A long Nobel line

Congratulations to Elinor Ostrom and Oliver Williamson for winning the pseudo-Nobel Prize in Economics. Ostrom (a political scientist by trade) studies cooperative management of resources (which is one way to manage public goods and exernalities without the aid of a government), and Williamson studies the internal decision-making processes of firms.

This was a big surprise to all those who thought the prize would go to Eugene Fama, who was favored to win at an astounding 2/1 odds in prediction markets. Fama, of course, is known for the Efficient Markets Hypothesis and the now-discredited Capital Asset Pricing Model, as well as other asset-pricing models. Other favorites included Fama's co-author French, as well as Robert Barro, one of the biggest critics of fiscal stimulus spending.

Some, of course, will interpret the decision as a direct political snub to Fama and French (who look pretty silly arguing that last year's crash was a result of "efficient markets") and to Barro (who looks pretty silly arguing that Obama's stimulus had no effect on the economy). Felix Salmon, ever the voice of reason, points out that this isn't necessarily the case - because economics is such a broad field, it's always pretty likely that the winner will be a dark-horse. This, he says, is the "long tail" in action.

But although Salmon is right, he might be missing a more subtle implication of this year's prize. Yes, economics is a diverse field, but even so, the kind of work done by Ostrom and Williamson is not in any of the big shots' definitions of the mainstream. Work on the internal institutions of the firm, for example, has been out of fashion for many decades. The fact that this kind of work is getting recognized, even as many of the founding fathers of neoclassical econ (Fama, Barro, Cochrane, etc.) have yet to receive "their" prizes, means that the "long tail" is getting longer.

Neoclassical economists - the kind of people who argue that people form rational expectations, markets price assets correctly, and recessions are just the economy's optimal response to bad news - have long promoted their outlook as a canon that forms the core of econ, much as Newtonian, relativistic, and quantum mechanics form the core of physics. To the neoclassical crowd, ideas like Rational Expectations and the Efficient Markets Hypothesis (EMH) are as basic, fundamental, and well-established as Newton's Laws.

The problem is, that's a load of BS. Newton's laws are proven and re-proven in a thousand high school physics classes; not one shred of evidence has been found in support of Rational Expectations or the EMH, or RBC models or whatever. The foundations of the neoclassical paradigm are not laws, they are assumptions. The whole thing was, as Richard Feynman would put it, a bit of "Cargo Cult Science."

And yet the neoclassical guys routinely expect us - the rest of the econ world, along with undergrad econ majors and the general public - to believe that their particular set of assumptions forms the indelible core of the discipline, the foundation upon which others must build. I won't go into how and why they've largely succeeded (as illustrated by the prizes given to Robert Lucas and Edward Prescott), but what is apparent is that their whole edifice is starting to crumble. It is becoming increasingly apparent to everyone involved that neoclassical econ, as often as not, is a shackle that prevents us from coming up with accurate descriptions of economic phenomena, from market crashes to unemployment to the very real and obvious effect of stimulus spending.

And so Fama, Barro, and company suddenly find themselves smaller fish in a much much larger pond. Although econ is still not a rigorous science - and the pseudo-Nobel still doesn't require theories to be tested in order to win the prize - at least the neoclassicists are now forced to compete with people who don't accept their premises. That is a start. Instead of counting time until their "canonical" work is feted with inevitable recognition, Fama, Barro, and the rest will have to stand around in the same line as everybody else.