Nobel Prize in neoclassical economics

This morning’s announcement confirmed, once again, that it is—and should be renamed—the Nobel Prize in Neoclassical Economics.

But, of course, there are two groups of neoclassical economists: those who celebrate markets, assume they operate seamlessly, and almost always achieve efficient outcomes; and those who celebrate markets, assume they operate with a certain amount of “friction,” and often fail to achieve efficient outcomes. On the latter view, markets need some help—a guiding hand instead of the invisible hand—to find the appropriate equilibrium.

The winners of this year’s prize—Peter Diamond, Dale Mortensen, and Christopher Pissarides—fall into the second category.

On many markets, buyers and sellers do not always make contact with one another immediately. This concerns, for example, employers who are looking for employees and workers who are trying to find jobs. Since the search process requires time and resources, it creates frictions in the market. On such search markets, the demands of some buyers will not be met, while some sellers cannot sell as much as they would wish. Simultaneously, there are both job vacancies and unemployment on the labor market.

In the world of DMP, an increase in either unemployment benefits or the costs of firing workers leads to a decline in job creation and higher unemployment. The recommendation, in this neoclassical view, is the development of better technologies to “match” available workers and jobs.

One problem is that productivity and workers’ wages have been diverging since the mid-1970s, leading up to the current crises. A second problem is that unemployment has skyrocketed in the current depression, and shows no signs of decreasing anytime soon.

All neoclassical economists can do with the DMP model is attempt to account for these problems via imperfect markets—search frictions, matching costs, and real-wage stickiness—and to recommend policies that create “better” labor power markets.

The alternative, of course, is to abolish the market allocation of labor power.