Mr Spence showed that top workers might signal their talents to firms by collecting gongs, like college degrees. Employers may struggle to tell which job candidates are best. Mr Spence’s flagship contribution was a 1973 paper called “Job Market Signalling” that looked at the labour market. Further breakthroughs soon followed, as researchers examined how the asymmetry problem could be solved. Yet the idea was new to mainstream economists, who quickly realised that it made many of their models redundant. And insurers had long recognised that their customers might be the best judges of what risks they faced, and that those keenest to buy insurance were probably the riskiest bets. The lemons paper was not even an accurate description of the used-car market: clearly not every used car sold is a dud. Is it really true that you can win a Nobel prize just for observing that some people in markets know more than others? That was the question one journalist asked of Michael Spence, who, along with Mr Akerlof and Joseph Stiglitz, was a joint recipient of the 2001 Nobel award for their work on information asymmetry. This “information asymmetry” between buyers and sellers kills the market. This is a tragedy: there are buyers who would happily pay the asking-price for a peach, if only they could be sure of the car’s quality. Sellers of lemons end up with the same price as they would have done were there no ambiguity.
Knowing they will only ever be sold a lemon, they offer only $500. As a result, the buyers face “adverse selection”: the only sellers who will be prepared to accept $750 will be those who know they are offloading a lemon. But dealers who know for sure they have a peach will reject such an offer. They might be willing to pay, say, $750 for a car they perceive as having an even chance of being a lemon or a peach. To account for the risk that a car is a lemon, buyers cut their offers. In reality, buyers might struggle to tell the difference: scratches can be touched up, engine problems left undisclosed, even odometers tampered with. If buyers can tell lemons and peaches apart, trade in both will flourish. A malfunctioning used car-a “lemon”-is worth only $500 to buyers (and, again, slightly less to sellers). Suppose buyers in the used-car market value good cars-“peaches”-at $1,000, and sellers at slightly less. Mr Akerlof’s idea, eventually published in the Quarterly Journal of Economics in 1970, was at once simple and revolutionary.
Mr Akerlof, now an emeritus professor at Berkeley and married to Janet Yellen, the chairman of the Federal Reserve, recalls the editor’s complaint: “If this is correct, economics would be different.” The Journal of Political Economy had almost the opposite concern: it could not stomach the paper’s implications. Perhaps as a result, the American Economic Review thought his paper’s insights trivial. At the time, Mr Akerlof was an assistant professor at the University of California, Berkeley he had only completed his PhD, at MIT, in 1966. Yet when, in the late 1960s, George Akerlof wrote “The Market for Lemons”, which did just that, and later won its author a Nobel prize, the paper was rejected by three leading journals. You might think that research upending that conclusion would immediately be celebrated as an important breakthrough.
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