long spells of unemployment, ‘is very much based on our work.’ But, as a report by former British welfare reform minister Frank Field for London-based think tank Reform shows, the program was costly without actually bringing young jobseekers back into work. ‘The results of the New Deal for Young People have however been modest, to put it mildly,’ Field concluded.

To round off the oddities about this year’s prize, one of the laureates, Peter Diamond, had been nominated by President Obama for a seat on the board of the Federal Reserve. His nomination has been blocked, however, because Republican opponents have doubts about his qualifications for the job.

It seems the main purpose of this year’s prize is to underline that markets often do not work, in this case because of search costs in labour markets. But that such costs exist is hardly disputed.

It would have been more appropriate if the Nobel committee had honoured an economist who had made contributions to showing how markets work. Like Liu Xiabao, who was widely pipped to win the Nobel last year, Israel M. Kirzner may have to wait one more year.

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