The Magazine


May 17, 1999, Vol. 4, No. 33 • By DAVID M. SMICK
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WANT TO MAKE ECONOMISTS REALLY SQUIRM? Tell them that Federal Reserve chairman Alan Greenspan should receive the next Nobel Prize for economics. It's not that the extraordinarily successful Fed chairman isn't highly respected within the field. It's just that a prize for Greenspan, based on policy achievement, would threaten the Nobel tradition of rewarding academic theory, practical results be damned.

Remember, a prize for economics was not among those awarded by the original Nobel Foundation, set up after Alfred Nobel's death at the turn of the century. The economics prize arrived on the scene in 1969, financed by the Bank of Sweden. Nominations are based on recommendations from a hodgepodge of Scandinavian professors, past prize winners, and others. To say that the prize has seen its share of political controversy is an understatement. No doubt there has sometimes been ideological bias (after years of delay, Milton Friedman was only reluctantly awarded the prize in 1976). A geographical quota system also certainly exists. Often the judges play favorites, with a strong does of Scandinavian provincialism mixed in.

Through all the controversy, though, the prize has been tied purely to academic research, regardless of results. The Nobel judges have sought to "distinguish between economics and economic policy," as 1985 winner Franco Modigliani of MIT has written. But why? Shouldn't the practical application of economic theory carry significant weight? Results are certainly considered in awarding the prizes for scientific achievement. Indeed, it's hard to conceive of a Nobel Prize in science being awarded for a theory that doesn't work or, worse, that might actually be harmful to humanity. Why not include such considerations in the deliberations over the economics prize?

The issue, ultimately, is one that economists have long disputed among themselves: whether their discipline is a science or more a form of art, the art of political economy. This is an important distinction, particularly in our era of huge financial markets and heightened risk. Late last summer, the Wall Street hedge fund Long-Term Capital Management nearly sank the entire world financial system using a method of pricing options formulated with the help of 1997 Nobel economic prize winner Myron Scholes. Deploying hundreds of billions of dollars of borrowed money, the firm tried to predict global financial markets with the precision of scientific theory. The result was an unmitigated disaster that might well have had severe consequences for the global economy had the Federal Reserve, under Alan Greenspan's leadership, not quickly stepped in.

The question can thus be posed starkly: In the pantheon of economics, shouldn't a man who saves the world financial system rank with one who makes a fundamental discovery in the field? As Fed chairman, Greenspan has been the very model of a practical man, immersed in the art of economics. He has turned U.S. monetary policy-making away from simple rules and toward a kind of enlightened discretion. He has leavened theory with a large dash of humility.

There is a lot to be said for a bit of humility in public policy, for not being overly confident about the reliability of theory. After all, Greenspan has presided over a period in which virtually the entire academic and financial communities have been wrong about inflation, wrong about unemployment, and wrong about the relationship between inflation and unemployment. Had the Fed chairman followed the theorists, the U.S. economy would have been crunched long ago, and maybe even the world economic system as well. Instead, Greenspan has shown an admirable willingness to sacrifice theory (sometimes his own) to maintain economic stability. From his years at the Fed, no theoretical prettiness can be discerned -- no nice, neat model that captures how the world works, the kind Nobel judges get so excited about but that too often ends up failing in practice.

It would seem a fitting change for the new millennium to make results matter more in awarding the economics profession's most prestigious prize. And if Alan Greenspan is not this year the most fitting recipient, then who is?

David M. Smick is the founder of Johnson Smick International and editor and publisher of the International Economy Magazine.