The not so noble Nobel Prize
Samuel Brittan: The Financial Times 19/12/03
The connection between the controversial film actor Russell Crowe and the state of contemporary economics might not seem obvious, but it exists.
Crowe took the starring role in A Beautiful Mind. This was the story of John Nash, a brilliant mathematician who descended into mental illness for several decades before recovering to become a joint winner of the Nobel Prize for economics in 1994 for his work on "game theory." While traditional economic theory was concerned with the behaviour of individuals or firms who could not affect their environment, in game theory interactions with others are studied in a highly stylised form with players, pay-offs and strategies. Game theory is now indispensable in the design of public auctions as well as in evolutionary biology. While the detail is highly mathematical many of its concepts have entered public discourse. Examples are zero sum games and non-cooperative equilibria.
The Nash Equilibrium, invented in 1950, is the best result that can be achieved by players who do not co-operate but know each other's possible moves. A standard example is that of two drivers in virgin territory deciding on which side of the road to drive. If both drive either on the right or on the left it is a Nash Equilibrium: any other result is not. But in more complex cases the Nash Equilibrium is not always the best possible one that could be achieved if there were co-operation or the intervention of some enlightened despot.
Nash is a mathematician, for whom economics is only one of many applications. His prize had to be in economics for, amazingly, there is no Nobel Prize in mathematics. The original Prizes established by the Swedish armament manufacturer, Alfred Nobel, were for physics, chemistry, medicine, "peace" and literature. There is no prize for instance for philosophy; and Bertrand Russell had to be given his award for literature.
The economics prize is not strictly speaking a Nobel Prize at all. It was established in 1968 by the Riksbank, the Swedish central bank "in memory of Alfred Nobel". But although the selection is initially made by a committee of economists from a list of over 100 names submitted from all over the world, the Swedish Academy of Sciences, which awards the mainline Prizes, has to give its imprimatur.
After seeing A Beautiful Mind, I happened to glance at the book of the same title by Sylvia Nasar on what it was based (Faber, 1998). There I came across a fascinating story which understandably, was not part of the film. The announcement of the 1994 economics prize winners came one and a half hours late. Although officials tried to explain away the delay Ms Nasar, who is neither an economist nor a mathematician but a very diligent biographer, discovered that there was an acrimonious discussion at the Academy before the decision was ratified.
Some economists needed to be persuaded that the theory of games was a genuine contribution to economics. The opposition here was led by Ingemar Stahl, who was close to the opposition conservative parties in Sweden. This was misplaced as game theory of is one of the very few genuine innovations in the subject. The next question raised was whether John Nash had recovered sufficiently to take part with dignity in the very elaborate ceremony where the prizes are awarded by the King of Sweden. As those watching the film will know, Nash survived this test with flying colours.
But by then the debate had moved to its real subject matter. Some members of the Swedish Academy were doubtful if economics was a genuine science and disliked the whole idea of awarding the prize. In the end the prize for Nash, jointly with two other winners, was approved, but after a majority vote -- something which learned and established bodies hate to have.
The aftermath was an inquiry into the future of the prize. It was decided to broaden it into a general prize for social sciences and to bring two non-economists onto the awarding committee. Some changes have been evident as a result. For instance in 2002 the award was shared by one experimental economist whose findings favoured the Austrian type of neo-classical theory and a psychologist who disputed most of the usual economic assumptions. Nevertheless the majority have still been given for research into mainstream topics. The joint 2003 prizes were awarded for innovatory statistical analysis of time series.
The dispute about the value of the prize is still running. A former Swedish finance minister, Kjell Olof Feldt, who himself subsequently became head of the Riksbank, has advocated abolishing the economics prize. Some members of the present generation of the Nobel family have done the same. One is reminded of the disputes among the descendants of the composer Richard Wagner, who still claim the right to decide the future of the Festival Theatre he established in Bayreuth.
Indeed a few of the economics prize winners themselves expressed reservations, Friedrich Hayek, the free market political economist who won the prize jointly with the Swedish socialist Gunnar Myrdal in 1974, was grateful that the prize rescued him from a long period of personal depression and had relaunched his ideas - well before Margaret Thatcher started to publicise his name. Yet he admitted that if he had been consulted on whether to establish the prize he would "have decidedly advised against it." Myrdal rather less graciously wanted the prize abolished because it had been given to such reactionaries as Hayek (and afterwards Milton Friedman).
How does the matter look now? A glance at the correspondence columns for the FT will show that mainstream academic economics is far from being the only source of ideas on the subject. Business school theorists, contemporary historians, engineers with an interest in policy and opinionated businessmen all weigh in. It is the Nobel Prize which gives some kind of imprimatur to mainstream academic ideas, which combine an emphasis on individual utility maximisation and the role of markets, with advanced statistical techniques. It has not however in the least increased the willingness of policy makers to accept international free trade or reject the "lump of labour" fallacy - matters on which most academic theorists are agreed.
An insight indeed comes from comparing two very recent books on Hayek. The first by Alan Ebenstein is simply called Friedrich Hayek, a Biography, (Palgrave 2001). The second is Bruce Caldwell's Hayek's Challenge, (University of Chicago Press, 2003.) While both books are sympathetic their interpretations are very different. Ebenstein follows Milton Friedman in treating Hayek as a distinguished political philosopher whose views on economic methods were antediluvian. He accepts Friedman's view of economics as science like any other and thus implicitly endorses the Nobel Prize.
Caldwell on the other hand steers as clear as he can of the political debate but shares Hayek's own scepticism about modern economics and its ability to make specific refutable predictions. (Hayek's Nobel Lecture was entitled The Pretence of Knowledge.) He asks whether there really has been steady cumulative progress as economic laws are discovered and improved empirical methods introduced. His own work on micro economics makes him extremely doubtful. And I would endorse this from the macro side. We know that an excess of purchasing power will lead to runaway inflation and that a deficiency will induce deflation and unemployment. We also know that a country cannot have an independent monetary policy if it is on a rigidly fixed exchange rate. But beyond such basics, forecasts are mainly ways of encapsulating what is already happening. The real drivers are so-called "shocks" which by definition are unpredictable.
Caldwell echoes Hayek in believing that the most that economists, like other social scientists, can hope to achieve is pattern predictions. Such consensus as exists among economists - for instance that demand curves slope downwards - is based much more on the way they have been brought up to think than any decisive empirical tests. If Caldwell is right then the Nobel Prize for economics was a mistake as the subject could not expect the kind of steady incremental progress achievable in the physical sciences - or for that matter in ancillary studies such as statistical theory. But having the Prize we are now stuck with it. To abolish would simply increase the influence of the kind of anti-economics which embraces for instance rent controls, minimum wages and arms promotion "for the sake of jobs". The best way forward would be to follow the tentative gropings of the Swedish Academy of the mid-1990s and extend the Prize to the social sciences in general and really mean it.
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