Posts Tagged ‘Nobel Prize’

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Lots of folks have been asking me about the significance of the so-called Nobel Prize in economics that was awarded yesterday to Richard Thaler.

They’re interested because they’ve read or heard about the large catalog of exceptions to the usual neoclassical rule of rational decision-making that has been compiled by Thaler and other behavioral economists.

One of my favorites is the “ultimatum game,” in which a player proposes an allocation of an endowment (say $5) and the second player can accept or reject the proposal. If the proposal is accepted, both players get paid according to the proposal; if the proposal is rejected, both players get nothing. What Thaler and his coauthors found is that most of the second players would reject proposals that would give them less than 25 percent of the endowment—even though, rationally, they’d be better off with even one penny in the initial offer. In other words, many individuals are willing to pay a cost (i.e., get nothing) in order to punish individuals who make an “unfair” proposal to them. Such a notion of fairness is anathema to the kind of self-interested, rational decision-making that is central to neoclassical economic theory.

Other exceptions include the “endowment effect” (for the tendency of individuals to value items more just because they own them), the theory of “mental accounting” (according to which individuals can overcome cognitive limitations by simplifying the economic environment in systematic ways, such as using separate funds for different household expenditures), the planner-doer model (in which individuals are both myopic doers for short-term decisions and farsighted planners for decisions that have long-run implications), and so on—all of which have implications for a wide variety of economic behavior and institutions, from consumption to financial markets.

So, what is the significance of Thaler’s approach economics?

As I see it, there are three stories that can be told about behavioral economics. The first one is the official story, as told by the Nobel committee, which starts from the proposition that “economics involves understanding human behaviour in economic decision-making situations and in markets.” But, since “people are complicated beings,” and even though the neoclassical model “provided solutions to important and complicated economic problems,” Thaler’s work (alone and with his coauthors) has contributed to expanding and refining economic analysis by considering psychological traits that systematically influence economic decisions—thus creating a “a flourishing area of research” and providing “economists with a richer set of analytical and experimental tools for understanding and predicting human behavior.”

A second story is provided by Yahya Madra (in Contending Economic Theories, with Richard Wolff and Stephen Resnick): behavioral economics forms part of what he calls “late neoclassical theory” that both poses critical questions about neoclassical homo economicus and threatens to overrun the limits of neoclassical theory by offering “a completely new vision of how to specify the economic behavior of individuals.” Thus,

Based on its psychological explorations, behavioral economics confronts a choice: will it remain a research field that merely catalogs various shortcomings of the traditional neoclassical model and account of human behavior or will it break from neoclassical theory to formulate a new theory of human behavior?

A third story stems from a recognition that behavioral economics challenges some aspects of neoclassical economics—by pointing out many of the ways individuals are guided by forms of decisionmaking that violate the rule of self-interested rationality presumed by traditional neoclassical economists—and yet remains within the strictures of neoclassical economics—by focusing on individual behavior and using rational decision-making as the goal.

Thus, Thaler’s work and the work of most behavioral economists focuses on the limits to individual rationality and not on the perverse incentives and structures that plague contemporary capitalism. There’s no mention of the ways wealthy individuals and large corporations, precisely because of their high incomes and profits, are able to make individually rational decisions that—as in the crash of 2007-08—have negative social ramifications for everyone else. Nor is there a discussion of the different kinds of rationalities that are implicit in different ways of organizing the economy. As I wrote back in 2011, “is there a difference between how capitalists (who appropriate the surplus for doing nothing) and workers (who actually produce the surplus) might decide to distribute the surplus to others?”

Moreover, while behavioral economics have compiled a long list of exceptions to neoclassical rationality, they still use the neoclassical ideal as the horizon of their work. This can be seen in what is probably the best known of Thaler’s writings (with coauthor Cass Sunstein), the idea of “libertarian paternalism.” According to this view, “beneficial changes in behavior can be achieved by minimally invasive policies that nudge people to make the right decisions for themselves.” Thus, for example, Thaler proposed changing the default option in defined-contribution pension plans from having to actively sign up for the plan (which leads to suboptimal outcomes) to automatically joining the plan at some default savings rate and in some default investment strategy (which approximates rational decision-making).

The problem is, there’s no discussion of the idea that workers would benefit from an alternative to defined-contribution plans—whether defined-benefit plans or the expansion of Social Security. It’s all about taking the institutional structure as given and “nudging” individuals, via the appropriate design of mechanisms, to make the kinds of rational decisions that are presumed within neoclassical economics.

Paraphrasing that nineteenth-century critic of political economy, we can say that economic decision-making appears, at first sight, a very trivial thing, and easily understood. Its analysis shows that it is, in reality, a very queer thing, abounding in metaphysical subtleties and theological niceties. We might credit Thaler and other behavioral economists, then, for having taken a first step in challenging the traditional neoclassical account of rational decision-making. But they stop far short of examining the perverse incentives that are built into the current economic system or the alternative rationalities that could serve as the basis for a different way of organizing economic and social life. And, in terms of economic theory, they appear not to be able to imagine another way of thinking about the economy, as a process without an individual subject.

However, taking any of those steps would never be recognized with a Nobel Prize in economics.

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Almost very time MFA hears a mainstream economist speak—on topics ranging from the danger of raising the minimum wage to how we all benefit from free trade and globalization—she responds, “Where did they get their degree, from a Cracker Jack box?”

No doubt, she’d react in the same manner if she listened to the members of the closing panel at the 2017 Lindau Meeting on Economic Sciences, who were asked to answer the following question: what could and should we do about inequality?

It’s a terrific question, given the obscene—and still rising—levels of inequality that characterize contemporary capitalism, in the United States and around the world. But those who take the time to watch the video (available here) just aren’t going to learn much about either the causes of inequality or what we can do about it.

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The panel consisted of three winners of the so-called Nobel Prize in Economic SciencesDaniel L. McFadden (2000), James J. Heckman (2000), and Christopher A. Pissarides (2000)—and one “young economist,” Rong Hai.

Individually and together, the panelists simply don’t have anything interesting or insightful to say about inequality.

It’s true, none of the men received their Nobel Prizes for research on inequality, although Hai is currently doing research on inequality (e.g., in relation to credit constraints and tax policy). That itself is a comment on how little inequality has figured as an important concern within mainstream economics. And, given the venue, they’re all mainstream economists. Because of that, there’s little they can say—and a great deal they simply can’t say—about inequality.

Their comments (only some of which were actually prepared) range from the obvious—the issue of poverty is different from that of inequality—to the all-too-frequent sidestep—inequality is caused by globalization and technology.

But they don’t have anything to say about contemporary economic and social institutions, especially those of capitalism, or about history. They don’t discuss in any detail the changes in recent decades that have led to the current obscene levels of inequality or, for that matter, the relationship between the factor distribution of income (e.g, between labor and capital) and the size distribution of income (e.g., the growing gap between the 1 percent and everyone else).

Their concern about and knowledge of the causes and consequences of inequality are, at least to judge from their presentations in this panel, stupefyingly limited.

Maybe MFA is right: they did get their degrees from Cracker Jack boxes.

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The election and administration of Donald Trump have focused attention on the many symbols of racism and white supremacy that still exist across the United States. They’re a national disgrace. Fortunately, we’re also witnessing renewed efforts to dethrone Confederate monuments and other such symbols as part of a long-overdue campaign to rethink Americans’ history as a nation.

In economics, the problem is not monuments but the discipline itself. It’s the most disgraceful discipline in the academy. Therefore, we should dethrone ourselves.

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In the United States, thanks to the work of the Southern Poverty Law Center, we know there are over 700 monuments and statues to the Confederacy, as well as scores of public schools, counties and cities, and military bases named for Confederate leaders and icons.

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We also know those symbols do not represent any kind of shared heritage but, instead, conceal the real history of the Confederate States of America and the seven decades of Jim Crow segregation and oppression that followed the Reconstruction era. In fact, most of them were dedicated not immediately after the Civil War, but during two key periods in U.S. history:

The first began around 1900, amid the period in which states were enacting Jim Crow laws to disenfranchise the newly freed African Americans and re-segregate society. This spike lasted well into the 1920s, a period that saw a dramatic resurgence of the Ku Klux Klan, which had been born in the immediate aftermath of the Civil War.

The second spike began in the early 1950s and lasted through the 1960s, as the civil rights movement led to a backlash among segregationists. These two periods also coincided with the 50th and 100th anniversaries of the Civil War.

The problem, of course, is those statues have stayed up for so long because, like so many other features of our everyday landscape, they became so familiar that Americans hardly even noticed they were there.

It should come as no surprise, then, that a majority of Americans (62 percent) believe statues honoring leaders of the Confederacy should remain. However, a similar majority (55 percent) said they disapproved of the Trump’s response to the deadly violence that occurred at a white supremacist rally in Charlottesville. As a result, I expect Americans will be engaged in a new conversation about their history—especially the most disgraceful episodes of slavery, white supremacy, and racism—and what those symbols represent today.

The discipline of economics has a similar problem—not of statues but of sexism and hostility to women. It’s been so much a feature of our everyday academic landscape that economists hardly even noticed it was there.

They didn’t notice until reports surfaced—in the New York Times and the Washington Post—concerning Alice Wu’s senior thesis in economics at the University of California-Berkeley. Wu analyzed over a million posts on the anonymous online message board, Economics Job Market Rumors, to analyze how economists talk about women in the profession.

According to Wu,

Gender stereotyping can take a subtle or implicit form that makes it difficult to measure and analyze in economics. In addition, people tend not to reveal their true beliefs about gender if they care about political and social correctness in public. The anonymity on the Economics Job Market Rumors forum, however, removes such barriers, and thus provides a natural setting to study the existence and extent of gender stereotyping in this academic community online.

And the results of her analysis? The 30 words most associated with women were (in order, from top to bottom): hotter, lesbian, bb (Internet terminology for “baby”), sexism, tits, anal, marrying, feminazi, slut, hot, vagina, boobs, pregnant, pregnancy, cute, marry, levy, gorgeous, horny, crush, beautiful, secretary, dump, shopping, date, nonprofit, intentions, sexy, dated, and prostitute.

In contrast, the terms most associated with men included mathematician, pricing, adviser, textbook, motivated, Wharton, goals, Nobel, and philosopher. Indeed, the only derogatory terms in the list were bully and homo.

In my experience, that’s a pretty accurate description of how women and men are unequally seen, treated, and talked about in economics—and that’s been true for much of the history of the discipline.*

But, of course, that’s not the only reason economics is the most bankrupt, disgraceful discipline in the entire academy. It has long shunned and punished economists who endeavor to use theories and methods that fall outside mainstream economics—denying jobs, research funding, publication outlets, and honorifics to their “colleagues” who have the temerity to teach and do research utilizing other discourses and paradigms, from Marxism to feminism. 

Even the attempt to convince economists to adopt a code of ethics—like those in many other disciplines, from anthropology to medicine—was treated with disdain.

Sure, there’s a Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel. And, in the United States, both a Council of Economic Advisers and a National Economic Council—but no White House Council of Social Advisers.

Economics may have national and international prominence. But it’s time we give up the hand-wringing and admit there is no standard of decency or intelligence (with the possible exception of mathematics) that economists don’t fail on.

We are, in short, a collective disgrace. That’s why we should dethrone ourselves.

 

*A history that includes Joan Robinson, who should have won the Nobel Prize in Economics but didn’t (because, of course, she was a non-neoclassical, female economist) and can’t (because she’s dead).

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Last year, as I reported the other day, I published over 800 new posts.

I’ve never done this before. However, I decided to look back over the year and choose one post for each month of 2016:

January—Liberal ideology

February—Who are the capitalists?

March—Yea, they’re angry!

April—Life among the liberal econ

May—Letting capitalism off the hook

June—Globalization, inequality, and imperialism

July—Trump and the Prosperity Gospel

August—The Mandibles and dystopian finance fiction

September—What about the white working-class?

October—Nobel economics—or why does capital hire labor?

November—Condition of the working-class in the United States

December—China syndrome

Enjoy!

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Special mention

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Mark Tansey, “Invisible Hand” (2011)

Yesterday, I explained that the 2016 Nobel Prize in Economics Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel was awarded to Oliver Hart and Bengt Holmstrom because, through their neoclassical version of contract theory, they “proved” that capitalist firms—employers hiring labor to produce commodities in privately owned corporations—were the most natural, efficient way of organizing production.

It should come as no surprise, then, that mainstream economists—initially in tweets, then in full blog posts—have heaped praise on this year’s award.

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Paul Krugman couldn’t believe Hart and Holmstrom hadn’t won the prize already, while Justin Wolfers considered them “an unarguably splendid pick.”

Tyler Cowen also expressed his conviction that the new Nobel laureates are “well-deserving economists at the top of the field.” (He then explains, in separate posts, the significance for neoclassical theory of Hart’s and Holmstrom’s research on the theory of the firm.) The other member of the Marginal Revolution team, Alex Tabarrock, follows up by criticizing the one instance in Hart’s work in which he actually criticizes private enterprise. Hart (in a piece with two other economists) argues one of the downsides of private prisons is that they sacrifice quality for cost—but, according to Tabarrock, “private prisons appear to be cheaper than public prisons but they are not significantly cheaper and the quality of private prisons is comparable to that of public prisons and maybe a little bit higher.”

And then there’s Noah Smith, who follows suit by praising “the new exciting tools that have been developed in the micro world,” including by the new Nobel laureates. He refers to that work in microeconomics as the “real engineering”—as against macroeconomics, “whose scientific value is still being debated.”

The fact is, the value of both areas of mainstream economics is still being debated, as it has been from the very beginning. There is nothing settled (except, perhaps, in the minds of mainstream economists) about either the theory of the firm or the causes of recessions and depressions, the determinants of a commodity’s value or the prospects for long-term capitalist growth, whether the labor market or the economy as a whole is in any kind of equilibrium.

Smith overlooks or ignores those debates, most of which occur between mainstream economists and other, nonmainstream heterodox economists. But then, in attempting to explain why this year’s prize went to microeconomists, Smith displays his real misunderstanding of the history of economics—arguing that “macro developed first.”

Economists saw big, important phenomena like growth, recessions and poverty happening around them, and they wrote down simple theories to explain what they saw. The theories started out literary, and became more mathematical and formal as time went on. But they had a few big things in common. They assumed the people and the companies in the economy were each very tiny and insignificant, like particles in a chemical solution. And they typically assumed that everyone follows very simple rules — companies maximize profits, consumers maximize the utility they get from consuming things. Pour all of these tiny simple companies and people into a test tube called “the market,” shake them up, and poof — an economy pops out.

Here’s the problem: macroeconomics didn’t develop first. Indeed, it wasn’t invented until the 1930s, when John Maynard Keynes published The General Theory of Employment, Interest, and Money. This should not be surprising, given the fact that the world was in the midst of the Great Depression, with at least 25 percent unemployment, after neoclassical microeconomists (following their classical predecessors, Adam Smith, David Ricardo, and Jean-Baptiste Say) had attempted to prove that markets would always be in equilibrium, which of course ruled out economic depressions and massive unemployment. Oops!

Since then, we’ve seen a mainstream tradition that combines (in different, shifting ways) neoclassical microeconomics and Keynesian macroeconomics—a tradition that failed miserably both in the lead-up to and following on the second Great Depression.

But no matter, at least from the perspective of mainstream economics, because its leading practitioners—sometimes from the macro side, this year from the micro side—continue, as if by contract, to be awarded Nobel prizes.

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Technically, there is no Nobel Prize in economics. What it is, instead, is the Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel, which members of the Nobel family and a previous winner (Friedrich von Hayek) have criticized.

So, where did the prize come from? As Avner Offer explains,

The Nobel prize came out of a longstanding social conflict. On one side, central banks and the better-off striving to keep property intact and prices stable; on the other, everyone else’s quest for economic security. The Swedish social democratic government clipped the wings of the central bank – Sveriges Riksbank – in pursuit of more housing and jobs. In compensation, the government allowed the central bank to keep some funds, which the bank used in 1968 to endow the Nobel prize in economics as a vanity project to mark its tercentenary.

This year’s Nobel Prize in Neoclassical Economics (as I dubbed it 5 years ago) was awarded jointly to Oliver Hart and Bengt Holmstrom. Officially, the 2016 prize recognized “their contributions to contract theory.” Unofficially, as I understand their work, it was all about attempting to solve a longstanding problem in neoclassical economic theory: the theory of the firm.

Historically, neoclassical economists (and, for that matter, not a few heterodox economists) simply assumed capitalist firms maximize profits. But, in the context of a market system, there’s no particular reason a non-market institution like “the firm” should exist (instead of, for example, everyone—workers, managers, suppliers, buyers, and so on—entering into market exchanges in parking lots or coffee shops each morning).* And yet corporations, many of them employing hundreds of thousands of workers and making record profits, have become central to the way capitalist economies are currently organized. Moreover, once you look inside that “black box,” a great deal more is going on. Workers are hired to perform necessary and surplus labor in the course of producing commodities by managers, who run the enterprise on a daily basis and receive a cut of the surplus from the board of directors, who themselves need to be elected by shareholders (who, together with money-lenders, merchants, government officials, and many others, inside and outside the enterprise, receive their own portions of the surplus). Corporations, as it turns out, are pretty complicated—political, cultural, and economic—institutions.

But when neoclassical economists like Hart and Holmstrom look inside the firm what they see is a single issue—a relationship between a “principal” and “agents.” Principals (e.g., capitalists) are presumed to enter into agreements—voluntary contracts—with agents (e.g., workers) to advance a goal (e.g., of maximizing profits). As they see it, contracts are risky because, first, principals and agents often have conflicting interests (e.g., principals want maximum effort while agents are presumed to engage in risk-averse, shirking behavior) and, second, measuring fulfillment of the goal is imperfect (that is, not all the actions of the agents can be perfectly observed). The whole point of contract theory, then, is to devise a relationship such that—through a combination of incentives and monitoring—agents can be made to work hard to fulfill the goal set by the principal.

In one of his most famous and influential papers, “Moral Hazard in Teams” (pdf, a link to the working-paper version), Holmstrom’s starting point is the idea that there’s a problem of “inducing agents to supply proper amounts of productive inputs when their actions cannot be observed and contracted upon directly” (in other words, moral hazard), especially when they work in teams. He then sets up a model in which he demonstrates that “separating ownership from production”—which also provides the incentive for limited monitoring by the owners (i.e., stockholders)—solves the problem of moral hazard and restores efficiency.**

In other words, the Nobel Prize-winning approach to contract theory is used to demonstrate what neoclassical economists had long presumed: that capitalist firms (and not, e.g., worker-owned enterprises) represent the most efficient way to organize production.

That’s why, from a neoclassical perspective, it is only natural that capital hires labor.

 

*In fact, Paul Samuelson (in 1957, in “Wages and Interest: A Modern Dissection of Marxian Economic Models,”American Economic Review) once argued that “In a perfectly competitive market, it really doesn’t matter who hires whom: so have labor hire ‘capital’.”

**Hart, for his part (in a paper with John Moore [pdf]), looked at the issue of property rights in relation to firms by distinguishing between owning a firm and contracting for services from another firm. Their model shows, once again in true neoclassical fashion, that the owner of an enterprise—who exercises “control,” not only over assets, but also over the workers tied to those assets—will have more control, leading to higher efficiency, if they directly employ the workers than if they have an arm’s-length contract with another employer of the workers. That’s because, under single ownership, the employer can “selectively fire the workers of the firm” if they dislike the workers’ performance, whereas under contracted services they can “fire” only the entire firm.