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Two Cheers for the 2002 Nobel Laureates

October 10, 2002

As an economist, I must admit to more than a passing interest in who receives the annual Nobel Prize for Economics.  While the results generally have been disappointing--witness one of last year's winners, Joseph Stiglitz, who has argued that socialism and other forms of government intervention can serve as a "signaling" device to denote high quality--I still am interested in what these economists have to say.

After all, Austrians have their own winner, 1974 laureate F.A. Hayek, who, unfortunately, had to share the prize that year with Sweden's Gunnar Myrdal, surely one of the worst economists who has ever lived.  Since Hayek received his Nobel for his rendition of the Austrian Business Cycle Theory, I can teach that theory to my students and its Nobel designation automatically confers (to them) a sense of legitimacy.  

However, the Nobels generally have not been kind to Austrians.  From the gaggle of economists from the University of Chicago to Paul Samuelson and other Keynesians, most Nobel winners have championed the role of the state as an omniscient "superplayer" in political economy.[i]  Since Hayek, nary an Austrian has even come close to winning a Nobel Prize, and the future does not look bright.

The Nobel Committee's selection of Vernon Smith (who shares the prize with Daniel Kahneman--more on him later), however, does present a bright spot.  Smith admits to being strongly influenced by Ludwig von Mises' treatise, Human Action, and for that Austrians can be grateful.  

He has written in the Cato Journal as follows:

"I first read Mises when I was a senior at CalTech, graduating in electrical engineering. It was one of several reasons why I subsequently shifted to economics. Reading Mises after 50 years, I am impressed with how stimulating, relevant, and crisp Human Action is for the state of economics at the end of the second millennium. It has endured well because many of its major themes—property rights, liability rules, the efficacy of markets, the futility of interventionism, the primacy of the individual—have become important elements in microeconomic theory and policy. Moreover, these themes have become important because of Mises, Hayek, and others on the fringe (e.g., Coase, Alchian, North, Buchanan, Tullock, Stigler, and Vickrey, to name a few) and not because of mainstream economic theory. There is plenty in Mises to update because of things we think we now know that we did not know 50 years ago. But Mises' basic message as to how economies function is as good today as it was then."

Furthermore, in a very wide sense, Smith's research has demonstrated time and again that the Austrians are correct regarding human action in the marketplace and the mainstreamers are flat out wrong.

Smith, who is on the George Mason University faculty, specializes in "Experimental Economics," which is research based upon individuals simulating economic exchange within a controlled environment.  As one can imagine, Austrians are not exactly enthralled with "Experimental Economics," as they think the whole thing to be rather silly.

The idea behind EE is this: individuals observed in the ordinary marketplace are not necessarily behaving in a "random" fashion, so the data needed for formal statistical studies may be biased, which then can render the hypothesis testing worthless.  (This does not stop economists from engaging in such studies, but that is another subject for another time.)  When individuals who serve as EE subjects operate under stylized conditions, however, supposedly that makes the data nonbiased, which then serves as a basis for proper studies.

When Smith began his research during the 1960s, mainstream economists simply assumed that government intervention into the economy was necessary, since constant "market failures" continually botched up the works and kept the economy from working at a high level of "efficiency."  That government could work such miracles in itself required a great amount of faith, since the assumption was that government agents were omniscient, or at least could see a much more clear picture of what needed to be done than the actual market participants themselves, who were hopelessly blinded by greed and selfishness.

Smith writes, however, that he discovered soon into his research that individuals actually could trade in an "efficient" manner, provided that free market prices and private property rights were permitted to be in effect.  Furthermore, things like "externalities" and all of the other problems that supposedly blocked the reaching of "efficient" solutions turned out not to be the problems that the mainstream literature was claiming them to be.

All of this is well and good, of course, but it does not "prove" that free markets are best for society at large.  That is not because Smith's work is slipshod or biased, but rather because it violates a central premise of Austrian methodology, that laws of human action cannot be "tested" for falsification.

Laws of economics in and of themselves cannot be set up for testing, as if they are found to be invalid in one place, by their very nature they would have to be invalid everywhere.  For example, when David Card and Alan B. Krueger published their notorious 1994 paper that claimed that increases in minimum wage in New Jersey and Pennsylvania actually led to more employment in fast food industries, what they were saying was that there can be exceptions to the law of demand.[ii]

However, if the law of demand is not valid for labor in New Jersey and Pennsylvania, who can say it is valid elsewhere?  Likewise, setting up the law of demand for falsification in a controlled laboratory setting might produce some interesting results, but "successful" results cannot mean that somehow the law of demand is actually true, since there is always the probability that a future experiment might negate the law of demand and send us back to the drawing board.

The law of demand is true, not because it has been demonstrated as true in a controlled setting, but rather because of the understanding that human beings act within time and space, and the implications of purposeful action lead us towards, not away from, the law of demand.  Laws of human action are immutable; they are not products of probability or hypothesis testing, but rather exist because of the very nature of humanity.

Thus, while I am glad to hear of Smith's affinity for Mises and Human Action--and I can say that his description of Mises and his major work was written far more eloquently than I could ever hope to do— I do not necessarily applaud his work.[iii]  Yes, I think that EE can be interesting, and no doubt it has provided enjoyment and insight for Smith and others.  However, even given that truism, EE does not and cannot "prove" that laws of economics are true.

As for the Nobel given to Daniel Kahneman of Princeton University, I admit to knowing nothing about the attempts to meld economics with psychology.  Historically, the two disciplines have operated in different spheres, as economists have assumed rational behavior on the part of individuals who are making decisions that they believe will make them better off, while psychologists look into the "why" of human decision making.

However, I don't believe that economists have ignored psychology, but when they have tried to use it, they simply blow it.  Perhaps the best example is that of John Maynard Keynes attempting to explain the behavior of investors as being moved by "animal spirits."  By so classifying investors, Keynes, in effect, said nothing worthwhile.

The "animal spirits" mumbo-jumbo lives on, however, from Paul Samuelson to Paul Krugman.  Thus, economists are not forced to deal with what Carl Menger called the law of cause and effect; bubbles and other economic maladies are not the effects of monetary policy run amuck or other harmful government intrusions, but simply are the product of greed and irrational animal-like behavior.

In the end, Mises had it correct.  Individuals look to make themselves better off, and the best way for large numbers of individuals to accomplish this important goal is for them to engage in peaceful, private exchange in the marketplace.  While Mises never won a Nobel Prize, I doubt that any Nobel laureate could have said it better.

William Anderson, an adjunct scholar of the Mises Institute, teaches economics at Frostburg State University. Send him MAIL. See his Mises.org Articles Archive. See also the interview with Smith in Reason.

[i] Although the Chicago winners generally have had the reputation of being "free market" in their outlook, most have looked to the state to perform a number of economic duties.  Milton Friedman (1976) holds that government should have a monopoly on money, while George Stigler (1982) actually believed that antitrust laws and enforcement benefited the economy at large.

[ii] Card, David and Alan B. Krueger.  1994.  "Minimum Wages and Employment: A Case Study of the Fast-Food Industry in New Jersey and Pennsylvania," American Economic Review, September, 84(4): 772-93.

[iii] Smith writes, “Even thought Hayek, in my view, is the leading economic thinker of the 20th Century who saw what must be the mainsprings of the extended order, Mises was the choice technician, and no one was better at articulating the primacy of the individual and the need to define and nurture individual rights.  Experimental economics, created in the 50 years since Human Action, is kind to the Austrians in enabling us to demonstrate that the spontaneous order, operating through property rights institutions, exhibits the desirable characteristics that Austrians claimed for it.”

Note: The views expressed on Mises.org are not necessarily those of the Mises Institute.

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