Their victory marks a mini-revolution in economics. More craft than science, economics never produces the momentous discoveries, such as cures for dread diseases, that characterize Nobel awards in the hard physical sciences. But if you care to know how the world works, care about this. What Stiglitz, 58, now at Columbia, Akerlof, 61, of the University of California, Berkeley, and Spence, 58, of Stanford, did was to re-establish the intellectual basis for activist government. Their work defied the prevailing wisdom of the ’90s, when big government was seen as failing, total government–communism–had collapsed and free markets were triumphant. Economists associated with the University of Chicago’s “no government is best” view had won nearly all the economic Nobel Prizes for the last dozen years.
Now comes the reversal. Stiglitz & Co. did what all good social scientists do: they observed the obvious. They argued that most consumers still know much less about the complicated products that they are buying than do the sellers. Do you, reader, really know as much about the computer you just bought as the geek who sold it? Purist free-market theory, by contrast, insists that markets are equal meetings of buyers and sellers with equal information. Hence markets are “efficient” or even “perfect” in the rhetoric of the profession. And the government should stay the hell out.
Akerlof was the first to challenge these assumptions. In a 1970 paper, “The Market for Lemons,” a reference to American slang for cruddy cars, he showed that consumers have informally devised ways to offset the “asymmetry of information” between them and used-car salesmen. Most buyers lack the expertise to tell a sound auto from a lemon, so they go to dealers who guarantee their cars’ soundness for a number of months. Buyers go to such dealers even though they could get identical models far more cheaply from private owners or garages.
Akerlof drew no broader conclusions. But governments in 22 American states have; they now legally require dealers to provide warranties. In 1973, Spence did similar research demonstrating that employers use educational achievement as an informal warranty against hiring “lemon” employees. The candidate’s education may not be required for the job, Spence found, but employers rightly assume that willingness to study is a good measure of ambition and intelligence. It may not matter what job applicants know, but success can be predicted from the applicant’s desire to know.
Stiglitz took this work and applied it to the broad field of free markets in general. He demonstrated how shortages of information–which means inefficient, imperfect markets–have created unemployment, financial crises and other disasters. Most importantly, between teaching jobs at half-a-dozen universities, he served as chief economist at the World Bank during the 1997 Asian financial crisis. In that post, Stiglitz argued that the West’s promotion of unfettered free-market policies in Asia during the early 1990s had itself been based on the imperfect assumption that Asian tiger economies had efficient markets, honest banks and, hence, the ability to profitably absorb huge flows of foreign loans. He also argued publicly that the U.S. Treasury and International Monetary Fund were compounding the debt problem by clapping traditional monetary and fiscal handcuffs on Thailand, Indonesia, South Korea and Malaysia. The IMF and World Bank subsequently admitted Stiglitz was right, but only after he had been fired for insubordination.
Stiglitz is cautious not to overstate the case for his imperfect-market theory. In an interview with NEWSWEEK, he admits that the U.S. Treasury and IMF policy blunders prove that governments can be just as imperfect. “My research does not indicate we should have big government over markets,” says Stiglitz. “It does prove that we need astute, active government to make private information and transactions efficient where they are failing.” No system deserves three cheers, says Stiglitz. “I still do two cheers for the markets. But I also give two cheers for government.” For free-market purists who have dominated economics over the last decade, that is two cheers too many.
