The Nobel prize in economics isn’t really a Nobel prize. There are five of those – in physics, chemistry, medicine, literature and peace. These “true Nobels” have been awarded since 1895, the year before the death of Alfred Nobel – the Swedish industrialist who made his fortune, famously, by inventing and selling dynamite.
It was only in 1969 that the Swedish Central Bank began dishing out a medal each year for research in economics, awarded in Nobel’s name. It remains separate from the main prizes established in his will – and so it should. That’s because Nobel was a scientist – and economics, categorically, is no science.
Aside from physics, chemistry and medicine, I hope we can agree that “peace” deserves a look-in. It may well be that Nobel only included it to assuage his guilt, given that his family accumulated part of its huge wealth selling arms, but it’s still a worthy cause. Similarly, had this enterprising polymath excluded “literature” from his original list, he may have seemed unrefined.
The annual “Nobel prize in economics”, though, often shared between two or three winners, is a posthumous add-on. As an economist myself, I admire many of its 75 recipients. Some I know and a handful have even taught me. But I still don’t think that economics, as a field of research or human pursuit, belongs with the other five Nobels and some of the awards made in recent years illustrate why.
Last week, the 2013 economics Nobel was awarded to three American professors – Eugene Fama and Lars Hansen of Chicago University, and Robert Shiller of Yale. They were jointly recognized for “laying the foundation for the current understanding of asset prices”, according to the Royal Swedish Academy of Sciences, which selects the winners. You may be forgiven for thinking that no-one truly understands asset prices. The global stock market turmoil of recent years is surely testament to that. Yet that was the explanation given.
The 2012 prize, the Academy said last year, was for a series of “systematic laboratory experiments”, amounting to “an outstanding example of economic engineering”. That doesn’t sound like economics to me. The 2011 prize recognized deeply obscure research into “macroeconomic stability” – yes, at a time when the global economy was on a knife-edge.
Economics is a study of human behaviour – above all the allocation of scarce resources between competing ends. It requires the analysis of economic, commercial and financial life in all its institutional richness, or it is nothing. A solid grounding in theory and numeracy is essential, but so too are broad dashes of politics, history, sociology and common sense.
Recent “Nobel” recipients have been rewarded, instead, for work that claims to have established “findings” and discovered “relationships” – all of which, when it comes to economics, is bunkum. We live in extremely tough times. Markets are volatile, trade wars are brewing and, as our societies age, we’re juggling some nasty demographic time bombs. The Western world is now so indebted that some large economies are creating moneyex nihilo to buy-up vast swathes of their own government bonds. And economic power is rapidly shifting east – a process that scares far more of our citizens than it inspires.
Yet academic economists, with a few honorable exceptions, have little to say about such uncomfortable realities. Those who do, it seems, can kiss their dreams of a “Nobel” goodbye. It is vital, if they are to retain any legitimacy with the broader public, that economists engage with, and tackle the pressing issues of our day – in a practical, rather than merely theoretical manner. That’s something the judges of the world’s most important economic prize have an urgent duty to encourage.
Eugene Fama’s reputation was built on his “efficient market hypothesis”, which has long been the bedrock of what economists call “finance theory”. His main idea boils down to the notion that share values are extremely difficult to predict in the short-run, given that all new information is quickly incorporated into prices.
I distinctly remember the first time, as an undergraduate, I came across Fama’s work. Having worked through all the fancy algorithms and mathematical hocus-pocus, I recall feeling a bit cheated and thinking “So what?” I encountered Fama again while studying for a post-graduate economics degree, this time with even more pseudo-scientific garnish – and my conclusion was the same. Yes, it obviously makes sense that share prices reflect all available information – which Fama stressed. But they also clearly reflect rumours, supposition, herd-instinct, prejudice, hubris, pessimism, and a myriad of other immeasurable qualitative factors, including occasional madness, which Fama largely ignores.
So why did his work, together with Hansen’s – largely concerned with the development of obscure statistical methods enabling the testing of asset price theories like those of Fama – become so popular? Well, “finance theory” in general has boomed because it says precisely what the mighty financial services industry wants it to say.
The main corollary of Fama’s work is that if financial asset prices are entirely “rational”, then it’s impossible to beat the market. Better, then, for ordinary investors who want to own shares to put their money in unit trusts and tracker funds – while swallowing the asset-management industry’s often very considerable charges.
This seems deeply unhelpful. Retail investors should be encouraged to analyze companies, buy shares directly, attend annual general meetings and think for themselves. Some may sneer, but back in the age of such “Aunt Agatha” investing, stock markets were much more stable, and served industry far better, than they do today. While I’m not saying it was his motive, Fama’s “leave it to the professionals” message has been used over many years to create an intellectual climate that discourages the kind of small-scale and activist investment that engenders accountability and promotes good corporate governance.
I have a lot more time for Robert Shiller – who, as it happens, is one of the main critics of the “finance theory” proposed by Fama and Hansen, even though he’s sharing the same Nobel prize. Shiller made his name with “Irrational Exuberance, a book he published in 2000, the title of which was notoriously used by Federal Reserve Chairman Alan Greenspan to describe the cause of the dot-com bubble.
I admire Shiller because, as economists should, he does his research and then has the courage to say what’s unpalatable. The ingenious Shiller-Case house price index he helped develop predicted the last US housing collapse, and is flashing red again – something he doesn’t shy from pointing out.
While Shiller deserved his prize, it troubles me that 19 of the last 20 Nobel economists are from the US. I admire many such winners – including Joe Stiglitz (who I sometimes disagree with) and Paul Krugman (with whom I rarely agree). Both combine world-class academic credentials and a determination to publicly influence policy. That’s precisely the kind of activity the Nobel committee should promote. But America is hardly a paragon of economic-policy virtue. So why should its economists win practically all the Nobels?
It is deeply unfortunate, also, given the changing shape of the world, that the last economist from an emerging market to win the Nobel was India’s Amartya Sen back in 1998 – and that was after having spent almost his entire professional life in the West.
My early 2014 nomination is a Peruvian economist called Hernando de Soto. He encouraged a property ownership revolution in his native land, undermining racketeering thugs from groups such as Sendero Luminoso, or Shining Path, by empowering the poor. So successful was he that, as he once told me, the guerillas blew-up his think tank. So De Soto showed a lot of guts then survived a brush with dynamite. That’s surely an economist worthy of Alfred Nobel’s approval.