The Market for “Lemons”: Quality Uncertainty and the Market Mechanism. Akerlof, George A., The Quarterly Journal of Economics, Vol. 84, No. 3. (Aug., 1970), pp. 488-500.Bill Black:
Economists have a Pavlovian response to any mention of Akerlof’s seminal article on lemon’s markets – “asymmetric information.” The committee that awards the prize in economics in honor of Nobel cited Akerlof and his co-awardees’ work in developing the economic implications of asymmetric information. Economists have tended to ignore, however, the context of Akerlof’s famous article. The specific examples of the sale of goods that Akerlof discusses are frauds. More particularly, each is an anti-customer control fraud – a fraud instigated by the person(s) controlling a seemingly legitimate entity where the primary intended victims were the customers. Akerlof did not discuss the variants of anti-customer control fraud that maim or kill – he focused solely on examples of economic injury due to fraudulent misrepresentations by the seller of the quality or quantity of the goods sold. More precisely, two of Akerlof’s examples – the fraudulent sale of defective cars and rice deliberately intermixed with stones – do maim and kill some customers, but Akerlof did not discuss this aspect. (Biting down on a stone can easily shatter a tooth. That causes excruciating pain, but it also exposes an Indian peasant – the fraud victims Akerlof was discussing – to a greatly increased risk of dental infection, which causes an increased risk of severe cardiac illness.) Akerlof had appropriately large ambitions in his article. He sought to provide a “structure … for determining the economic costs of dishonesty” (p. 488). Goods that maim and kill the customer impose the primary economic costs of dishonesty.
Akerlof explained [how unprosecuted fraud undermines market mechanisms] in his 1970 article:I wanted to quote at length here, because Black highlights a peculiar lacunae in the customs and language of Economics: the allergy to, and disinterest in fraud. The use of opaque jargon, "asymmetric information problems" to obscure the nature of the beast is an imperative cultural norm of economics. And, it is not just the professional need for a distinguishing jargon, which drives it; it is linked, always, to the need to see the economy as "natural" and naturally tending, without government intervention, to optimal results.
Gresham’s law has made a modified reappearance. For most cars traded will be the “lemons,” and good cars may not be traded at all. The “bad” cars tend to drive out the good (p. 489).When cheaters prosper, market mechanisms become perverse and can drive the honest from the marketplace. The market becomes dominated by cheats because they obtain a competitive advantage. The most common reason that firms can cheat with impunity is that their CEOs are cronies of powerful politicians. The defining characteristics of crony capitalism are that the cronies receive subsidies, favors, and immunity from normal rules and laws. The cronies dominate the big corporations and provide reciprocal benefits to controlling politicians. Managerial incompetence and wealth flourishes under crony capitalism. Merit and efficiency suffer, income inequality surges, and class and who one knows become the primary determinants of economic and political success and power. The elites become pervasively corrupt.
[D]ishonest dealings tend to drive honest dealings out of the market. There may be potential buyers of good quality products and there may be potential sellers of such products in the appropriate price range; however, the presence of people who wish to pawn bad wares as good wares tends to drive out the legitimate business. The cost of dishonesty, therefore, lies not only in the amount by which the purchaser is cheated; the cost also must include the loss incurred from driving legitimate business out of existence (p. 495).
Consideration of the phenomena of market economy certainly doesn't suggest to an unclouded mind that achieving optimal results is effortless or even usual. I would say that there's nothing inherent in good economic theory to suggest that actual economies will be "naturally" efficient. Something else is driving the economists to an unwarranted faith in certain precepts.
Black suggests that Powell, a lawyer and moderate conservative, was blinded in his point-of-view by his commitment to class solidarity. With regard to academic economists, I think the roots of the poisonous weeds grow primarily from other seeds; though class may sow some seeds, there are others, more shameful to an intellectual.
