By JON E. HILSENRATH
Staff Reporter of THE WALL STREET JOURNAL
The Nobel prize for economics was awarded to three Americans who challenged an assumption that has underpinned economic theory ever since Adam Smith wrote of the "invisible hand" that guided human behavior. That theory: Markets operate efficiently.
In awarding the most coveted prize in economics to George Akerlof, 61 years old, of the University of California at Berkeley, Michael Spence, 58, of Stanford University, and Joseph Stiglitz, 58, of Columbia University, the Royal Swedish Academy of Sciences is tipping its hat to economists who subscribe to less laissez-faire principles.
The three, who will share the nearly $1 million award, have long argued that markets don't always operate efficiently because buyers and sellers don't always have access to the information they need to make optimal choices. "There are all kinds of reasons why liberal economists say that markets are inefficient and that we must replace the invisible hand with a visible hand," said Jagdish Bhagwati, an economics professor at Columbia and former classmate of Messrs. Akerlof and Stiglitz. "These guys found a new reason for inefficiency in markets that people had not thought of: imperfect information."
To some, this line of reasoning, which is based on theories of so-called asymetric information, amounts to an economic argument for more government regulation, which many free-market economists abhor. The thinking goes that if imperfect information sometimes distorts markets, then governments sometimes need to fix those distortions.
Mr. Akerlof helped to pioneer this branch of economics with a 1970 paper called "The Market for 'Lemons.' " That paper explained why it was hard for used-car sellers to make a market for their products when buyers were so uncertain about what problems resided under the hoods of different vehicles.
"If you are the buyer of a used car, you have to be suspicious of the motives of the person who wants to sell the car. But if you are a seller, you feel that you can't get the price that you deserve," Mr. Akerlof explained Wednesday in an interview.
Mr. Stiglitz wrote a series of papers explaining how such information uncertainties led to everything from unemployment to lending shortages. As the chairman of the Council of Economic Advisers during the Clinton Administration and former chief economist at the World Bank, Mr. Stiglitz was able to put some of his views into action. For example, he was an outspoken critic of quickly opening up financial markets in developing countries. These markets rely on access to good financial data and sound bankruptcy laws, but he argued that many of these countries didn't have the regulatory institutions needed to ensure that the markets would operate soundly.
Even in the U.S., he says, the breakdown in security at airports, apparent since the Sept. 11 terrorist attacks, is an example of new demands for government intervention in inefficient markets. "There are certain activities like airport security that should not be in the private sphere. That market is not self-adjusting," he said Wednesday.
Mr. Spence explained how market participants sometimes adjusted to information shortfalls by using what he called "signaling." Employers, for instance, often rely on the educational background of job hunters as a sometimes imperfect signal of how productive they might be as workers.
Ironically, the strongest proponents of efficient markets in recent years have been at the University of Chicago, which dominated the Nobel Prize award for much of the 1990s. But the economics profession might be gravitating slowly toward a concern with market inefficiencies. In April, for instance, the American Economic Association awarded its prestigious John Bates Clark medal -- for leading economists under 40 -- to Matthew Rabin, a University of California at Berkeley economist who has developed mathematical models to explain why people do irrational things like procrastinate.
Gary Becker, a Nobel laureate and economist at the University of Chicago, said he agreed with this year's winners that markets are sometimes inefficient because of bad information. But he said that doesn't lead logically to a call for more government intervention in markets. "Governments face asymetric information too, and they do things for a variety of reasons," Mr. Becker said. "I believe the government generally make things worse."
Messrs. Akerlof and Stiglitz were classmates at the Massachusetts Institute of Technology during the mid-1960s, where their questions about the classical economics of Adam Smith began to germinate. They also had a close connection to the Clinton administration: Mr. Stiglitz was chairman of Mr. Clinton's Council of Economic Advisers as was Mr. Akerlof's wife, Janet Yellen.
The award is formally called Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel.
See the Nobel website for a more information.