The argument of the volume
The case for leaving markets alone rests, at bottom, on a claim about knowledge. No central mind could gather what is known to the butcher, the baker, and the candlestick-maker — the local facts of scarcity and desire scattered across a million heads — yet the price, its defenders say, gathers it for us: each trader, knowing only his own corner and the prices he faces, is led to act as though he knew the whole, and the market coordinates strangers who know almost nothing of one another. The price is the great economizer of knowledge, the signal that lets a society act on information no one possesses entire.
That marvel assumes something the textbook states quietly and the world often denies: that both sides of a trade know what is being traded. Lift the assumption — let one side know what the other cannot, and let their interests diverge — and the signal begins to lie. The price a seller will accept now reveals what he knows of his own goods; the eagerness of a buyer betrays what he has discovered; the very willingness to trade becomes evidence about the thing traded, and usually bad evidence. Knowledge that is private and unequal does not flow into the price and clear the market; it sits behind the trade as a hazard, and the more one side knows that the other does not, the less the price can be trusted to mean what it says.
The consequence is the family's defining mark: not a market that prices imperfectly, but a market that can destroy itself. When buyers cannot tell good from bad, they will pay only for the average; at the average price the best sellers withdraw, their goods worth more than they can fetch; the average falls; better sellers withdraw in turn; and the market unravels toward a residue of lemons, or vanishes. The same averaging falls on people as well as goods: where a worker's own worth is hidden and his group is the cheapest guess at it, he is priced by the group's average and not his merit, the asymmetry shading into a statistical discrimination that can make its own grim prophecy come true. That trade survives at all under such pressure is the achievement of an elaborate and costly apparatus — signals that the informed pay to send, screens that the uninformed design to sort, warranties and brands and reputations posted as hostages against deceit — every piece of it a charge that asymmetry levies, a price paid to convey by other means what the market price can no longer carry. This volume anatomizes the disease and the cures, and ends by turning on the price itself, to find that its celebrated power to inform is exactly what hidden knowledge takes away.
The argument remains open. What follows is an attempt to fix its exact edges.
The twelve plates of this volume
- i The Lemonin print Akerlof's market for lemons: how hidden quality lets the bad drive out the good, until the honest seller withdraws and the market thins toward ruin. Read the plate →
- ii The Applicantin print adverse selection in insurance and credit; the applicant who knows his own risk, and the borrower who knows his own intent. Read the plate →
- iii The Diplomain print Spence and the signal: why a costly credential can be worth its price even when it teaches nothing, and what it means that we burn years to prove what we already are. Read the plate →
- iv The Screenin print Stiglitz and the screen: how the uninformed side can design a menu — the deductible, the cheaper version, the test — that makes the informed sort themselves. Read the plate →
- v The Hazardin print moral hazard, the hidden action: how a contract changes the conduct it insures, and why every policy against loss is also a temptation toward it. Read the plate →
- vi The Agentin print the principal and the agent; incentive pay, the informativeness principle, and the price of being unable to watch. Read the plate →
- vii The Warrantyin print warranties, brands, and reputation; the costly hostage a seller posts against his own cheating. Read the plate →
- viii The Signalin print the price as a broken signal: how asymmetry turns a market into a game of inference, and how it survives — when it survives — only by paying, in real resources, to reveal what the price no longer can. Read the plate →
- ix The Mechanismin print mechanism design and the revelation principle; rules built so that honesty is the best policy, and the rent the honest still collect. Read the plate →
- x The Stereotypein print statistical discrimination; the group taken as a proxy for the person, and the prophecy that fulfills itself. Read the plate →
- xi The Paradoxin print Grossman and Stiglitz; the impossibility of a price that has already learned everything there is to know. Read the plate →
- xii The Secretin print information as a good; the paradox of the thing you cannot value until you have it, and cannot be sold once you do. Read the plate →
In closing
This volume opened the second of the table's questions. The first family asked what a price conceals — and found, beneath each, a contest over who gets what. This family asks whether the price mechanism works, and the asymmetry, its first member, finds that it works only on a condition the celebration of markets tends to leave unsaid: that both sides know what they trade. Where that fails, the market does not merely misprice; it can unravel.
The unravelling, the volume showed, is the work of hidden information. When the seller knows what the buyer cannot — the lemon among the used cars, the illness behind the insurance application — the buyer, unable to tell good from bad, offers only what the average is worth; the good withdraws; the average sinks; and quality and the market decline together, the bad driving out the good. Against this the market improvises. The informed can signal, burning real resources on a credential or a guarantee that is credible precisely because the dishonest could not afford to fake it; the uninformed can screen, offering a menu — the deductible, the stripped-down version, the probationary term — designed so that the different types sort themselves by which option they choose. And where the danger is not hidden knowledge but hidden action — the insured who grows careless, the agent who shirks — the contract must be bent to restore the incentive that observation cannot, trading away the very insurance the agent sought in order to keep him diligent. And the averaging cuts deeper still where the unseen quality is a person's own: when a worker's group is the cheapest proxy for his worth, he is judged by its average rather than himself, in a statistical discrimination that needs no prejudice and can confirm itself, the low expectation it visits on a group depressing the very investment that would refute it.
And then the volume turned on the price itself, and found the deepest failure there. The price is celebrated as the signal that lets a market run on almost no knowledge — but that is exactly the function asymmetry destroys, for when one side knows what the other does not, the price ceases to be an honest report of worth and becomes a move in a game of inference, each party reading the other's offers for what they betray. The market survives, when it survives, only by manufacturing at great cost the trust the price can no longer supply; the signals and screens and warranties are the measure of what ignorance costs, paid over and over to reveal what symmetric knowledge would have made free. So the first of the failures sets the family's theme. The prices, the first family taught, are not the innocent measures they seem; the failures, this family will show, are not the rare exceptions the textbook treats them as, but the standing condition of markets wherever knowledge is unequal, spillovers are uncounted, or the thing in question is owned by everyone and so by no one. The price was supposed to spare us the need to know. The asymmetry is the discovery that, where knowing is unequal, the price is the first thing to fail.
If the price can be trusted to tell us what a thing is worth only when both sides already know, then in every deal where one side knows more, what are we reading when we read the price — the value of the thing, or only the shape of what the other is hiding?