‘Classical’ irony in Thaler’s Nobel prize

Classical economic theory, also known as laissez faire, claims that leaving individuals to make free choices in a free market results in the best allocation of resources. Since individuals made choices, the emphasis was on understanding human beings and their behaviour as individual and as groups.

Neo-classical economists based their thinking on the assumptions that people have rational preferences; individuals maximise utility and firm’s profits; and people act independently.

Consequently neo-classical economists distanced themselves from psychology and sought explanations for economic analysis heavily based on the concept of rational expectations.

For most of the last century, economics became increasingly mathematical. Much of economic theory came to be presented as mathematical models, mostly calculus, to clarify assumptions and implications. It is not as if the switch was complete. Many great economists such as Vilfredo Pareto, John Maynard Keynes and Joseph Schumpeter continued to base their analysis on psychological explanations. In more recent times, this school of economics has been given greater importance and is reflected in the award of Nobel Prizes to behavioural economists such as Daniel Kahneman of Princeton University and now to Richard Thaler.

Making the announcement Nobel Committee said: “His empirical findings and theoretical insights have been instrumental in creating the new and rapidly expanding field of behavioural economics, which has had a profound impact on many areas of economic research and policy.”

There is a delicious irony in the award of the Nobel to Richard H. Thaler. He works in the University of Chicago, the nursery of classical economics, where he is the Ralph and Dorothy Keller Distinguished Service Professor of Behavioral Science and Economics at the Booth School of Business. Incidentally, Raghuram Rajan who is also an economics professor is a colleague, who was also, we are told being considered for the Nobel this year.

The dominance of the classical school on the world of economics can be gauged from the fact that since the relatively recent inception of the Nobel Prize in Economics in 1968, the Chicago economics department faculty have won the Nobel as many as 12 times, twice as many as MIT, which has six Nobel laureates.

Seen from Harvard University’s ivory tower, even MIT is considered as leaning more towards classical economic theory. Recent Harvard winners for economics such as Oliver Hart (2016), Alvin Roth (2012) and Eric Maskin (2007) were rewarded for their work based on mathematical empiricism than behavioral speculation.

Amartya Sen (1998) was one of the few who broke this mould and won it in recognition of his work and abiding interest in welfare economics.