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Practicality in Economics

Explorations in Pragmatic Economics Selected papers of George A Akerlof

Reviews

Practicality in Economics

Explorations in Pragmatic Economics Selected papers of George A Akerlof, Oxford University Press, New York 2005, New Delhi 2006; pp 522, $ 49.95.

KAUSHIK BASU

R
eviewing a collection of George Akerlof’s papers is a difficult task for me, since, unlike other books that arrive on my desk, I am already familiar with the bulk of the contents of this one; and at least two of the papers (‘The Market for Lemons’ and ‘The Economics of Caste’) have profoundly influenced my own thinking in economics. So I cannot deny that I approached this new book with opinions largely formed, and expectations firmly in place. Yet there is a surprise in seeing so many of Akerlof’s finest papers (20 of them) all together. Despite one’s awareness that he is one of the finest economists of our generation, seeing the sheer range of his contributions between the covers of a single book takes the breath away. The book makes us aware of his striking originality. By the standards of modern economics, Akerlof uses little mathematics. He seldom runs regressions, let alone long, complicated ones. He uses the simplest of examples to illustrate his arguments and it is easy to slip into the complacency of thinking that, like the examples, the points he is making are simple. Many a journal editor fell into this trap, when they rejected his early papers on grounds of being trivial. But once these simple arguments sink in, one realises how profound they are, altering the way economic thought was conducted at the time of their publication.

Originality and Simplicity of Thought

The collection begins with what is, arguably, his best-known paper, ‘The Market for Lemons’, first published in 1970. Much of the economics of demand and supply was, in those days, presumed that both the buyer and seller knew the quality of the product being traded. Sensible economists knew that this was not true in reality but treated it as a harmless assumption. Akerlof argued that in many markets information is not only imperfect but asymmetric. In the market for used cars (or “lemons” in slang), for instance, the seller is likely to know much more about the product than the buyer (the fact that the car stalls after 30 minutes of smooth driving). Akerlof’s paper demonstrated that this little con cession to reality could dramatically alter the standard paradigm. Free markets no longer act as guarantors that the outcome will be socially optimal, as previously supposed and, in fact, markets free from government intervention are often shown to break down.

He submitted the paper at the end of 1967 to the American Economic Review and received a prompt rejection on the grounds that the journal “did not publish articles so trivial”. He happened to spend the next academic year in India and revised the paper quite a bit, adding examples from India and from development economics, and then sent the revised version to Review of Economic Studies. But to no avail; the paper was rejected. It was then submitted to the Journal of Political Economy, only to be rejected again. It finally appeared in the Quarterly Journal of Economics and within a short time, was being hailed as a classic.

The Indian influence on Akerlof’s work is also evident in his paper ‘The Econo mics of Caste and of the Rat Race and Other Woeful Tales’ (Quarterly Journal of Economics, 1976). The paper shows how political and social institutions can persist even when no one wants them to persist. Akerlof demonstrates that certain caste practices and customs can have this trait. What makes this such a deep paper is the way it carries over to other areas, such as the persistence of certain unwanted political regimes and peer pressure among teenagers. I have, in my own work, tried to show how this argument can be used to explain the persistence of certain totalitarian regimes.

When one hears everybody express distaste for some custom (which they all never theless practise), for instance, the giving and taking of dowry, our tendency is to presume that some of those people are lying Why else will they adhere to the custom? Akerlof constructs an abstract argument to show that no one is lying. All individuals could be “victims” of the custom. Once again his theory militates against the pervasive view in economics that individual selfish rationality leads, via the invisible hand of the market, to social optimality.

His ability to use simple examples to construct powerful theories is in full view in his paper ‘Procrastination and Obedience’ (American Economic Review, 1991). The model begins with his experience in India, when his friend, economist Joseph Stiglitz, on his way home to the US from New Delhi, faced an unexpected restriction on carry-on luggage and so gave Akerlof a parcel to mail to him. In Akerlof’s words, “Each morning over the next eight months I woke up and decided that the next morning would be the day to send the Stiglitz box”. He explains that if on the first day he confronted the choice between sending it that day or eight months later, he certainly would have sent it that day. But having the choice each day of a one-day postponement meant that he ended up procrastinating for eight months. Once the model is formalised, it sheds light on a variety of real-world pheno mena, ranging from drug addiction to torture.

In this paper and elsewhere Akerlof draws extensively from psychology, sociology and anthropology. One sees evidence of this also in his papers on unemployment, inflation and wage-stickiness. He approaches these neighbouring disciplines not with the imperialist’s baton as economists have done in the past in the eagerness to spread the “economic approach” to other subjects but with a genuine openness to bring to economics what is best elsewhere. He has brought to economics important ideas such as “cognitive dissonance”, “gift exchange” and “collective identity”.

In addition to the familiar essays on macro economics, labour economics, the economics of information and more, this book has a newly-written introduction, where the

Economic and Political Weekly September 1, 2007 author spells out his methodo logical predilection. He outlines Milton Friedman’s well known paper on methodology and the kind of approach which Friedman would label as misguided, and then promptly adds, “I am proud to be among the misguided”. He makes a spirited case for constructing models using realistic micro assumptions and not be guided simply by the urge to construct statistically testable propositions. In life one picks up information all the time and there is no reason to not use this in formation and to wait for formal statistical data. He stresses the power of intuition and judgment and argues that to be scientific should not mean a denial of these traits.

All in all this is a superb collec tion. It contains the best of George Akerlof and, assuch, the best of contemporary economics.

EPW

Email: kb40@cornell.edu

Economic and Political Weekly September 1, 2007

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