Hoover Daily Report

An Economist Who Made the Science Less Dismal

via Wall Street Journal
Tuesday, February 19, 2013

In 1975, I attended a week-long conference in Connecticut at which the star attraction was Friedrich Hayek. Hayek, who had shared the 1974 Nobel Prize in economics with Swedish economist Gunnar Myrdal, was doing a kind of victory tour of the United States. I told him that I thought Armen Alchian, one of my mentors when I earned a Ph.D. at UCLA, also deserved the Nobel Prize. I asked Hayek what he thought.

Hayek gave his characteristic wince, paused, and said, "There are two economists who deserve the Nobel prize because their work is important but won't get it because they didn't do a lot of work: Ronald Coase and Armen Alchian."

Sixteen years later, in 1991, Ronald Coase did win the Nobel Prize. When I got the news, I called Armen and told him the story. He got a kick out of it and seemed to have a new hope that he would win. He didn't, and now he can't. Armen Alchian died on Tuesday at the fine age of 98.

What was so important about Alchian's work? There were three aspects. First, he was one of the last economists of his generation to communicate mainly in words and not equations. Second, although economists often use the word "unrigorous" to refer to communication in words rather than math, Alchian was profoundly rigorous, writing clearly and carefully and using basic logic to reach sometimes-startling conclusions. As a result, many of Alchian's papers, even those from the 1950s, are still widely cited.

Third, Alchian is known for his textbook, "University Economics," first published in 1964 and later called "Exchange and Production," coauthored with UCLA colleague William R. Allen. That text is unique in economics. It is much more literary and humorous than any other modern economics textbook that deals with complex issues for an undergraduate audience. Example: "Since the fiasco in the Garden of Eden, most of what we get is by sweat, strain, and anxiety."

Alchian had his largest impact on the economic analysis of property rights. Most of his work in this area can be summed up in one sentence: You tell me the rules and I'll tell you what outcomes to expect.

In their textbook, for example, Alchian and Allen ask why the organizers of the Rose Bowl refuse to sell tickets to the highest bidders and, instead, give up wealth by underpricing the tickets. Their answer is that the people who make the decision on the prices don't have property rights in the tickets, so the wealth that is given up by underpricing wouldn't have accrued to them anyway. But the decision makers can give underpriced tickets to their friends and associates.

Thomas Hazlett, former chief economist at the Federal Communications Commission and now a professor at George Mason University Law School, used this same line of reasoning to explain why Michigan Congressman John Dingell blocked the FCC's early attempts to auction off the electromagnetic spectrum and, instead, favored giving it away. Auctioning would have reduced Mr. Dingell's power.

Alchian also used the analysis of property rights to explain racial and ethnic discrimination. In a 1962 paper coauthored with the late University of Chicago economist Reuben Kessel, Alchian—himself subject to anti-Armenian discrimination early in his life—pointed out that discrimination was more pervasive in private firms whose profits were regulated by the government. Alchian and Kessel explained that discrimination is costly, not just to those discriminated against, but also to those who discriminate. The discriminators give up the chance to deal with someone with whom they could engage in mutually beneficial exchange.

Therefore, argued Alchian and Kessel, discrimination would be more prevalent in situations where those who discriminate don't bear much of the cost from doing so. A company whose profits are not regulated would see the cost of discrimination in the form of lower profits. A company whose profits were limited and that was already at the limit would face no cost from discriminating.

Alchian first major article, "Uncertainty, Evolution and Economic Theory," was published in 1950. It was his response to a controversy about whether companies really do maximize profits. Alchian argued that even though all companies may not maximize profits, those that survive will be ones whose managers, by luck or design, came close to maximizing profits. Therefore, those that we observe will have maximized profits. So, for the long term at least, Alchian argued that economists don't need to show that all companies try to maximize profits in order to derive the standard conclusions from the profit-maximization assumption.

My personal favorite of his published papers is "The Economic and Social Impact of Free Tuition" (1968). Alchian pointed out that government aid to higher education is a transfer to the relatively rich. That's because people who can make it through college, even though they may have a low current income, have a high wealth.

He compared subsidizing college to subsidizing drilling expenses for someone sitting on a large pool of oil. The untapped student's potential is the analogue of the untapped oil. Alchian argued that lack of current income might be a justification for loans to aspiring college students but not for outright subsidies. He cinched the argument with the following story:

One poor, "uneducated" resident of Watts, upon hearing Ralph Bunche [a well-known black educator and diplomat] say that he could not have had a college education unless tuition were free, opined, "Perhaps it's time to repay out of his higher income for that privilege granted him by taxes on us Negroes who never went to college."

I still make Alchian's point in my classes and, although it upsets my students, not a single one has been able to undercut the fundamental soundness of Alchian's argument.

Mr. Henderson is a research fellow with the Hoover Institution and an economics professor at the Naval Postgraduate School. His latest book is "The Concise Encyclopedia of Economics" (Liberty Fund, 2008).