The Chicago School of Economics did not arrive fully grown in 1946 and 1950 with the arrivals of Milton Friedman and Friedrich von Hayek. Strong foundations had been laid during the inter-war years by the deep-thinking Frank Knight and the analytically brilliant Jacob Viner, together with the strong (though not unequivocal) support of Paul Douglas and Henry Simons. The soil was fertile for Hayek and Friedman to carry the baton of free market economics on its second lap.
For an economist to make a real impact, in my opinion, four ingredients are necessary. The first ingredient is genius, the ability to see through the fog of a complex world and identify new insights of true significance for the discipline. The second ingredient is an understanding that economics is about economizing, and that economizing requires that economic models themselves must be economical: they must produce a lot from a little, not a little from a lot. The third ingredient is communication skills. Writing in simple clear sentences is the art of good communication. If an economist uses mathematics and econometrics as a crutch rather than as a tool, he is lost in translation, just as an attorney is lost before a jury if he has to resort to a blackboard to make his point. The fourth ingredient is relevance. Great economists do not waste their talents on the third order of smalls. They direct their energies exclusively to issues of the highest contemporary importance.
Hayek was endowed in full measure with these four ingredients, and used them well. Hayek’s early career focused on the role of knowledge and discovery in market processes and on the methodological underpinnings of Austrian economics, notably subjectivism and methodological individualism. Throughout a long career, Hayek focused attention on economics as a coordination problem, and on the role of markets as spontaneous orders that, to a greater or a lesser degree, resolve that problem of coordination, not least by signaling inconsistency among the plans of individuals and by providing incentives for the resolution of such inconsistencies. Hayek was no Utopian. He fully recognized that market economies periodically experience profound failures of coordination, that panics and recessions, even depressions do occur. He explained, better than anyone else, just how those failures occur, who and what is primarily responsible, and how the process of regeneration can and will occur in a well-functioning market economy. How much his wisdom would be missed in September 2008 by the fatal conceit of an economics profession that rushed to constructivist rationalist solutions that he had long abjured!
Friedman also was well-endowed with those four ingredients, though in a different balance. Friedman was less philosophical than Hayek, better trained in advanced economic theory and econometrics, more narrowly focused on economics, and much more aggressively brilliant in debate. In my judgment, Hayek ranks first, and Friedman second, as the two most influential economists of the second half of the twentieth century. Friedman had a wonderful sense of what was important in the debate between mercantilism and free markets. His work on the consumption function embraced the economics of Keynes while invalidating the Keynesian theory of a powerful fiscal multiplier. His reformulation of the quantity theory of money and his rigorous testing of its predictions, laid the foundations for the 1980s re-emergence of monetary policy from its long dangerous sleep throughout the Western World. His insights on flexible exchange rates provided a crucial basis for the worldwide globalization that surely followed its implementation. His influential critique of the military draft saved countless Americans from temporary enslavement by the state. Most important of all, his consistent application of high-quality price theory to an understanding of economic issues provided a beacon of light to the economics profession thus transforming the discipline world-wide.
Inevitably, the presence of two such towering intellects drew the brightest and the most ambitious young (and older)economists to Chicago like moths to the flame. Those economists, for a time, at least, inspired by what they believed to be the ‘fire of truth’, worked wonders on economics, literally forcing back the powerful divisions of progressive socialism that swamped out the US economics profession during the middle years of the century. Among these eager scholars, were Ronald Coase, Harold Demsetz, Harry Johnson, Gary Becker, Sam Peltzman, Reuben Kessel, Richard Epstein, Richard Posner and William Landes, names that are now renowned (if not always revered) for the contributions that they made to free market economic thinking.
Unfortunately, this beautiful program would not last, in fact would not long survive the departure of Milton Friedman from Chicago. Some attrition came through premature deaths, some through departures to sunnier climes, some through eventual changes in economic philosophy. Most important, however, was the fault-line that developed when Chicago faculty determined to emulate their Saltwater rivals and to substitute high technology for human capital, complex modeling for simple modeling, impressive incoherence for simple communication skills, and third order of smalls for relevance, in order to attract mathematicians to the doctoral program and to publish in journals whose editors had lost all sense of what is important and what is not. As one renowned faculty member listed above advised me just a few years ago: ’Charles, I would never have graduated through the Chicago program as it now is. I am not a world-class mathematician, and I do not emanate from the People’s Republic of China.’
When an economist substitutes technique for quality-thinking, writes in jargon rather than in good prose, directs his attention to problems where data sets exist for mining, rather than because the problems are of substantive importance, and focuses attention on making marginal contributions to a well-researched field rather than redirecting economic research through discrete innovative steps, he downgrades his impact and renders himself vulnerable to irrelevance when a crisis truly emerges. Too many Chicago economists fell for such low-hanging fruit over the past quarter century. As I shall demonstrate in tomorrow’s column, this would cost them dearly in September 2008.
Tags: chicago economics at its best, Friedrich Hayek, ingredients for success in economics, lessons unlearned, Milton Friedman, relevance of Austrian economics, relevance of good microeconomic theory, the fall from grace