The Nobel Series : Early institutionalists

The Nobel Prize in Economic Sciences was awarded jointly to Gunnar Myrdal and Friedrich von Hayek in 1974. The official website of the Nobel Prize states thus:

"Their pioneering work in the theory of money and economic fluctuations and for their penetrating analysis of the interdependence of economic, social and institutional phenomena. The Academy of Sciences considers that Myrdal and von Hayek have, in addition to their contributions to central economic theory, carried out important interdisciplinary research so successfully that their combined

contributions should be awarded the Prize for Economic Science."

Interestingly, the Nobel was awarded to Myrdal and von Hayek for going beyond 'pure economic theory' as the official website says. While Myrdal applied economic tools to social issues, von Hayek extended his research to include issues such as the importance of a legal framework of economic systems, how social systems function and organisational issues. In that sense, both Myrdal and von Hayek were paving the way for later research in institutional economics, which was later pioneered by economists such as Douglass North, Ronald Coase, Oliver Williamson, Elinor Ostrom and Mancur Olson among others. In the following sections, we will look at the main works of Myrdal and von Hayek and how they apply to public and economic policy.

Works of Gunnar Myrdal

Myrdal studied at Stockholm University, from where he got a law degree in 1923 and PhD in economics in 1927. Myrdal's PhD thesis was titled 'The Problem of Price Formation under Economic Change', where he used a mathematical model to examine the role of expectations (ex-ante and ex-post) in price formation. He also carried forward Wicksell's work on monetary economics and underlined the importance of uncertainty (on the lines of Frank Knight). He also spent time in Britain and Germany as a student and as a Rockefeller Fellow in the USA in 1929-30. While in the USA, he wrote a book titled, 'The Political Element in the Development of Economic Theory'.

Myrdal was one of the earliest economists to question the 'rationality' assumption of neoclassical economics and introduced the political aspect in his economic analysis. In that sense, he was also an institutionalist and underlined the importance of social structure, demographics and institutions in resolving problems of development economics such as poverty eradication, distribution of wealth and social welfare.

Myrdal is perhaps best known for two of his works: 'An American Dilemma: The Negro Problem and Modern Democracy', which was published in 1944 (co-authored with ME Sterner and Arnold Rose) and 'Asian Drama: An Inquiry into the Poverty of Nations' published in 1968 (co-authored with his wife Anna Myrdal).

In the first book, he discussed the contradiction between American ideals of equality and civil rights and the deplorable conditions of African Americans. Interestingly, Myrdal suggested that two economic policies of the Roosevelt administration inadvertently destroyed jobs for hundreds of thousands of African Americans. The first such policy involved restrictions on cotton production instituted to raise the incomes of farm owners. Myrdal wrote:

"It seems, therefore, that the agricultural policies, and particularly the Agricultural Adjustment program (AAA), which was instituted in May 1933, was the factor directly responsible for the drastic curtailment in the number of negro and white sharecroppers and negro cash and share tenants."

The second policy was the minimum wage which, Myrdal pointed out, made employers less willing to hire relatively unskilled people, many of whom were African American.

After Gunnar Myrdal worked with UN from 1947-1957 and returned to teach at Stockholm University in 1960, he got interested in development challenges facing South Asian countries. From 1960 onwards, he focused on such problems, which culminated in his three-volume book 'Asian Drama'. He analysed development challenges such as poverty eradication in developing countries such as India.

Myrdal also contributed to population studies and was worried that the rate of population growth would worsen poverty and hunger in developing countries. This Malthusian approach was however proven wrong when more and more developing countries became self-sufficient in food and were able to address poverty eradication issues successfully.

Myrdal is also known for his work on 'circular cumulative causation'. This emphasises that the functioning of a social and economic system is based on a 'circular cumulative causation' process (CCC). This process underlines feedback effects and basically says that if an event A gives rise to another event B, the latter produces feedback on the former. In other words, event A is both a cause and effect of event B.

Myrdal dabbled in politics and became a Social Democrat Member of Parliament from 1933, and again from 1945 to 1947, he served as Trade Minister. During World War II, Myrdal was vocally anti-Nazi and wrote 'Contact with America' in 1941 (co-authored with his wife), which praised the United States' democratic institutions.

Works of Friedrich von Hayek

Hayek grew up in Vienna under the Austro-Hungarian empire. Like Myrdal, Hayek got his first degree in Law in 1921 and a doctorate in political economy in 1923 from the University of Vienna. He got a second doctorate in political economy at the same time. Hayek also met his mentor Ludwig von Mises while studying for his doctorate, who honed his skills in monetary economics and business cycles. Later, in the early 1930s, Hayek left for London School of Economics at the invitation of Lionel Robbins and stayed at the LSE till 1950. As soon as he arrived in London, Hayek was famously involved in a rather public debate with Keynes on the role of money in the economy. Hayek was commenting on Keynes' 'A Treatise on Money'. We may recall that in his treatise, Keynes had suggested that economic events are triggered by a mismatch between savings and investment. Hence, if savings exceed investment, it restricts consumption and effective demand, which in turn leads to unemployment. The solution offered by Keynes to raise effective demand was public spending. Hayek criticised Keynes' view and countered that depressions occur because of the availability of easy money and credit, which was unsustainable. Hayek argued that while a government stimulus may work in the medium to long term, but the market would become so distorted that when the stimulus was removed employers would be left making goods that were no longer needed. Hayek's ideas, which he set out in his book. 'The Pure Theory of Capital', appeared only in 1941 and was overshadowed by Keynes' 'General Theory'. It may be interesting to watch the rap song 'Fear the Boom and Bust', released on YouTube in 2010, where proxies of Keynes and Hayek battle it out on the cause of business cycles.

Hayek's other contribution was his development of a business cycle theory that built on the earlier work by Swedish economist Wicksell and von Mises. Hayek's theory says that the natural interest rate is an intertemporal price; that is, a price that coordinates the decisions of savers and investors through time. The cycle occurs when the market rate of interest (that is, the one prevailing in the market) diverges from this natural rate of interest. This causes the structure of the capital stock to become distorted so that it no longer reflects the desires of savers and investors as expressed in the market.

From pure economic theory, Hayek drifted into the methods of economics and while at Cambridge, he took up a project titled 'Abuse of Reason', where he criticised the blind imitation by economists of the methods of other sciences. This project became the basis for a number of essays and also led to the 1944 publication of Hayek's most famous book, 'The Road to Serfdom'.

After World War II, Hayek mostly wrote on subjects which were on the periphery of pure economics. These included theoretical psychology, the movement to set up open and free societies (he set up the Mont Pelerin Society in Switzerland along with the likes of Lionel Robbins, Milton Friedman, George Stigler, Frank Knight, Michael Polanyi and the famous philosopher Karl Popper).

After his stint in London, Hayek taught social thought and philosophy of science at the University of Chicago in the 1950s, where Milton Freidman was laying the foundation for the monetarist revolution. While at Chicago, he wrote his book on psychology, 'The Sensory Order', He also wrote articles on a number of themes such as political philosophy, the history of ideas, and research methodology. Aspects of his wide-ranging research were woven into his 1960 book on political philosophy, 'The Constitution of Liberty'. Later, in the 1960s, Hayek taught at the University of Freiburg and Salzburg in Germany.

Hayek returned to Freiburg permanently in 1977 and finished work on what would become the three-part 'Law, Legislation and Liberty' (1973–79), a critique of efforts to redistribute incomes in the name of 'social justice.' Later in the 1970s Hayek's monograph, 'The Denationalisation of Money' was published by the Institute of Economic Affairs in London, one of the many liberal think tanks that Hayek was involved with.

In the early 1980s, Hayek began writing what would be his final book: a critique of socialism. Because his health was deteriorating, another scholar, philosopher William W. Bartley III, helped edit the ultimate volume, 'The Fatal Conceit', which was published in 1988. Hayek died in 1992, having lived long enough to see the reunification of Germany.

Myrdal, Hayek & public policy

Even in his early works, Myrdal was interested in marrying political and economic analysis and hence making economic research more relevant to public policy. His book, 'Vetenskap och politik i nationalekonomien', 1930, ('The Political Elements in the Development of Economic Theory'), was a critique of how political values in many areas of research are inserted in economic analyses.

His work on the social and economic challenges facing African Americans in the USA referred to above was also an example of using economic analysis to address sociological issues. This research is still relevant in today's USA where racial tensions have come to the forth in the past few years

Again, Myrdal's research into the problems of developing countries is still relevant for public policy in these countries. This is simply because great importance is attached to political, institutional, demographic, educational and health factors in Myrdal's analysis; something that is missing in the neoclassical model.

Hayek's research also was driven by making it relevant to public policy. While Hayek was an unabashed critic of socialism, his critiques including economic and socio-political factors. It was this political stance that Hayek countered in 'The Road to Serfdom' and other publications.

Hayek was a great advocate of individual liberty and free and open societies. He began from the premise that in civil society every individual pursues his own set of values. Many forms of planning, however, implicitly assume that a common set of values exists; otherwise it would be impossible to gain consensus on how resources are to be allocated. Hayek argued that without a shared set of values, the planners would inevitably impose some set of values on society. In other words, government planners could not accomplish their tasks without exerting control beyond the economic to the political realm: something that Hayek was not comfortable with. Hence, according to Hayek, planning would inhibit rather than promote freedom. Only when a free market system is allied with democratic political institutions would freedom of choice be allowed to persist.

In his pursuit of individual liberty, Hayek wrote 'The Constitution of Liberty' where he identified the social institutions that he felt would most effectively achieve the goal of liberty. Only free markets — in a democratic polity, with a private sphere of individual activity that is protected by a strong constitution, with well-defined and enforced property rights, all governed by the rule of law will support the set of institutions that both permits individuals to pursue their own values and allows them to make the best use of their own localised knowledge. In 'Law, Legislation and Liberty' he was not too impressed with the concept of 'social justice' pursued by the modern welfare state, since the latter could be captured by special interests.

As the developments of the last few decades have shown, Hayek's economic arguments concerning the viability of socialism have proved telling. By the turn of the 21st century, there were few advocates of central planning among economists.

Conclusion

While Myrdal and Hayek shared the Nobel Prize in the same year, they were on opposite sides of the ideological spectrum. Myrdal thought that the government had an important role in addressing social and political issues. Hayek, on the other hand, was concerned more about individual liberty and had more faith in the market. Hayek was a member of the Austrian School, a free-market tradition that has been marginalised for about 50 years. When Hayek was endorsing free-market economics from the 1930s to the 1960s, Keynesian economics and socialist and welfare state policies held forth. As an early opponent of Keynes, Hayek lived through an era (especially in the 1950s and '60s), the Keynesian doctrine of widespread government intervention in the economy was, by and large, universally accepted in the western democracies. Only when stagflation (high levels of inflation and unemployment coupled with low growth) hit us in the 1970s was Keynesian policy thought called into question. And with the collapse of communist states in the former Soviet Union and Eastern Europe, Hayek's contributions came to be viewed in a new light.

One thing that united Myrdal and Hayek was that both injected institutions into their analysis. In that sense, they were the early 'Institutionalists'. While Myrdal emphasised the role of institutions and governance in overcoming problems of poverty, health and education in developing countries, Hayek underlined the importance of democratic political institutions in realising the true potential of free and open societies.

The writer is an IAS officer, working as Principal Resident Commissioner, Government of West Bengal. Views expressed are personal Views expressed are personal