The Evolution of the 'Nobel Prize' in Economics
The Sveriges Riksbank Prize in Economic Sciences
in Memory of Alfred Nobel was instituted in 1968 by the Swedish central bank,
and laureates are selected by the Royal Swedish Academy of Sciences. It is
commonly called the Nobel Prize in Economics, though the Nobel Endowment has
nothing to do with it. It has mostly tended to go to scholars doing esoteric
research in economics.
Much of economic research has tended to be quite remote from influencing public
policy. My professor at the Kennedy School of Government, Harvard University,
Professor Thomas Schelling who taught me "game theory" used in nuclear
strategy, and only sometimes in economics, got an Economics Nobel for just that
In 1997 Robert Merton and Myron Scholes at MIT were awarded the Nobel "for a
new method to determine the value of derivatives". They fathered the
Black-Scholes-Merton mathematical model to" understand the dynamics of
financial markets". Their theories were put to work at the Long-Term Capital
Management L.P. (LTCM), a hedge fund that used "absolute return" trading
strategies combined with high financial leverage.
In 1998 LTCM spectacularly imploded in the wake of the 1997 and 1998 economic
crises. The theories were just theories. It also provided us with an additional
insight into the notion of ceteris paribus.The concept of ceteris paribus is
important in economics because in the real world, it is usually hard to isolate
all the different variables that may influence or change the outcome of what
you are studying.
Now the trend from the esoteric and philosophical is moving towards the more
universally applicable. The award of the Nobel to the husband and wife team of
Abhijit Banerjee and Esther Duflo at MIT and Michael Kremer at Harvard for
their for "their experimental approach to alleviating global poverty". The
Swedish Academy of Sciences noted: The Laureates' research findings - and those
of the researchers following in their footsteps - have dramatically improved
our ability to fight poverty in practice.
As a direct result of one of their studies, more than five million Indian
children have benefitted from effective programs of remedial tutoring in
schools. Another example is the heavy subsidies for preventive healthcare that
have been introduced in many countries". The research led to the raising of
vaccination rates and educational standards in schools, touching hundreds of
millions of people across the globe.
Last year two American economists, William Nordhaus and Paul Romer, were
awarded the Nobel Prize in Economics for their work in two diverse areas, but
current concerns. Nordhaus won it for his warning policymakers during the first
stirrings of concern about climate change in the 1970s that their economic
models were not properly taking account of the impact of global warming and he
is seen as one of the pioneers of environmental economics.
The co-winner - Romer - is seen as the prime mover behind the endogenous growth
theory, "the notion that countries can improve their underlying performance if
they concentrate on supply-side measures such as research and development,
innovation and skills".
This simply means developing nations that want to get out of their rut, like
India, must invest in quality education and R&D. Instead our bureaucratic
centralism has created a huge system whose outcomes are so low-grade, that
mediocrity passes off as brilliance. The fact that Indian students and scholars
have to go abroad to fully harness their brilliance and gain recognition tells
us what has gone wrong with our system.
Paul Romer has argued, "Technological change can be accelerated by the targeted
use of state interventions in areas such as R&D tax credits and patent
regulation". He called it "post colonial endogenous growth theory". This
famously inspired an Oxford don, the economist Derek Morris, to write an ode to
it. Its the history of economic theory in verse and is very witty and clever.
The relevant verse for us is:
inventions seemed to have any effect
from where these arose everyone was quite bereft
people then began to get rather weary
the once almighty neoclassical growth theory
new explanation arrived,
which there was quite a fuss
progress - innovation, ideas - were "endogenous"
was crucial but needed embodiment
people - in skills - and in capital investment
these were important to make growth shine
others had known this for a very long time."
But how does one nurture invention without a national mood? For it is now well
understood that how we do as a nation depends a great deal on how we perceive
ourselves? This psychological factor is now understood to be critical to
sustained economic growth.
Classical economics was linked closely with psychology. Adam Smith's other
great work was "The Theory of Moral Sentiments" and dealt with the
psychological principles of individual behavior. Smith emphasized the concept
of empathy, the capacity to recognize feelings that are being experienced by
another being. Jeremy Bentham described "utilitarianism as the greatest
happiness of the greatest number that is the measure of right and wrong" and is considered by many as the father of the welfare state.
Classical economic theory, also known as laissez faire, claims that leaving
individuals to make free choices in a free market results in the best
allocation of resources. Since individuals made choices the emphasis was on
understanding human beings and their behavior as individual and as groups.
Neo-classical economists based their thinking on the assumptions that people
have rational preferences; individuals maximize utility and firm's profits; and
people act independently. Consequently neo-classical economists distanced
themselves from psychology and sought explanations for economic analysis
heavily based on the concept of rational expectations. For most of the last
century economics became increasingly mathematical. Much of economic theory
came to be presented as mathematical models, mostly calculus, to clarify
assumptions and implications.
In more recent times the traditional school of economics has been given greater
importance and is reflected in the award of Nobel Prizes to behavioral
economists like Daniel Kahneman of Princeton University and last year to
Richard Thaler. Making the announcement Nobel Committee said: "His
empirical findings and theoretical insights have been instrumental in creating
the new and rapidly expanding field of behavioral economics, which has had a
profound impact on many areas of economic research and policy."
There is a delicious irony in the award of the Nobel to Richard H. Thaler. He
works in the University of Chicago, the nursery of neo-classical economics,
where he is the Ralph and Dorothy Keller Distinguished Service Professor of
Behavioral Science and Economics at the Booth School of Business. Incidentally
Raghuram Rajan who is also an economics professor is a colleague, was onetime
reported as being considered for the Nobel for his "contributions illuminating
the dimensions of decisions in corporate finance".
The dominance of the neo-classical school on the world of economics can be
gauged by the fact that since the relatively recent inception of the Nobel
Prize in Economics in 1968, the Chicago economics department faculty have won
the Nobel as many as twelve times, twice as many as MIT, which has six Nobel
Seen from Harvard University's ivory tower even MIT is considered as leaning
more towards classical economic theory. Recent Harvard winners for economics
such as Oliver Hart (2016), Alvin Roth (2012) and Eric Maskin (2007) were
rewarded for their work based on mathematical empiricism than behavioral
speculation. Amartya Sen (1998) was one of the few who broke this mold and won
it in recognition of his work and abiding interest in welfare economics.
Every politician worth his salt knows that national mood and perceptions are
decisive in determining national outcomes. And often people do not always make
rational choices, something that marketers of diverse products such as
automobiles and soap, and political dreams know.
Abhijit Banerjee has been a trenchant critic of Narendra Modi's demonetization,
that he holds primarily responsible for the present economic crisis in India.
This will not endear him to the powers that be. Already the RSS batteries are
firing away at his being unfamiliar with Indian conditions and even being a
foreigner. Yet the same lot reveled in the adulation of the Howdy Modi crowd of
NRIs in Houston.