October 24, 2001
The press reports that accompanied the announcement of this year's Nobel laureates in economics discussed the imbalance in information that exists between management and labor, and between buyers and sellers of some goods. Indeed, George Akerloff's 1970 paper on the used car market was cited in many of the reports.
In general, if one party to a transaction has more information than another, the price at which the transaction is completed is not the price that establishes equilibrium in the market. Indeed, a used car buyer is unwilling to pay what the seller believes is the intrinsic value of the used car because the potential buyer believes something must be wrong with the vehicle being sold. In many cases, a transaction is not completed.
While the used car problem certainly is interesting, many people must have wondered why three people were honored with a Nobel prize for stating the obvious. In fact, the Wall Street Journal was especially clever at discussing the works of George Akerloff, Joe Stiglitz, and Dr. Spense without indicating why their work is especially important for economics.
John Maynard Keynes indicated many years ago that if markets cannot attain equilibrium prices, then the economic system will alter quantities instead of prices. If wages cannot fall below some socially accepted minimum even when the value provided by the last people hired is lower than that minimum, then some people will remain unemployed.
As Japan is re-learning, if the market interest rate that will utilize otherwise idle resources is lower than the current rate, then investment will fall short of levels needed to prevent recession. In short, if prices cannot reach equilibrium, then quantities must adjust to clear the prevailing market conditions. As a result, long periods of under-utilized resources can develop.
The misinformation problems that these Nobel laureates have explored leads to a resurrection of the Keynesian system of market adjustment. Not surprisingly, such information imbalance also leads to Keynesian solutions to economic problems.
In short, if the markets will not adjust prices to fully utilize resources, then external help is needed. This could be in the form of government insuring that the information is balanced. Or government could enforce lemon laws that allow the buyer to return bad vehicles. In effect, the government imposes conditions on a market which diminishes the costs borne by those acting upon insufficient information.
That external help could also be in the form of government spending or tax reductions. Why does an economy need an economic stimulus package if prices will adjust until all markets are in balance at high levels of resource utilization?
Indeed, George Akerloff is considered one of the leaders of this neo-Keynesian school of economics. I actually think that Joe Stiglitz's work is more eclectic than the others, but his understanding of how economic systems behave clearly is well ahead of most economists.
In fact, some economists have credited Stiglitz's editing of the first two volumes of the Collected Works of Paul Samuelson with aiding Dr. Samuelson's Nobel cause. Dr. Stiglitz's complaints about how the International Monetary Fund "aids" ailing economies are very much Keynesian in nature.
I will be looking forward to the papers that these newest Nobel laureates will present when they receive their awards later this year. I probably will not agree with all that they contain. Market solutions can be found to overcome market distortions. However, those solutions take time. That time might be unacceptably long.
These are arguments I learned many years ago. However, Akerloff, Spense, and Stiglitz provide new avenues to arrive at old destinations. And recent stock market performance strongly suggests that markets may not always arrive at correct solutions. That may be the subliminal message given by these Nobel awards.