Rethinking the Nobel Prize in Economics
Every year around this time, economists patiently await the announcement of who will win the profession’s highest honor. This is the Nobel Prize in Economics and the countdown to October 12 has started. Considering the prestige associated with the price, it’s worth asking why it exists and what value it offers – not only to the economy but to society.
There is nothing wrong with the prices, of course. We need to recognize important contributions where and when they occur, and reward people accordingly. However, there is also a danger in situations where we elevate and institutionalize controversial ideas, which have not yet been proven or just plain wrong.
Even Nobel laureates make mistakes, and while some are willing to admit them, other intellectuals can hold their ideas rigidly, even in the face of huge counter-evidence. It is simple human nature. When there is no personal cost in making mistakes, and significant costs in admitting mistakes, our natural instinct is to dig rather than seek the truth.
The Nobel Prize can make certain ideas dominant and respectable, thus strengthening their place in science. It can also make a problematic idea difficult for opponents to defeat. A clear example comes from the work of economist Kenneth Arrow. Undoubtedly a brilliant man, Arrow won the Nobel Prize in 1972, along with John Hicks, for “his pioneering contributions to the theory of general economic equilibrium and to the theory of welfare”.
Arrow’s work in the two areas mentioned by the Nobel Committee is perhaps best illustrated by two of his most famous articles. One, published in 1950, attempted to identify a âsocial protection functionâ that could assist in the design of electoral systems and, more generally, in policy making.
Arrow was looking for a decision framework that could be applied to a wide range of social issues in order to rank how different options improve the well-being of the population. He wanted this framework to be based on the preferences of members of the governed community, and his surprising conclusion was that – given some fairly strict assumptions – the only decision rule that could be applied consistently without running into paradoxes of various types was to: anoint a dictator. In other words, one person in the community has to decide for everyone.
Arrow’s theorem came early in his career, and it paved the way for much of his life’s work. After allegedly proving that the only rational way to make collective choices is dictatorship, he proceeded to describe the dictator’s “welfare function” and to detail the resource allocation problem that this theoretical person is. responsible for solving for the company.
That’s where Arrow’s next Nobel contribution comes in. Together with economist (and eventual Nobel Prize winner) Gerard Debreu, he proved that there is a solution to this central planning problem facing the dictator.
Arrow’s work can best be described as interesting, mathematically elegant, and ingenious in its own way – but it’s also totally out of touch with reality. Who is this benevolent dictator responsible for allocating resources to the economy? What does it mean even if a policy increases the well-being of the dictator?
However, Arrow’s ideas have proven to be extremely influential, not only in the academy, but in shaping practical and practical policies. Regulators and economists use cost-benefit analysis to assess how public policies increase social welfare, as measured by a mathematical social protection function measuring what is essentially the welfare of the benevolent dictator of ‘Arrow.
Cost-benefit analysis has become increasingly important over the past 40 years. Regulatory agencies are now expected to justify their most important policies on cost-effectiveness considerations, and courts are stepping in and punishing agencies when their analyzes fail.
One of the reasons regulators, judges and economists have such confidence in cost-benefit analysis is that some deny its theoretical foundations. But Arrow’s Nobel Prize almost certainly played a role, too. He was one of the first economists to win it, and also one of the youngest. He continued to work for many decades after receiving the award and always had an aura of authority. At the time of his death, many of his earlier works were considered classics among the younger generations of economists. His words had a weight rarely accorded to other intellectuals.
And yet, many of Arrow’s ideas aren’t convincing once you think about them carefully. A few seem downright silly, in fact. Still, you’ll be hard pressed to find one of his critics among economists. Why? Partly because a Nobel Prize is so cherished and respected.
The many revolutionary economists whose work has taken the field to new levels, and who in many cases have improved people’s lives, deserve our praise and admiration. Sometimes, however, it seems like the price may be more important than the truth.
James Broughel is Principal Investigator at the Mercatus Center at George Mason University. Follow him on twitter @JamesBroughel.