What does the latest Economics Prize in honour of Alfred Nobel tell us about economics as a science?

Alfred Nobel did not endow a prize in economics. In 1968 the Swedish National (i.e. central) Bank founded a ‘Prize in Economic Sciences in Memory of Alfred Nobel’. The award’s announcement is coordinated with the annual Nobel Prize awards.

So are economists worthy of such an award? Before going further, allow me to join the general muttering that the awards can be erratic – just as ever so many such awards made in New Zealand reflect the idiosyncrasies of the panel rather than good judgments.

I learned this early in the case of Nobel Laureates. In its seventh year – in 1975, the International Year of Women – the prize was widely expected to be awarded to Joan Robinson, unquestionably the most outstanding women economist ever, who had made pioneering contributions to the theory of imperfect competition (including inventing the term ‘monopsony’) and many other branches of economics. However, one member of the committee blocked her nomination for political reasons and she did not get the award then, or ever. I have no objection to those the committee actually nominated in 1975 but her omission from the list  reminds me of the eccentricity of the selection processes – there are also disgraceful omissions from the literature list. (I still recommend Joan’s marvellous little book, Economic Philosophy to those who are concerned about the foundations of economics,)

Many object to the award being for contributions to economic ‘science’. If science means – as it sometimes does on the European continent – ‘knowledge’, then there can be little objection to the term. But what about ‘science’ in the Anglo sense of systematic knowledge based on empirical evidence? (Warning to readers: your columnist is greatly influenced by Karl Popper.)

In my view some economics is scientific in this sense, but much of what purports to be economics is not. Much is based on theories which have been not been empirically tested. Indeed the holders of such theories do not care about the evidence, especially when it contradicts their beloved ideologies.

This is nicely illustrated by the work of this year’s economic laureates who were awarded ‘for their contributions to contract theory.’

Contract theory studies how economic actors can and do construct contractual arrangements, generally in the presence of asymmetric information, in which the parties are unaware of everything the other side knows. (There are further complications like ‘informal contracts’ – key notions are unstated and incomplete – which do not cover all the eventualities.)

One of the complainers about this year’s economic laureates opined that economists are only interested in markets, ignoring the award was for activities which need not be in markets; frankly they could give the prize to the family cat and the complainers would say exactly the same things. People think they can be expert on economics having spent a whole year studying it. All talk to one another, which is why economics as a science is so frequently misrepresented. (Economics is not an esoteric subject, but you have to work to master it; because you can count does not make you a mathematician.)

Contract theory and its related issues are not a new area in economics and a number of Nobel prizes have been already awarded for it. (The laureate you may be most familiar with is Joseph Stiglitz.) It is an evolving area, so characteristic of science with incremental developments as researchers identify new areas and new situations. Thus this year’s laureates.

Among the practical applications of their work was to understand privatisation better. Twenty years ago one of the new laureates (Oliver Hart), with some colleagues

            ‘showed that incentives for cost reduction are typically too strong. The desirability of privatisation therefore depends on the trade-off between cost reduction and quality. [They] were particularly concerned about private prisons. Federal authorities in the United States are in fact ending the use of private prisons, partly because – according to a recently released U.S. Department of Justice report – conditions in privately-run prisons are worse than those in publicly-run prisons.’ (here)

In the subsequent twenty years New Zealand has introduced privately run prisons despite the longstanding theory and evidence doubting their efficacy. Huh! It is not the only example where we have pursued particular ideological strategies ignoring the scientific evidence.

The long list reflects a failure to think carefully about issues using adequate frameworks. Where is there a centre in universities or government which is focused on developments in contract theory or utilising the developments to design better decision systems?

Are the powers-that-be up with the play? Recall they certainly were not when they introduced Rogernomics (although neither was Muldoonism). That is why our market liberalisation was such a botched job.

You can see why there is an ambiguity in the public’s mind as to whether economics is a science (in the Popperian sense). Yes there is  scientific element to the subject, but too often we see a primitive form of economics – as if chemistry had not got past phlogiston – and ignore the scientific evidence when it suits us – as too many have done over global warming.

The Nobel citation concluded, ‘contract theory does not necessarily provide definitive or unique answers to these questions, as the best contract will typically depend on the specific situation and context. However, the power of the theory is that it enables us to think clearly about the issues involved.’

A salutary characteristic of science is that it progresses. The scientist has to be humble, because he or she knows that the current theories they hold will be developed and replaced. As Joan and Karl taught us, the significance of scientific economics is getting rid of bad theories. Alas some bad ones still dominate our public discourse.

Comments (5)

by Murray Grimwood on October 18, 2016
Murray Grimwood

But science - real science - gets to a place where there is no dissention. No scientist really backs the 4,000 year creation story. It's been disproved, and the remnant who claim to be both scientist and creation-believers can be classified by the latter term - believer.

Economics may be a tool which has some use in the future, but as long as inconvenient real ramifications are duck-shoved off the balance-sheets, it runs the risk of being a nonsense - indeed I contend it is there now. 

http://www.inscc.utah.edu/~tgarrett/Economics/Physics_of_the_economy.html

All things being equal, private enterprise should be more costly that public, by the margin of profit. End story. Both are capable of efficiencies, both are capable of corner-cutting, both of ineptitude. (Prisons and hospital food are classic cases of private being not as good, but a thought-provoking treatise the other way is Nevil (Shute) Norway's autobiography 'Slide Rule'. He compares the Vickers airship R100 (designer Barnes Wallis, engineer Norway) with the R100 (Government organised). The former flew the Atlantic, the latter crashed in France on it's maiden flight.

Thanks for the thoughtful posts, Brian.

 

by Fentex on October 19, 2016
Fentex

All things being equal, private enterprise should be more costly that public, by the margin of profit.

Logically therefore everything is better if done by public investment and management sans the profit motive - therefore the Soviet Union ought to have caned the west in production and development of new things.

While I agree that the profit motive puts the lie to many claims of benefit through privatising public duties the matter is much more complex - most importantly in the incentives and opportunities visible to individuals. Strict hierarchy and publicly minded fair promotion rules suppress individual enterprise, political expediency undermines financially disciplined accountability.

When NZ transitioned much of our economy in the 1980's and created the State Owned Enterprise there was an immediate and remarkable improvement in performance by those enterprises which both supports the idea the state can run business well and that financial incentives must be involved.

The argument that public officials can't run a business applies just as well to contracting and managing private contractors so isn't any argument for private provision - and is a better argument against letting public officials negotiate with the oh so very capable private sharks they aren't fit to swim with.

Just as the argument private incentives to efficiency outstrip public ones can fail -  the incentive for private business to rort and rifle through the public treasury is pretty damned strong too and supported by the political incentive not to admit error or reveal exploitation.

At the end of the day there's more to judge any given suggestion by than the merely theoretical - where failure can be tolerated and competition abounds private enterprise can be mighty fine, where the states power, small populations limiting competition and political incentives to lie abound keeping responsibilities within the public sphere can be wiser for the accountability it maintains.

Our governments efforts at privatising prisons demonstrates much of this - they try to hide issues from the public by invoking private business privileges for something that is very much the public business and when caught out initially tried to brush off Serco's lying and thieving demonstrating the incentive to avoid the accountability contracting is supposed to invoke.

Political standing is a currency that cannot be divorced from the trivial cash balances weighed in considering the cost and force of incentives when contemplating public contracting of private providers - it often disappears from peoples minds when they think they're hard headed economists looking at numbers into the blurry collection of 'marginal' costs and values when it's anything but marginal.

by Stewart Hawkins on October 24, 2016
Stewart Hawkins

Surely the Nobel committee has done enough to bring itself into discredit (no comment on Bob Dylan except Churchill would be spinning on his turntable) with the "Peace" prize for Obama and doesn't need to dive deeper into Economic slime to render the Nobels irrelevant? At least these politically correct twerps don't control the Fields medal.

Swedicide anyone?

by Brian Easton on October 25, 2016
Brian Easton

New Zealand’s first three-way kidney plant has just been announced. They arise because the characteristics of the  kidney of the donor (perhaps a spouse) do not match those of the recipient. Instead one looks for another donor whose kidney is more compatible. Sometimes a third pair is necessary; hence a three-way swap.

The technique was developed at the New England Program for Kidney Exchange over a decade ago. Among the economists – yes, economists – who developed the algorithm which identifies the matching was Alvin Roth who shared the economics prize in honour of Alfred Nobel in 2012, for the underlying theory which led to the algorithm. (They also showed it was efficient to do a three-way swap.)

This economist takes pleasure that three more New Zealanders have functioning kidneys – and looks forward to even more when we team up with Australia to deepen the pool; he greatly admires the skills of the  surgical teams involved. But he also takes pride in that economists were involved, that one was so honoured, and that some economic theory has such a practical relevance.

 I greatly enjoyed Roth’s book Who Gets What and Why.

by Brian Easton on October 25, 2016
Brian Easton

My understanding, Stewart, is that quite different committees award the various prizes, although the physics and chemistry committees, for instance, have been known to coordinate their decisions.

I think Stewart is alluding to the controversial Nobel award in literature to Churchill in 1953. At least it was not the peace prize. 

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