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  Allen R. Sanderson

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The life and tomes


Wealth of notions
Finally, 22 economists whose ideas have at least one point in common: they all won the Nobel Prize. Here, in translation, are the theories that made Chicago famous.

At last we reach dead center: nine faculty members recognized immediately and completely as Chicago economists.

On the bicentennial anniversary of the publication of Adam Smith's The Wealth of Nations, Milton Friedman, AM'33, became a 1976 laureate "for his achievements in the fields of consumption analysis, monetary history and theory and for his demonstration of the complexity of stabilization policy." From Capitalism and Freedom (1962) to Free to Choose (with his wife, Rose Director Friedman, PhB'32, 1980), Friedman has been an indefatigable debater and defender of market capitalism and individual freedoms. But the award was for his contributions to macroeconomic thought, theory, and policy.

PHOTO:  Milton FriedmanIn A Theory of the Consumption Function (1957) and A Monetary History of the United States (with Anna J. Schwartz, 1963), Friedman established himself as a principal critic of Keynesian economics and the leader of the Monetarist revival-a belief that fluctuations in the supply of money are the principal cause of business cycles and inflation. He views economic fluctuations and instabilities as monetary phenomena that generally originate in Washington, D.C., and his macroeconomic policy recommendations are few and simple: the federal government and the Federal Reserve System should not attempt to fine-tune the economy with changes in spending, taxes, or interest rates; rather, directors at the Fed should expand the money supply at a known, steady rate (4 percent annually) and then head to the tennis courts.

In Friedman's view, given policy lags and political overlays, proposals to stimulate a sluggish economy through more spending and tax cuts, such as those the Bush administration and Congressional Democrats have proposed, or continued intervention by the Fed in credit markets, are likely to harm-not help-the economy. He ardently opposes the view that there is any long-term tradeoff between inflation and unemployment that policy makers can influence through their incessant tinkering. In short, his Nobel came for recognizing the complexity (and Friedman would add, the futility) of stabilization policy.

Theodore W. Schultz (1902-98), who taught at Chicago for more than 50 years, shared the 1979 award with Sir Arthur Lewis for "pioneering research into economic development research with particular consideration of the problems of developing countries."PHOTO:  Theodore W. Schultz

Schultz's initial interest was in U.S. agriculture, a base from which he shifted first to agricultural productivity and economic growth and then to economic development. Never straying far intellectually or emotionally from his rural Midwest heritage, Schultz had enormous faith in farmers' commonsense responses to incentives in their choices of production techniques and resource allocations, a belief that figured prominently in his criticisms of public-policy interventions and recommendations when it came to alleviating poverty in underdeveloped nations.

Not cited explicitly, though integral to his research on economic development, was Schultz's other extraordinary contribution to economics: his work on human capital (the knowledge and skills acquired through formal education and on-the-job training). In addition to his own work linking theory with data, Schultz was a tireless mentor for colleagues and students and was the intellectual inspiration for what has come to be known as "the new home economics," Chicago-style research devoted to the study of family decision making with regard to fertility, marriage, and education.

PHOTO:  George J. StiglerGeorge J. Stigler, PhD'38 (1911 -91), received the 1982 prize for "seminal studies of industrial structures, functioning of markets and causes and effects of public regulation." The study of market processes and industry structure is called Industrial Organization, and Stigler's applied, empirical orientation improved understanding of the entire spectrum from pure competition to monopoly, including the behavior of prices and the scale of operations. He favored a minimalist antitrust policy, preferring competition (and potential competition-the threat of new entrants into an area or industry-later termed "contestable markets") to reduce firms' ability to charge excessive prices or to control the supply of a good or service.

When it came to government regulation of industry, Stigler was a skeptic who argued convincingly that: (a) regulation often occurs because of producers' interests-the desire to be protected from market forces and to be under the apparent thumb of a regulatory agency they could co-opt (his "capture theory" of regulation)-not consumers' interests; and (b) whether in housing, utilities, or labor markets, regulation is unlikely to result in discernible consumer or worker benefits. (Were he alive today, he would oppose the bailout of the airline industry and the shift of airport security from the private to public sector.)

Though not noted in his Nobel citation, Stigler founded the economics of information; he introduced the costs of acquiring information-whether it be for sellers and buyers of products or employers and employees in a labor market-explicitly in his models and analyses of prices and wages. Work by other laureates (including Simon in 1978, Mirrlees and Vickrey in 1996, and Akerlof, Spence, and Stiglitz in 2001) on information, including asymmetric information problems, can be traced to Stigler's work.

The 1990 prize was awarded jointly to GSB faculty member and Scholes's thesis adviser Merton H. Miller (1923- 2000), Markowitz, and Sharpe for their "work in the theory of financial economics," with Miller specifically cited for "fundamental contributions to the theory of corporate finance." In collaboration with 1985 laureate Franco Modigliani, Miller revolutionized corporate finance theory and how firms think about financing both their operations and their investments.

PHOTO:  Merton H. MillerHis specific insight was that the costs of raising capital for a corporation by selling more stock-equity-or issuing more bonds-debt-should be equal, and thus a corporation's value in the stock market is independent of its capital structure. He called this the "irrelevance principle" and used a pizza analogy-for a given-size pizza the number of pieces into which a pizza is sliced doesn't affect the underlying amount of pizza one has-to drive home that point. He later factored in complications such as how a nation's tax structures and bankruptcy policies affect the relationship between a firm's capital structure, dividend policies, and market value.

PHOTO:  Ronald H. CoaseIn 1991 Ronald H. Coase became the first faculty ember in a law school to earn the prize, for "his discovery and clarification of the significance of transaction costs and property rights for the institutional structure and functioning of the economy." Coase made two important points: first, factors that determine the size of firms (and why firms even exist in the first place), and, second, conditions under which private voluntary arrangements, without government intervention, can handle "externality" or "third-party" problems associated with production or consumption. Although not part of the Nobel citation, Coase's 20-year stewardship as editor of the Journal of Law and Economics influenced research directions and practical applications in economics and the legal world.

Coase's 1937 paper, "The Nature of the Firm," discussed how firms, in pursuit of efficiency, decide to produce some things on their own versus, in popular parlance, "outsourcing" these tasks. For Coase, the key element was the "transactions costs" associated with that choice. Today his work has new implications for the size of firms and the degree of specialization in an Internet world, where transaction costs become smaller and smaller.

In what may be the most often-cited article in both economics and law, "The Problem of Social Cost" (1960), appeared the proposition, now known as "The Coase Theorem," that when transactions costs are small, the assignment of legal property rights (say, between a factory that emits air or water pollution and individuals affected by it) will have no impact on the allocation of resources. Transacting parties-a cattle rancher and a farmer, a polluter and downstream homeowners-can weigh costs and benefits and then bargain privately to produce an efficient outcome. Thus government intervention is not necessary to handle cases where private and social costs may diverge.

In what could be regarded as a veritable understatement, in 1992 the Academy awarded the Nobel prize in economics to Gary S. Becker, AM'53, PhD'55, for "having extended the domain of microeconomic analysis to a wide range of human behavior and interaction, including non-market behavior." A theme of Becker's work is that individuals and organizations respond purposefully and predictably ("rational choice") to a given set of constraints and incentives to achieve a given objective, regardless of the type of activity under consideration.

PHOTO:  Gary S. BeckerBeginning with his dissertation on the economics of discrimination, Becker, a professor in sociology as well as economics, has applied economic theories to an array of social problems and aspects of human behavior. This seeming encroachment on other social-science disciplines, reflected best, perhaps, by the title of his 1997 collection of Business Week columns, The Economics of Life, has prompted some criticism that economics is attempting to become the "imperial science." Becker's intellectual breadth is demonstrated by his theoretical formulations and empirical study of the economics of crime and punishment; racial and gender discrimination; education and returns on investments in human capital; the allocation of time; the family, household production, and decision making with regard to marriage, divorce, and fertility; and addiction. His post-Nobel research includes work on how preferences and values are shaped (Accounting for Tastes, 1996) and how the social environment influences choices (Social Economics, with Chicago colleague Kevin M. Murphy, 2000).

GSB scholar Robert W. Fogel and Douglass C. North were honored in 1993 "for having renewed research in economic history by applying economic theory and quantitative methods in order to explain economic and institutional change," recognizing their methodological contributions to quantitative or econometric history-also referred to as "Cliometrics" or "the new economic history."PHOTO:  Robert W. Fogel

In his dissertation, which appeared in book form as Railroads and American Economic Growth (1964), Fogel used econometric tools and compiled enormous historical data sets to test a counterfactual ("what if") proposition about the development of the United States in the absence of railroads. He demonstrated that waterways, canals, and roads could have handled transportation needs adequately, and thus railroads were not vital to the nation's development.

His second controversial foray was in 1974 when he and Rochester economist Stanley Engerman published Time on the Cross, an analysis of slavery and the Southern economy, which they determined-on economic, not humanitarian or ethical grounds-to be prosperous, viable entities on the eve of the Civil War.

Fogel's contributions in the last decade have been twofold: a large-scale demographic study of nutrition and mortality, and an examination of recurring long-term economic, political, and religious cycles in the United States (The Fourth Great Awakening, 2000). In addition, Fogel's doctoral students have contributed new studies of labor history, monetary and financial history, the distribution of wealth, demography, tariff legislation, and other public policies.

Robert E. Lucas Jr., AB'59, PhD'64, became a laureate in 1995 for "having developed and applied the hypothesis of rational expectations, and thereby having transformed macroeconomic analysis and deepened our understanding of economic policy." Keynesian economics assumes in part that changes in central government spending or tax policies, or changes in the money supply or interest rates by the central bank, can influence a nation's level of employment, inflation, and economic growth. Not so, says Lucas.

PHOTO: Robert E. Lucas, Jr.To theextent that individuals and businesses can anticipate such policy changes, they may well take steps (say, consuming less and saving more if there is a tax cut because at some point in the future the government will raise taxes to recoup its revenues) that could offset this public action-the "policy-ineffectiveness" theorem. Thus the term used by the Academy -rational expectations-to characterize Lucas's contributions.

The practical implication is that Lucas and other "new classical economists" remain skeptical about the government's or the Federal Reserve System's ability to fine-tune the economy in the short run or to affect systematically long-term employment or the rate of economic growth. The recommended macroeconomic policy prescription in light of September 11 and the aftermath: Provide a steady, stable framework through which financial and industrial markets and individual households can respond most effectively.

In the last few years Lucas has turned to a vexing and vital issue: the widening income gap between rich and poor nations. In modeling long-term economic growth, Lucas estimates that this disparity will narrow considerably throughout the 21st century, bringing more beneficiaries of economic growth and thus modifying Adam Smith's title slightly to read The Wealth of All Nations.

PHOTO:  James HeckmanJames J. Heckman shared the 2000 prize with McFadden for his "development of theory and methods for analyzing selective samples," methodological insights Heckman brought to wide-ranging individual and policy issues. For example, comparing subsequent wages earned by those who enter and complete job training programs to the wages earned by those who do not shows a respectable rate of return to this investment in education. But that assumes the two groups are identical, isolating the effect of a single variable: the training program. Heckman demonstrated that there may be underlying differences in motivation and/or self-discipline between the two groups (or samples), and thus an inherent selection bias.

When Heckman adjusted for such biases in job training programs, his analyses of the earnings of high-school dropouts who completed a GED showed no economic returns. This work has implications for how government agencies at all levels allocate their resources, and his recommendations for human-capital investments would be to focus instead on preschool years when skill formation is crucial.

Heckman has also studied the effects of the civil-rights movement, measuring discrimination, labor market decision making by married women, and factors contributing to the widening inequality of income. A "busman's holiday" contribution was his rebuke of authors Charles Murray and Richard Herrnstein, criticizing their controversial 1995 book The Bell Curve, for underlying methodological errors and selection biases.





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