George Stigler by Edward S. Herman

A second major figure of the modern Chicago School, and another Nobel Prize winner in economics, was the late George Stigler, a specialist in economic theory, industrial organization (monopoly and competition), and regulation. His writings on the first two topics tended to show the beauties of competition and the relative unimportance and impermanence of monopoly, absent government intervention.

Perhaps his greatest mark, however, was made in developing and sponsoring analyses of the inefficiency of government regulation. In one of his most famous articles on this subject, "Public Regulation of the Securities Markets," published in the University of Chicago School of Business's Journal of Business in April 1964, Stigler used an ingenious model of "before and after" effects of regulation to demonstrate that the Securities and Exchange Commission's (SEC's) requirement of full disclosure in new securities issues was of no value. His method was to compile a sample of new security issues of certain size and other properties for several years in the 1920s and a sample in the late 1930s issued under SEC regulation, and then compute what happened to their prices in the years following issuance. If the SEC was effective, and securities buyers were better informed, one would expect the post-offering prices to be closer to the initial prices and the dispersion of price ratios to be less in the post-SEC period. Stigler claimed that his test showed no improvement in the post-SEC period.

Professor Irwin Friend and this writer did a collaborative analysis of Stigler's study, including a sample review of his original data as well as an examination of his reasoning. In our review of his sample data, we uncovered 25 errors in his reporting of data, 24 of which were in the direction supporting the hypothesis that Stigler was trying to prove, and sufficiently important to affect his significance tests, even though based on only a partial review of his data. With the corrections, the performance under regulation was indisputably superior to the unregulated performance, as measured by average price ratios of the 1920s and in the post-SEC period. In Stigler's own analysis, the dispersion of price ratios was also substantially lower in the post-SEC period, but Stigler "reinterpreted" the test, retrospectively claiming that the lower dispersion meant that regulation had reduced the willingness of risky firms to enter the market (this is Diesing's item 3 in the list given above of Friedman's methods of "testing"). Ironically, Stigler had written an earlier article on "The Economics of Information," whose main theme was that increased information reduces price dispersion, which he implied was beneficial and desirable.

Our showing that Stigler had doctored the data in a very serious way, and misread his own results, was published in the Journal of Business in October 1964, with an appendix listing the 25 errors and showing in a table the large effect on the test results. Stigler did not challenge the criticisms in substance, but proposed using different data (Friedman's method 4, in the Diesing list above). This exchange occurred in the very year Stigler was made president of the American Economic Association, but had no noticeable effect on his reputation. In subsequent years, Stigler's Chicago School associates continued to cite his original article as proving the ineffectiveness of SEC regulation and full disclosure, which is comparable to a physical anthropologist in the 1980s continuing to cite the Piltdown Man as a valid member of the evolutionary ladder. But if Piltdowns are a commonplace in the "science" and one operates on principles of a truth above fact, it is all comprehensible.

Stigler himself and many of his followers continued their modelling of regulation and its effects by the same or related methods. The most important Stigler follower in this area was Sam Peltzman, who wrote a Ph.D. thesis under Stigler's direction in 1965 that purported to show that the extension of federal regulation to virtually all banks in 1935 caused the entry of new banks to drop by 40-50 percent. Peltzman's method was to specify several factors that might influence entry rates, most importantly bank profit rates, and then explain any decline in entry after 1935 not attributable to the chosen factors by a "residual" called "government regulation." Although branch banking was growing rapidly in this period, Peltzman never included new branches in his model. Among the many other intellectual crimes committed by Peltzman, the model had the interesting characteristic that the poorer the explanatory variables, the better the result from the Chicago School standpoint (i.e., the larger the residual "government regulation").

This terrible study was cited as authoritative in the years that followed, and was never rebutted, in part because the formulation and testing of a rival model required data collection back into the 1920s and would have been very arduous. Peltzman followed up this success with studies of drug and auto safety regulation, each demonstrating by means of the new Chicago School methodology-us¬ing dubious explanatory variables, and leaving government regulation as the residual-that government regulation was ineffective. Several analysts went to the trouble of showing that Peltzman's further studies were fraudulent, but his studies continued to be cited as authoritative demonstrations that the case for drug and auto safety regulation was dubious.

See also

• Milton Friedman by Edward S. Herman
• The Chicago School