A Prize For the Most Useless?

• Gary S. Becker

In 1992, Gary S. Becker won his Nobel Prize for extending microeconomics to a broad array of subjects, including discrimination, crime and punishment, human capital, family dynamics, and politics. He sounds, frankly, like a lot of the students I counseled at the Stanford Career Planning & Placement Center, who couldn’t decide between economics and political science. Most wanted the economics degree because they thought it might help them get a job after graduation. The job they most wanted, though, was President of the United States, so the political science gig might come in handy. Ultimately, the liberals ended up in journalism writing political essays disguised as economic analysis, while the more conservative grads went into investment banking and now own several Senators of their own.

Some things just aren’t taught at the undergraduate level.

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Becker spent most of his career as a member of the University of Chicago’s distinguished faculty. He was even considering leaving economics entirely until he met world renowned monetarist Milton Friedman who convinced him that economics was not a game played by clever academicians but rather a powerful tool to analyze the real world. A rejuvenated Becker began extending theories of rational choice to areas previously unblemished by economic analysis. Becker’s studies generated a great deal of criticism and many economists didn’t really consider him a student of economics at all, which (again) probably goes back to the fact that he wanted his research to be useful beyond the walls of the university. Becker even went so far as to agree to become a regular columnist for Business Week magazine, submitting his ideas and research to the general reader instead of just publishing in obscure journals.

Ultimately, Becker took the fundamental precepts of economic analysis (ludicrous assumptions obscured by complex mathematics) and applied them to other areas of debate. With a libertarian mindset and a fistful of equations, Becker proved things like legalizing illegal drugs and slapping on a tax would be more effective than prohibiting drugs like methamphetamines. And who wouldn’t question a study based on meth users doing what’s in their own rational best interest? Except, maybe, for anyone conscious of the paradoxical notion of a rational meth user. What exactly do they look like? Perhaps he’s really envisioning a young meth user with dentures, because the older ones couldn’t possibly be accused of having behaved rationally unless they’ve always harbored a secret desire to look like a pruned version of Gollum from “Lord of the Rings.”

Becker’s central premise is that rational economic choices, based on self-interest, govern most aspects of human behavior, and not just purchase and investment decisions that are traditionally the purview of economic analysis. Becker used charts and graphs and calculus to make assumptions and draw conclusions about racial discrimination in labor markets, job training, family size, divorce, criminal behavior and the role of women in the workplace. It’s going beyond the Peter Principle. It’s reaching beyond your own circle of incompetence and expanding into new service areas. It is the opposite of focusing on your core strength.

I know of several super regional bank trust departments which failed, year after year, to beat the market with their investment management model, which have decided they should tackle “both sides of the client balance sheet” and have begun offering a broader array of advice on a wider range of investment alternatives and decisions regarding both asset and liability decisions. In other words, since they didn’t do a very good job of investing client assets, they decided to expand their scope of services to include advising clients on how much they should borrow and invest in the new, probably also unsuccessful, investment strategies. All this is being done in the name of offering “wealth management services” to their affluent clients.

If an advisor can’t manage a long-only stock portfolio, how in the world does it propose to make competent real estate decisions as well? If it won’t take a stand on stocks versus bonds, how do they expect to offer expertise in deciding among complex hedge fund strategies? If running is a problem, try walking. Don’t start designing cars.

Becker is sort of like the carpenter for whom every problem requires a hammer. We all look at problems with our own biases and from our own point of view. Successful investors, however, find that when their view of the world conflicts with reality based on faulty underlying assumptions, it is their pocketbook which is incurs a sub-optimal result.

• Douglass North

Douglass North, a 1993 Prize winner, may be as important as John Maynard Keynes was to macroeconomics, the traditional branch of economics that deals with the performance, structure, and behavior of the national economy as a whole. These two branches, microeconomics and macroeconomics, form the core curriculum of many economics programs.

My roommate at Stanford and I would debate the key questions of economics, sometimes for hours – depending on whether or not we ran out of beer. The key question is, “which is the most worthless, micro- or macro-economics. There was no question, really, that they were both worthless. The only real point of contention was which was worse.

Micro focuses in on the smaller unit, such as an individual consumer or small business entity. Macro, on the other hand, considers the grand scheme of things. It looks at national statistics, international trade, and price and inflation statistics. I’ve always been a fan of entrepreneurs, so was somewhat sympathetic to the microeconomists I’ve met. Not because they are in any way useful, of course, but at least they seem to be rooting for the right team. My roommate argued that because the microeconomists were always assuming perfectly efficient companies and perfectly rational consumers, any conclusions drawn from their resulting charts and graphs must be fundamentally flawed. After all, when was the last time you met someone who worked for a perfect business? And let’s be honest, just how rational is your spouse when it comes to spending money?

I, however, always presented the case against macroeconomics. Economics majors, like Literature majors, are great fans of irony. Indeed, one of the big factors behind Arrow’s Nobel Prize win was the fact that he had a paradox named after him. Arrow’s paradox, also known as “Arrow’s impossibility theorem” examined various economic criteria, including the “independence of irrelevant alternatives.” I mean, doesn’t that phrase have “Laureate” written all over it? It doesn’t matter a whit that nobody understands what it means (and sounds like the definition of the word “trivia”). The phrase is steeped in so much cosmic irony that it practically demands that students do a word search in Shakespeare to see if Arrow lifted the concept from an old book. Economists delight in irony the same way that conservative pundits savor the fact that Al Gore, the inventor of the internet, received a C- in Natural Sciences and a D in Man’s Place in Nature during his stay at Harvard (where he spent much of his sophomore year shooting pool in the Dunster House basement lounge, watching television, eating hamburgers, and hacking his way into the Defense Department’s ARPA net to steal code). It’s that geekish sense of intellectual humor of a brainiac screaming “notice how smart I am!” In Arrow’s case, Alfred Nobel’s minions in Stockholm, Sweden chuckled at the irony of his famous phrase and voted him into the club. (In Gore’s case, they are said to have actually guffawed.)

Outside of the merry pranksters in Sweden, however, few people actually paid much attention to Arrow, North, or Becker, so not many people could be hurt. No harm. No foul. Things were done in the traditional spirit of Ivy League antics with no one really getting hurt except for the parents of underclassmen who were saddled with the tuition bills. The next four gentlemen to win were pushing theories that reached out and touched investors portfolios and proved to be a little more dangerous.

Next post: A Prize For The Most Useless - Part II

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Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies.

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