Sharecroppers, stoneless rice and the Nobel

By Achin Chakraborty

THREE AMERICAN economists, George Akerlof, Michael Spence and Joseph Stiglitz, have won the Nobel Prize in economics for their contributions to information economics. The reader, who has not had the misfortune of learning economics at any point in life, would normally find no compelling reason to be curious about it. To the outsider, information economics, or any other branch of theoretical economics for that matter, may appear to be an esoteric, even absurd, affair. But if one is curious about things in general, and has an analytical bend of mind as well, there is much in information economics which would surely stir up one's interest. To sensationalise a bit, it is the Indian sharecropper, the outcaste and the Indian housewife busy sorting stones from rice who triggered this branch of knowledge in economics. To many economists, this is one of the most exciting things to have happened in economics in the recent past.

Throughout much of the 1950s and 1960s, the main body of economics was largely concerned with discussing the conditions under which competitive market structures result or fail to result in an efficient allocation of resources. In this phase, mainstream economics traded breadth for rigour. In the idealised frictionless world of impersonal markets, where buyers knew fully well what they were buying, and sellers had no reason to do mischief with prices, things could be put in elegant mathematical language. While many brilliant minds busied themselves with this esoteric task of finding abstract answers to abstract intellectual questions through a rigorous mathematical route, more down-to-earth thinkers, concerned with economies of the third world, carried on their difficult struggle to seek an alternative route. They, for good reason, refused to give too much weight to mainstream economists' intellectual playthings, and got marginalised in the process.

All this had a significant impact on the way economics used to be taught in India. For much too long, students of economics in many Indian Universities had been fed with the well-worn piece of wisdom from their respected teachers: ``mainstream economic theories produced and sold by the West are all useless when you try to deal with economies of this part of the world''. This typical attitude has been nicely captured in the following anecdote, which Professor Kaushik Basu heard from Professor V.M. Dandekar. When Professor Dandekar was a young man attending a seminar by a pompous senior economist, he spotted a simple mathematical mistake on the blackboard and pointed it out. The senior economist glared at him, and said, ``young man, we are not talking about the efficient, smooth economy of an industrialised nation; but about the chaos and clutter of underdevelopment.''

What we did not know at that time was that ``the chaos and clutter of underdevelopment'' would change mainstream economics forever. Some of the main ideas, which have had considerable influence in recent advances in economics, were originally conceived in the context of developing economies such as India. George Akerlof was a young man of 27 when he spent a year in India. In his own words, ``after being to India I understood that economic systems don't necessarily work as they do in standard economics, where markets always clear. The caste system somehow provided me with an alternative model for how economic systems might work.'' The uncertainty about the product qualities that he observed in the Indian markets profoundly influenced him. When the buyer is less informed than the seller about the quality of the product, he/she would refuse to pay the price for good quality since the product bought might turn out to be bad. Then the seller will also have no incentive to make good quality products available. In other words, the bad quality product will push the good quality out of the market. This Akerlof generalised in a rigorous way so that a variety of situations involving `thin' markets could be explained.

Markets tend to be thin or underdeveloped if making transactions is difficult for informational problems. Development thinkers of yesteryears knew it well. But the theoretical implications were never fully worked out until Akerlof came up with his paper ``The market for `Lemons'' published in 1970. In this paper, he picked up the example of the market for used cars (a lemon is a bad car in U.S. parlance), perhaps to impress the editors of the U.S. journals that he was dealing with a general problem (read American), not with the problems of the `other' world which should better be left to the soft disciplines such as anthropology and sociology. But this eminently suitable strategy did not work in Akerlof's case. Three top journals rejected the paper before it was finally accepted by the fourth.

If a seller wants to convince his customer that his product is good what should he do? In the case of durable goods, a possible strategy is to offer warranty. The offer of warranty signals that the product is good.

The amusing sign `Stoneless Rice Available Here' put up by the Indian shopkeeper is also intended to serve a similar purpose, but one is not sure about its power to convince the potential customer. The same idea can be extended to explain labour market features as well. If the employer has little prior information on his/her employee's ability, he/she would hesitate to pay a high salary, which in turn would discourage more productive workers to join. The more productive job-seeker would then need to give a signal which would help his/her employer to sort out the good from the bad. The level of education may perform this signalling function, because more productive workers usually have a greater incentive to acquire education. Issues of this kind form the core of Michael Spence's theory of market signalling.

We thus see in the real world a variety of spontaneous responses to problems arising out of the fact that between two parties in a transaction, one has more information than the other. Although this informational asymmetry is universal, it is more pervasive in the developing world. Joseph Stiglitz provided the leadership to a whole group of development economists in their endeavour to understand various aspects of agrarian institutions, such as share tenancy, in terms of risk-sharing and asymmetry of information. The landlord, just by looking at the harvest, cannot ascertain whether the labourer worked hard or not. A bad crop does not necessarily mean less effort was put in. So what should the landlord do? Close monitoring is needed. But if the landlord's time is not cheap it may be ideal for him to enter into a share contract, where the tenant farmer partly shares the risk of bad harvest.

Among the three laureates, Stiglitz is perhaps the most widely- known, for his tirade against World Bank policies. Until recently he held the position of the chief economist at the World Bank and made himself deeply unpopular with the orthodoxy. Following the route shown by information economics, we now understand in a deeper way the problems of simple-minded shock therapy prescribed by the World Bank and the IMF (alternatively referred to as the Washington Consensus) for reforming economies. The Washington Consensus took, according to Stiglitz, ``an ideological, fundamental, root-and-branch approach to reform as opposed to an incremental, remedial, piecemeal, adaptive approach''. He attributes the glaring failure of shock therapy in the transition economies of the former Soviet Union and Eastern Europe to their advisers' failure to understand modern capitalism. It was not just the result of poor implementation of sound policies, but also of a failure to understand that the success of a market economy crucially depends on supporting institutions, such as a suitable legal framework and social norms favouring compliance with the rules of the game. It is the profound insight of information economics that would help us reject both kinds of fundamentalism - a simple-minded blitzkrieg approach to `level the evil institutions of socialism', on the one hand, and the `market-is-what-we-have-instead-of-the-devil' approach, on the other.

(The writer is Associate Fellow, Centre for Development Studies, Thiruvananthapuram.)

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