20 October 1982

THIS YEAR’s PRIZE IN ECONOMICS IS AWARDED FOR RESEARCH ON MARKET PROCESSES AND THE CAUSES AND EFFECTS OF PUBLIC REGULATION

The Royal Swedish Academy of Sciences has decided to award the 1982 Alfred Nobel Memorial Prize in Economic Science to

Professor George Stigler, University of Chicago, USA,

for his seminal studies of industrial structures, functioning of markets and causes and effects of public regulation.

George Stigler’s Principal Contribution
Through long and extensive research efforts with strong empirical orientation, George Stigler has made fundamental contributions to the study of market processes and the analysis of the structure of industries. As part of this research he has investigated how markets are affected by economic legislation. His studies of the forces which give rise to regulatory legislation have opened up a completely new area of economic research.

Stigler’s achievements establish him as a leader in applied research on markets and industrial structure – a field often known as industrial organization. Through particular features of his research, Stigler is also recognized as the founder of “economics of information” and ”economics of regulation”, and one of the pioneers of research in the intersection of economics and law.

Market Processes and Industrial Structure
Despite strong simplifications, basic economic theory has proved effective in explaining and predicting the dominant features of market events. At the same time, the high level of abstraction has left many individual market phenomena unexplained. This is the premise for Stigler’s research work. His underlying ambition has been to seek explanations for the distinctive features and peculiarities of markets and structural developments within the framework of basic theoretical assumptions about firms’ and households’ optimizing behavior and the interplay between supply and demand.

This is exemplified in Stigler’s studies of the role of information in market processes. According to traditional theory, the result of optimization and market processes should be that every commodity, except for transport costs, is sold for one and the same price everywhere. But, in practice, price variation is observed on most markets. Stigler has shown that this can be explained if the costs of searching for, and diffusing information about, goods and prices are incorporated in the model along with production and transport costs. The basic properties of traditional theory do not have to be challenged. It has merely been too schematic by assuming “perfect information”, in the same way that fundamental theories in physics simplistically assume the existence of a vacuum.

A market participant’s lack of knowledge about goods and prices can, of course, be alleviated by collecting and furnishing information. The amount of information a firm or household acquires is guided by the same comparisons between costs and benefits as the production of any commodity. That is, information is gathered until the expected utility of further search no longer outweighs additional search costs. The information a subject acquires is consciously chosen. Conversely – and more provocatively – even a lack of market information is rationally and deliberately chosen

These, and similar achievements prove an indispensable complement to basic theory. Subsequent research has shown how phenomena such as price rigidity, variations in delivery periods, queuing and unutilized resources, which are essential features of market processes, can be afforded a strict explanation within the framework of basic economic assumpions. They are no longer unnecessary market imperfections which can give rise to government intervention. The results have also contributed to explaining inflation and unemployment. An appreciable amount of the research on these phenomena during the last decade has also followed this line of reasoning. Thus, Stigler is not only the foremost originator of economics of information. He is also among those who have provided the basic postulates for today’s research on the theoretical foundations of macroeconomics.

In another important study, Stigler examines the traditional theoretical prediction that differences in rates of return are rapidly erased though movements of capital and from low-yield to high-yield firms – one of the cornerstones of the neoclassical concept of market mechanisms. On the basis of extensive compilation of American earnings and capital data – in itself a pioneering effort in economic statistics – Stigler also finds that differences in rates of return are effectively equalized, even if the process might take as long as a decade. The fact that an industrial sector is profitable, or unprofitable, one year indeed indicates that it can be expected to remain so in the coming 2-3 years. But it says hardly anything whatsoever about the condition of the sector after 7-8 years. Sluggishness can postpone equalization, but it will emerge eventually. Differences in rates of return between firms or sectors may appear to last a long time, but this is often because new, highly-productive firms and sectors rise, while firms and sectors which were profitable fall. There are many indications that these tendencies have recently been reinforced by increased internationalization of the economic system. In principle, these processes appear to be equally prevalent in many countries as they are in the USA.

In another study, Stigler shows that, in practice, clear-cut conclusions about economies of scale and similar phenomena cannot be drawn on the basis of traditional cost data in order to determine optimal firm size in every industrial sector. A firm’s vitality and development capacity are only weakly related to cost conditions in production itself, but depend instead on various factors which are difficult to observe. This brought Stigler to the so-called survivor principle which states that, first, those categories of firms which actually exhibit an ability to survive should be determined; then, the properties which yield this ability should be sought. Stigler himself has carried out a study along these lines which has had many successors.

Stigler’s contributions to the empirical study of markets and sectoral structure based on economic theory also include a number of further investigations. One of them is a survey of pricing behavior in American industry. Others refer to the significance of monopoly and oligopoly.

Causes and Effects of Public Regulation
As early as the 1940s, Stigler studied the effects of some features of regulatory legislation in the USA, particularly rent controls and minimum-wage legislation. He indicated that far-reaching, unintended side-effects could arise alongside the primary desired effects. A later study showed that regulation of electricity rates completely lacked observable effects. As a conceivable explanation, Stigler saw that regulation can be based on erroneous perception of real conditions and thus, in practice, be difficult to implement, and on the fact that the intended effects can be neutralized by external pressures. This work on the consequences of regulatory legislation have set a pattern for numerous similar studies, performed by other researchers in many countries.

In later studies of regulatory legislation, Stigler has emphasized its causes rather than its effects. Preliminary observations led him to the hypothesis that, in practice, some regulations protect firms, organizations and professional and occupational groups – i.e., producer interests – instead of the general public that, according to stated motives, they were intended to protect. Stigler himself found firm empirical support for this hypothesis in a number of studies; it is still too early to assess its ultimate scope. But Stigler’s results do show that legislation can also be an outflow of market participants’ optimizing behaviour. To the extent that this is so, legislation is no longer an “exogenous” force which affects the economy from outside, but an “endogenous” part of the economic system itself. This approach constitutes a further step towards extending the sphere of application for the basic assumption of economic theory.

Stigler’s studies have opened up a new area of research known as economics of regulation. In many quarters, it has resulted in fundamental testing of the forces, purposes and effects of different aspects of legislation. These achievements have also made Stigler one of the pioneers in another new field of research, law and economics.