Justin Fox says that yesterday's Nobel Prize is part of a longer trend in which the Nobel committee has stopped rewarding economists who make the world look elegant and begun favoring economists who prove that the world is messy:
Diamond wasn't out to further prove the perfection of markets. He was trying instead to show how, with the injection of the tiniest bit of reality, the perfect-market models he'd learned so well in grad school began to break down. Today he won a third of the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel (it's not technically a "Nobel Prize"), mainly for a paper he wrote in 1971 that explored how the injection of friction between buyers and sellers, in the form of what he called "search costs," prices would end up at a level far removed from what a perfect competition model would predict. The two economists who shared the prize with him, Dale Mortensen of Northwestern University and Christopher Pissarides of the London School of Economics, later elaborated on this insight with regard to job markets (as did Diamond).
The exact practical implications of this work can be a little hard to define -- although Catherine Rampell makes a valiant and mostly successful effort in The New York Times. What this year's prize does clearly indicate is that the Nobel committee believes economic theory is messy and getting messier (no, I didn't come up with this insight on my own; my colleague Tim Sullivan had to nudge me). The last Nobel awarded for an all-encompassing mathematical theory of how the economic world fits together was to Robert Lucas in 1995 for his work on rational expectations. Since then (with the arguable exceptions of the prizes awarded to Robert Merton and Myron Scholes in 1997 for options-pricing and to Fynn Kydland and Edward Prescott in 2004 for real-business-cycle theory) the Nobel crew has chosen to honor either interesting economic side projects or work that muddies the elegance of those grand postwar theories of rational actors buying and selling under conditions of perfect competition. The 2001 prize for work exploring the impact on markets of asymmetric information, awarded to George Akerlof, Michael Spence and Joseph Stiglitz, was probably most similar to this year's model (and, not coincidentally, Akerlof and Stiglitz were also MIT grad students in the 1960s).
| October 12, 2010; 9:06 AM ET
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