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American economist Vernon Lomax Smith was born in Wichita, Kansas, on January 1, 1927. In 2002 Smith became the co-laureate of the Nobel Prize in Economics “for having established laboratory experiments as a tool in empirical economic analysis, especially in the study of alternative market mechanisms” (Nobel Foundation 2002). In awarding Smith the prize, the Nobel committee recognized the well-known observation that Smith is the father of the discipline of experimental economics.
Smith’s official Nobel autobiography (Nobel Foundation 2002) provides a moving description of life in the Depression-era Kansas of railroads, farming, oil drilling, and relatives who die too young. This was also a world in which a graduate of a one-room schoolhouse who became a distracted “C” student in high school could gain admission to one of the world’s finest universities, the California Institute of Technology (Caltech), by passing the rigorous admission exam. By 1955 Smith was a graduate of Caltech (B.S., 1949), the University of Kansas (M.A., 1951), and Harvard University (Ph.D., 1955), with a faculty position at Purdue University in Indiana.
Smith’s initial research areas were in capital theory, investment, and financial economics. At about this time, a fortunate synergy among teaching and research emerged. The behavior of the stock market is certainly relevant to capital theory and financial economics, and Smith pondered how to get these ideas across in his classes. He recalled from his days as a graduate student at Harvard that economist Edward Hastings Chamberlin (1899-1967) had created a simulated “random meetings” market in a classroom, in which demand and supply curves were constructed from hypothetical benefits and costs assigned to the students. Chamberlin’s markets famously failed to find the competitive equilibrium. Smith’s changes were initially to use a different trading institution, the oral double auction (an analog of stock exchange trading rules), and to repeat the markets across time. Later, after conversations with psychologist Sidney Siegel (1916-1961), Smith made a third important innovation: costs and valuations were no longer hypothetical, and participants were actually paid according to their earnings. The Chamberlin findings dissolved; the markets converged to the competitive predictions. Smith’s first research results in experimental economics were published in the Journal of Political Economy in 1962. Further exploration of the double auction institution followed. Then, Smith applied the methodology to a different institution, the sealed bid auction (as used in U.S. Treasury securities auctions). Along the way, Smith continued to make seminal contributions in financial economics, environmental economics, and economic anthropology.
During a visiting appointment at Caltech in 1974, Smith found that a former Purdue faculty member, Charles Plott, had moved to Caltech and become an enthusiastic proponent of experimental methodology. This began a period of fruitful collaboration between them. Smith left for the University of Arizona in 1976 and then George Mason University in 2001. Smith’s reputation as the “father of experimental economics” coalesced, due not only to the original Purdue innovations but also to the breadth of his new applications and the development of key methodology treatises on laboratory experiments. In the former category, Smith’s work expanded to include public goods provision mechanisms, oral auctions, industrial organization, asset pricing, and the concept of computer assisted “smart markets.” His methodological articles address the concept of “induced valuation” (reflecting his earlier decision to pay subjects based upon earnings). In 1982 his tour de force, “Microeconomic Systems as an Experimental Science,” was published. Nationally and internationally, the number of researchers adopting the methodology increased dramatically. Smith was the driving force behind the founding of the Economic Science Association in the mid-1980s.
In his Nobel autobiography, Smith singles out two books in economics that attracted his attention prior to graduate school, one by American economist Paul Samuelson, the other by Austrian economist Ludwig von Mises (1881-1973). This observation is a foreshadowing of Smith’s career. His lifetime of contributions to traditional mathematical microeconomic theory (the Samuelson stream) by themselves would be stellar, but his work in experimental economics is equally important. For Smith, experimental economics is immersed in a different way of looking at the world. Smith’s mother had strong socialist leanings, and his graduate training at Harvard in the early 1950s was hardly an incubator for a libertarian worldview, certainly not foreshadowing his later active involvement with the Mont Pelerin society. But Smith’s economics (not merely his experimental economics) are very different from that which his early background might suggest. This could be due to his early reading of von Mises and German economist Friedrich von Hayek (1899— 1992). It could also reflect the striking observation from his first experiments: markets that do not efficiently capture gains from exchange under one institution will do so under another. Whatever the history, there is no better place to find Smith’s views than in his 2002 Nobel lecture, “Constructivist and Ecological Rationality in Economics.” The lecture has obvious overtones of Austrian economics, but Smith presents a tantalizing paradox. Experimental economics can be viewed as buttressing a Hayekian view of economics, but Hayek himself seemed to anticipate, and then reject, the methodology of experiments.
Bibliography:
- Chamberlin, Edward H. 1948. An Experimental Imperfect Market. Journal of Political Economy 56: 95–108.
- Nobel Foundation. 2002. The Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel 2002. Press Release, Autobiography, and Prize Lecture. http://nobelprize.org/nobel_prizes/economics/laureates/2002/.
- Smith, Vernon L. 1962. An Experimental Study of Competitive Market Behavior. Journal of Political Economy 70: 111–137.
- Smith, Vernon L. 1982. Microeconomic Systems as an Experimental Science. American Economic Review 72: 923–955.
- Smith, Vernon L., Gerry L. Suchanek, and Arlington W. Williams. 1981. Bubbles, Crashes, and Endogenous Expectations in Experimental Spot Asset Markets. Econometrica 56: 1119–1151.
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