When I was an undergraduate student in Israel, I remember asking one of my professors, 'Who is the greatest economist in the world today: Samuelson or Friedman?' His answer surprised me: Arrow.
I was embarrassed not to know him, and asked "Who?!" My professor replied, "If you go to graduate school, you’ll learn about him."
Indeed, when I took a few masters courses in Israel, and then later while getting my Ph.D. at Berkeley, I realized that Kenneth Arrow truly was the greatest. He impacted almost every major topic within economics. He introduced measures of risk aversion and developed tools that allow us to quantify how people respond to risky choices when they make investments or deciding whether to adopt a technology.
His work on healthcare introduced the notion of asymmetric information between a buyer (in this case, a patient) and a seller (the doctor). In the 1970s, several people received the Nobel prize by expanding this idea into different areas, and emphasizing the important role of signals, branding, screening mechanisms, etc. For example, a college degree doesn’t only provide practical knowledge, but the fact that you got it serves as a signal that you have skills worth investing in.
I was even more excited by his work on "learning-by-doing." He realized that knowledge and technology evolve with experience and learning, and later on others developed theories that really show that the key component for economic growth is accumulated knowledge from experience and research. Arrow was among the first to start the literature on the economics of R&D. It was amazing that in almost every field, he has made immense contribution.
Arrow was the youngest recipient of the Nobel Prize in Economics for his work on general equilibrium that showed that under certain conditions, markets reach outcomes that are socially optimal. But in my view, his more radical work was his "impossibility theorem" that argues that voting systems don’t necessarily result in outcomes that are socially optimal. Recently, we have observed application in the spirit of this theorem in quite a few places. While I admired Arrow immensely for his creativity and breakthrough ideas, I considered him a traditional economist who believed in market solutions and embodied the status quo of advanced economics.
I discovered a totally different side of Arrow in 2006 when he presented his Galbraith Medal speech. I invited him to give the talk at the AAEA meeting in Long Beach. He answered his phone immediately and when I asked him if he was willing to give a talk in honoring Galbraith, he said, "Count me in."
In his talk, he said that while he and Galbraith approached economics in different ways, they shared many similar views and values. Then he said that economic theory suggests that the main role of governmental intervention is to correct externalities (e.g. control pollution), provide public goods (defense, basic research), address non-competitive behavior and assure free flow of information.
But many of the government activities are in support of the poor, provision of health and education, and even foreign aid in countries without political motive. This suggests that our theory is not complete; that we have elements of compassion, community and caring that need to be incorporated into economics. The work of economic theory is far from done — we need to work with other social sciences to incorporate their insights and input into how people actually think and behave and bring it to economics. This includes better understanding of national and global communities, and recognize that we are beyond a collection of individuals and individual interests.
Later on, my friend Avishay Braverman told me that when he spoke with Arrow, he considered the most important breakthrough in economics to be the work of Kahneman and Tversky, the emergence of behavioral economics, and the merging of psychology into mainstream economics. Arrow was actively working with Dasgupta and others to incorporate environmental and social values into our national indicators of economic activity, as well as developing an economic theory of sustainability.
Arrow passed away on February 21 st this year. We lost a brilliant person who not only led the way in developing economics to what it is today, but had a vision of economics as a more inclusive social science that integrates many important aspects of human behavior. A true loss for humanity and the environment.