MIT Professor : Modigliani Wins ’85 Nobel in Economics

Franco Modigliani of the Massachusetts Institute of Technology, a Renaissance man of economics whose work has had broad impact on areas as diverse as corporate finance, the impact of high federal deficits and patterns of household savings, was named Tuesday as the 1985 Nobel laureate in economics.

According to prominent economists around the country, Modigliani stands at the intellectual forefront of an astonishing range of issues in the field.

“He’s extremely versatile,” said James Tobin, a Yale economist and the 1981 Nobel economics laureate. “He’s covered almost every topic.”

Colleagues said Modigliani’s theoretical distinction is served by an effusive personality. “He’s very bouncy, full of enthusiasm and exuberance and passionately interested in the impact of his theories,” Tobin said.

Criticizes Administration

At a press conference and interviews following Tuesday’s announcement, Modigliani promptly used his new prominence to criticize the economic policies of the Reagan Administration.

“I would say the important thing is to reduce the deficit very promptly,” the 67-year-old MIT professor said in an interview. “I would personally be ready to reduce defense expenditures.”

Modigliani explained that he considers the U.S. tax rate to be low relative to those of other major industrialized countries and the impact of a tax increase to be far more salutary than the continued deficit, which saps the economy of the capital needed for expansion and drives equity overseas.

“The government deficit and the foreign trade deficit are all the consequence of the same policy.

“I see no consequence to raising taxes to cover what we’re spending,” he said. “I say don’t make it a fetish that taxes can’t be touched.”

‘Life-Cycle’ Hypothesis

Like most enduring economic ideas, Modigliani’s theories often have the retrospective ring of common sense--among them his postulates that people save money chiefly for their retirement and that future generations pay the price, in high interest rates, for excessive government deficits. But they have tended to contradict the received wisdom of their times.

In its award citation, the Royal Swedish Academy of Sciences stressed the importance of Modigliani’s pioneering “life-cycle” hypothesis of how people decide whether to spend or save their income. The theory, since borne out by decades of postwar economic experience, states that people save chiefly to have money for their retirement years. This explains why savings rates decline as national pension plans such as Social Security improve.

The theory contradicted prewar economics, which was based on the Great Depression experience.

“The reigning model of consumption at the time was a rather naive one that said one’s consumption right now depends on one’s income right now,” Tobin said. “Franco’s work provided a good common-sense explanation that said that, unless people are living hand to mouth, they’re going to smooth out (their income) so they have something left over when they retire.”

“The ‘life-cycle’ theory is built on the biological fact that we outlive our working years,” said Paul A. Samuelson, a 1970 Nobel economics laureate and a colleague of Modigliani’s at MIT. The theory explains that the Reagan Administration tax cuts did not foster increased personal savings, as they were designed to do, because people viewed them as a permanent boost to their income.

“Based on his life-cycle model,” Samuelson said, “he was a critic as early as 1980 of supply-side economics.” Supply-side theorists argued that tax cuts would spur the economy by encouraging people to save, thus providing more capital for industrial growth.

Other Economic Areas

Samuelson and other economists said Modigliani is also a pre-eminent theorist in several other economic areas. With Merton Miller, now at the University of Chicago, the new laureate developed the so-called M-M hypothesis of corporate finance. This theory, first published in 1958 and also cited by the Nobel committee, states that, except for tax implications, the underlying value of a corporation is unaffected by the ratio between its debt and equity, a thesis currently being tested by the sharp increase in debt and corresponding drop in equity undertaken by public companies facing takeover threats.

In the interview, Modigliani said that he stands by his general conclusion that “there are some advantages to leverage, particularly as inflation abates.” But he cautioned that such developments as leveraged buy-outs may be saddling purchased companies with too much debt.

“Generally speaking, the work I’ve done does not suggest that the more the better,” he said.

Macroeconomic Theorist

Modigliani is also a leading macroeconomic theorist; in the prewar years he was one of the first major interpreters of the writings of John Maynard Keynes, the father of modern economic theory. He also developed an econometric model--that is, a statistical measure of the economy--still used by the Federal Reserve System to gauge the impact of its policies.

Modigliani was born in Rome in 1918 and earned a doctorate in jurisprudence at the University of Rome in 1939. One year later, he and his wife fled the fascist regime of Benito Mussolini to come to the United States. He is a naturalized U.S. citizen.

Modigliani is the 13th American to win or share the Nobel Memorial Prize in Economic Science since it was established in 1968 by the Riksbank, the Swedish national bank. Although it is the only Nobel award not provided by the will of Alfred Nobel, the inventor of dynamite, it carries the same cash award as the other prizes--about $225,000 this year.

Modigliani said he would use his prize money “in accordance with my own theories of how people behave--namely, distribute it over the rest of my life. I’m not going to go on a binge. I will use it gradually. That’s what my theory says people do.”

THE NOBEL PRIZE IN ECONOMICS Past winners 1984 Sir Richard Stone British, for development of accounting systems that help governments allocate their financial resources. 1983 Gerard Debreu American, for research on equilibrium in a market economy. 1982 George J. Stigler American, for pioneering studies of industrial production. 1981 James Tobin American, for analysis of financial markets and their relations to spending decisions, employment, production and prices.