The Economics Nobel

Goes to Chris Simms and Tom Sargent. From the Nobel announcement:

The art of distinguishing between cause and effect in the macroeconomy

How are GDP and inflation affected by a temporary increase in the interest rate or a tax cut? What happens if a central bank makes a permanent change in its inflation target or a government modifies its objective for budgetary balance? This year’s Laureates in economic sciences, Thomas J. Sargent and Christopher A. Sims, have developed methods for answering these and many other questions regarding the causal relationship between economic policy and different macroeconomic variables such as GDP, inflation, employment and investments.

The economy is constantly affected by unanticipated events. The price of oil rises unexpectedly, the cen- tral bank sets an interest rate unforeseen by borrowers and lenders, or household consumption suddenly declines. Such unexpected occurrences are usually called shocks. The economy is also affected by more long- run changes, such as a shift in monetary policy towards stricter disinflationary measures or fiscal policy with more stringent budget rules. One of the main tasks of macroeconomic research is to comprehend how both shocks and systematic policy shifts affect macroeconomic variables in the short and long run. Sargent’s and Sims’s awarded research contributions have been indispensable to this work. Sargent has pri- marily helped us understand the effects of systematic policy shifts, while Sims has focused on how shocks spread throughout the economy.

Being primarily a microeconomist I don't regularly interact with their work. However, I learned the technique of overlapping generations in dynamic models (which I still use all the time) from Sargent's book, and in my limited time-series econometrics training, Sims' vector autoregression was probably the most important and useful tool.

And there is already a lot of fighting about whether this is a freshwater (rational expectations - Chicago and Minnesota) or a saltwater (new Keynesian - Cambridge and Berkeley) prize.  I think it is explicitly neither. Neither of the economists was wedded to a particular camp and what might distinguish them is a search for truth without philosophy.  Perhaps this is the message the Nobel committee is sending.

Nobels: Young and Old

I realized my view of the Nobel prizes has been biased by the Economics Nobel (yes, I know, not really a Nobel) which is generally given to an economist well into his or her august years.  Perhaps it is a function of our quasi-science (pseudo-science?; quackery?) that it takes a long time to develop a body of research that means anything truly useful.  So when I saw the face of physics Nobel laureate Adam Reiss my immediate thought was of how young he looked and, in fact is: he is 41.

So it got me thinking about how young the youngest Nobel laureate of all time was and what are the average ages for the prizes.  And wouldn't you know but the Nobel organization themselves has a handy se of tables for such things.

Here are the youngest ever:

Here are the oldest ever:

It looks like physicists are well represented among the youngest, while the geezers are from all over.  But my impression of economics is basically correct, the youngest ever is 51 and it also has the oldest laureate (which I guess means that economists lead long lives):  

Two things come to mind in looking at this: one is the old adage in math that mathematicians are essentially washed up by 35; and the other is that as the economics prize is relatively young, it has been playing catch-up - trying to award the big contributors before they croak and become ineligible.  The really youngest on the list are the physicists from the golden age of physics - what a great time it must have been! Notice how among the oldest are physicists who won the prize in the 21st century.  The truly big discoveries in physics are bloody hard now and take a lifetime perhaps.

Why you should find this interesting is beyond me but I am tired of writing about how bad the world economy is tanking....

The Economics Nobel

The 2010 Nobel Memorial Prize in Economic Science (not a real Nobel! - there are you haters satisfied) went to three economists for their work in labor markets and their frictions.

I have actually referenced this work recently (unbeknownst to my readers) in my post on tip credits.  Many bloggers and reporters are explaining the work and what it means and each person will have their own unique take on it, so here I will give you mine.

Standard textbook models of labor markets assume no frictions and complete information.  Everyone knows everything about everything and therefore hiring the right person for the job is a snap.  In fact 101 level models have a labor supply curve and a labor demand curve and thus assume homogeneous workers and jobs.  This might be (and probably is) a good starting point but of course the real world is a lot different.  People possess unique skills and qualities and jobs require unique skills and qualities but finding the right match in a job search process on either the worker or the employer side is a challenge. This can lead to delays in filling jobs and in finding jobs.  We had understood such frictions in principle for eons and thus would talk of 'natural rates of unemployment' without really understanding the process or the implications.

The theoretical challenges were hard, you had to work in a dynamic environment with heterogenous agents and probabilities of matches.  Thankfully methods from macroeconomics provided a starting point, but there was a lot of heavy lifting to be done.  Now we have a much better understanding of the type of frictions that exist in job markets and what happens in things like recessions.

It is also a framework through which we can assess things like the effect of minimum wages on employment (which is where my reference to the work entered in my tip credit post).  101 level textbooks just model a wage floor and resulting unemployment - but search models suggest that things like if minimum wages increases the tenure of workers, this can cut down on costly search activities in markets and leave us better off.

It is no accident that they were awarded the Nobel this year when unemployment is on the top of everyone's mind, but this is Nobel quality work regardless.

Kudos.

NB: Here is Ed Glaeser's write-up - the best I have seen so far.

The Economics Nobel

Just two quick things to say about the Nobel Prize to Elinor Ostrom and Oliver Williamson (okay, okay, The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel):

One, I had never heard of Ostrom before and her inclusion (she is a political scientist) is further evidence of the economics prize slowly morphing into more of a social science prize. Many have figured it would undergo such a transformation given that it has caught up pretty well with all of the old stuff and either has to become very contemporary or more broad.

Two, any modern economist is very familiar with Williamson's work as it is fully entrenched part of the canonical PhD curriculum - especially if you study industrial organization as I did. His work explored the black box of 'the firm' which prior to his work was simple an entity that too inputs and transformed them into outputs. But what are the internal incentives of the firm? What are the principal-agent problems of firms? Where do firms stop and why? (Or to put this last one in clearer terms - why do firms exist at all, why don't they just contract with private individuals?)

Perhaps the heart of the work is in institutional decision making in the absence of markets (or in the presence of institutionally created markets). This is very timely, as the internal incentives of Wall Street firms were seriously skewed and are largely responsible for the collapse of worldwide credit markets that set of the current crisis. These incentive problems need to be addressed institutionally through a renewed set of modern regulations and the place to start thinking about these issues economically and politically is with Ostrom's and Williamson's work.

Beeronomics: Krugman, the Nobel Prize and Beervana

So this blog post has been brewing in my head for a while now (rim-shot please), but now that Paul Krugman is in Sweden to collect his much-deserved Nobel, let's think about how his ideas explain Beervana.

[From Paul's NY Times page: The marquee for his talk at the Bagdad - Paul , Beer, Oregon - get it?]

Paul's most influential insights came from the idea that there may be increasing returns in trade. When applied to trade this insight helped explain why we see two-way trade in things like cars and was the principle reason he won the Nobel. But this insight quickly spilled over into other areas as well - for example, why is Silicon Valley still the center for high tech industry given that it is perhaps the most expensive place on earth to do business? Paul's answer has a lot to do with heads starts and learning curves: It may be cheaper to move Silicon Valley to Bangalore if you could do it overnight, but you can't - it takes time to build up the knowledge base and skilled work force and while that is happening, Silicon Valley can compete the nascent Bangalore away. This helps explain that while Bangalore has been able to chip away a little bit at Silicon Valley's dominance it hasn't done that much. This story is half trade and half economic geography. Economic geography talks about increasing returns that come from concentration: part of why Silicon Valley is so successful is because of the close connection inventors, entrepreneurs and venture capitalists have by virtue of being neighbors and part is the concentration of skilled workers to populate the firms.

So what does this have to do with Beervana - Portland (and Oregon's) disproportionate number of breweries and beer drinking? Well the same stories about Silicon Valley can be told here: brewing and beer drinking are both learning processes and ones that benefit from concentration. Brewing takes skill and practice and a there are a lot of knowledge spill-overs that comes from brewers talking and sampling each others products. Beer drinkers have to learn about the ingredients, how they taste and develop a palate and taste for the more robustly flavored beers. So the punchline is you tend to have concentration rather than dispersion and that places that get early starts tend to hold onto that advantage - familiar themes from Paul's work.

So really, beer drinkers of Oregon, this Nobel's all about you! Let's toast to that...

By the way, just to complete the circle - Beervana blogger Jeff Alworth left a comment on the same Krugman blog page that includes the picture above.

Krugman Wins Nobel

I am often asked by my non-economist friends (yes, I do have some) what I think about New York Times columnist Paul Krugman.  They know him only as a sometimes acerbic left-of-center political commentator that occasionally veers off into partisan rants. [Though he would defend himself by saying that stuff that he was accused of engaging in hyperbole about early on in the Bush administration has proven to be essentially correct] Usually they want to know what kind of economist he is - especially since his column is now only occasionally about economics.

What I have always said is that Krugman is a lock to win a Nobel Prize - he is that good an economist.  I did think it was going to be another decade or two before he won it, the Nobel is not awarded posthumously so they tend to try and make sure that the old folks get it before they perish (but they are now catching up and the winners are getting younger).  As a trade theorist, Krugman made perhaps the most significant contributions of the second half of the 20th century.  He showed how increasing returns to scale could provide a rationale for trade and helped explain the trade patterns seen in the real world.  The simple example is this: old style trade theory (Ricardo and Heckscher-Ohlin) shows how comparative advantage (through either natural productivity advantage - Ricardo - or through differences in natural endowments - HO) can cause some goods to flow from country A to country B and other goods to flow from county B to country A.  This is all correct and immensely powerful - it still provides the basic rationale for trade, that everyone can benefit through efficient allocation of production.  But these theories fail to explain why we see cars from Germany shipped to the US and US cars shipped to Germany, for example, nor do they explain why so much production occurs in so few countries.  Krugman, by applying insights from industrial organization (or essentially, the study of firm behavior) developed theories that explained these patterns of trade.  Economies of scale and product differentiation when applied to trade go a long way to explain these patterns. Krugman made the first major contributions to this theory and figured out how to do it in a tractable way theoretically.  

What is especially beautiful about his work, and what has echoes in his popular writing, is how simple and elegant his models are - something I strive for in my work.  In the modern era, where a lot of credit is given for elaborate mathematical tricks in models (economics training is highly mathematical these days) it is rare to see such elegance.  And herein lies the essence of Paul Krugman - a man with extraordinary economic insight that is able to translate that insight simply and plainly.  I think this is a prize that is richly deserved and I am delighted to see him win it.  This has nothing to do with Krugman the political commentator and one always wonders how much politics comes into play with the Nobel committee's decisions.  Krugman was going to win the Nobel anyway, but I thought he would win it with others and in another ten years.  On the eve of the US election, is it coincidence that one of the highest profile leftist commentators in America gets the Nobel?  I wonder....