Presentation Speech by Professor Lars Werin of the Royal Academy of Sciences
Translation from the Swedish text
Your Majesties, Your Royal Highnesses, Ladies and Gentlemen,
Every science is a mixture of tradition and change. In the science of economics, tradition is represented by the basic theory of markets and price formation which originated over 200 years ago with Adam Smith and has then been successively refined. It is based on simple, even crude, assumptions about the behavior of individuals, households and firms when they seek employment, produce, buy and sell. Nevertheless, for generation after generation of economists this theory has demonstrated its power to explain and predict the essential features of market processes.
However, as economic life has become increasingly complex, ever more phenomena remained unexplained. Some market phenomena even seemed to be at variance with the theory. The fact that the market mechanism became increasingly intertwined with legislation remained entirely outside the theory. It is for his contributions to reintegrating basic theory with the actual market processes, and for clarifying the role of economic legislation that George Stigler has been awarded this year’s Nobel Memorial Prize in Economic Sciences.
Stigler has carried out his research program in a long series of studies. He has built bridges between theory and facts in one area after another, resolving seeming contradictions between them. In most cases, contradictions disappear if households’ and firms’ costs of obtaining information on market opportunities and adjusting to them are integrated into the theory along with the more tangible production and transportation costs which have always been included in it. The basic properties of the traditional theory thereby remain intact. But the theory proved to be too schematic in its disregard for adjustment phenomena – in much the same way as a vacuum is sometimes assumed in physics.
In one of his studies, Stigler showed how costs of searching for and disseminating information about prices, qualities of goods and purchase opportunities imply that buyers normally neither can, nor want to be fully informed. Lack of information results in price rigidity, price and quality differences, waiting time and similar phenomena, which, evidently, are normal and unavoidable characteristics of market performance rather than irrational and functional deficiencies that could warrant special intervention. In further work, Stigler extended his analysis to the labor market. These particular studies by Stigler established a new area of research known as the “economics of information”, providing one of the most stimulating impulses for economic analysis in recent years, and a significant point of departure for current research on the ultimate origins of unemployment and inflation.
Stigler devoted other investigations to the study of the adjustment lags that impede rapid movement of capital and labor from low-profit to high-profit industries. On the basis of extensive empirical data – the collection of which was a pioneering effort in economic statistics – he found that such lags do indeed exist, but that their empirical significance had been exaggerated. These results indicate that, regardless of whether an industry performs well or poorly one year, hardly anything can be said about its condition 7-8 years later. By that time re-allocative movements and other equilibrating forces will have been operative. Good times and bad times alternate in economic life. Further evidence for this was uncovered in an inquiry into the factors underlying the firm’s capacity to survive. By compiling numerous observations, Stigler found that ability to adapt flexibly to the winds of change in technology and markets is imperative for the capacity to survive, whereas ability to exploit conventional economies of scale in production is rather unimportant. Thereby he toppled what was an established doctrine in unsophisticated textbooks, perhaps also a favorite idea of some industrial planners.
Some 200 years ago Adam Smith wrote: “People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise the prices”. Stigler examined this phenomenon as well. He showed that the possibilities for a group of firms to form a cartel with monopoly power are constrained by the member firms’ costs of monitoring each other and enforcing sanctions on those who attempt to violate the agreement. These costs are usually high. This inspired Stigler to undertake a series of studies seeking to test a hypothesis, which, to paraphrase bluntly his own wording, reads: what you cannot achieve yourself, let the state do for you. He encountered cases where economic legislation proved to be designed so as to favor special producer interestsfirms, industries, occupational groups-rather than the general public it was intended to serve. The explanation was that specific groups had succeeded in influencing legislation and its implementation to their own advantage.
The extent of validity of this hypothesis is still unknown. Stigler’s contributions have, however, inspired substantial research on the effects of regulatory legislation and the driving forces behind it. He stands as the foremost creator of the new and vital field of research known as the “economics of regulation”.
Perhaps these results might have been expected to lead Stigler to a critical attitude towards regulatory legislation. However, the greater the validity of the hypothesis on the driving forces behind regulation, the more complex the problems which arise. Legislation is not – as economists used to believe – an “exogenous” force which affects the economy from outside, but an “endogenous” part of the system itself. Regulation is generated by economic processes, and faithful to the principal task of the scientist, Stigler restricts himself to observing and analyzing it. But reading between the lines of his recent writings, perhaps the hope may be discerned that the research which he has begun so successfully will also stimulate those engaged in politics to become more immune to external pressures.
In a long series of investigations, you have extended and enriched our knowledge of the way markets function, the forces that determine the structure and organisation of industries, and the role played of economic legislation and regulation. In doing this, you have transformed basic economic theory into a powerful tool for applied economic analysis and reconciled it to the complexities of modern economic life; and you have also opened new, important fields for economic research. It is for these fundamental contributions that the Royal Academy of Sciences has decided to award you this year’s Nobel Memorial Prize in Economic Sciences.
On behalf of the Academy I wish to convey to you our warmest congratulations, and I now ask you to receive your Prize from the hands of His Majesty the King.