This year, let’s cancel the Nobel Prize in economics
Each year around this time, the top prize in the field of economics is awarded to an economist (or economists) of extraordinary influence and prominence. The Nobel Memorial Prize in Economic Sciences is undoubtedly the highest honor any economist can receive. As economists sit with bated breath for the next award to be announced on October 14th, perhaps they should consider a few reasons why the prize should not exist at all.
Despite incorporating aspects of philosophy, statistics and even sociology, economic science is also inextricably connected to politics. It’s a field where powerful ideas can be turned into instruments of public policy. These concepts can be a force for good, as when the Federal Reserve tamed the inflation that plagued the United States throughout the 1970s. But they can just as easily become dangerous, such as when communism took hold in countries around the globe.
There’s an inherent danger in elevating economists to the level of prestige and influence a Nobel Prize affords them. Ironically, the economist most associated with this cautious view was F.A. Hayek, himself a winner of the prize. During his Nobel acceptance speech, Hayek warned that it was a mistake to treat economics as akin to physical sciences traditionally associated with the Nobel Prize. Economics involves complex social phenomena while physics or chemistry deal with more-or-less regular, predictable, and replicable subject matter. The extensive use of mathematics in economics exacerbates this false perception of scientific precision.
Economists often win a Nobel after developing an economic model that captures some significant insight. Paul Romer and William Nordhaus won last year for incorporating technological innovation and climate change into models of economic growth. These were intriguing contributions, no doubt, but one shouldn’t place too much faith in any single model. Like a compass that fails to point due north, all economic models are off to some extent; following an imprecise or incorrect model can lead society far astray.
Consider the case of economist John Hicks, who in 1972 (along with Kenneth Arrow) was awarded the Nobel for “pioneering contributions to general economic equilibrium theory and welfare theory.” Hicks was a brilliant economist, but even he was prone to making mistakes like any other person.
In 1937, Hicks proposed what would become one of the most influential macroeconomic models of the 20th century: the “IS-LM model.” To this day, the model maintains a prominent place in some of the most popular economics textbooks.
The IS-LM model was essentially an attempt to reconcile the revolutionary views of John Maynard Keynes with some aspects of classical economics. One key disagreement was over how interest rates are formulated. Keynes, in his book “The General Theory of Employment, Interest and Money,” emphasized the public’s desire to hold liquidity. He thought this was a factor in business cycle fluctuations. Meanwhile, classical economists emphasized the market for loanable funds.
To reconcile these views, Hicks presented a system where both these markets — the market for money and the market for the public’s savings—simultaneously determine interest rates. But the model has a problem.
While Keynes was right that during downturns, the public’s demand for cash often rises, he was wrong to think the force equilibrating supply and demand of money is the interest rate. While interest rates are a factor influencing how much money people want to hold, the inflation rate is the relevant “price” that brings the money market into equilibrium.
The point here is not to wax poetic on economic theory, but to highlight a model that is rather unambiguously wrong in some important respects continues to exert enormous influence. Ironically, Hicks himself grew dissatisfied with it decades after proposing it, later noting, “Those two curves do not belong together…. They have no business being on the same diagram.” Yet by that point the model had become entrenched. Hick’s association with it, and by extension the model’s association with the Nobel Prize, no doubt contributed to its lasting influence.
Adding to its popularity may have been that government planners liked its conclusions. The IS-LM model gives the impression that a single interest rate brings the entire economic system into alignment. All the government needs to do to reach full employment, the planners like to believe, is to tweak “the” interest rate until a natural rate is discovered that clears the market. This is the sort of hubris Hayek predicted.
Adam Smith, the founder of modern economics, warned of dangerous statesmen who believe themselves suited to control others. According to Smith, such authority “would nowhere be so dangerous as in the hands of a man who had folly and presumption enough to fancy himself fit to exercise it.” The Nobel Prize adds to this sense of folly. So this year, perhaps the Royal Swedish Society should do the world a favor: Just stay home.
James Broughel is a senior research fellow with the Mercatus Center at George Mason University and an adjunct professor of law at the Antonin Scalia Law School.
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