Chicago school of economics
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The Chicago school of economics is a neoclassical school of economic thought associated with the work of the faculty at the University of Chicago, some of whom have constructed and popularized its principles.
In the context of macroeconomics, it is connected to the freshwater school of macroeconomics, in contrast to the saltwater school based in coastal universities (notably Harvard, MIT, and Berkeley). Chicago macroeconomic theory rejected Keynesianism in favor of monetarism until the mid-1970s, when it turned to new classical macroeconomics heavily based on the concept of rational expectations. The freshwater-saltwater distinction is largely antiquated today, as the two traditions have heavily incorporated ideas from each other. Specifically, New Keynesian economics was developed as a response to new classical economics, electing to incorporate the insight of rational expectations without giving up the traditional Keynesian focus on imperfect competition and sticky wages.
Chicago economists have also left their intellectual influence in other fields, notably in pioneering public choice theory and law and economics, which have led to revolutionary changes in the study of political science and law. Other economists affiliated with Chicago have made their impact in fields as diverse as social economics and economic history. Thus, there is not a clear delineation of the Chicago school of economics, a term that is more commonly used in the popular media than in academic circles. Nonetheless, Kaufman (2010) says that the School can be generally characterized by:
A deep commitment to rigorous scholarship and open academic debate, an uncompromising belief in the usefulness and insight of neoclassical price theory, and a normative position that favors and promotes economic liberalism and free markets.
The University of Chicago Economics department, considered one of the world's foremost economics departments, has fielded more Nobel Prizes laureates and John Bates Clark medalists in economics than any other university.
The term was coined in the 1950s to refer to economists teaching in the Economics Department at the University of Chicago, and closely related academic areas at the University such as the Booth School of Business and the Law School. They met together in frequent intense discussions that helped set a group outlook on economic issues, based on price theory. The 1950s saw the height of popularity of the Keynesian school of economics, so the members of the University of Chicago were considered outside the mainstream.
Besides what is popularly known as the "Chicago school", there is also an "Old Chicago" school of economics, consisting of an earlier generation of economists such as Frank Knight, Henry Simons, Paul Douglas and others. Nonetheless, these scholars had an important influence on the thought of Milton Friedman and George Stigler, most notably in the development of price theory and transaction cost economics. However, their relationship to the modern macroeconomists (the third wave of Chicago economics), led by Robert Lucas, Jr. and Eugene Fama, is more blurred.
Gary Becker (1930–2014) was a Nobel Prize-winner from 1992 and was known in his work for applying economic methods of thinking to other fields, such as crime, sexual relationships, slavery and drugs, assuming that people act rationally. His work was originally focused in labor economics. His work partly inspired the popular economics book Freakonomics.
Ronald Coase (1910–2013) was the most prominent economic analyst of law and the 1991 Nobel Prize-winner. His first major article, "The Nature of the Firm" (1937), argued that the reason for the existence of firms (companies, partnerships, etc.) is the existence of transaction costs. Rational individuals trade through bilateral contracts on open markets until the costs of transactions mean that using corporations to produce things is more cost-effective.
His second major article, "The Problem of Social Cost" (1960), argued that if we lived in a world without transaction costs, people would bargain with one another to create the same allocation of resources, regardless of the way a court might rule in property disputes. Coase used the example of an 1879 London legal case about nuisance named Sturges v Bridgman, in which a noisy sweetmaker and a quiet doctor were neighbours; the doctor went to court seeking an injunction against the noise produced by the sweetmaker. Coase said that regardless of whether the judge ruled that the sweetmaker had to stop using his machinery, or that the doctor had to put up with it, they could strike a mutually beneficial bargain that reaches the same outcome of resource distribution. Only the existence of transaction costs may prevent this.
So, the law ought to pre-empt what would happen, and be guided by the most efficient solution. The idea is that law and regulation are not as important or effective at helping people as lawyers and government planners believe. Coase and others like him wanted a change of approach, to put the burden of proof for positive effects on a government that was intervening in the market, by analysing the costs of action.
Eugene Fama (born 1939) is an American economist who won the Nobel Prize in Economics in 2013 with Lars Peter Hansen and Robert Shiller for their work on asset pricing. He has spent all of his teaching career at the University of Chicago and is well known as the father of the efficient-market hypothesis. Starting with his 1965 Ph.D. thesis, "The Behavior of Stock Market Prices", Fama concluded that stock prices are unpredictable and follow a random walk pattern of movement. He solidified this idea in his 1970 article, "Efficient Capital Markets: A Review of Theory and Empirical Work", which brought the idea of efficient markets into the forefront of modern economic theory.
Robert Fogel (1926–2013), a co-winner of the Nobel Prize in 1993, is well known for his historical analysis and his introduction of New economic history, and invention of cliometrics, a notation system for quantitative data. In his tract, Railroads and American Economic Growth: Essays in Econometric History, Fogel set out to rebut comprehensively the idea that railroads contributed to economic growth in the 19th century. Later, in Time on the Cross: The Economics of American Negro Slavery, he argued that slaves in the Southern states of America had a higher standard of living than the industrial proletariat of the Northern states before the American civil war. Fogel believes that slavery was morally wrong, but argues that it was not necessarily less efficient than wage-labour.
Milton Friedman (1912–2006) stands as one of the most influential economists of the late twentieth century. A student of Frank Knight, he won the Nobel Prize in Economics in 1976 for, among other things, A Monetary History of the United States (1963). Friedman argued that the Great Depression had been caused by the Federal Reserve's policies through the 1920s, and worsened in the 1930s. Friedman argued that laissez-faire government policy is more desirable than government intervention in the economy.
One of the great mistakes is to judge policies and programs by their intentions rather than their results.—Milton Friedman Interview with Richard Heffner on The Open Mind (7 December 1975)
Governments should aim for a neutral monetary policy oriented toward long-run economic growth, by gradual expansion of the money supply. He advocated the quantity theory of money, that general prices are determined by money. Therefore active monetary (e.g. easy credit) or fiscal (e.g. tax and spend) policy can have unintended negative effects. In Capitalism and Freedom (1967) Friedman wrote:
There is likely to be a lag between the need for action and government recognition of the need; a further lag between recognition of the need for action and the taking of action; and a still further lag between the action and its effects.
The slogan that "money matters" has come to be associated with Friedman, but Friedman had also leveled harsh criticism of his ideological opponents. Referring to Thorstein Veblen's assertion that economics unrealistically models people as "lightning calculator[s] of pleasure and pain", Friedman wrote:
Criticism of this type is largely beside the point unless supplemented by evidence that a hypothesis differing in one or another of these respects from the theory being criticized yields better predictions for as wide a range of phenomena.
Lars Peter Hansen
Lars Peter Hansen (born 1952) is an American economist who won the Nobel Prize in Economics in 2013 with Eugene Fama and Robert Shiller for their work on asset pricing. Hansen began teaching at the University of Chicago in 1981 and is the David Rockefeller Distinguished Service Professor of economics at the University of Chicago. Although best known for his work on the Generalized Method of Moments, he is also a distinguished macroeconomist, focusing on the linkages between the financial and real sectors of the economy.
Frank Knight (1885–1972) was an early member of the University of Chicago department. His most influential work was Risk, Uncertainty and Profit (1921) from which the term Knightian uncertainty was coined. Knight's perspective was iconoclastic, and markedly different from later Chicago school thinkers. He believed that while the free market could be inefficient, government programs were even less efficient. He drew from other economic schools of thought such as institutional economics to form his own nuanced perspective.
Robert E. Lucas
Robert Lucas (born 1937), who won the Nobel Prize in 1995, has dedicated his life to unwinding Keynesianism. His major contribution is the argument that macroeconomics should not be seen as a separate mode of thought from microeconomics, and that analysis in both should be built on the same foundations. Lucas's works cover several topics in macroeconomics, included economic growth, asset pricing, and monetary Economics.
Richard Posner (born 1939) is known primarily for his work in law and economics, though Robert Solow describes Posner's grasp of certain economic ideas as "in some respects,... precarious". A federal appellate judge rather than an economist, Posner's main work, Economic Analysis of Law attempts to apply rational choice models to areas of law. He has chapters on tort, contract, corporations, labor law, but also criminal law, discrimination and family law. Posner goes so far as to say that:
[the central] meaning of justice, perhaps the most common is – efficiency… [because] in a world of scarce resources waste should be regarded as immoral.
George Stigler (1911–1991) was tutored for his thesis by Frank Knight and won the Nobel Prize in Economics in 1982. He is best known for developing the Economic Theory of Regulation, also known as regulatory capture, which says that interest groups and other political participants will use the regulatory and coercive powers of government to shape laws and regulations in a way that is beneficial to them. This theory is an important component of the Public Choice field of economics. He also carried out extensive research into the history of economic thought. His 1962 article "Information in the Labor Market" developed the theory of search unemployment.
Some claim that Chicago School economists are associated with Washington Consensus, which John Williamson says is "disappointing". A significant body of economists and policy-makers argues that what was wrong with the Washington Consensus as originally formulated by Williamson had less to do with what was included than with what was missing.
Economists overwhelmingly agree that the Washington Consensus was incomplete, and that countries in Latin America and elsewhere need to move beyond "first generation" macroeconomic and trade reforms to a stronger focus on productivity-boosting reforms and direct programs to support the poor.
Paul Douglas, who returned to teach economics at the University of Chicago after his military service in WW II, and in 1947 was elected president of the American Economic Association, was uncomfortable with the environment he found at the university. He stated that,” . . . I was disconcerted to find that the economic and political conservatives had acquired almost complete dominance over my department and taught that market decisions were always right and profit values the supreme ones . . . The opinions of my colleagues would have confined government to the eighteenth-century functions of justice, police, and arms, which I thought had been insufficient even for that time and were certainly so for ours. These men would neither use statistical data to develop economic theory nor accept critical analysis of the economic system . . . (Frank) Knight was now openly hostile, and his disciples seemed to be everywhere. If I stayed, it would be in an unfriendly environment.”
The Chicago school's methodology has historically produced conclusions that favor free market policies and little government intervention (albeit within a strict, government-defined monetary regime). These policies came under attack in the wake of the financial crisis of 2007–2010. The school has been blamed for growing income inequality in the United States.
Economist Brad DeLong of the University of California, Berkeley says the Chicago School has experienced an "intellectual collapse", while Nobel laureate Paul Krugman of Princeton University, says that recent comments from Chicago school economists are "the product of a Dark Age of macroeconomics in which hard-won knowledge has been forgotten." Critics have also charged that the school's belief in human rationality contributed to bubbles such as the recent financial crisis, and that the school's trust in markets to self-regulate has offered no aid to the economy in the wake of the crisis.
In response, Chicago economists such as James Heckman have conceded that there were excesses in the use of Chicago school theory by politicians and public commentators, but that this represented a small fraction of the contributions of Chicago school economics. In particular, Heckman points out that the alleged failures or misapplications of efficient-market hypothesis is a fault of Chicago's contributions to financial economics, which are conceptually distinct from its widely praised contributions to microeconomics and macroeconomics.
- Bruce Kaufman in Ross B. Emmett, ed. The Elgar Companion to the Chicago School of Economics (2010) p. 133
- Sturges v. Bridgman (1879) 11 Ch D 852
- Coase (1960) IV, 7
- Coase (1960) V, 9
- Coase (1960) VIII, 23
- Fogel, Robert (December 1966). The New Economic History. Its Findings and Methods. Economic History Society. JSTOR 2593168. "The 'new economic history', sometimes called economic history or cliometrics, is not often practiced in Europe. However, it is fair to say that efforts to apply statistical and mathematical models currently occupy the centre of the stage in American economic history."
- Friedman (1967) p.
- Friedman (1953) I,V,30
- Solow, Robert M. (2009). "How to Understand the Disaster". The New York Review of Books 56 (8). Retrieved 31 August 2012.
- Richard Posner, Economic Analysis of Law (1998) p. 30
- "The Theory of Economic Regulation." (1971) Bell Journal of Economics and Management Science, no. 3, pp. 3–18.
- See also, "The Economics of Information," (1961) Journal of Political Economy, June. (JSTOR)
- Sivalingam, G. (2005). Competition Policy in the ASEAN Countries. Cengage Learning Asia. p. 6. ISBN 978-981-254-964-8.
- Palley T. (2008). Breaking the Neoclassical Monopoly in Economics. Project Syndicate.
- Williamson J. (2002). Did the Washington Consensus Fail?
- See, as examples representative of a much more extensive literature, e.g., Birdsall and de la Torre. "Washington Contentious" (2003); Kuczynski and Williamson (eds.), "After the Washington Consensus" (2003).
- See, e.g., Birdsall and de la Torre, "Washington Contentious" (2003); de Ferranti and Ody, "Key Economic and Social Challenges for Latin America" (2006): http://www.brookings.edu/views/papers/20060803.pdf
- Paul H. Douglas, In the Fulness of Time, 1972, p. 127-128
- "How Did Economists Get It So Wrong?". The New York Times. 2009-09-06. Retrieved 2010-04-28.
- "The other-worldly philosophers". The Economist. 2009-07-16.
- Emmett, Ross B., ed. The Elgar Companion to the Chicago School of Economics (Edward Elgar, 2010), 350 pp.; ISBN 978-1-84064-874-4
- Emmett, Ross B. (2008). "Chicago School (new perspectives)," The New Palgrave Dictionary of Economics, 2nd Edition. Abstract.
- Friedman, Milton; Friedman, Rose (1998). Two Lucky People: Memoirs. Chicago: University of Chicago Press. ISBN 0-226-26414-9.
- Hammond, J. Daniel; Hammond, Claire H. (2006). Making Chicago Price Theory: Friedman-Stigler Correspondence, 1945–1957. London: Routledge. ISBN 0-415-70078-7.
- Hovenkamp, Herbert (1985). "Antitrust Policy after Chicago". Michigan Law Review (Michigan Law Review, Vol. 84, No. 2) 84 (2): 213–284. doi:10.2307/1289065. JSTOR 1289065.
- Kasper, Sherryl (2002). The Revival of Laissez-Faire in American Macroeconomic Theory: A Case Study of Its Pioneers. Cheltenham: Edward Elgar. ISBN 1-84064-606-3.
- Miller, H. Laurence, Jr. (1962). "On the 'Chicago School of Economics'". The Journal of Political Economy 70 (1): 64–69. doi:10.1086/258588.
- Nelson, Robert H. (2001). Economics As Religion: From Samuelson to Chicago and Beyond. University Park, PA: Pennsylvania State Univ. Press. ISBN 0-271-02095-4.
- Reder, Melvin W. (1982). "Chicago Economics: Permanence and Change". Journal of Economic Literature 20 (1): 1–38. Reprinted in John Cunningham Wood & R.N. Woods (1990), Milton Friedman: Critical Assessments, pp. 343–393.
- Stigler, George J. (1988). Chicago Studies in Political Economy. Chicago: University of Chicago Press. ISBN 0-226-77437-6.
- Stigler, George J. (1988). Memoirs of an Unregulated Economist. New York: Basic Books. ISBN 0-465-04443-3. Description & preview.
- Valdes, Juan Gabriel (2008): Pinochet's Economists: The Chicago School of Economics in Chile (Historical Perspectives on Modern Economics), Cambridge University Press, ISBN 0-521-06440-6
- Wahid, Abu N. M. (2002). Frontiers of Economics: Nobel Laureates of the Twentieth Century. Westport, CT: Greenwood Press. ISBN 0-313-32073-X.
- Thomas Sowell
- The University of Chicago Department of Economics
- Commanding Heights, PBS Documentary, Chicago Against the Tide
- Essay on the Chicago School, the financial crisis, and wishful thinking