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A Free-Market Outpost in the Midwest

Thursday, May 17, 2007

A new book details the influential economists at the University of Chicago.

Chicago SchoolThe Chicago School: How the University of Chicago Assembled the Thinkers Who Revolutionized Economics and Business by Johan Van Overtveldt (Agate, April 2007)

Today, some propositions are widely accepted within the economics profession. Markets are usually the best way to allocate resources among different industries. Expansionary monetary policy may stimulate the economy in the short run, but cannot do so in the long run. Antitrust law should aim to eliminate monopoly distortions, not oppose big business as such. Economic growth is driven not just by physical capital and raw labor, but also by human capital—the education and training that workers have accumulated. People increase their consumer spending more when their income goes up permanently than when they receive a one-time windfall.

Each of these ideas was either introduced or refined by economists at the University of Chicago during the past half century. Of course, Chicago economists have also weighed in on many other topics, some of which remain unsettled. The influence of Chicago economists is reflected in their disproportionate share of Nobel Prizes and other economics awards.

In his new book, Johan Van Overtveldt traces the history of the Chicago School, drawing upon extensive research and more than 100 interviews conducted over the course of a decade. After discussing the founding of the University of Chicago in 1890 and its early years, Overtveldt devotes separate chapters to the impact of Chicago scholars on price theory, macroeconomics, the roles of markets and government, and law and economics, with additional chapters on the business school and the role of Chicago economists in politics.

Overtveldt describes Ronald Coase’s presentation of a celebrated result about the role of property rights to a skeptical group of 20 Chicago economists at a dinner party in 1960—and how he managed to persuade them by the end of the evening. He recounts the career of Chicago economist Paul Douglas, who was investigated by the FBI in 1941 for alleged communist tendencies, enlisted in the military in 1944 at the age of 50, was wounded at Okinawa, and served as a U.S. Senator from 1948 to 1966.

Anecdotes aside, the book traces the broad sweep of the history of thought at Chicago. In fact, the reader learns that the limited-government viewpoint did not become entrenched at Chicago until after World War II. Before then, a number of Chicago economists favored extensive government intervention to counter the widespread monopoly that they perceived in private industry. Interdisciplinary work has always been emphasized, with key contributions by faculty at the business and law schools, although scholars in other fields sometimes saw the Chicago contributions as economic imperialism rather than interdisciplinary cooperation.

The influence of Chicago economists is reflected in their disproportionate share of Nobel Prizes and other economics awards.

Overtveldt describes perennial disagreements among Chicago scholars about economic and statistical methodology, including some that degenerated into feuds. He notes that the economics department refused to hire the famous free market advocate Friedrich A. von Hayek, who was ultimately hired elsewhere in the university, due to methodological disagreements. Overtveldt emphasizes, though, that dissenters from the Chicago viewpoint have always been present on the campus—not every member of the economics faculty has been a member of the Chicago School. Oskar Lange promoted market socialism in the early twentieth century and Richard Thaler searches for financial-market inefficiency today.

Different audiences will value different features of the book, although each will find some limitations. Professional economists will enjoy following the historical development of the doctrines that are now received wisdom and reviewing the breadth of the discoveries made at Chicago. They will, however, find parts of Overtveldt’s discussion, such as his description of the quantity theory of money, somewhat imprecise.

For non-economists, the book offers an opportunity to learn about some of the ideas put forward by Chicago economists. Overtveldt describes the leading Chicago economists’ key insights, including Milton Friedman’s model of consumer spending, Gary Becker’s analyses of criminal justice, racial discrimination, and the family, Robert Lucas’s explanation of the business cycle, Robert Fogel’s historical analysis of slavery, George Stigler’s ideas on government regulation, and many others.

Readers will often be frustrated, though, by the brevity of the discussion. The ideas of each of these economists would have warranted several times more space than that actually allotted; such additional discussion would have been more valuable than the biographical information provided for numerous minor economists. The discussions of macroeconomics and industrial organization are particularly sketchy. Still, the book provides a useful introduction to the Chicago economists’ key ideas.

What does the future hold for the Chicago School? After expressing some concerns, Overtveldt rightly ends on an optimistic note, saying that the story of economics at Chicago is that of a cat with far more than nine lives. Indeed, two of his concerns seem unfounded.

One thing that worries him is the economics profession’s growing use of general equilibrium analysis. This technique models  the entire economy in very simplified form, and traces the effects of a policy throughout all of the economy’s sectors. In contrast, partial equilibrium analysis examines only the impact in the directly affected sector. In the epilogue, Overtveldt puzzlingly states that the rise of general equilibrium analysis poses a strong challenge to Chicago’s cherished price theory, the economic model of how prices convey information about costs and preferences. This statement has absolutely no economic foundation; price theory is as valid, and even more elegant, in general equilibrium analysis, which shows that prices convey information throughout the entire economy.

Overtveldt also notes that the Internet and greater ease of travel are ending the isolation of the University of Chicago from the rest of the city and the country, an isolation to which he ascribes some of its past success. Surely, though, greater interaction with the rest of the profession will only amplify the influence of the Chicago department.

The ideas of the Chicago school will remain an important part of the economics profession’s thinking. Some of this thinking will take place in Hyde Park. But, the Chicago School’s real triumph is that its ideas will continue to be applied, tested, and refined in academic and policy circles throughout the United States and the world.

Alan D. Viard is a Resident Scholar at the American Enterprise Institute.

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