Nobel Prize, Economics A Leading Economist of the 20th Century Editor-in-Chief, Handbook of Economics Series Stanford University	September 2004
	"It may seem a little abstract, but once you can get to the logical reasons why some economies are related to each other, you can provide a basis for empirical work. As a matter of fact, my very abstract work, along with others on general equilibrium (which is the study of the interconnections of markets; how one market influences another) served as a basis for a great deal of analysis of economic fluctuations."

Could you explain to us the range and importance of your contributions to the field of Economics?
My contributions have been in several different fields. There is a certain underlying logic to economic analysis based on assumptions about how individuals behave and how they interact, especially through economic markets. So, a part of my work has been on the underlying logic of the connection.

It may seem a little abstract, but once you can get to the logical reasons for why some economies are related to each other, you can provide a basis for the empirical work. As a matter of fact, my very abstract work along with others on general equilibrium (which is the study of the interconnections of markets and how one market influences another) served as a basis for a great deal of analysis of economic fluctuations.

You won your Nobel Prize for General Equilibrium, correct?
Well, I won that for two concepts really, though somewhat dimly related to each another. The Nobel Prize stretched a little bit to try to find a common ground between the two.

One was the concept of GE (General Equilibrium) in particular and its extensions to time and uncertainty. Markets influence each other, but you have to take into account that markets today and markets for future goods are interrelated; plans made for the future depend on what you purchase today. So there are commodities which amount to claims made on the future. For example, a security is a claim on future earnings and a bond is a promise to pay in the future. More sophisticatedly, you have various kinds of arrangements where risk is shared. An obvious example is insurance policies, but there are more advanced ones than that. Even common stock is a risk-sharing enterprise; the original owners of a company can, through an IPO, share their future gains with others, though of course those future gains involve a lot of uncertainty. There are many other examples of uncertainty, which I won't go into here. GE theory is an attempt to combine all of these factors into a common framework and to show that this approach is consistent.

The other concept for which I was given the Nobel Prize started from the concept of asking the question "What do we mean when we say a policy is good? What do we mean when we say that society, as a whole is better off if we do one thing rather than another?" Like a Free Trade Agreement, or whether you cut taxes or raise taxes or whatever it may be. One point is that society is an abstraction as there are many people, and individuals are affected in different ways. This gives rise to the political differences and conflict. I was trying to restrict that problem of social choice down to its elementary parts, to show it in some way that there just cannot be any universally satisfactory system for bringing different peoples' preferences together. People have thought one scheme or another might work, but fundamentally, there's a little gap that just cannot be filled in any ordinary way, which you might be able to compromise over.

Is it possible to develop one economic model to cover all situations?
The central idea is that choices made in different situations will be inconsistent with each other. If we follow any simple rule for example, with majority voting, a way of simply putting preferences together; do you want to go with "A" or "B"? The problem is when you have different As and Bs you can get into inconsistencies when you get into the choice with majority voting. The same applies in a number of other systems that have certain reasonable properties. So this last result has had as many implications for political science as it has for economics.

I've done other things in more specialized sub branches; I've done some work on medical economics, which has had great effect. One of the most interesting ideas that go beyond medical economics is that people are dealing with each other under conditions where information differs. For instance, a professional situation such as going to a Dr., you go to see him because he knows more about a certain subject (yourself) than you do. And you trust him because he knows, which makes sense, but since he knows more than you, you can't really check on his performance. There is the same situation with your auto mechanic or your CEO. They're all in a position because they know more, but the question is how to create incentives for those who know more about a subject from slacking off, self-dealing, etc. Of course the corporate scandals were a great example of this. Somebody called this idea Asymmetric information. The concepts were introduced to the literature with medical terms and situations, but it is a very universal phenomenon that has very profound effects in the areas of finance and organizational structure. It is safe to say this has had a very profound effect on the various interests of economics over the past 40-50 yrs.

You've developed the means for studying this phenomenon empirically?
Yes, there have certainly been lots of empirical studies and it has provided a particular way of looking at it with an answer in mind, of actually answering the problems, though you will have different answers in different situations. The answer to the medical context doesn't necessarily apply to the others, and people have explored this at great length.

I've looked at a number of other things, fairly specialized levels. I was working on one particular theory about how people hold inventories. Setting forth the balancing of losses due to holding excess inventories vs. losses due to being out of stock. So, there are lots of areas where I've contributed to over the years and those contributions have started different fields.

Has much of what you've studied filtered down to average readers?
Yes, some has become fairly common property. A good amount remains the property of theorists and specialists.

Tell me more about the series of handbooks.
The general field of economics: it has really changed very greatly in the past 50 years over the post-war period. There are several factors, one of which is the availability of very high-powered theoretical methods, and high-powered empirical methods. A revolution has occurred in the methods of statistical analysis and applied economics. This was really made possible by the computer revolution, of course. So many of these statistical ideas were around but nobody could really do the calculations, even myself. I remember sitting down with a calculator and doing even the most straightforward calculations, they were very time-consuming, I can assure you. It took me about eight hours to do a calculation that might take 5 seconds today. This has allowed us not only to do things that used to take us 8 hours, but has introduced new solutions to us that we would have never imagined because they would have taken 8 years.

Secondly the data sources have improved considerably. In part that's a response, because as soon as we can do more with the data, there's a tendency to get more of it. But that is mainly a by-product of government activity, and the economic field increased so much that we just have so much more data. Economists have had an impact on the data collected and do so with regard to the analytic categories that other economists have created. So we have extremely elaborate questionnaires and surveys of things like young people and how they go through their education and about their early job experiences. You can collect data on their economic background, their family background, their social background, etc. So the sheer volume of economics is just much bigger than it was. Instead of 8 good journals, we now have 50-60 good journals to work with. And of course, that makes the need for some kind of survey all the greater, a need addressed by these handbooks.

It was possible when I was a beginning economist to read all the journals and really keep up with what was going on. You couldn't really study a subject if you wanted to, but you had a sense of all of it, anyway. Now, that's impossible. I can't even keep up with a certain specialty, much less the entire field of economics. So this has created a lot of material for handbooks and a lot of value to their use. If you want to go into a field and know a field, it helps to have somebody already in that field to survey it. The result is that the number of fields for which we want to have handbooks keeps increasing and the availability of people to do them is increasing. I imagine it will reach some sort of limit eventually, but there is just more all the time.

We find these days, for example, if you produce a handbook volume on a particular subject, it can be out of date within 8 years. I wouldn't say obsolete, but definitely out of date and time for a new volume on the same subject. There are a lot of new things, and a good deal of our product has been new editions of old handbooks.

Are we in a time where much of the activity is applied vs. theoretical?
Yes, that's the case, but everything's going on right now. One of the interesting things is how quickly new and sophisticated theoretical concepts get translated into applied work. The result is whole new set of attitudes, you see this effect take hold very quickly in fields like industrial organization, things like anti-monopoly policy, regulation (like utilities regulation) and things of that kind. There are all kinds of regulation in the world these days, such as the regulation of prices, and natural monopolies. The theory, which in this case is game theory, has had tremendous impact and ended up changing the field, resulting in proceedings before the Federal Communications Commission. They rely on sophisticated game theory models. People try to fit those models into empirical data, so I think we've had a big impact, but the fundamentals are very important, and you have got to keep on updating them. We have run into something that doesn't seem to fit the theory, and the next thing that happens is people start constructing new theoretical categories and analyses to meet these challenges.

Are you frightened at all by the acceleration you've seen in your lifetime of that cycle?
Well, not "frightened" because it's glorious and of course the natural sciences have long since seen this kind of thing. Take a field like biology for instance where nobody can know more than a tiny fraction of it. Economics is not quite in that category yet, but it does mean that you feel like you're losing your grip in the sense that it's hard to keep up with everything going on not just in other fields rather in fields close to your own. So there is a frightening element in the sense of sheer volume of material. But as a scientist, I've lived with this for a long while. And what you get now is lots of specialization with the occasional attempt at synthesis.

And this is where your handbooks come in?
Yes, exactly where handbooks like ours come in. If I happen to want to work in a related field, say labor economics, I'll have a look at the handbook covering that field. Even though I don't work in labor economics, I may find something relevant to what I'm doing.

Other researchers we've spoken with talk quite a bit about interdisciplinary studies. Are you seeing interdisciplinary trends in economics?
The problem of coordination, even within the field of economics, is becoming more difficult. We're also increasingly finding ourselves interacting with other fields. In the last 15 years or so, Psychology has come to bear on economics. There are lots of questions of cognitive errors and the like, led particularly by Daniel Kahneman, among others. These are psychologists as economists who were recognized for the Nobel Prize because there is no Nobel Prize for psychology. Anyway, the result of their work and work of others is that some of our theories based on complete rationality are undergoing significant modification.

Also, a new kind of evidence is being introduced into economics, experimentation. Experimentation has never played a significant role in economics until recently, to a great extent by force of the psychologists. I think in the field of environmental economics there is a tremendous interaction between engineers on one hand and biologists on the other. So you find economists writing on things like species diversity and what it means and how we value it. Economists and engineers collaborate on things like climate change, so we're getting into interactions on that level.

"Integrated assessment" is a term that's been used, and at a very rapid rate it has created a whole new set of interdisciplinary studies. I think Sociology is the next field where we will see interactions with economics and of course political science and economics have enjoyed tremendous cross-fertilization over the years, due largely to books like mine and by James Buchanan. The literature goes back earlier than either of us, but our books may have had a larger impact on the political scientists overall, so there's a whole field of political economy which now bridges both disciplines. Integrated assessment is a very active field with lots of people from both the political science and economics sides.

Are there any economists that you are intrigued by right now?
Yes, there are some. The greatest generation is the one that is now in their forties and fifties. Frankly, I'm not so sure of this youngest group, although maybe that's just me being a curmudgeon. The behavior economists have made a very good impact, they are the ones who have stressed the psychological impacts on economics, but the full impact has yet to be seen. How we are going to use this knowledge is still to be seen, but there is no doubt it's had an important effect on policy and even economic analysis.

I think the group having achieved the biggest feat recently are those who have been concerned with the asymmetric information story, where bargaining transactions take place between parties who have different information, and know it. People like Joseph Stiglitz, George Akerlof and Paul Milgrom (a younger person) have been great people in economics. One thing is that there has been much more work on economic institutions, that's primarily the work of the last 10 years that's been most important, in my opinion.

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This article by Joe Martis
j.p.martis@elsevier.com