nobel prize. akerlof-spence-stiglitz.doc

7/25/2019 nobel prize. akerlof-spence-stiglitz.doc

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[Review of Political Economy, forthcoming]

A Nobel Prize for Asymmetric Information:

The Economic Contributions of George Akerlof,

Michael !ence, an" #ose!h tiglitz

J. Barkley Rosser, Jr.

James Madison University

[email protected]

A$T%ACT

This paper reviews the research related to asymmetric

information of eorge !kerlof, Michael "pence, and Joseph

"tiglit# for which they $ointly received the %o&el 'ri#e in

(conomics for )**+. !fter a reconting of their overall

careers, the history of the asymmetric information idea is

presented and then their key papers are discssed. This is

followed &y an e-amination of varios applications of the

concept, inclding in indstrial organi#ation and

microeconomic dynamics, efficiency wage theories of

nemployment, credit market rationing theory, and isses of

economic development and glo&al sta&ility. The degree to

which these latter theories can &e considered to &e trly

eynesian is also considered.

The athor wishes to acknowledge comments and sefl

provision of materials &y eorge !kerlof, Michael "pence,

and Joseph "tiglit#, as well as comments &y "teven 'ressman

and several informants who have re/ested anonymity. The

sal caveat applies.

1
mailto:[email protected]:[email protected]


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&' Intro"uction

The )**+ Bank of "weden 'ri#e in (conomic "ciences in

Memory of !lfred %o&el was awarded to eorge !. !kerlof, !.

Michael "pence, and Joseph (. "tiglit# for their work on the

economic implications of asymmetric information dring the

+01*s. The press release and the presentation speech &y

J2rgen 3ei&ll noted specific key papers for each

recipient44 !kerlof on the market for lemons 5+01*6, "pence

on signaling in la&or markets throgh edcation 5+0176, and

"tiglit# 58 Rothschild, +0196 on self4screening in insrance

markets.

:t is a sign of how important the economics of

information has &ecome, and the key role of asymmetric

information in the economics of information, that a %o&el

'ri#e was given largely for work on asymmetric information

to 3illiam ;ickrey 5+09+6 and James Mirrlees 5+01+6 only

five years earlier.+ !t that time, the %o&el committee

signaled that the work of ;ickrey and Mirrless had important

conse/ences and cited the later work of !kerlof as evidence

of this fact. By awarding a %o&el 'ri#e in )**+ to !kerlof,

1Although Mirrlees's paper appeared after Akerlof's, it was written considerablyearlier and had circulated widely in mimeo form. Stiglit !"###a, p. 1$%#& notes thatthis was true of seeral important early papers in this area as many of them werehard to get published due to their unconentional content.

"


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"pence, and "tiglit#, whose work comprises the hard core of

what is now known as the


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has &een writing more specifically on microeconomics, as in

his paper on the market for lemons that was cited &y the

%o&el 'ri#e committee. !kerlof and "tiglit# are among the

chief developers and e-positors of New Keynesian

macroeconomics, which seeks to se rational e-pectations

argments to refte the policy ineffectiveness argments pt

forth &y the %ew @lassical "chool dring the +01*s.

The ne-t section of the paper will e-amine the careers

of the three )**+ %o&el 'ri#e winners. The following

section will discss the evoltion of the idea of asymmetric

information, focsing especially on the work of ;ickrey and

Mirrlees and their predecessors. The section after that

presents the main argments of !kerlof, "pence, and "tiglit#

a&ot asymmetric information. This will &e followed &y a

section on e-tensions and applications with s&sections

dealing respectively with indstrial organi#ation and

microeconomic dynamics, %ew eynesian theories of

nemployment, %ew eynesian theories of credit market

rationing, and models of economic development and glo&al

financial sta&ility. The final section discsses the degree

to which the %ew eynesian approach of !kerlof and "tiglit#

can &e viewed as geninely eynesian.

(' The Men an" their Careers

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2.1 George A. Akerlof

eorge !kerlof was &orn in +0A* in %ew =aven,

@onnectict, where his parents, "wedish immigrant stav,

and erman4Jewish descended Rosalie, were &oth gradate

stdents in chemistry. =is father, a research chemist, was

involved in the Manhattan 'ro$ect, as was his maternal

ncle, Joseph =ershfelder, a famos physical chemist. This

family emphasis on chemistry and physical science led eorge

to feel inferior as a yoth to his older &rother, @arl, who

wold &ecome a physicist. !kerlof was somewhat sickly when

yong, and admits to having &een in a circle of friends who

in today?s terminology wold &e called nerds.C =e remem&ers

first thinking of economics at the age of ++ when he

independently discovered the principle of the mltiplier

while contemplating the possi&le nemployment of his father,

an early signal of his lifelong interest in the pro&lem of

nemployment.

!kerlof received his B.!. and his 'h.D. from Eale

University in +09) and +099 respectively, following in the

footsteps of his parents and his &rother. From that time

forward he has &een located at the University of @alifornia4

Berkeley where he has &een 'rofessor of (conomics since

+0>*. 3hile maintaining his &ase at Berkeley, !kerlof has

en$oyed visiting positions at nmeros instittions

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inclding the :ndian "tatistical :nstitte, =arvard

University, the staff of the @oncil of (conomic !dvisers,

the "pecial "tdies "ection of the Board of overnors of the

U.". Federal Reserve "ystem 5where he met his crrent wife,

Janet Eellen6, the Gondon "chool of (conomics, and the

Brookings :nstittion. =e has served as ;ice 'resident of

the !merican (conomic !ssociation, was its (ly Gectrer in

+00*, and was Director of the %ational Brea of (conomic

Research.

=e has &een coeditor of Economics and Politics,and an

associate editor of the American Economic Review, Qarterly

!ornal of Economics, and !ornal of Economic "e#avior and

$rgani%ation, where he is now an honorary editor. =e has

also &een a Fellow of the (conometric "ociety, the !merican

!cademy of !rts and "ciences, the :nstitte for 'olicy

Reform, and the !merican !cademy of 'olitical "cience, an

!ssociate of the @anadian :nstitte for !dvanced Research

and the Mac!rthr :nitiative on (conomics, rop ;ales and

%orms, and a Mem&er of the Rssell "age Fondation

Rondta&le on Behavioral (conomics.

Besides his famos work on asymmetric information,

!kerlof has p&lished many papers on macroeconomics whose

ma$or focs has &een on e-plaining involntary nemployment.

=e has &een a crcial pioneer in &ringing insights from

)


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psychology and sociology into economic analysis, and in

recent years has focsed on &roader social isses of

identity and social class formation. Besides great &readth

and innovativeness, !kerlofHs work has also long &een noted

for its wit. This is demonstrated in the /ite amsing

titles he has chosen for his articles and &ooks44 for

e-ample,


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and Related Processes5"pence +01Aa6. =e followed this

initial work &y applying the notion of signaling to the

field of indstrial organi#ation, an area in which "pence

wold &ecome a leading figre 5@aves, 'orter 8 "pence, +0>*

=ayes, Marks 8 "pence, +0>76. =e provides a smmary of his

signaling work in his %o&el 'ri#e address 5"pence, )**)6.

=e has also p&lished in sch areas as growth theory and

natral resorce economics.

"pence was !ssociate 'rofessor of (conomics at "tanford

University from +01741K and then was $ointly 'rofessor of

(conomics and Bsiness !dministration at =arvard University

ntil +00* when he retrned to "tanford from where he

retired in )*** to (merits stats. %amed eorge nd

'rofessor in +0>7, he served as @hairman of the Bsiness

(conomics 'rogram from +0>+4>7, as @hairman of the (conomics

Department in +0>74>A, and as Dean of Faclty, +0>A40*. =e

was also Dean at "tanford from +00*400.

"pence has &een a Fellow of the (conometric "ociety and

the !merican !cademy of !rts and "ciences as well as serving

on varios corporate &oards of directors. =e received the

John enneth al&raith 'ri#e for (-cellence in Teaching in

+01> and the John Bates @lark !ward in +0>+. :n recent

years he has &een involved in nmeros antitrst cases, many

of them involving high technology indstrial enterprises.

+


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!lthogh his work in academic administration kept him

from &eing involved in economic research after +0>*,

"pence?s academic career mst &e noted for its e-ceptional

/ality. The Dean of Faclty at =arvard is arga&ly the

most powerfl academic officer of that premier academic

instittion, as is the e/ivalent position at "tanford. =e

has &een descri&ed &y o&servers as having &een incredi&ly

smart and hard4workingC in those positions and as having

&een likely to &ecome 'resident of =arvard e-cept for having

gotten athwart of his long4serving &oss, Derek Bok.C

Despite his earnestnessC in these positions he is

descri&ed as having retained a 'ckish delight in e-treme

sports and similar activities.C Ine weekend dring the

+0>*s he escaped to a family retreat in Maine where he went

skinny4dipping &y moonlight in a local pond. =e was

attacked &y a grop of &eavers that drove him to shore and

re/ired him to receive ra&ies shots. Bt then nothing

compares to the attacks deans receive from irate faclty

mem&ers. !lfred ahn, long time Dean at @ornell, once

remarked that a dean is to a faclty what a fire hydrant is

to a pack of dogs.C

2.- !ose(# E. 'tiglit%

Joseph "tiglit# was &orn in +0A7 in ary, :ndiana, the


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hometown of 'al "amelson whose ollected Pa(ershe wold

edit. =e received his B.!. from !mherst @ollege in +09A and

his 'h.D. from M:T in +091. "tiglit# was a Fl&right

"cholar and Tapp Jnior Research Fellow at @am&ridge

University in +01*. !ppointed 'rofessor of (conomics at

Eale University in +090, he moved to 'rinceton University in

+010, where he remained ntil +0>>. Then he went to

"tanford University. From +007401 he served on the @oncil

of (conomic !dvisers, eventally &ecoming its @hair. Dring

+0014)*** he was "enior ;ice 'resident for Development

(conomics and @hief (conomist at the 3orld Bank. =e left

there after a widely p&lici#ed dispte with then Treasry

"ecretary Gawrence "mmers a&ot the management of glo&al

economic policy. =e crrently holds a $oint appointment in

the (conomics Department, the "chool for :nternational

!ffairs, and the radate "chool of Bsiness at @olm&ia

University. "ince departing the 3orld Bank he has &ecome a

very p&lic critic of the policies of the 3ashington

@onsenssC on international economics.

=e is a Fellow of the %ational !cademy of "ciences, the

!merican !cademy of !rts and "ciences, the (conometric

"ociety, and the !merican 'hilosophical "ociety. =e has

also &een elected to varios honorary societies in Britain,

:taly, France, and ermany, and has received nmeros

1#


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honorary doctorates. =e received the John Bates @lark !ward

in +010. =e has served on the &oards of editors of many

$ornals and was the Fonding (ditor of the !ornal of

Economic Pers(ectives.

"tiglit# is one of the most prolific living economists.

=is list of p&lications e-tends to 7* pages in small font

and incldes te-t&ooks in varios fields and at different

levels as well as monographs, position papers, and articles.

The &readth of his interests was reported &y the !merican

(conomic !ssociation when he was awarded the John Bates

@lark !ward in +010, well &efore a ma$ority of his p&lished

research, as inclding growth and capital to the economics

of discrimination, p&lic finance to corporate finance,

information to ncertainty, and competitive e/ili&rim with

e-hasti&le resorces to monopolistic competition and

prodct diversity. !nd this is now a very incomplete list.

=e has smmari#ed his own work in his %o&el 'ri#e address

5"tiglit#, )**)6.

"tiglit# has long &een reported to have a tendency

towards a&sent4mindedness and mild eccentricity,

characteristics associated with academic &rilliance &t

thoght not to travel well into the arena of p&lic policy

making. !t "tanford, one secretary was assigned solely to

him, partly &ecase of his immense prodctivity, &t also to

11


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keep an eye on him to make sre that he did not tie his

shoelaces together or engage in other similar acts. 3hen he

&ecame 'resident @linton?s @hair of the @oncil of (conomic

!dvisers he attended ca&inet meetings. !t an early one,

prior to @linton?s arrival, "tiglit# was sitting with his

tie wrapped arond the otside of his collar. Treasry

"ecretary Gloyd Bentsen, known to &e a fashiona&le dresser,

walked over and rearranged his tie for him.

!s with many academic economists who &ecome policy

makers, "tiglit# constantly confronted conflicts &etween the

ideals of economic theory and the compromises of practical

political economy, a pro&lem he discssed in a distingished

lectre to the "ociety of overnment (conomists 5"tiglit#,

+00>6. !n anecdote not inclded in that lectre &rings home

this conflict. Dring an episode of high oil prices that

wold lead 'resident @linton to decide to release oil from

the "trategic 'etrolem Reserve into the market, "tiglit#

met with @linton and @hief of "taff Geon 'anetta to discss

the matter. "tiglit# advised against releasing the oil on

the gronds that doing so wold have no effect on the market

and that the price of oil wold come down on its own fairly

soon anyway. 'anetta responded to this argment &y

declaring that @linton shold therefore go ahead and release

the oil anyway &ecase it won?t case any harm and we?ll

1"


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get the credit for the drop in the price of oil.C 'anetta?s

argment carried the day.

)' *e+elo!ment of the Economics of Asymmetric Information

!s noted earlier, &y previosly awarding a %o&el 'ri#e

for the economics of asymmetric information to ;ickrey and

Mirrlees, the pro&lem of the economics of information and

the special isse of asymmetries of information had &een

nder discssion for some time prior to the crcial

&reakthroghs &y !kerlof, "pence, and "tiglit# in the +01*s.

!ccording to "tiglit# 5+0>1, )***a6 early economists who

evinced some awareness of information isses inclded !dam

"mith 5+1196, "imonde de "ismondi 5+>+A6, John "tart Mill

5+>A>6, !lfred Marshall 5+>0*6, and Ma- 3e&er 5+0)K6. "mith

o&served that as interest rates rise the &est &orrowers drop

ot of the market. Marshall o&served that workers are not

always paid on the &asis of tasks performed &ecase of the

difficlty of o&serving e-actly what they do, and arged

that information imperfections wold


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GLon 3alras 5+>1A6, who wrestled with the pro&lem of

achieving a general e/ili&rim, failed to make "tiglit#H

list. !lthogh it has not &een widely noted, the pro&lem of

t/tonnementis at least partly an information processing

pro&lem. The actioneer gathers the varios responses to

the proposed price vectors in order to ad$st the price

vector toward the general e/ili&rim, all prior to any

market trading taking place. :n the earlier editions of his

work, 3alras was clearer that this was an artificial

mechanism and that the pro&lem in real markets was very

serios, althogh he tended to downplay this in the more

widely read later editions 53alker, +0096. This later

attitde was predominant when !rrow 8 De&re 5+0KA6

formlated their now standard version of general e/ili&rim

theory, and essentially assmed perfect information withot

even discssing the matter.)

!lso on "tiglit#H list is Friedrich =ayek 5+0AK6, a

previos %o&el 'ri#e winner. "tiglit# arges that =ayek did

not really appreciate the isse of asymmetric information,

&eing concerned more with prices serving as efficient

information signals regarding relative scarcities. Bt this

"Although Arrow ignored information issues in his work with -ebreu, he would laterbecome one of the most important students of the problem, inenting the concept ofmoral haard !1*1& and independently publishing a paper on educational signalingin the same year !1*(& as Spence. his work arose from his studies of risk bearing!1)$&.

1$


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misses an important aspect of =ayekHs work. =is work on

dispersed and tacit information grew ot of his involvement

in the socialist planning controversy. The controversy

concerned whether or not socialist planners cold play the

role of the 3alrasian actioneer and gather sfficient

information in a centrali#ed way to achieve an efficient

general e/ili&rim. =ayek arged that socialist central

planners wold never &e a&le to plan efficiently. This

argment ltimately drew on an asymmetric information

concept, althogh he did not se this terminology. For

=ayek, the central planner wold never &e a&le to learn the

information that is dispersed throghot the economy in a

tacit way, and therefore cold never play the role of the

3alrasian actioneer. :ronically, "tiglit# himself wold

come to emphasi#e sch information isses when he came to

discss economic transition pro&lems in his &ook, 0#it#er

'ocialism5+00A6.

!lthogh !rrow and De&re essentially ignored the

possi&ility of imperfect information, another %o&el

Gareate, =er&ert "imon 5+0KK, +0K16, emphasi#ed it

forceflly when arging for the inevita&ility of &onded

rationality. "imon was concerned more with pro&lems of

compta&ility, in particlar the sheer scale and comple-ity

of information, rather than with asymmetric information in

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specific transactions. =owever, !kerlof arges in his %o&el

address 5)**)6 that asymmetric information ltimately leads

s to &ehavioral economics, and many see "imonHs work as

fndamental for this whole approach.

Berle 8 Means 5+0776 were among the first to

specifically identify asymmetric information as a pro&lem

for firm management. 3hat they la&eled the


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that imperfect information can lead to incomplete contracts

with reslting inefficiencies. 3illiamson 5+0106, a stdent

of &oth "imon and !rrow, identified transactions costs as a

sorce of incomplete contracts, and =irshleifer 5+01+6

arged that e-cess incentives to search for information

might arise.

!lthogh mch of this literatre to the present

identifies e/ili&ria in which transactions costs are

acconted for, a more fndamental pro&lem was raised &y

Raiffa 5+09>6 that remains nresolved. This is how to

optimi#e the discovery of transactions costs or the degree

of imperfect information. Ultimately this involves an

infinite regress of economi#ing on economi#ing on

economi#ing. Binmore 5+0>16, Gipman 5+00+6, and oppl 8

Rosser 5)**)6 have stdied this pro&lem, and @onlisk 5+0096

identifies it as a fndamental sorce of &onded rationality

in economic decision making.

' The Core Arguments

The key paper in the economics of asymmetric

information is !kerlofHs 5+01*6 stdy of the market for

lemons, one of the most fre/ently cited papers in the last

half of the )*thcentry. The lemonsC in /estion are sed

cars. !kerlof &egan &y noting that the owner of a car knows

1*


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more a&ot it than any potential &yer. Therefore, the sed

car market inevita&ly involves asymmetric information.

!kerlof 5)**)6 claims that he first &ecame interested in the

sed car market from his interest in macro flctations, and

from the fact that the new car market e-hi&its large

flctations that contri&te significantly to macro

flctations. Bt he soon reali#ed that applications of his

discovery went well &eyond &oth the sed car market and

&asic macroeconomics.

!kerlof showed that awareness of their relative

ignorance wold lead potential &yers to assme that any

sed car wold have a high pro&a&ility of &eing low /ality,

a lemon. This wold case them to &id down the price of

sed cars in general, and this wold drive most high /ality

sed cars ot of the market. :ndeed, in his original

theoretical model !kerlof showed that in principle only

lemons wold &e offered for sale.

=owever, !kerlof o&served that in the real world some

people wold &e forced &y circmstance to offer a high

/ality car for sale, sing the e-ample of someone

transferred a&road. The inefficiency arising from

asymmetric information wold essentially &e &orne &y these

individals, who wold &e na&le to receive a sfficient

price for their car &ecase it was likely to &e viewed as

1+


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$st another lemon. !lthogh there are markets where repeat

sales and reptation may resolve the pro&lem, !kerlof

o&served that in many markets they are not easily resolved,

inclding insrance, la&or, and credit. =is finding of

lemons driving ot good cars from the market is known as

adverse selection.

Jst as !kerlof noted that reptation may resolve the

pro&lem, "pence 5+0176 prsed this particlar soltion in

his stdy of signalingin la&or markets. =e fond that it

does not always work to remove inefficiency. :n his e-ample

the asymmetry is &etween an employer and a potential

employee. Becase the employer is na&le to accrately

discern the skills of the potential employee, she relies

pon signals. The most prominent signal is the costly

attainment of certain edcational levels &y the potential

employee. :t is &elieved that only employees who are

sfficiently skilled will &ear the costs of getting edcated

and ths sending the signal. "pence notes that the signal

will only signify something real if there is a negative

correlation &etween signaling costs and prodctive

capa&ility. This means 5for the case of edcation as a

signal6 that grades in schools 5and the availa&ility of

scholarships6 mst &e positively correlated with prodctive

work capa&ility.

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"pence identifies the possi&ility of an infinite set of

signaling e/ili&ria, each associated with a ctoff level of

edcation 5or amont of the signal6, which will &e &ased on

the conditional pro&a&ilities &elieved in &y the employers.

'otential employees will &e sorted as &eing either a&ove or

&elow this level and, in theory, people will either invest

in the signal p to that level and no frther or will not

invest in the signal at all. !s the level of the signal

rises, the higher grop will &e worse off de to higher

signaling costs. !lthogh the lower grop is not hrt &y an

increase in the signal level, it is worse off than a no4

signal e/ili&rim in which every&ody gets paid their

nconditional e-pected marginal prodct.

!lthogh it is possi&le to constrct cases where some

grops gain from signaling, very often all grops wold &e

&etter off with no signaling, a clear case of a 'areto

inferior otcome. ! crcial part of the argment is that

the cost of generating the signals lowers net aggregate

prodct, althogh "pence recogni#es that edcation may have

e-ternal &enefits that overcome this factor. =e frther

notes the possi&ility of signaling &ecoming entangled in

varios kinds of nfair discrimination in la&or markets

5"pence +01Aa, +01A&, +019a6.

"#


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Rothschild 8 "tiglit# 5+0196 e-tend the analysis &y

introdcing the concept of screening. They apply this to

insrance markets which, as noted a&ove, are rife with

asymmetric information pro&lems leading to &oth adverse

selection and moral ha#ard. The screening mechanism is to

offer a variety of contracts that encorage agents to reveal

accrate information a&ot their riskiness throgh a process

of self4selection. Ths, lower risk agents will tend to

select contracts that charge lower premims &t higher

dedcti&les. =owever, there is an inherent conflict &etween

the two fnctions of transmitting information and

redistri&ting risk.

"tiglit# 5+01K6 applies this argment to the edcation

e-ample stdied &y "pence and comes p with reslts that are

partly similar and partly dissimilar. =e also identifies

mltiple e/ili&ria that can &e 'areto ranked and notes

varios costs of screening. =owever, he arges that the

'areto optimal soltion wold &e a fll screening that

properly identifies each agentHs tre capa&ilities. Bt

this otcome is not sstaina&le as a market e/ili&rim.

-' E.tensions an" A!!lications

.1 *ndstrial $rgani%ation and &icroeconomic 3ynamics

:n response to Rothschild 8 "tiglit# 5+0196, "pence

"1


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5+019a6 arges that there is no meaningfl distinction

&etween signaling and screening. Both are self4selection

mechanisms. 3hat matters are two things44 whether &yers or

sellers do the self4selecting, and the details of the

information cost strctres. This has shifted the

discssion in the direction of /estions more closely

related to indstrial organi#ation and micro market

dynamics.

"pence 5+019&6 arged that competition in signaling can

redce the inefficiencies associated with it, there&y

initiating a line of argment that has resonated in many

areas of economics. =e distingishes &etween(assive

res(onse signalsand active res(onsesignals. The former

involve receivers of signals simply reading them in the

light of past market e-periences. These cases lead to

inefficiency as there tends to &e overinvestment in the

signals. 3ith active response signals, the receivers

anticipate the effect of their own responses on the patterns

of investment in the signal and attempt to compete in this

dimension. This allows for the possi&ility of improved

efficiency.

Besides the kinds of mltiple contract offerings

sggested for insrance companies &y Rothschild 8 "tiglit#

5+0196, "pence 5+0116 notes that prodct garantees are

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another way to achieve sch a goal &y sing competitive

signaling. !lso, prodct differentiation, which is

associated with monopolistic competition, redces

information pro&lems &y e-panding the availa&ility of

options 5"pence +019c6. This argment was followed p on &y

Di-it 8 "tiglit# 5+0116, whose work has &een widely cited as

a fontainhead of &oth the 6. Bt, "citovsky

5+0K*6 arged that even a small amont of imperfect

information can lead to monopoly power. Di-it 8 "tiglit#

5+0116 and "alop 8 "tiglit# 5+0116 frther prse some of

these themes. Ine otcome of this work is that dispersions

of information will lead to dispersions of price as well as

of prodct /ality and advertising. "tiglit# 5+0106 also

provides an information4&ased argment for kinked demand

"(


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crves in monopolistic competition. :n a world of search

costs, if a firm raises its price, its cstomers may search

for lower priced competitors however, if it lowers its

price, too few other cstomers will learn a&ot it to make

it worthwhile.

This strand of research clminated in the argment

5"tiglit#, +0>16 that if price &ecomes a signal of /ality,

then


25/45

!kerlof was motivated to stdy the sed car market

in order to nderstand macroeconomic flctations. !lthogh

his lemons paper 5!kerlof, +01*6 was written prior to the

emergence of the %ew @lassical revoltion in macroeconomics

&ased on the assmption of rational e-pectations 5Gcas,

+01)6, the models of asymmetric information that have

followed from his lemons paper nderpin the %ew eynesian

conterattack against the %ew @lassical revoltion. :n

essence, rational e-pectations in the face of asymmetric

information can &e shown to reslt in sticky wages that are

a&ove market clearing levels and ths can e-plain the

e-istence of


26/45

wage hypothesis, drawing partly on the difficlty potential

employers face in learning the /alities of potential

employees and the associated difficlties nemployed

potential employees face in o&taining a $o&, implies that

/its will fall as nemployment rises. 3orkers, or at least

some workers, will &e paid more than their nconditionally

e-pected marginal prodct in order to indce greater

prodctivity ot of them. Fear of &eing laid off, and the

associated difficlty of getting rehired, &ring this a&ot.

This argment was developed from the mid4+01*s to the mid4

+0>*s 5"tiglit#, +019 "alop, +010 "olow, +010 "hapiro 8

"tigit#, +0>A !kerlof, +0>A Eellen, +0>A Bowles, +0>K6.

!kerlof, in trn 5+019, +0>*, +0>), +0>A !kerlof 8

Eellen, +00*6, has sed the asymmetric information argment

to prse more sociologically and psychologically &ased

theories of nemployment. This has led to his more recent

interest in sociological and psychological models 5!kerlof,

+00+ !kerlof 8 ranton, )***6. The emphasis is on

interactions among workers themselves more than any

interactions &etween &osses and workers as in the efficiency

wage hypothesis. @oncerns a&ot e/ity and fairness and

grop dynamics come to the fore. !kerlof has emphasi#ed a

stdy &y Donald Roy 5+0K)6 regarding the &ehavior of workers

in an :llinois machine shop. :n effect, workers have a

")


27/45

great deal of control over their own and each otherHs

prodctivity and effectively work together to keep ot

workers who wold lower the going wage. :n a 5!kerlof6 +0>*

paper sch &ehavior leads to social cstoms that inclde

nemployment, and in a 5!kerlof6 +0>) paper, la&or and

management engage in partial gift e-changes of higher

prodctivity for efficiency wages.

!kerlof has provided two frther elements to this

strand of argment. =is widely cited (ly Gectre 5+00+6 has

&een seen as encoraging concern for psychological elements

and also for highlighting the strength of &oth fairness

motives and the endowment effect in leading to downward

stickiness of wages 5Ra&in, +00>6. The endowment effect

depends on people measring their tility relative to some

level to which they are adapted and to demand mch greater

compensation for a given loss than they wold &e willing to

pay for an e/al gain. This deeply rooted downward

stickiness of wages implies that it is non4optimal to have

#ero inflation &ecase there will &e a failre of la&or

markets to ad$st relative wages sfficiently rapidly

5!kerlof et al., +009, )***6.

! more general reslt derived from asymmetric

information, which has &road microeconomics and

macroeconomics implications, is the theory of near

"*


28/45

rationality5!kerlof 8 Eellen, +0>Ka, +0>K&6. The e-istence

of asymmetric information implies that there are some small

deviations from optimal &ehavior. :n contrast to the

argments of Marshall and "tigler, as well as !rrow and

De&re, these small deviations from rationality can have

large economic implications. For e-ample, a small amont of

wage4price inertia can indce large aggregate demand

flctations. "tiglit# 5)***a6 cites this general reslt as

one of the most important emerging from the entire

asymmetric information literatre44 small changes in

information conditions can generate large changes in final

otcomes.

.- New Keynesian redit &arket Rationing

"tiglit# 5)***a6 points ot that the idea of credit

rationing was first noted &y !dam "mith. Bt since "mith?s

time economists have failed to give clear e-planations as to

why it occrs 5Jaffee, +01+ Jaffee 8 Rssell, +019 eeton,

+0106. "tiglit# 8 3eiss 5+0>+, +0>76 &roght the discssion

within the framework of asymmetric information that had

developed &y this time, with &anks &eing the less4informed

principals dealing with the &etter4informed &orrower agents

regarding their own risk. :n sch an environment, two

interest rate e/ili&ria can arise and the interest rate can

"+


29/45

serve as a screening device. :n a high interest rate

environment, good &orrowers will &e driven away, $st as

!dam "mith o&served and $st as people with good sed cars

cannot sell them for a decent price in the lemons market.

@redit is ar&itrarily restricted &y &anks, implying

different channels for monetary policy to work than in Ild

eynesian or Monetarist models.

Ine particlar reslt of these models is that an

ar&itrarily volatile flctation of credit can arise, with

o&vios implications for macroeconomic 5in6sta&ility. :t

also sggests a violation of standard financial theory,

developed &y Miller and Modigliani /a"" references01,

&ecase there is now a ma$or difference &etween de&t and

e/ity financing de to this &ehavior &y the &anks.

The implications of these argments for macroeconomic

sta&ility are laid ot in reenwald 8 "tiglit# 5+0>1, +0>>6

"tiglit# 8 3eiss 5+00)6, and "tiglit# 5+00), +000a6. These

papers com&ine the %ew eynesian la&or market reslts

discssed a&ove with the credit rationing model. !s

"tiglit# 5+000a, p. >*6 pts it,


30/45

worth noting that these final remarks were made near the end

of "tiglit#Hs tenre at the 3orld Bank when he was in deep

disagreement with the 3ashington @onsenss 5and Treasry

"ecretary Gawrence "mmers and the :MF6 over their handling

of the (ast !sian financial crisis of +001, and he concldes

this paper &y specifically applying them to that particlar

sitation.

.5 Economic 3evelo(ment and Glo6al 'ta6ility

Both !kerlof and "tiglit# e-hi&ited great interest in

pro&lems of economic development /ite early in their

careers 5!kerlof, +090 "tiglit#, +01A6.A "tiglit# 5+01A6

was arga&ly one of the first places in which he postlated

a version of the efficiency wage model. The argment was

e-panded and applied to compare sharecropping and fi-ed wage

payments in rral agricltre in less developed economies,

with the landlord now in the position of the principal and

the peasant in the position of the agent 5Braverman 8

"tiglit#, +0>)6. :ndeed, this paper dates from the same

period that "tiglit# 8 3eiss 5+0>)6 were developing their

credit rationing argment, and it wold &e later noted that

$Although they collaborated on only one paper 4uite early in their careers !Akerlof 8Stiglit, 1)&, it did not contribute much to the deelopment of the ew 2eynesianapparatus based on asymmetric information that both of them hae played suchlarge roles in deeloping, despite proiding some hints of what was to come. ater intheir careers they would also both write about problems of economic transition!Akerlof et al., 116 Stiglit, 1$&. oweer, neither of them has eer coauthoredwith Spence.

(#


31/45

the restrictions on credit &y a landlord in this sitation

resem&le those &y a &ank in a financially advanced economy

5=off et al., +0076.

Unsrprisingly, after "tiglit# &ecame @hief (conomist

of the 3orld Bank dring a period of erpting international

financial crises, his attention trned to the pro&lems of

glo&al financial sta&ility. =e carried his analysis of

asymmetric information in credit and financial markets from

less developed contries to the glo&al level, arging for an

e-treme fragility and volatility de to the pro&lems in the

financial sectors of these contries. "tiglit# applied this

analysis to (ast !sia after the +001 crisis in what wold

&ecome his very p&lic criti/e of the policies of the

3ashington @onsenss as em&odied in the :MF and Gawrence

"mmers 5Frman 8 "tiglit#, +00> "tiglit#, +000&, )***&6.

To him, the policies recommended &y the :MF of monetary and

fiscal asterity simply e-acer&ated the nderlying pro&lems.

=e has since &lamed sch policies for the more recent crisis

in !rgentina 5"tiglit#, )**)a6.

:n his %o&el address, !kerlof 5)**)6 also addresses the

pro&lem of financial volatility at some length, tying it to

the deeper psychological and sociological factors that he

has come to see as the more profond e-tensions of

asymmetric information. =e particlarly praises the work of

(1


32/45

Ro&ert "hiller 5+0006 in this regard and sees this as one of

si- fndamental pro&lems that &ehavioral macroeconomics may

&e a&le to help s nderstand.K 3hen one contemplates

!kerlofHs discssion on myopia and procrastination dating

from his +00+ (ly Gectre, it is tempting to say that he has

shifted the grond of asymmetric information from &eing

&etween two parties in e-change to &eing within a single

party, e-periencing conflict &etween the self at one point

in time and the self at another point in time. Ths, the

time inconsistency associated with hyper&olic disconting

5"trot#, +0K9 Gai&son et al., +00>6 can &e seen as an

internal species of asymmetric information and the pro&lem

of the market for lemons.

2' $ut is it 3eynesian0

!lthogh "pence has mostly worked in the area of

microeconomics and avoided the &attles over la&els and

identities that have plaged macroeconomics, &oth !kerlof

and "tiglit# have plnged wholeheartedly into macroeconomic

de&ates. They have &oth &een self4styled and strong

advocates of %ew eynesian macroeconomics, &asing it on the

asymmetric information models discssed a&ove. They have

%he other Be are the e3istence of inoluntary unemployment, the impact ofmonetary policy on output and employment, the failure of deCation to acceleratewhen unemployment is high, the prealence of undersaing for retirement, and thestubborn persistence of a self>destructie underclass.

("


33/45

arged that while eynes 5+0796 was wrong in varios

particlars 5a&ot the natre of &ond markets, a&ot the

cases of the persistence of nemployment, a&ot the

channels of monetary policy, and varios other items6 some

of his important views have &een essentially correct44 that

there can &e persistent involntary nemployment, that

flctations of aggregate demand can trigger flctations in

that nemployment, that savings may &e disconnected from

investment, and that fiscal policy may &e sefl to overcome

these pro&lems in managing aggregate demand 5reenwald 8

"tiglit#, +0>1 !kerlof, )**)6.9

!kerlof and "tiglit# arge that they have provided the

key to trning &ack the tide of %ew @lassical macroeconomics

&ased on rational e-pectations asymmetric information

implies very different otcomes and policy approaches even

when rational e-pectations holds. There is no do&t that

this argment is correct and that they have played a ma$or

role in reviving the respecta&ility of eynes in the

economics profession in recent years. Bt this does not

mean that they have the final word.

Their models, especially their la&or market models,

still rely on the idea that nemployment fndamentally

)Akerlof is more strongly complimentary of 2eynes than is Stiglit, seeing in him aforerunner of the sort of psychological analysis and approach that Akerlof himselfcurrently faors, although he beliees that 2eynes' psychological arguments were nottoo sophisticated.

((


34/45

arises from wages in some sense &eing


35/45

in financial markets, given his more recent remarks a&ot

the work of "hiller.

Finally, there is a &roader arena of dynamic analysis

involving models of learning that are receiving attention

from eynesian macroeconomists of varios stripes as well as

many %ew @lassical economists 5Brock 8 =ommes, +00>

"argent, +007, +00>6. The older asymmetric information

models of !kerlof, "pence, and "tiglit# had a certain degree

of certitde a&ot them, with known pro&a&ilities of &eing

a&le to o&serve otcomes. These were the elements that

saved this variety of the economics of information from the

horri&le parado-es of infinite regress and trying to

economi#e on how to economi#e first sggested &y Raiffa

5+09>6. :n a world of deeper eynesian ncertainty, the

processes &y which agents learn these pro&a&ilities, and

whether they can even do so, have moved to the fore,

especially in a world increasingly hanted &y the specter of

comple- nonlinear dynamics.1

4' Conclusion

Ir s&$ects mst &e given their de. They have

enormosly increased or nderstanding of models a&ot

*oweer, Stiglit !"###a& has recently cited work out of the Santa De ?nstitute andAkerlof supported the work of arious comple3ity economists while at the Erookings?nstitution.

(%


36/45

knowledge and what they can imply and what they can lead to,

especially when that knowledge is distri&ted asymmetrically

among interacting agents. Their inflence has &een vast and

deserved, as is their receipt of the Bank of "weden pri#e in

(conomic "ciences in Memory of !lfred %o&el in )**+. Both

microeconomics and macroeconomics have &een profondly

transformed &y their efforts.

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