Nobels that aren't, but someday could be

Willem Buiter in the Financial Times reports on Kornai's soft budget constraint as it applies to bailouts and the financial crisis

In a post a few days ago, (After subverting bank insolvency, our leaders are now about to make a mess of liquidity) , I argued that hard budget constraints were the defining characteristic of a well-functioning market economy. Many/most of the advanced industrial countries were weakening or even undermining the capacity of their financial sectors to intermediate efficiently by permitting a softening of the budget constraints of banks and other financial institutions that were deemed systemically important and/or were too politically connected to fail. I noted that the concept of the soft budget constraint (SBC) came from professor János Kornai, a great economist and a Nobel prize winner (the overlap is by no means perfect - there are type I and type II errors).

I'm rather sure that Kornai has not received a Nobel. I love his work on the soft budget constraint and I would love a world in which his kind of work (like Ostrom's), rather than the latest refinements of statistical techniques, gets Nobels in Economics. Hopefully we're moving to such a world. But we're not there yet.

Kornai gives some rather nice cautionary notes about bailouts.

One strong concern expressed more than once in discussions on the present financial crisis has been this: the interventions by the state are smuggling a bit of socialism into the capitalist economy. This is the side of the debate to which I would like to contribute, as a research economist who has spent several decades examining the socialist system from inside. My subject here is not the post-socialist region, but the rest of the world-though I look upon it with the eyes of one who has himself experienced socialism at first hand.

Back in 1968, when attempts began in my native Hungary to implant “market socialism” into the socialist economic system, the heads of state-owned enterprises were urged to increase their profits. Managers were to do well if their enterprises made money, as they would receive a share of the profits. But there was little cause for concern if the enterprise made a loss and fell into debt: in almost every such case, some kind of rescue operation was mounted. For instance, there might be a bailout funded out of the state budget, or the state-owned bank might extend extra credit, without much hope of the loan being repaid. Losses and debts were unpleasant, of course, but they were not a life-or-death matter for an enterprise.

Managers, based on their experience of repeated rescue operations, could more or less bank on their enterprise surviving. Despite all the stress on the profit motive, the incentive remained fairly weak in reality. Why bother too much about cost-cutting or innovating if there was no threat of insolvency? The financial situation of the enterprise did not place a real constraint on its spending, its borrowing or its expansion. This was the state of affairs that I called at that time a “soft budget constraint” (SBC).
...
Capitalism developed gradually out of the pre-capitalist social environment, by an organic process of growth. As capitalist forms came to dominate the economy, so the influence of business on politics increased. Socialism, on the other hand, did not seep gradually into the fabric of society in Tsarist Russia or post-World War Two China. The communist party became capable under specific historical conditions of seizing political power, taking control of the machinery of state, and then imposing the socialist economic system on society by state force. Every means was used, including merciless repression. The developmental process of the socialist system, unlike that of capitalism, began in the political quarter, not the economic.

However many bailouts there may be, however much the budget constraint may soften, there is no danger of socialism returning in that sense - which is the most important point. It is meaningless to raise that spectre in the United States, Western Europe or other developed countries, where democracy has sent down deep roots. There may be times when public discontent is stronger and more widespread than in other calmer and more prosperous periods. But only incorrigible revolutionists given to hoodwinking themselves believe such discontent can overthrow the foundations of the system. That prediction indicates a failure to understand the history of the communist system.

In other words, Hayek's mechanism in Road to Serfdom is wrong. Read the whole thing...

The importance of screening

Will Wilkinson points to a comment thread over on the Econ Job Rumours bulletin board where a bunch of folks finishing up their PhDs and looking at the job market complain about the Ostrom Nobel on grounds that she isn't an economist, that she didn't publish in the top economics journals, that her work wasn't mathy enough, that they never saw her stuff on any of their course reading lists, and that it was just a token throw to a woman. And, the occasional comment from someone claiming to be from the "demand side" warning these idiots that the market is weighing more heavily interdisciplinary work and that they might expect to be asked questions summarizing Ostrom's work when they get to the ASSA meetings.

The Ostrom Nobel of course now makes an Ostrom question a much coarser screen than it once would have been: they'll at least now have heard of her and the sensible ones will have a few canned answers prepped up.

I still like to ask candidates who their favorite economics bloggers are and what recent working paper from outside their dissertation area they've found most interesting. 'Cause why would I want a colleague who can't talk about anything beyond what he or she's currently working on? Boring....

More Ostrom

Marginal Revolution points me to Pete Boettke's excellent write-up on the Ostrom prize, who points to Steve Levitt's profoundly disappointing reaction to it. Writes Levitt:

The reaction of the economics community to Elinor Ostrom’s prize will likely be quite different. The reason? If you had done a poll of academic economists yesterday and asked who Elinor Ostrom was, or what she worked on, I doubt that more than one in five economists could have given you an answer. I personally would have failed the test. I had to look her up on Wikipedia, and even after reading the entry, I have no recollection of ever seeing or hearing her name mentioned by an economist. She is a political scientist, both by training and her career — one of the most decorated political scientists around. So the fact I have never heard of her reflects badly on me, and it also highlights just how substantial the boundaries between social science disciplines remain.

So the short answer is that the economics profession is going to hate the prize going to Ostrom even more than Republicans hated the Peace prize going to Obama. Economists want this to be an economists’ prize (after all, economists are self-interested). This award demonstrates, in a way that no previous prize has, that the prize is moving toward a Nobel in Social Science, not a Nobel in economics.

Whose work is more consistent with good economics: somebody who takes methodological individualism seriously and studies spontaneous and emergent order, or somebody whose specialty is coming up with cute instrumental variables strategies for identifying relationships where endogeneity issues otherwise make inference difficult? One's economics, the other is applied statistics. If your view of economics is applied statistics, then maybe you won't have heard of Ostrom.

The part of the economics profession that would hate a prize going to Ostrom is the part I want nothing to do with. Writes Boettke:

But Lin Ostrom is firmly seated in the mainline tradition of economic scholarship from Adam Smith and David Hume to F. A. Hayek and James Buchanan --- As Lord Acton put it: “But it is not the popular movement, but the traveling of the minds of men [and women] who sit in the seat of Adam Smith that is really serious and worthy of all attention.” So in what sense is she not an "economist" in the proper sense of the word (remember her early work was on local public economics and her more recent work was on development economics)? It is because her methods were chosen to be appropriate to the task she was pursuing. Humanly rational choice, institutional analysis, field work, and experimental design were her tools for social understanding. She did not limit her work to that of Max U notions of "choice" nor instituitonally antiseptic models of 'markets' nor one size fits all models of economic development. Instead, she has been a major contributor to public choice economics, new institutional economics, and to our understanding of polycentricity and political economy.

Ostrom and Williamson! [updated]

What a great pick! Not what I was expecting, but Seamus and Paul were partially right. Paul was thinking it would be a pure "theory of the firm" prize, and that's not it. Instead, Ostrom and Williamson share it for governance: Ostrom for governance and the commons, Williamson for governance and the firm.

I'm especially pleased that Ostrom was picked. Williamson certainly also is deserving, but there was very high probability that he'd eventually get it for some variant of a theory of the firm prize. Ostrom's work is less well known and is underappreciated. From the prize site:

Elinor Ostrom has challenged the conventional wisdom that common property is poorly managed and should be either regulated by central authorities or privatized. Based on numerous studies of user-managed fish stocks, pastures, woods, lakes, and groundwater basins, Ostrom concludes that the outcomes are, more often than not, better than predicted by standard theories. She observes that resource users frequently develop sophisticated mechanisms for decision-making and rule enforcement to handle conflicts of interest, and she characterizes the rules that promote successful outcomes.

The operation of de facto systems for governing the commons, or informal transactions more generally, typically works out much better than we'd predict.

As expected, Marginal Revolution provides useful comment.

Tullock didn't get his due, but I like this prize.

Update: The National Business Review casts this as a rebuff to mainstream economics and a victory for the behaviorists. Humbug. Ostrom's work is Hayekian, not behaviorist. The behaviorists took some of her insights to test in the lab, especially concerning the nature of reciprocity. Ostrom's work isn't about how people screw things up because of poor decision making or irrationality; it's about how folks successfully can govern their own affairs even when the blackboard treatment says they can't.

It's telling that NBR also quotes Krugman, last year's winner, as saying he wasn't familiar with her work. A Prof walking down our hallway also confessed unfamiliarity. All the more reason why it's important that she won.

Nobels

Our Department holds an esteem-only Nobel sweeps each year. Last year, my three guesses were

• Dixit/Krugman trade
• Alchian/Demsetz micro
• Tullock/Krueger rent-seeking

I was half right. But, as nobody else had Krugman even joint, I won the sweeps. This year is tougher. Last year just felt like a trade year and I had an itch that they were going to give it to Krugman.

This year, I'd expect them to stay away from macro/finance unless there were an obvious big name from 20 years ago who laid out the mechanisms explaining what's currently going on. I don't know of any.

So my picks for this year

• Weitzman/Nordhaus/Grossman (Gene) for environmental
• Alchian/Demsetz micro
• Tullock/Krueger rent-seeking

Yeah, the first one is a bit of a cheat since they'll only award to two. But I'd reckon decent odds on an environmental pick in a year where economists are otherwise taking a beating. Last one is always my dark horse. Odds are slim to none, but Tullock very much deserves it. I haven't put any money on it over at InTrade -- no liquidity over there, and it isn't exactly the kind of market where we expect prediction markets to do well.

In other Nobel news, fun reactions to the Obama Peace Prize:
Pro:

• Gans

  Basically, the Nobel Prize Committee are awarding the US people for their choice and what it means. In terms of symbolic moves, that seems pretty appropriate even if it is not what we usually expect.



• Kevin Grier

  Here's Kevin Grier wondering whether an Obama prize will make it harder for Obama to pursue an aggressive foreign policy. Maybe we aren't giving the prize committee enough credit: maybe they aren't giving him a medal to wear, but an albatross. Are they hoping that this will render politically unsaleable a lot of possible foreign policy options that would be unbecoming of a Nobel Peace Prize winner?

Con:

• Mankiw (seriously hilarious)

  The surprise choice of first-year graduate student Quintus Pfuffnick for the Nobel Prize in Economics drew praise from much of the world Friday even as many pointed out the youthful economist has not yet published anything in scholarly journals.



• Fafblog

  n other news, the Nobel Prize for Literature was awarded to a man who set fire to a library and then promised to write a book about it.



• Cheryl Cline

  I, unlike many others, did not come to the mistaken conclusion that it was merely an Onion story.



• Art Carden

  ...is hoping that Kanye attends the Nobel awards ceremony.



• Patri Friedman

  It's so ridiculous and ludicrous that it seems like something that would be done as a parody by The Onion, or by the anti-Obama people who point out (with some truth, I think) that he is an empty vessel of empty words that people project their own hopes onto. His policies since entering office have been more of the same old same old - warmongering, anti-civil liberties, plus a dash of expanded federal spending and power.

...And the nays have it.

Update: I've seen a few folks calling a Fama/French/Thaler prize for behavioral finance. But Kahneman got it with Smith in '02, so it might be tough for Thaler to still be in the running. I'd still expect them to steer clear of finance this year, and especially efficient markets folks. Hey, I'd think it very cool if they decided to go with an EMH prize to Fama this year of all years, and Fama is odds-on in some markets. I'd still be surprised.