Vernon Smith ’49 gets ready to meet the press
at Virginia’s George Mason University after learning
that he is corecipient of the 2002 Nobel Prize in Economics.

Mr. Smith goes to Stockholm

By Michael Rogers

No matter how exceptional you think you are, the proper response to the news that you’ve won a Nobel Prize is genuine surprise or at least a convincing approximation of it. On the morning of October 9, when Vernon Smith ’49 got the call from Stockholm, and the official who relayed the news that he was a cowinner of the Nobel Memorial Prize in Economic Sciences asked him how he felt, Smith says that he replied, “I’m relieved.”

Relieved? Not even Richard Feynman would have been so brazen. But if you’re acquainted with the 76-year-old economist with the ponytail and Western twang in his voice, then you know that there wasn’t a bit of hubris in his comment.

“I was relieved, because my friends have been predicting this for years and they were finally right,” explains Smith, speaking by phone from his home in Tucson, where he was preparing the speech he would give at the Nobel Prize ceremonies in Stockholm in December. “When you hear these things from friends and people who have nominated you in the past, all it expresses is their hopes. When I didn’t get it, I’d feel as though I’d let them down, even though there was nothing I could do about it.”

Smith, a professor of economics and law at George Mason University, shares the prize with Daniel Kahneman, a professor of psychology at Princeton. He now becomes Caltech’s 29th Nobel laureate, and the winner of the Institute’s 30th Nobel Prize, counting the two won by Linus Pauling, PhD ’25, who taught Smith chemistry in the 1940s.

According to the Royal Swedish Academy of Sciences, Smith won the Nobel “for having established laboratory experiments as a tool in empirical economic analysis, especially in the study of alternative market mechanisms.” Over a nearly 50-year career, Smith founded and promoted the field of experimental economics, changing economics from a science of observation to one where theories could be tested and confirmed or refuted through controlled experiments. While the trend toward experimentation has met resistance from some economic theorists, numerous institutions, including Caltech, have established experimental economics programs. In a few cases, the discipline has changed the way business and government are practiced.

Smith’s first introduction to economics came at Caltech. The son of socially conscious parents with eighth-grade educations, Smith grew up in Wichita, Kansas. Smith says he was an average student. He first heard about Caltech as a high-school senior when he went to the local library to gather information on universities. He picked up a book that pronounced Caltech the best institution of higher learning in the country. “So, I said to myself, ‘Why not just go there?’” says Smith. After taking a year of science and math courses at a local college, he passed the Caltech entrance exam and went off to Pasadena in 1945.

“I just worked for four straight years at Caltech, including weekends,” he recalls. “I didn’t have a social life. I worked very hard and never regretted it.”

Smith’s father, a machinist, had instilled in him a desire to understand how things work. Taking his first economics course his senior year, Smith recalls, “I guess I realized that economics was not that different from physics.” But unlike physics, “economics didn’t have a foundation in empirical work. It was not clear that the way it was taught was how things actually worked.” Theories were just accepted without proof. Smith would eventually challenge that notion.

After Caltech, Smith went to the University of Kansas and got a master’s degree in economics in 1952, and then went to Harvard, where he got his PhD in economics in 1955. At Harvard, he was influenced by a professor who provided classroom demonstrations to show that the prevailing theories of competition among small groups of individuals were unrealistic.

When Smith left Harvard for his first teaching job at Purdue University, he began to set up experiments using students to simulate different market situations. Challenging classical economic theory of supply and demand, Smith showed that markets could work efficiently even if buyers and sellers had incomplete information about each other’s strategies and preferences.

“The more you know about the circumstances of other people, the more you should be able to use that to your advantage,” he says. “But what you know may be inaccurate. So having more information may not be better.”

Smith left Purdue in 1967, was at Brown University briefly, and then went to the University of Massachusetts. In 1973, he returned to Caltech as a Sherman Fairchild Distinguished Scholar and, along with Charles Plott (today Caltech’s Harkness Professor of Economics and Political Science), taught a course in experimental economics in which faculty members sitting in the class outnumbered the students by a margin of two to one. Plott had introduced experimental economics to Caltech the previous year and, when Smith returned, they conducted experiments that advanced the discipline and helped make Caltech the nation’s leading center of experimental economics.

“Vernon is the prime evangelist for the whole field of experimental economics,” says Ross Miller ’75, one of the students who took the Plott/Smith class. Miller’s book about Smith and the field he established, Paving Wall Street: Experimental Economics & the Quest for the Perfect Market, was published in 2002. “He’s wonderful in all dimensions; a great teacher and researcher who has influenced hundreds of students over time,” said Miller, a financial consultant.

“When he returned to Caltech as a Fairchild Scholar, Vernon brought with him a wealth of knowledge of techniques that he had learned in the ’60s,” says Plott. “He had stopped doing experimental economics for several years, and this brought him back to experimentation. He was the first person to observe the law of supply and demand working in its quantitative form and, if nothing else, he deserved the Nobel Prize for that.”

Plott, who had been an associate professor of economics at Purdue before coming to Caltech, had been Smith’s fishing buddy in Indiana, and the two spent countless hours driving to lakes and rivers to fish for bass during the two years that Smith was teaching at Caltech.

“We just talked economics the whole time,” Smith says. It was the middle of the Arab oil embargo and the energy crisis, when gas stations’ supplies were limited by the government, based on quotas that were linked to the stations’ previous year’s sales. Smith recalls that while the gas stations in Pasadena were running low on gas, he and Plott would pass station after station in the desert that were overflowing with supply that they couldn’t sell because urban residents were passing up road trips for fear that there would be no gas available to get them home. “You could see the economics of controls working so badly,” Smith says.

The market effects of government regulations would figure in Smith’s experiments and in the applications of his research. After leaving Caltech, he went to the University of Arizona, where he established a research group in experimental economics in 1975.

Expanding his research into so-called irrational markets, Smith saw that government regulations, which purport to create fairness by establishing a level playing field with a free flow of information, often create unfair situations. In the case of auctions for oil drilling rights, for example, Smith says that the government not only publishes successful bids but also the names of the bidders, which he says makes it easier for collusion to take place.

Over the past few years, Smith has focused on the creation of private markets for trading electricity, a sore subject for many U.S. consumers, who watched their utility bills skyrocket in 2001 thanks to the artificially inflated prices orchestrated by rogue companies like Enron.

His research has had a positive influence in Australia and New Zealand, where he has helped those countries develop a spot market for electrical power. Due to increased competition among utilities and a proliferation of technologies that allow consumers to automatically limit their electricity usage during peak periods, prices have dropped.

Smith and his experimental economics group left Arizona in 2001 and moved to George Mason University in Virginia. Caltech’s newest Nobelist says that he will give his half of the approximately $1.07 million Nobel award to the International Foundation for Research in Experimental Economics, the foundation he established in 1997 to support his group’s research.

And Smith definitely won’t let his newfound fame keep him away from his own active role in that research. “The Nobel Prize is only the beginning for experimental economics,” he says. “There is still much to do.”