Published in The National Business Review (Auckland), 25 October 2013 (PDF)
The economics Nobel Prize is a funny thing. Not just because it does not exist. When Alfred Nobel donated his fortune to the awards in his name, he included Physics, Chemistry, Literature, Peace and Medicine. Economics, meanwhile, only got included when the Swedish central bank established the prize “in memory of Alfred Nobel” in the late 1960s.
Since then, the economics Nobel Prize has been almost as controversial as the Peace prize. The reason is simple. Whereas in Physics, Chemistry and Medicine, the scientific relevance of a discovery or an invention can be demonstrated relatively easily, especially with the typical benefit of a few decades of hindsight, economic theory does not advance in a similar fashion.
In the history of economic thought, there have been few genuine eureka moments. Adam Smith’s understanding of the division of labour comes to mind (1776). David Ricardo’s explanation of comparative advantage is another such breakthrough (1817), as was the joint but independent discovery of marginal utility by William Stanley Jevons, Carl Menger and Léon Walras (1871-74).
Since these glorious early days of economics with their path-breaking insights, it is fair to say that the refinement of economics has not produced similar advances in knowledge. In an odd kind of way, at least this corresponds to the law of diminishing returns. In production processes, you typically realise the biggest output increases in the beginning. Why should it be any different in the production of knowledge?
However, the real tragedy for economics is not with the production of new economic knowledge. Unfortunately, we often discard and abandon the things we have learnt in the past. As Friedrich Hayek, himself a Nobel laureate, once said in a lecture, “in economics you can never establish a truth once and for all but have always to convince every generation anew.” Instead, Hayek believed that “knowledge once gained and spread is often not disproved, but simply lost or forgotten.”
The challenge for economists is often not so much the design of a grand new theory but to keep alive the ideas of great past economists and apply them to new policy challenges. That is worthwhile, no doubt about that, but is it really prize worthy?
The other main problem with the economics Nobel is that there remains a substantial amount of disagreement within the economics profession. The prize committee then has to do something that economists typically try to avoid: pick winners.
In their past decisions, it is obvious how uncomfortable the committee often were with their choices. We can tell because they often hedged their bets, which leads to the bizarre outcome that in economics it is possible to share a Nobel Prize for saying opposite things. It is unthinkable in the natural sciences to give a prize to two scientists whose research led them to diametrically opposed conclusions. Not so in economics, where we have become used to it.
Thus Hayek, an arch-liberal, had to share his prize with Swedish socialist Gunnar Myrdal in 1974. For the same reason, this year’s prize is shared by Eugene Fama and Robert Shiller. The former explained why market prices typically reflect all available information; the latter why markets tend to exaggerations and bubbles.
The problems with the economics Nobel Prize unfortunately do not end with such ambiguity. The prize is also notorious for being awarded to people whose subsequent behaviour may be embarrassing. Myron Scholes, the 1997 winner, is the perfect example. Scholes may have produced great work in the field of financial markets theory. However, his personal record in the markets will forever be overshadowed by the failure of his hedge fund Long-Term Capital Management (LTCM). A year after Scholes had won the prize, LTCM collapsed, losing $US4.6 billion of investment.
In a similar way, one may well feel that Paul Krugman may have deserved his 2008 Nobel for his contributions to trade theory. Whether Krugman’s New York Times column and political activism would warrant similar accolades is a matter for debate.
The prize is not only controversial for the people who have received it but also for those who have not. For example, the foundations of public choice theory were jointly laid by James Buchanan and Gordon Tullock, not least through their joint book The Calculus of Consent: Logical Foundations of Constitutional Democracy. But only Buchanan won the Nobel, presumably because Tullock had always been the more outspoken, or shall we say politically incorrect, part of the couple.
Finally, the prize has become an annual occasion to test one’s professional self-esteem. Having waited with bated breath for the winner, it all too often happened that I and some well-informed economist colleagues scratched our heads after the announcement. Who is Lloyd S Shapley? Or Christopher A Pissarides? Or Reinhard Selten?
Shortly after this moment of embarrassment, one then wonders what happened to one’s favourite economists who once again missed out. Say, Alberto Alesina for his work between macroeconomics and politics, Vito Tanzi for his analysis of long-term government spending trends, Richard Epstein for his work in law and economics or Israel M Kirzner for his theory of entrepreneurship and his development of Austrian school methodology.
No matter how you look at it, the economics Nobel Prize does not make much sense. Yet it is hard to abolish something that does not really exist, so here are a few recommendations on how this odd prize could be reformed:
- Award it posthumously for the great discoveries in economic science, starting with Adam Smith (if the committee can’t agree on him, Smith could share the prize with Karl Marx);
- Give the prize to politicians who demonstrate a rudimentary understanding of basic economics (hard to find – we may have to turn it into a biannual or even rarer prize);
- Turn it into a specific challenge, say a prize for the economist who shows a way to revive the stuck WTO trade talks; and
- Combine it with the literature award (so columnists like Paul Krugman still stand a chance).
If none of this works, the Swedish Riksbank might award the prize to itself every year – for keeping Sweden out of the eurozone.