Why Did This Year's Laureate Trio Win?
The average person must have chuckled in disbelief, while economists of the Austrian School had a right to smile ironically.
I refer, of course, to this year's winners of the Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel. The 10 million Swedish krona (about $950,000 by the current exchange rate) will be shared equally by economists George A. Akerlof of the University of California at Berkeley, A. Michael Spence of Stanford University, and, the best-known by far, Joseph E. Stiglitz-former chairman of the Council of Economic Advisers under President Clinton, most recently chief economist at the World Bank, currently at Columbia University, and the subject of a profile in last year's Barron's ("Sound the Alarm," April 17, 2000).
For the layperson, the funny part was the headline statement about what these thinkers won all that money for. The Swedish Academy's press release began with, "Many markets are characterized by asymmetric information: actors on one side of the market have much better information than those on the other."
Or as the New York Times put it, "Their theories incorporated 'imperfect information' into economics-a concept at odds with the mainstream view that markets are all-knowing and self-correcting." Or as Reuters would have it, they "challenged traditional theory that open and unregulated markets function with perfect efficiency."
Now, if economists ever had to be told that markets aren't "all-knowing" or "perfect"-or that, when you go to a specialist about your hemorrhoids, he or she knows more than you-the ordinary person might think they'd want to suppress that fact.
Economists of the Austrian School not only understood that markets can fail, they even insisted on that point. In his classic work, Human Action, Ludwig von Mises emphasized the "uncertainty inherent in every action," even adding the old adage, "There's many a slip 'twixt cup and lip." Which isn't to say the nature of these slips isn't worth investigating, or that the writings of Akerlof, Spence, and Stiglitz on that topic lack all insight.
But once you defrock these authors of their supposedly radical breakthrough, then books like Israel Kirzner's Discovery and the Capitalist Process and especially Thomas Sowell's Knowledge and Decisions turn out to be far more enlightening on the topic of imperfect markets. Economists Sowell and Kirzner both acknowedge their deep intellectual debt to F.A. Hayek, the only Austrian ever to win a Nobel-and in a better world, the Swedish Academy would have bestowed its award on them. At least, Knowledge and Decisions comes closer to formulating a "general theory of markets with asymmetric information" (to use the Academy's phrase) than anything I've read by Akerlof, Spence, and Stiglitz.
Consider a 1970s locus classicus of George A. Akerlof's writings (cited by the academy), "The Market for 'Lemons': Quality Uncertainty and the Market Mechanism." It plunges us into a very strange kind of market for cars, with no brand names or warranties, dealers with reputations they need to preserve, or even friendly auto mechanics who might examine a used car before we decide to buy it. In Akerlof's words, "There are just four kinds of cars . . . A new car may be a good car or a lemon, and of course the same is true of used cars."
But then, after bringing us through this and related examples, the author informs us that, lo and behold, there are indeed "Numerous institutions . . . to counteract the effects of quality uncertainty," including brand names and guarantees.
Or consider a classic 1973 piece by A. Michael Spence, also cited by the academy, called "Job Market Signaling." The author signals that he thinks he's on to something big by coyly refusing to define "market signaling." But plow on, and you find the insight is simply that people might edge out others for a job by going to college-i.e., by "signaling" that they're smarter or perhaps more persistent than most, rather than specifically competent to do the work.
But even this frail insight gets a bit confused. The author cynically informs us that, while education need not be "strictly unproductive . . . if it is too productive relative to the costs, everyone will invest heavily in education, and education ceases to have a signaling function."
Well, no; you can stand out from the crowd (signal you're better) by being first in your class, or by getting a stellar recommendation from your teacher.
Finally, terms like "market failure," which recur in Stiglitz's writings, often lead to a grand non sequitur invoked by the press last week: that where markets fail, government intervention succeeds. Better to speak of institutional failure, since institutions fail us all the time, but market institutions far less than others.
(c) copyright 2001 Barron's
Gene Epstein of Barron's is one of the outstanding economic journalists of our time, and is also deeply influenced by Misesian theory. You can reach him at MAIL. See his interview in the Austrian Economics Newsletter. This article appeared in Barron's on October 12, 2001.