Has the institution of the Nobel Prize in economics been a cause of the global economic woes of the last 20 years – its financial crises, its economic slowdowns and its increasing intra-national inequalities? In their recent book, The Nobel Factor: The Prize in Economics, Social Democracy, and the Market Turn, authors Avner Offer and Gabriel Söderberg make a good, if somewhat haphazard, case that it has.
The entrenched mindset
A recent article by John Cassidy in The New Yorker, titled “Hillary Clinton’s Plan to Squeeze the Ultra-Rich,” begins with a photo caption reading, “Democrats in 2016 are making the case that using the tax system fairly aggressively to counteract inequality and boosting G.D.P. can actually be complementary.”
Why the “actually”? The word “actually” is generally used to buttress an assertion when it seems counterintuitive or unlikely to be true. This suggests that, to most readers, the notion that an aggressive use of the tax system could be complementary to boosting G.D.P. is counterintuitive.
If this seems counterintuitive to you, then your intuition may have been influenced by a series of Nobel Prize winners in economics. Prior to the awarding of these Nobel Prizes, that was probably not most people’s intuition.
It is the effect of this creeping certainty about particular economic relationships that the authors wish to highlight – and to note that these relationships have never been proven true; even the creators of these theoretical relationships do not believe them to be true in the real world.
The origin of the Nobel Prize in economics
Offer and Söderberg are economic historians. Much of their book is taken up with economic history, a lot of it specific to Sweden. Though I read at rapid speed much of their Swedish economic history, their account of the creation of what is widely believed to be the Nobel Prize in economics is particularly interesting.
The originator of the idea was Per Åsbrink, Governor of the Riksbank, Sweden’s central bank. For a variety of reasons in the 1960s the bank had accumulated a substantial fund from its profits. It decided to use part of it to create a “special jubilee” to take place on May 15, 1968, to celebrate the bank’s tercentenary (300th anniversary). About 100 central bankers and other dignitaries would be invited.
As the date approached, Åsbrink, in 1967, reluctant to hand the bank’s profits back to the Treasury, came up with the idea of using them to establish a Nobel Prize in economics. He discussed it with his young special advisor Assar Lindbeck, who pursued it from there. There were some objections from scientists, who didn’t believe economics merited such an award, and from the Nobel family itself. However, since the money didn’t come from Nobel family funds but from the Swedish taxpayer, they had little say in the matter.
The only concession to the family was made when its oldest living member, an 87-year-old woman, insisted on setting the prize apart by naming it “The Prize in Economic Science in Memory of Alfred Nobel,” versus the other, more simply named awards, such as the Nobel Prize in Chemistry. As Offer and Söderberg say, “This showed a remarkable presence of mind, since the awkward title has continued to tarnish the award ever since.” Peter Nobel, Alfred’s great-great nephew, according to Offer and Söderberg, later wrote that “The Economics prize has nestled itself in and is awarded as if it were a Nobel Prize. But it is a PR coup by economists to improve their reputation.”
Market liberalism versus social democracy
The main subject of the book is the clash between what the authors call market liberalism and social democracy. The differences are vast. For market liberalism the fundamental unit is the individual, and self-interest the driving force. In social democracy, the authors say, “the basic impulse was not gratification but obligation, the basic unit not the individual but the group, family, class, and nation.”
Market liberalism was on the ascendancy partly due to the influence of the economics Nobel Prize when it took hold politically in 1980 in the U.K. and the U.S. under Margaret Thatcher and Ronald Reagan. It was in part a response to excesses of social democracy and especially to the mistaken impression among many, especially at the extreme left of the political spectrum, that the Communist experiment was proving itself successful. The fall of the Soviet Union in 1991 confirmed market liberalism’s supremacy, at least in the relatively diluted form it had taken in Western countries, as opposed to the extreme form of social democracy represented by Communism.
However, in the U.S. the real and perceived successes of market liberalism powered a movement to the effect that if a little market liberalism is a good idea – for example deregulating airlines – then why not a lot of it, indeed as much as possible, to the exclusion of social democracy.
This trend enabled many people to believe that the pursuit of self-interest alone always led to the best result; that the private sector always did things better than government; and that redistribution by government always harmed the economy. It enabled Grover Norquist, whose stated goal was to get government “down to the size where we can drown it in the bathtub,” to persuade 238 of the 435 members of the U.S. House of Representatives to sign a pledge never to raise taxes; this makes it virtually impossible even to simplify and rationalize the tax code, since it may lower taxes in some areas while raising them in others.
The theoretical justifications for market liberalism
Market liberals – even, perhaps particularly, of the extreme form – believe their heritage comes from the famed economist Adam Smith. Smith’s insight that a healthy economy is driven by self-interest is encapsulated in an oft-cited quote, “It is not from the benevolence of the butcher, the brewer, or the baker, that we can expect our dinner, but from their regard to their own interest.…directing…industry in such a manner as its produce may be of greatest value, he intends only his own gain… led by an invisible hand to promote an end which was no part of his intention.”
This idea was formalized by two economics Nobel Prize winners, Kenneth Arrow and Gerard Debreu, who developed a mathematical model showing that under a set of tortured assumptions, in “general equilibrium” the sole pursuit of individual economic interests would result in an economic optimum. Offer and Söderberg, citing Edmund Phelps, another Nobel Prize winner, say that Arrow himself and many other Nobel Prize winners have explicitly rejected the idea that this result can be applied in practice.
Smith’s maxim and the support of academic models have justified the idea that if everyone were free to look after their own self-interests, the economy would thrive at its economic optimum. Anything that gets in the way of that freedom – including most government intervention other than enforcing contracts – will only detract from the optimum.
Seemingly overlooked, however, is another Adam Smith quote:
“The wise and virtuous man is at all times willing that his own private interest should be sacrificed to the public interest of his own particular order or society. He is at all times willing, too, that the interests of this order or society should be sacrificed to the greater interest of the state sovereignty, in which it is only a subordinate part.”
Based on this quote, one would expect Adam Smith to be viewed as the progenitor of social democracy, not of market liberalism.
It is also often overlooked that one of the principal exponents of free market theory, Nobel Prize winner Friedrich Hayek, found no contradiction between his views and the idea that government should provide social insurance such as health care. The current form of market liberalism adhered to by many in the United States and elsewhere is little more than an abstract concept that is nevertheless believed applicable in practice in its most extreme form.
Offer and Söderberg cite a passage written by the economist John Hicks, 1972 Nobel Prize winner: “There is much of economic theory which is pursued for no better reason than its intellectual attraction: it is a good game. We have no reason to be ashamed of that, since the same would hold for many branches of pure mathematics.”
And that is quite true. And, like pure mathematics, which is also pursued for no better reason than its intellectual attraction, some of economics may someday, after a long stream of thought experiments, prove to have some practical value. But in the present day, as Offer and Söderberg say, “such models provide no warrant to rule out collective action, or indeed (on their own) for any other policy.”
An example of the direct harm of market liberalism in the investment field
In the investment field, we find a good example of the direct harm that can be done to individuals by market liberalism, especially the idea that the private sector can always do things more efficiently than the public sector.
Here is a quote from Offer and Söderberg on the subject of public versus private pensions:
“The Social Democratic approach…is not consistent with the…preference for private profit. But [it] is actually more efficient: it provides universal coverage, it draws on a large and stable revenue stream (the tax base), it has the largest risk pool, and it is an order of magnitude cheaper to administer. In contrast, privatized pension companies cream off typically between a quarter and forty percent of contributions as fees and profits; final payouts depend on financial market performance.”
The one-quarter to forty percent of contributions creamed off as fees and profits is in fact true on average, when the effect of those fees year by year on final pension benefits is measured.
It would be unthinkable, of course, to propose in the U.S. that the federal government provide all pensions. In fact, in the George W. Bush administration, there was an effort to eliminate even that relatively small part of pensions that the federal government now provides: Social Security. But a fervent belief in applying extreme market liberalism to their own retirement benefits hadn’t quite penetrated to a majority of the voting public, and that effort was abandoned. (And due to the rapid trend toward privatization and individualization of risk, a surprising number of retirees in the U.S. are now living entirely, or almost entirely, off that “small” part of their supposed pensions.)
When it comes to efficiency, however, let’s look at the federal government’s own pension plan for its employees, the Thrift Savings Plan (TSP). That plan has average net expenses of $0.29 per $1,000 invested; yes, 0.029% or 2.9 basis points. How many privately run plans are that efficient? Similarly, government healthcare programs like Medicare have much lower administrative costs as a percent of payouts than private programs.
It is time for the tide to turn again
Thatcher and Reagan embraced market liberalism in part because some aspects of social programs weren’t working well. Unionism was causing industrial paralysis in the U.K. and welfare payments in the U.S. were thought to be responsible for cheating, sloth, structural unemployment and cultural collapse. It is difficult to say how much truth there was to this, but there was, and is, a certain logic to the argument that too much social democracy can undermine the economy – and the Soviet Union was ultimately proof of this.
I was a strong believer in market liberalism in the 1990s, and around the turn of the millennium, influenced in part by some conservative economists, I participated in seminars with people who believed in “free-market” environmentalism (including Garrett Hardin, the author of the seminal 1968 article, “The Tragedy of the Commons”), in part by reading Hayek’s The Road to Serfdom, and in part by the history of the turn toward market liberalism in the 1980s and 1990s recounted in Daniel Yergin’s and Joseph Stanislaw’s fascinating book, The Commanding Heights: The Battle for the World Economy.
The tug-of-war and the balancing between market liberalism and social democracy will undoubtedly go on forever. The political scientist, historian and author Alexis de Tocqueville, renowned for his 19th century book Democracy in America, also wrote an essay on social welfare titled, “Memoir on Pauperism: Does Public Charity Produce an Idle and Dependent Class of Society?” The remarkable thing about this memoir is that, although it was written in 1835, I could have sworn it was written in the present day when I read it in the 1990s.
But at this time, we have seen enough to conclude that in recent years, the trend toward market liberalism has gone too far and has become too ideological, and that we need to dispense with much of its ideological tinge and embrace a return to a pragmatic combination of social democracy and market liberalism
Although much of Offer and Söderberg’s book is written in somewhat convoluted language and some of their assertions are unsatisfyingly supported only by brief references to other books, their overall theme is sound. The Sverige Riksbank Prize in Economic Sciences in Memory of Alfred Nobel has, in large part unintentionally, helped to cause too much public policy to be based on an impractical and utopian belief system.
Michael Edesess is a mathematician and economist, a senior research fellow with the Centre for Systems Informatics Engineering at City University of Hong Kong, chief investment strategist of Compendium Finance and a research associate at EDHEC-Risk Institute. In 2007, he authored a book about the investment services industry titled The Big Investment Lie, published by Berrett-Koehler. His new book, The Three Simple Rules of Investing, co-authored with Kwok L. Tsui, Carol Fabbri and George Peacock, was published by Berrett-Koehler in June 2014.
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