On The Economics Of Art And The Art Of Economics

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On the Economics of Art and the Art of Economics Whittier College, May 16, 2003 by Ohan S. Balian

Thank you all for coming and thank you professor Thomas for your introduction. Most of you have been taking exams in recent days and are probably fed up from economics – what I like to call ‘economics fatigue’ - synonymous with ‘donor fatigue’ experienced by multilateral organizations. So today I’ll try to use as little mathematics and graphs as possible and approach economics from an ‘artistic’ perspective. Today’s talk is a modified version of a talk I gave a few years ago at a symposium on the political economy of art. ‘Modified’ in the sense that I have toned down political economy issues and have tried to be more in-tune with the core values of a liberal arts college. When I first came to Whittier, I had no idea what a liberal arts college was and thought it was just another fancy Californian name. I soon realized that most of my colleagues weren’t sure either, which was evidenced through my discussions in faculty meetings and curriculum development committees. So I thought this would be the perfect setting to give this talk, especially given the high degree of uncertainty surrounding the relationship between the arts and the sciences. It is important to point out at the outset that by ‘economics’ I do not mean the science of economics alone. Economics encompasses all the social sciences, mathematics, model building, and more. Similarly, by ‘art’ I mean all forms of art, visual, fine arts, performing arts, music, and literature. So we see that both disciplines are very general, and it is very difficulty to determine the influence of one discipline on the other. The motivation for today’s talk is to tease out the differences and similarities

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between these two wide disciplines in the hope of determining the influence of one on the other. Let me start with the ‘Economics of Art’. If you type in the word ‘economics of art’ in any search engine on the Internet, you get hundreds of results, but almost all deal with how auction houses operate, what is the type of the art market structure (monopoly, duopoly, oligopoly), what is the power of the buyer (monopsony), but very few articles deal with using economics for valuation purposes. I am interested in using economics to determine the price of a painting or a piece of art. Why are some paintings sold for millions while others are sold for a few hundred dollars? Why do governments, in using contractionary fiscal policies, reduce government expenditure on the arts and education – the current Bush plan. (As we will see later in the talk, this is only one interpretation of the ‘economics’ of art). This takes us back to a very simple question posed by Adam Smith in 1776: “Why are diamonds more expensive than water?” It is also known as the water/diamond paradox – a paradox in the sense that water is a necessity (hence, should be expensive). The immediate response would be “what a silly question. Of course water is cheap and diamonds expensive because there is a lot of water and diamonds are scarce”. That’s fine. But diamonds are also ‘forever’. Once we realize this, we can explain the price differential between diamonds and water using the Diminishing Marginal Returns hypothesis. In other words, the value or ‘price’ of a good is determined by the marginal (extra) satisfaction one gets from consuming an extra unit of that good. As an example, suppose you’re in the desert and haven’t drank for a few days. (This reminds me of the Clint Eastwood movie: ‘The Good, the Bad, and the Ugly’). How much would you pay for the first cup of water? The answer, of course, is a lot. As you drink the second cup, you would still pay a lot but not as much as the first cup,

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and less and less for consecutive cups of water until you have quenched your thirst. So how much would you pay for the ‘last’ cup of water. The simple answer would be by the amount of the marginal or extra satisfaction that you get from drinking that last cup of water. In other words, the price of a cup of water is determined by the extra satisfaction from drinking that ‘last’ or marginal cup. If we apply the same reasoning to diamonds and ask the question: “How much would we pay for a diamond?” The answer would be: a lot. And how much would we pay for the second diamond? It depends on the extra satisfaction that you get from ‘consuming’ that second diamond. Would it be more or less than the first? The answer would be at least the same, or even more. Hence, we would assume that since we get more satisfaction from the second diamond (unlike the second cup of water), its price would still be high, and even higher than the first diamond. Applying this reasoning to a ‘luxury’ good like a famous Renoir, we would see that the consumer would get a higher utility from a second Renoir than the first, and hence pay a higher price. One of the few papers that look at the behavioural relationship between art and economics is by Lanyon and Smith (1999): “A Portrait of the Artist as a Young, Middle Aged, and Elderly Man.” They look at the age-value and age-quantity correlation for 53 Western painters whose paintings have been auctioned in the last decade. They show that the average value of their paintings increases till the age of 32, slowly declines until the age of 47, and then dramatically falls in old age. They also find a similar trend when they look at the age-quantity relationship – namely, artists produce substantially more in the early stages of their careers, then output declines dramatically in old age. Their main finding is that artists paint significantly more, the higher is the average value of their paintings. What do these findings suggest? Well, isn’t this the positively sloped supply curve based on the objective of profit maximization?

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Now let me say a few words on the relationship between economics and literature. A few years ago, I was watching a program on CNN called Questions & Answers (Q&A). This is a truly interactive program in which the host of the show (Riz Khan) invites guests and people from all over the world call to ask questions. The guest on the show at the time was Vikram Seth, a Nobel Laureate in English Literature. I had read somewhere that he had an undergraduate degree in economics, and started listening very carefully to what he was saying. He was talking about how successful he was in his ability to market his books in the US (compared with other authors) and I could detect traces of economics in his argument. So I picked up the phone and asked the following question: “To what extent your background in economics has influenced your writings.” He laughed for a few seconds and said that he doesn’t even remember his demand and supply curves, and gave an ‘acceptable’ answer but not a very convincing one. Then there was another caller, and then a third caller who again asked a question about his ability to market his novels, and in his answer to this third question, he subconsciously used the term “Diminishing Marginal Returns.” He paused for a few seconds, and said: “I guess economics has affected my thinking after all” – referring to my earlier question. And this made me so happy because I was so sure that he was one of ‘us’, even though he was a Nobel Laureate in ‘English’. At the time I was also deep into my dissertation and whenever I needed to take a break from my ‘equations’, and as if through an ‘invisible hand’, I was drawn into literature books. (My wife is an English Literature major and we have no shortage of literature books at home). I could clearly see the close relation between mathematics and literature: how equations are formed, and how sentences are structured. During this period, I also ‘discovered’ William Hazlitt, an 18th century English liter-

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ary critic who wrote about self-interest, imagination in the arts, and ‘gusto’, terms that are heavily used in economics. (Remember that this was in Adam Smith’s time in 1776). We do not have the time to go into Hazlitt today (also because I don’t know much about him!) but I was very happy and fulfilled that at least my ‘intuitions’ were correct. In concluding my thoughts on ‘The Economics of Art’, we see that there is a lot of documentation and loose connections between these two very general fields, but little systematic analysis to scientifically explain this relationship. Now lets turn to ‘The Art of Economics’, and here by the ‘art’ I mean the methodology of economics, and the ability and effectiveness to explain complex economic phenomena to the general public. Again let me make a few remarks through real world experience. I was watching a C-SPAN program a few weeks ago and there were three well respected economists on the program: Joseph Stiglitz, Lawrence Klein, and Franco Modigliani, all Nobel laureates, but they couldn’t make a convincing case against the Bush tax plan. (Remember that C-SPAN is a program for the general public, but even I, considered an economist, could not follow their argument). They talked about the ‘Term Structure of Interest Rates’, ‘Marginal Propensities’, and other esoteric terms to make a very simple point: namely, if the government reduces taxes, it must also reduce its expenditure, which will cause a lot of problems. And that’s it. Now the disagreement is on what should be ‘cut’ in government spending and what is the effect of the tax cut on consumer spending (Consumption) and business spending (Investment). Now regardless of whether you’re for or against the Bush tax plan, if the reduction in taxes (a source of revenue) is greater than the reduction in government spending (a source of expenditure), then the budget deficit will deteriorate and the rate of interest

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will eventually rise. If the reduction in taxes is less than the reduction in government spending, then the budget deficit will improve and the rate of interest will eventually decline. You don’t have to be an economist to understand this. In other words, if you spend more than you earn, you are in trouble one way or another. If you earn more than what you spend, then you’re fine. The disagreement stems from the ‘Supply Siders’ (pro Bush) who say that as taxes are reduced, it is good for businesses (because they have lower costs) and therefore will produce more and generate economic growth. The point that I am trying to make is that economists, even well respected ones, are sometimes unsuccessful in explaining complex economic phenomena to the general public. In explaining economic phenomena, we use models based on ‘assumptions’. It is sometimes very frustrating to use unrealistic assumptions to explain real world phenomena. We keep telling our students that assumptions are used to ‘filter’ important variables from less important ones, and to simplify the real complex world. To express my frustration, a few weeks ago we were at UCLA with our Whittier College students to hear a talk by Joseph Stiglitz on Globalization. Although he had some very interesting things to say (after all he is a Nobel Laureate), for over an hour he bashed the International Monetary Fund (IMF), and in one of his examples he said that the privatization policies adopted by the IMF in Argentina were so inappropriate that even if we assumed that corruption was virtually non-existent, the privatization program would not have succeeded. After his talk, the audience was given a chance to ask questions but unfortunately he spent too long on each question and there was no time for my question. I was going to ask the following question: “Mr. Stiglitz, using your same analogy, if we assumed that the IMF did not exist, would the world be a better place?” Now based on how he used his assumption on the non-existence of corruption

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in Argentina, his rational answer should’ve been, yes. But we all know that even with all the mistakes and imperfection of IMF policies, surely it has had some positive effect on world economic development. Let me now say a few words on the ‘art of model building’. In economics, we build economic models, and in art, we build ‘clay’ (or using some other medium) models. There are basic ingredients in both, they follow certain predetermined established rules, but they are independent of each other. The fundamental difference is that ‘art’ models try to interpret reality, whereas economic models deal with reality. We call this ‘bounded rationality’ in the sense that economic reasoning is ‘bound’ by certain assumptions and rational behaviour. In other words, as policy makers, we need to be very careful of our policy prescriptions (based on our models) because we can affect the lives and well being of millions of people. One final point on ‘The Art of Economics’ is that this ‘art’ can be modified and improved. As an example, lets look at the theory of Asymmetric Information and how it can be modified. This theory basically says that the seller in a market usually has more information than the buyer, and hence, can extract a larger benefit. When I was in contact with Professor Steven Overturf at Whittier before my arrival, the good professor was explaining to me how he ended up buying his dream house, a house to which they were closely attached since they rented it in the summer vacations. Although he was very happy that they eventually bought the house, he was a little bit uncomfortable since, as an economist, he ended up paying a higher price than the market price. To him, this was not a ‘rational’ behaviour. At the time I was working on an idea at the Hebrew University in Jerusalem on asymmetric information from the consumption side – Consumption Advantage. The idea is that a brick layer can buy a house at a lower price than a doctor, who in turn can buy a health service at a lower

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price than an economist, who in turn can buy, say, a financial instrument at a lower price than a non-economist, and so on. The reason is that consumers have asymmetric information in consumption depending on their professions and levels of skill. At the time I related this reasoning to professor Overturf’s experience and I was successful in convincing him that his behaviour was not ‘irrational’ after all. He knew the house intimately since they were vacationing in it for the past 20 years, and his Marginal Utility was very high as he moved to the new house. As he began to ‘consume’ more and more of the house, his marginal utility began to fall until it was equated to the market price. Hence, he was acting rationally after all. In conclusion, let me leave you with two related questions, which also bring together the differences and similarities between art and economics: Does it help to be a good economist if you are a good artist? The answer is unambiguously yes. But does it help to be a good artist if you are a good economist? Here, the answer is ambiguous. Although there is a lot of documentation on the relationship between art and economics, much more empirical research is needed to provide a convincing answer. I thank you for your attendance and hope that I have succeeded in making economics much more interesting than the ‘dismal’ science for which it is sometimes known.

Whittier College, California, May 16, 2003