Living the Legacy: Chicago Economics through the Years

Living the Legacy: Chicago Economics through the Years

With six senior economists representing an estimated 229 years of cumulative experience in University of Chicago economics on stage, no panel was better qualified to provide a definitive view of the legacy of Chicago economics.

No such luck. Instead, what emerged were varied perspectives, experiences, and ultimately, differing views. And that, in fact, reflects what Chicago economics has been and remains today. Far from a universal school of thought, it is an approach marked by serious scientific analysis of real-world problems—and serious arguments about how best to study them.

“Throughout decades we see an enduring and intense commitment to the use of economic analysis as an explicit guide to economic research and more generally to social policy,” moderator Lars Peter Hansen said.

However, Hansen continued, in piecing together the interactions of this rich intellectual history, “we become awakened from some simplistic notion of a Chicago School of Economics to something much richer. As we open the hood, so to speak, we begin to see some fascinating complexities.”

Starting off the discussion, Professor Emeritus Arnold Harberger, AM’47, PhD’50, came the closest to defining the so-called Chicago School.

“Three principles come to mind. First, the world is so complicated, so unfathomably complex, that we need theory to make sense of it,” Harberger said. “Second, theory is useful only to the extent that it helps us predict outcomes.”

“Third, make sure that market forces work. I liken market forces to wind and tides. It’s at your own peril that you try to defy them.”

“This picture covers everybody I know associated with the Chicago school,” Harberger noted.  “Closely associated with that is the way price theory is taught, mixing theory with observations; the word ‘diagnostic’ applies more closely than it does at other schools.”

Observation and Evidence

Harberger, now a professor of economics at University of California, Los Angeles, is known for his contributions to public finance and his impact on economic policy in developing nations around the world. He cited examples of how Chicago economists used observed data to correct or revise the conventional wisdom.

For instance, T.W. Schultz, a great economist who won a Nobel Prize for his transformational work in agricultural economics, doubted the common idea that developing nations had unlimited supplies of labor, which would set the marginal product of agricultural labor zero. Seeking evidence, he gathered data from matched agricultural sectors during the 1918–19 global flu epidemic, to compare the marginal product lost in areas with differing loss of labor due to flu deaths. “That put a solid nail in the coffin of the idea of zero marginal product,” Harberger said.

Moving forward to 1995, Harberger recalled attending a conference at China’s central bank where UChicago economists were well represented. The goal was to control inflation plaguing China at the time. China adopted a fixed exchange rate, which meant that the central bank had to buy up all the dollars that came flooding in during an enormous export boom.

China’s money supply then quadrupled in eight years, and any economist would have predicted skyrocketed inflation. In fact, the price level barely budged. Why? Harberger explained that it reflected people’s demand to hold money rather than spend. That, in turn, could be explained by China’s one-child policy. Traditionally in China, aging adults relied on their children for economic security. When limited to just one child to support them, millions of Chinese realized they now needed to save for old age.

“That gives an idea of simple Chicago economic thinking linking to real-world problems in, I hope, an interesting way,” Harberger concluded.

Mad about Methods

Professor Emeritus Lester Telser, AM’35, PhD’56, focused his comments on his experiences with the Cowles Commission. In its years at UChicago from 1939 to 1955 under the leadership of first Jacob Marschak and later Tjalling Koopmans, it was “the most highly regarded collection of outstanding economists ever assembled in one place,” Telser stated. The commission was closely linked to the emergence of the field of econometrics; nine economists associated with the group over those years went on to win Nobel prizes.

As a second-year graduate student, Telser was a research assistant on study of organized commodities futures markets underway at Cowles, while Koopmans led a Rand Corporation-funded study of US railroads. That “should dispel the view that Cowles was a collection of mathematical eggheads…doing nothing of value to economics,” Telser commented.

He vividly recalled the moment at a seminar in 1953 or 1954, when the Cowles group first heard a presentation based on new work by young Dutch economist Henri Thiel offering a new approach to estimating simultaneous equations. “It was about two stage least squares [regression].  I peeked a look at Tjallings’ face. We were stunned; I don’t recall that anyone said anything. We knew it was a historical moment.”

Milton Friedman was no fan of the Cowles Commission and their methods. Friedman got into such a heated argument at Telser’s thesis proposal seminar that Marschak resigned from Telser’s committee and Friedman took his place.

When James Tobin was picked as the commission’s next director, Friedman blocked Tobin’s faculty appointment, leading the commission to depart for Yale. “As is often the case, both parties in divorce were worse off,” Telser remarked. “When I spent a year at the Cowles Commission in 1964–65, it was nothing like the old commission.”

“Time does not permit me to describe my collaboration for decade with Robert Graves; this work in mathematical economics led to many practical results, including the foundation of rational expectations,” Telser concluded. “In view of Milton Friedman’s hostility to mathematical economics, this work refutes his claim that mathematical economics is an exercise in aesthetics.”

Foundations of Finance

Eugene Fama, who joined the Chicago Booth faculty in 1963 after earning his MBA and PhD there, recalled that he grew interested in economics because much of the other business coursework at the time was so poor. Statistics courses with Harry Roberts and economics with Milton Friedman were an exception, he said.

“At that time, there was no marketing research, no academic accounting; finance didn’t exist, really. All of this work was basically new and evolving when I arrived on the scene,” recalled Fama, the Robert R. McCormick Distinguished Service Professor of Finance.

“Now we have a first-rate stats department, a world-class economics department, and, what I’m most proud of is the whole field of finance basically evolved through my lifetime, and lots of it was done by my particular cohort. Finance is, in my view, the most successful branch of economics in terms of theory, empirical work, the interaction between the two, and the impact on the real world. No other branch of economics has had more impact.”

Fama said at the business school, famously lively intellectual exchanges run on an unwritten rule:  “If you’re on the faculty, on you’re free to talk however you like and we will treat you respect. Everybody gets listened to. We don’t care what your political dispositions are. If you’re the best at what you do, we want the best players the field and we’ll have incredible diversity.”

Fighting pays off, he said, because “especially over academic issues no one is completely right and it always enriches you to listen to other people talk about their work. It will change the way you think. This gives rise to interactions that make everybody better off.

This hit home when he was on extended leave in Europe in 1975. “I was terribly productive,” he recalled, churning out something like seven papers.  But when Fama returned to campus and showed them to business school colleague Merton Miller, “Mert said, ‘Junk, junk, junk, this one’s pretty good, junk.’  Would have saved an enormous amount of time if somebody would have told me it was junk while I was doing it.”

“That’s what happens in a highly interactive environment that makes the whole bigger than the sum of its parts.  We have that now; I hope we can keep it.”

Lasting Lessons from the Classroom

Robert E. Lucas Jr., AB’59, PhD’64, addressed the common misconceptions of the “Chicago vs. the world” view: “All our students were monetarists, everyone at MIT and Harvard were Keynesians, and never the twain shall meet— except that’s never been close to true,” he said.

For Lucas and students of his generation, Friedman was a huge influence. “He taught this fabulous introductory price theory course was for people who knew nothing about economics,” Lucas said. Friedman eschewed formal methods and deep dives into data in favor of addressing problems with the simple tools of economic thinking.

“It was a fabulous influence on me. When Milton retired, Gary Becker picked up this same style, and now Kevin [Murphy] carries the baton,” noted Lucas, the John Dewey Distinguished Service Professor Emeritus in Economics.

“The best macroeconomics I got—and I believe the best available in the world at the time—was Al Harberger’s,” Lucas said.

It was actually a public finance course, not macroeconomics, but Harberger figured fiscal policy was a key part of macroeconomics, so he led the class on an effort to analyze the fiscal multiplier. It was generally believed that the multiplier was 5—that a dollar of government spending would spur $5 of private consumption.

“Al’s course was OK, let’s see what the evidence was behind the multiplier.  I still have the notes I took from Al’s lecture. The reading list was economic reports from the president, going back to 1929, in those days. The idea was to estimate—and as Al says, this is how theory comes in—how this history might have been different. “

In pre-computer days, students followed along as Harberger worked out the trail of spending decisions from available data in complex equations on the blackboard.

“This was an exciting thing. It was my initiation into the world of applied science. I came to understand that economics is not something that you know; it’s something that you do.”

“So what’s the multiplier? It’s not 5; we found it’s something like 1.1. Was this Chicago economics, Keynesian economics?  Who cares? It’s good economics. I thought of it as Harberger economics. The experience that I had in Econ 362 is one many, many people have had in other classes, and it’s something we as school can be proud of.”

Engaging the Real World

Like Fama, James J. Heckman addressed the Chicago tradition of argument, quoting Friedman: “Controversies among faculty members, mostly on intellectual basis, helped to make the department an exciting place to study, preserved an atmosphere of search for truth, and developed a tradition that what mattered in intellectual discourse was only the cogency of the argument, not the diplomacy with which it was stated or the seniority of the person who stated it. “

But Heckman went back further to address a deeper and persistent theme in Chicago economics: “That is, its engagement with real world problems. It’s a well-kept secret,” he said. “If you scroll all the way back to 1892, the first chair of the department, J. Laurence Laughlin, was interested in monetary economics and concerned with issues of the day.”

Heckman, the Henry Schultz Distinguished Service Professor in Economics,  traced strands of a common lineage through seemingly different intellectual trends. In early days, institutionalists like Thorstein Veblen and Wesley Clare Mitchell attacked pure theory that had nothing to do with the real world, leading to the data-driven empiricism of Mitchell, Arthur Burns, Simon Kuznets and others at the National Bureau of Economic Research—all powerful influences on Friedman.

But the NBER approach of gathering a great deal of data led to an assemblage of facts, and no way to interpret them, Heckman said. This was the criticism from the Cowles Commission, where Koopmans famously critiqued blind empiricism as “measurement without theory,” sparking a famous argument with rejoinders from the likes of Knight and Viner.

“I think Lester is dead right that the Cowles Commission’s optimal period of productivity was here, and I think that productivity came about precisely because there was that tension, with each side trying to grapple with the question of how we deal with data.,” Heckman said.

“I think Friedman’s ‘Methodology of Positive Economics’ was a response to ‘Measurement Without Theory.’ It led to issues still not fully resolved; how do you interpret data?  How do you interpret the world?

“It’s not so much that there is an answer that is right or wrong. It was that the discussion was at a very high level,” he concluded. “I think that’s what continues today, in that people are interested in serious questions, and trying to understand how to learn from data. The view is that anything that’s useful should in the end have some content with real-world phenomena. The idea is to engage the world and try to understand it, and Chicago has been extremely successful at it.”

Then, engaging the audience, Hansen took a few questions, and panelists demonstrated Chicago economics in action: in response to a query about formalism vs. intuitive economics, a hearty argument broke out.

—Toni Shears