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The Nobel for Economics?

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.