Key Chicago School Analytical Developments
The Chicago School is best known, of course, for monetarism: a macroeconomic policy regime of stable long-term economic growth with minimal inflation guided by a stable rule for growth of the monetary base.
Monetarism was designed to counter the Keynesian manipulation of fiscal policy levers to achieve the same goals, thus wedding a monetary theory which enabled market prices to function efficiently with a critique of interventionist policies in the macroeconomic realm that paralleled the Chicago School’s other economic policy arguments. The controversy between Keynesians and monetarists raged over the late 1960s and 1970s (Johnson 1972) and spilled over into international economics as Harry Johnson and Robert Mundell created the monetary approach to the balance of payments (Frenkel and Johnson 1976).The formal basis for the monetary rule was a restatement of the quantity theory of money (Friedman 1956). The restatement was rooted, however, in an implication of Friedman’s consumption theory (1957): a stable relation between consumption and permanent income implied that savings would not be a stable function of current income, which had been the operative assumption in earlier macroeconomic theories. Friedman’s permanent income hypothesis, then, enabled monetarists to focus attention on the policy implications of a stable demand for money in a quantity theory of money setting.
But monetarism is only one of several key Chicago School contributions to modern economic analysis. In microeconomic and industrial organization theory, Stigler led a group of scholars who challenged assumptions about the analytical relevance of price theory to a wide range of industrial policy. Stigler’s interest in how knowledge acquisition affects an economic agent’s market behavior led him through the application of statistical decision theory within a competitive price model to information search theory (Stigler 1961), a theme which Chicago economists, following Stigler’s lead, made central to labor economics and industrial organization, among other applications.
Stigler also turned his attention to regulation. With his long-time research assistant Claire Friedland, he examined systematically the empirical evidence on the effects of public utility regulation, showing that regulation had little or no impact on utility pricing (Stigler and Friedland 1962). He also argued that the existence of demanders of regulation as well as suppliers created a market-like environment for government regulation of economic affairs. However, in a political context without competitive pressures, demanders would capture the suppliers, rendering regulation socially inefficient (Stigler 1971). Stigler’s empirical work on regulation also led him to join Director in becoming more sanguine about the benefits of antitrust action.Two related developments emerged from the work of Ronald H. Coase, who arrived at the University of Chicago’s law school in 1964, and took over editorship of the Journal of Law & Economics. Coase’s two major articles, on the firm (Coase 1937) and on private versus social costs (Coase 1960), both continue the Chicago notion of using the basic insights of price theory to examine the operation of real markets. The first article introduced the costs of creating and sustaining markets, initiating the modern theory of the firm and the development of transaction cost economics, which reaches beyond industrial organization to law and economics, economic history, and the emergence of new institutional economics. Indeed, the field of law and economics is commonly said to have been created by the Chicago School; certainly, several of its most famous members - Coase, Becker, Richard Posner, Henry Manne, and Robert Bork - were faculty or students in the university’s law school. Coase’s second article also played an important part in the development of law and economics, as well as informing almost every area of economic policy analysis. Within the Chicago School, the use of Coase (1960) was largely shaped by Stigler’s interpretation, labeled the “Coase theorem”: in perfect competition, private and social costs would be equal (Stigler 1966: 113).
Harold Demsetz, who was a faculty member in the university’s graduate business school from 1963 to 1971, drew upon Coase and Stigler in developing a theory of property rights which contributed not only to law and economics, but also to the emergence of the new institutionalist economics (Demsetz 1967).A third theme of modern economic analysis that owes much to its development in the Chicago School is human capital. Schultz had long stressed the relationship between economic development and investment in human capabilities, and sought in the late 1950s to measure the impact of education on capital formation (Schultz 1960). At the same time, Becker and his Columbia University colleague Jacob Mincer were also examining the monetary return to post-secondary education. Becker’s Human Capital (1964) provided a formulation of the concept that enabled several generations of Chicago School students - among them Kevin M. Murphy, Finis Welch, and Richard Freeman - to apply price theory to lifelong individual decisions and public investment questions.
The Chicago School that emerged in the postwar period created an approach to the economic analysis of policy issues that tested the basic insights of price theory against empirical evidence provided by policy outcomes. While the Chicago approach initially differed substantively both in method and findings from the disciplinary mainstream, it eventually became the vanguard of developments across the discipline, as well as a leader in pushing the discipline into areas of social analysis into which it previously had not ventured.
Ross B. Emmett
See also:
Ronald Harry Coase (I); Milton Friedman (I); Frank H. Knight (I); Robert E. Lucas (I); Monetarism (II).