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.
IN THEIR BLOOD
Closer to the central core are ten Nobelists who were graduates
of the College and/or the Social Sciences Division (ten of the
22 economics laureates have U of C degrees, including four from
the College; three earned both their undergraduate and graduate
degrees from Chicago) or were on the faculty or in research
positions for a substantial length of time. Their work reflects
Chicago's approach, and in many instances they were honored
implicitly for contributions they made while on the quadrangles.
A. Samuelson, AB'35,
has been a recognized name in economics for a half century. Born
in Gary, Indiana, he attended Hyde Park High School and the College
but then took a left turn on Interstate 80 and has spent the rest
of his career in Cambridge, Massachusetts, as a graduate student
at Harvard and on the MIT faculty. He was honored in 1970 "for
the scientific work through which he has developed static and
dynamic economic theory and actively contributed to raising the
level of analysis in economic science." Simply put, although
he wasn't the first economist to use quantitative tools, Samuelson
dramatically upped the level of mathematical and analytical sophistication,
a path the discipline has followed ever since. His first major
publication, Foundations of Economic Analysis (1947), promulgates
that theoretical rigor and remains a classic.
is also associated with Keynesian economics and its emphasis on
fiscal policy-active manipulation of federal government spending
and taxes to achieve full employment, contain inflationary pressure,
and promote economic growth. Needless to say, these public-policy
prescriptions, which he brought to the Kennedy administration
in the early 1960s, do not sit well with most Chicago macroeconomists.
is probably best known, however, for his introductory text, Economics,
first published in 1948 and now coauthored by William Nordhaus
at Yale, through which millions of undergraduates, including me,
were introduced to the dismal science.
and economic opposites, Friedrich
August von Hayek (1899-1992), a professor in the Committee
on Social Thought (1950-64), and Sweden's Gunnar Myrdal shared
the 1974 prize "for their pioneering work in the theory of
money and economic fluctuations and for their penetrating analysis
of the interdependence of economic, social and institutional phenomena."
Monetary economist Hayek's contributions centered on the role
of money, credit, interest rates, and capital in business cycles,
as well as the efficiency of economic systems.
criticism of central economic planning, which he viewed as inefficient
because of what a later Chicago laureate, Ronald Coase, termed
"transactions costs," was consistent with his views
that economic and political freedoms are inexorably linked, and
with the high value he placed on individualism and liberty. A
staunch defender of the free market and a rejecter of socialism
(and Keynesian economics as well), he lived long enough to witness
the collapse of the Soviet Union and other command economies in
University of Chicago Press published both his most popular book,
The Road to Serfdom (1944), and what is considered his
most important volume, The Constitution of Liberty (1960),
written at Chicago.
C. Koopmans (1910-86) shared the 1975 prize with Russian
economist Leonid Kantorovich. Koopmans, a research associate in
economics in the mid-1940s, was from 1948 until 1955 a professor
and director of research for the Cowles Commission. Founded in
1932 and based at Chicago from 1939 until 1955, the commission
worked to promote research in forecasting techniques and quantitative
and mathematical economics and to encourage work in econometrics.
and Kantorovich were recognized for their "contributions
to the theory of optimum allocation of resources." Together
the two economists, one from a market system and one from a society
that favored central planning, studied the relationship between
inputs and outputs in production processes to answer basic economic
questions of what goods should be produced, how
scarce resources can be used most efficiently when there are alternative
production methods available, and the distribution of that
output between the present and the future. Koopmans advanced our
understanding of how those decisions are made, the value judgments
behind them (sometimes referred to as the normative theory of
resource allocation), and the relationship between inputs and
outputs in an economy.
mathematician who switched to physics, Koopmans was a government
statistician during World War II and a leading Cowles econometrician.
He was intrigued by problems associated with efficiency in transportation
systems, such as moving wood pulp from its source to newspaper
plants or sequencing airplanes and routes, and managing large-scale
operations, such as scheduling oil refinery operations. Today,
spinoffs of his theories are key elements in operations research
and linear programming-mathematical and computational techniques
for solving economic, business, and engineering problems.
A. Simon, AB'36, PhD'43 (1916-2001), entered the College
in 1933, intent on becoming a mathematical social scientist. His
doctoral dissertation was on administrative decision making, and
he held faculty appointments in political science, psychology,
and information sciences. His 1978 prize for "pioneering
research into the decision-making process within economic organizations"
recognized his interdisciplinary work at the intersection of economics
and psychology. Much of that work stemmed from Simon's participation
in the Cowles Commission.
popular view of classical economics-and one with which most economists
still begin their modeling and explorations into business behavior-is
that it assumes firms approach decision making in a fully informed,
rational way, with the goal of maximizing profits. Starting with
his 1947 classic, Administrative Behavior, Simon complicates
that picture with notions such as "bounded rationality"
and "satisficing" to suggest that constraints on information
and complementary goals may lead firms and their managers to adjust
their aspirations upward or downward in this imperfect world and
thus settle for a comfortable, quick-and-easy outcome or profit
Debreu, the 1983 laureate "for having incorporated
new analytical methods into economic theory and for his rigorous
reformulation of the theory of general equilibrium," was
at Chicago as a research associate with the Cowles Commission
(1950-55). Debreu and 1972 laureate Kenneth Arrow are often considered
in one breath, and his contributions are to some extent the result
of his early-1950s collaboration with Arrow.
individual recognition was for extending the mathematical rigor
of welfare economics and demonstrating the stability of the overall
general equilibrium system. In his 1959 volume Theory of Value
and elsewhere, he was able to validate mathematically the logical
consistency of Adam Smith's contention in The Wealth of Nations
that when individual self-interest confronts the "invisible
hand" in a decentralized market economy, it will lead to
an efficient allocation of resources.
M. Buchanan Jr., PhD'48, was honored in 1986 "for
his development of the contractual and constitutional bases for
the theory of economic and political decision-making." Beginning
with The Calculus of Consent: Logical Foundations of Constitutional
Democracy (1962, with Gordon Tullock) Buchanan's work combines
economics and political science, and he is considered the founder
of the public-choice school of economic thought.
traditional raison d'être for government in a market economy,
known as the public-interest theory, is to correct market imperfections
(such as monopoly power or third-party effects-"externalities"),
to enforce contracts, and to handle public goods (which could
include some redistribution of income), and thereby make the system
more efficient and more equitable.
contrast, public-choice theory applies basic economic principles
of costs, benefits, and incentives to the political marketplace,
where citizens and firms demand things and politicians and bureaucrats
supply them, to make themselves better off. Special interests
use "rent seeking," logrolling, and pork-barrel legislation
to divert potential surpluses to themselves. As a result, government
participation reduces rather than increases efficiency-and government
failure is more likely than market failure.
1989 Nobel prize was awarded to Trygve
Haavelmo (1911-99), a research associate in economics
in the 1940s and a visiting professor (1957-58), for "his
clarification of the probability theory foundations of econometrics
and his analyses of simultaneous economic structures." It
was during his sojourn at Chicago with the Cowles Commission in
the 1940s that he helped lay the foundations of modern econometrics-which
his fellow Norwegian laureate, Ragnar Frisch (who won the prize
in 1969), defined as the unification of statistics, economic theory,
econometrics and its statistical and mathematical cousin, regression
analysis, are fundamental building blocks in business, economics,
most other social sciences, and even in legal circles. But it
was not always so. What Haavelmo did was to show that, based on
probability theory, one could surmount problems associated with
the lack of a natural ceteris paribus environment and the
presence of interdependent relationships ("simultaneity"
and "identification" problems) and thus apply statistical
methods to economic data, test economic theories empirically,
and draw statistical inferences. Lacking the physical scientist's
laboratory to estimate, for example, how much smoking would be
affected by an increase in the tax on cigarettes, the economist
has to grapple with any concomitant "other things being equal"
influences of education, income, and constraints on where one
can light up; the ceteris is generally not paribus.
M. Markowitz, PhB'47, AM'50, PhD'55, shared the 1990
prize with Merton Miller and William Sharpe "for their pioneering
work in the theory of financial economics." With this Nobel,
the first ever to business-school faculty, finance theory came
in from the cold, taking its rightful place as an integral part
the adage "Don't put all of your eggs in one basket,"
it took Markowitz to prove that diversifying one's assets is the
correct strategy and to show how to make those allocations optimally.
Markowitz's "portfolio theory," which he developed at
Chicago in the early 1950s, analyzes how a household's or firm's
wealth can be invested in assets that vary in terms of expected
return and level of risk to produce a desired outcome.
S. Scholes, MBA'64, PhD'70, who taught at the Graduate
School of Business from 1973 until 1983, shared the 1997 prize
with Robert C. Merton "for a new method to determine the
value of derivatives," a class of financial instruments used
to manage risk, especially due to unanticipated changes in price
(or supply), and thus bring stability to markets, financial institutions,
or production. Through a mathematical formula, Scholes and Merton
provided the theoretical underpinnings of how one could assign
a value to an "option," or the right-but not the requirement-to
purchase an asset (or "put"), such as a stock, foreign
currency, or a commodity, at a fixed price at some future date.
If the stock rises in the meantime, you discard that option; if
it goes down, you exercise the option. (A recent controversial
example of this was the alleged purchases of United and American
stock options by certain parties in the days leading up to the
September 11 terrorist attacks; knowing in advance airline stocks
would take a beating in response to fears about more hijackings
and air travel safety would allow one to profit from the tragedy.)
Chicago Board Options Exchange (CBOE), which began operations
in 1973, functions largely on the basis of Scholes's and Merton's
work. Farmers use derivatives when they sell on futures markets
crops they have yet to plant. Options also ease international
trade by letting trading partners hedge against fluctuations in
exchange rates among currencies. And, in theory, they also make
recessions less severe, helping economic agents to guard against
unexpected changes in raw material prices and interest rates.
New laureates also can apply the model, deciding whether to hedge
in currency markets to protect themselves against an adverse fluctuation
in the value of the Swedish kronor between the mid-October announcement
and the December 10 check presentation.
a footnote to this prize. A 1974 rule change permits posthumous
awarding of a prize only if the recipient named in October dies
before the December ceremony (witness the 1996 case of Columbia
economist William Vickrey, who won on a Tuesday and had a fatal
heart attack while traveling to Boston three days later). If,
however, Fischer Black, who taught in the GSB from 1971 to 1975,
had survived his battle with cancer (he died in 1995), he would
have undoubtedly shared the 1997 prize with Scholes and Merton.
In fact, the mathematical equation that solved the option pricing
problem is known as the Black-Scholes model.
A. Mundell, a professor in economics (1966-71), was
awarded the 1999 Nobel for work in two aspects of international
trade and finance and macroeconomic theory. Although Mundell was
teaching at Columbia in 1999, it's easy to defend the claim that
his most important work was done at Chicago (his collection of
papers, International Economics, was published in 1968),
when he and colleagues Harry Johnson and Lloyd Metzler were three
of the world's most recognized experts on international trade.
work the award called his "analysis of monetary and fiscal
policy under different exchange rate regimes," he compared
stabilization policies-the use of monetary and fiscal policy to
produce full employment, no inflation, and economic growth-when
a nation's currency was fixed in value with other currencies to
stabilization policies in a country in which the currency's value
"floated" (as had been the case for most nations since
the 1970s). One conclusion: monetary policy is more important,
and fiscal policy far less important, under market-determined
currency values, a conclusion that reinforces policy conclusions
of other Chicago macroeconomists.
second part of Mundell's Nobel recognized his "analysis of
optimum currency areas," early research that extended the
logic of a national currency-all U.S. states use the same monetary
system, which reduces uncertainty and transactions costs in purchasing
goods, traveling between the states, or extending loans across
them-to the same advantages inherent in moving to a regional or
international currency. In January 2002, 12 European nations move
to precisely that concept: a common currency, the euro. (Not content
to rest there, Mundell has now proposed moving to a world currency,
presumably the U.S. dollar.)
TASTE OF CHICAGO
IN THEIR BLOOD
THE CIRCLE BE UNBROKEN