Year of Economics #5.1 and #5.2 Asymmetrical information / Fire engines

Year of Economics – September 26, 2003 – 5.1: The Problem of Asymmetrical Information (A Brief Digression)


Dear Abhay,

Can we revisit the classic axiom of the baker and the bread?

A person goes to the baker and buys a loaf of bread. One can conclude from the very occurrence of this event, that both the person and the baker have benefited from the exchange.

I began my last correspondence with this parable, from Deirdre McCloskey’s book The Secret Sins of Economics. She notes that it has become the foundation for free-market theorizing: since the baker offers the bread voluntarily and the customer purchases it voluntarily, they must both benefit from the exchange. Therefore, the free market benefits all participants. (Otherwise, why would they participate?) I would like to accept for the moment the retroactive qualifiers added in attempts to keep the parable true: that people enter into exchanges voluntarily, that people behave rationally, etc. I want to focus instead on another qualifier which, as I understand it, economists added still later: if information is symmetrical.

1. What is asymmetrical information?

I understand this to mean that both participants benefit from the exchange as long as they share the same information about the commodities exchanged and the exchange itself. As long as the customer knows everything relevant about the bread that the baker knows, and as long as the baker knows everything relevant about the customer’s finances that the customer knows, and as long as both share the same information about the price of bread – the exchange remains beneficial. I have added the word relevant because obviously the baker usually knows more about the bread than the customer, but not all of that information is relevant to the exchange. If the baker knows, however, that the bread is defective because of some baking error, yet this information remains unknown to the customer who pays the regular price, the exchange has become less beneficial to the customer. If the customer writes a check for the bread, knowing that the bank account has a zero balance, but this information remains unknown to the baker, the exchange becomes non-beneficial to the baker. If only one of them knows that the value of bread has changed radically because of market conditions, the exchange becomes less beneficial to the other. Each of these circumstances, I think, exemplifies how asymmetrical information disrupts the mutually beneficial market.

Assuming I am correct in my analysis, my first question is this: how does asymmetrical information differ from lying?

Thirty years ago, the economist Joseph Stiglitz researched problems of asymmetrical information in work that won him the Nobel in 2001. He explored common situations in which one party to a transaction knows more than the other party. Typically, when I take out a life insurance policy, I know more about my health than the insurance company. The company may try to draw conclusions about my health based on a statistical analysis of me. But my knowledge of my health does not become lying unless I deliberately misinform the company in some way relevant to the exchange. This reminds me of Rod Steiger, in the 1970 disaster film Airport, taking out a life insurance policy with the intention of detonating a bomb on an airplane, killing himself and destroying the evidence of his asymmetrical information, so his widow will collect the premium and no longer live in poverty. A more quotidian example occurred in our household yesterday, when Lin received a mail-order product she had ordered last week. To her surprise, a sheet of New Testament Bible quotations accompanied the receipt. She immediately returned the item, not wanting to support a business that proselytizes, revealing its intentions only after the sale. Stiglitz showed that asymmetrical information can lead to complete market failure. But did he in doing so show that asymmetrical information equals lying? Or did he simply suggest that asymmetrical information, which may or may not involve lying, still paralyzes markets? Furthermore, even if we assume that “asymmetrical information” is an economic formulation of a concept, and “lying” is an ethical formulation of the same concept, why would I seek a meeting place between the two?

2. What is lying?

When a question like this comes up, I turn to the philosophy I feel most akin to, and of which I have a modestly more thorough understanding than economics – Buddhism. Buddhism defines right speech with the clarity of its typically negative articulation: to abstain from false speech.

Herein someone avoids false speech and abstains from it. He speaks the truth, is devoted to truth, reliable, worthy of confidence, not a deceiver of people. Being at a meeting, or amongst people, or in the midst of his relatives, or in a society, or in a king’s court, and called upon and asked as witness to tell what he knows, he answers, if he knows nothing: “I know nothing,” and if he knows, he answers: “I know”; if he has seen nothing, he answers: “I have seen nothing,” and if he has seen, he answers: “I have seen.” Thus he never knowingly speaks a lie, either for the sake of his own advantage, or for the sake of another person’s advantage, or for the sake of any advantage whatsoever.

From the point of view of Buddhism, all cases of false speech have a deceptive intention in common. The nature of false speech depends on the deceptive intention, which can take three forms: greed, aversion, or delusion. Greed as motive results in the lie aimed at gaining some personal advantage for oneself or those close to oneself – material wealth, position, respect, or admiration. With hatred as the motive, false speech takes the form of the malicious lie, intended to hurt and damage others. The motive of delusion results in a less pernicious falsehood: the irrational lie, the compulsive lie, the interesting exaggeration, lying for the sake of a joke. The Buddhist stricture against lying rests upon several reasons. First, lying disrupts social cohesion. People can live together in society only in an atmosphere of mutual trust, where they have reason to believe that others will speak the truth; by destroying the grounds for trust and inducing mass suspicion, widespread lying becomes the harbinger of a fall from social solidarity to chaos. But lying has equally dangerous personal consequences. Lies tend to proliferate. Lying once and finding our word suspect, we feel compelled to lie again to defend our credibility, to paint a consistent picture of events. So the process repeats itself: the lies multiply until they lock us into a cage of falsehoods from which it is difficult to escape. The lie thus offers a miniature paradigm for the process of subjective illusion. Truthful speech attempts to establish a correspondence between our own inner being and the nature of phenomena. This correspondence allows the occurrence of wisdom. More than an ethical principal, the Buddhist devotion to truthful speech is a matter of taking a stand on reality rather than on illusion, on the possibility of wisdom rather than the fantasies of desire.

When I read of Stiglitz’s work on the economic consequences of asymmetrical information, it reminded me of the Buddhist doctrine on the consequences of false speech. Stiglitz’s articulation, however, struck me as even more unforgiving. For Stiglitz, I would venture, the motivation (greed, aversion, delusion), and form of the lie does not matter. It is the actual asymmetry, the imbalance of information, that disrupts the exchange. In this respect, any manner of preserving the asymmetry, whether lying or simply withholding information, has the same destructive economic effect.

I realize the absurdity of me, the eternal beginner, writing on the economics of Joseph Stiglitz. I have tried to speak from the point at which ignorance becomes knowledge. This intention produces misstatements, restatements, understatements, overstatements, and half-understandings. Nevertheless, before I turn this problem over to you for a more informed economic response, I will push it one step further.

3. The public’s innumeracy

I am not content to practice economics sub specie aeterni, dehistoricized, from the viewpoint of eternity. Therefore I want to raise the issue of what has been called the Bush Tax Cut. In a debate with Vice President Al Gore, candidate George W. Bush, speaking of his tax plan, said, “most of the tax reductions go to the people at the bottom end of the economic ladder.” The economist Paul Krugman has called this kind of statement Mr. Bush’s “willingness to trust in the public’s innumeracy.” (Around this time, the Bush team began accusing candidate Gore of “serial exaggeration.”) Statements of this sort have proliferated into the Bush presidency. As the tax plan has played out, only the wealthiest will receive reductions in future years. The rest of us received a check for a few hundred dollars, which we had to pay back at the next tax collection time. Still, many public economists refer to this as a tax cut. It seems to me more like a loan. Now people debate the efficacy of tax reduction (for multi-millionaires) as a strategy for job creation.

In today’s political turmoil of wars and terrorism, it may not occur to people to wonder if a tax cut is a tax cut. Apologists in the daily papers, too numerous to refute individually, seem “to trust in the public’s innumeracy” on economic issues. Maybe we will have time to examine some of their arguments in the future. For now, I want to focus on the topic: assymetrical information.

I want to raise the issue of the administration’s obsession with secrecy. One can argue the advantages of government secrets, or the rights of the government to keep secrets, but none would debate that this administration has them. Does overt secrecy in itself represent assymetrical information? It seems to me that it must, particularly as one party in the exchange knows that the other party is withholding information. In addition to the secrecy, the pattern of statements (President Bush: “most of the tax reductions go to the people at the bottom end of the economic ladder,” or Vice President Cheney: “I have no financial interest in Halliburton of any kind and haven’t had, now, for over three years” when he received $162,392 in 2002 from Halliburton, the corporation in charge of rebuilding Iraq) suggest, if not lying, at least a willingness to mislead and trust in ignorance. These statements (false speech), coupled with the withheld information (secrecy), would seem to me to produce an atmosphere of mutual mistrust, regarding exchanges in which the Executive Branch is a party. Taxation represents such an exchange, as does the role of cabinet appointments, such as head of the Securities and Exchange Commission, in overseeing corporate investments and markets.

So here are my questions to you.

Does the asymmetrical information of the Bush administration have an adverse effect on markets?

Is lying bad for the economy?

I look forward as always to your response,
Matthew

Year Of Economics 5.2 - Four fire engines, two police cars and an ambulance (Response to a digression). September 29, 2003.

My dear Matthew,

1.
We start in the cafeteria. A busy time of the day there. Groups of students sit glued to giant TV screens swallowing large mouthfuls of tasteless cafeteria fare. Suddenly one student runs to a garbage can and starts vomiting violently. Another runs to him and fusses over him. 30 seconds later, another student starts vomiting. Every 30 seconds a new vomiting sound is heard. Soon the cafeteria is full of students leaning over oversized garbage cans. The spell cast by the drone of the large TV sets is broken. Everyone is fully present. The air is dense with the sublime impotence of awareness. The students leave their garbage cans and return to their tables. They have spent three years taking the shit we feed them. They've just recycled it.

2.
Consider the possibility for the existence of a market for lies. Economists say a market exists when potential buyers and sellers of something are in communication. Let us begin with a state of equilibrium or position of rest. The laws of supply and demand say that this position would be maintained indefinitely unless the supply or demand conditions change.

In a democracy, we narrow down or zoom in to certain individuals who we believe best represent the interests of our society and elect them. The people they then appoint share that same characteristic: they are the chosen few. Their actions then, have a reverse or broadening effect, a zooming out, a magnifying effect.

Now suppose we have a sudden increase in the quality and quantity of lies being circulated by people in public office. While the lie of the average person resonates in his or her own circle of interaction, the lie of the public official acts as what economists would call a multiplier.

3.
A student screams: my purse! They've taken my purse...we see two young men running with the screaming student behind them. The Dean and business office manager spring into action. The two robbers are chased by two middle-aged men in suits, down the corridor, even as one of the students calls to the other, Ricky, my man, run! They are after us! No one else moves. They stare at the garbage cans as if they, the garbage cans, being temporally first in the chain of events are somehow causally linked as well. Once the TV watching has ceased, it is difficult to make sense of the world.

4.
Let us return to the possibility of a market for lies. We notice a marked increase in the frequency and magnitude of lies being blatantly circulated by public officials such as our President. This would cause an increase in the supply of lies. Because of the multiplier effect, there would be a tremendous increase in the supply of lies. An elementary principle of economics states that when the supply of something increases, its price will drop. Under the present political conditions, lying is cheap and getting cheaper!

5.
Ronald is sitting next to me. We are of course still in the cafeteria. A beautiful woman approaches him, says I'm sorry, and pours her extra large yellow icy drink on his head. Ronald sits there with no visible change in expression. Now a large bald student approaches Ronald, empties a custard-style fruit yogurt on his head and proceeds to massage it into his curly hair. I watch Ronald and the bald man in fascination and so does everyone else. As if we had each paid our nickels to peep through the hole to watch.

6.
We have so far only considered the possibility of supply changing. We have logically followed the effects of changing supply on the price of lies. Now we can meditate upon the further effect of prices on the amounts or magnitudes of lies that will be demanded by society in the long run.

In the case of lies, the falling prices will stimulate greater quantities of lies to be demanded. In economic terms, the quantity demanded (though for technical reasons not the demand) of lies will increase over time. People will accept, even want, more lies over time.

7.
We are in the library now and for a long time nothing happens. Then I hear the thickly accented voice of Gloria, my student from Mexico: I don't feel too good. Gloria is pregnant and due in March. Soon the two young men at her table are leading her carefully towards the exit. I hear whispers. Water...broke...hospital. Suddenly a woman in her thirties (not a group member, takes charge and is ordering everyone around. No don't do that she scolds the young men helping Gloria and scatters them with a regal wave of her hand. This woman is now cooing to Gloria. You sit right here.....honey is this your first......no you go get the car and you go get her stuff.....I just felt a contraction!

8.
We observe an increasing disregard for truth in public office and cases such as that of Eric Schaeffer, the Environmental Protection Agency's director of civil enforcement convince us that truth-sayers must resign from office. Truth is becoming a rare commodity. In terms of the economics of supply and demand, the supply of truth decreases. Through the operation of the multiplier, there is a significant reduction in the supply of truth. Now applying the elementary principle of economics in reverse, we notice that the price will rise. Truth is expensive and getting more so.

9.
The strange situations I have described in this letter are site-specific performance pieces performed by my students all over the campus of our little technical college.

Groups of students were instructed to do something unexpected, create an informational asymmetry, and to blur the lines between performance and everyday life, between performer and audience, and intended audience and unintended audience. They were to think of their pieces as social interventions, experiments. They were to note, measure, and reflect on the responses to their works.

10.
In the case of truth, the rising prices will reduce the quantities of truth demanded. In economic terms, the quantity demanded (though, once again, not the demand) of truth will decrease over time. People will reject, want less of, truth over time.

11.
Given the informational asymmetry (only the students performing were aware that the strange occurrences were performances), onlookers chose to do one of three things. Firstly, a large number of people simply watched, as voyeurs stumbling onto unsettling scenes. Secondly, some people chose to get involved, but in a way where they were in charge. They simply did not ask if they could be of help, or offer their services, instead choosing to direct. Thirdly, some people chose neither to simply watch nor direct the proceedings but to call emergency services without announcing their actions. No one said: I have called 911. They chose to do it in secrecy. And we ended up with four police cars, two fire engines, and an ambulance.

12.
Asymmetric information is a destabilizing force. Lies are a form of asymmetric information. Therefore lies are destabilizing.

However lies may be applied towards constructive or destructive purposes. What my students are doing in their performances is a form of lying. They stage situations in public places that are destabilizing. This destabilization, however, is brief and has as its ultimate purpose the creation of a greater awareness of place. Students debrief onlookers as soon as the performances are over and openly discuss matters with the unknowing participants. My students and I sincerely believe that these destabilizing interventions have a positive effect in the fact that the equilibrium that we shatter (media induced ennui) is a harmful one. Our lying moves our college community out of its negative equilibrium and towards a positive equilibrium.

An article in this week’s issue of Scientific American on the Economics of Child Labor, describes the possibility of two equilibria. One is negative, at a low wage, forcing the family to send the children to work. The other takes place at a wage that is high enough to support the entire family’s needs, allowing the children to be educated instead. This is the positive equilibrium. Both equilibria are efficient by economic standards but one is crippling in its effects while the other is life affirming. It makes sense to destabilize the system when it is stuck at the negative equilibrium.

The blatant and open lying of public officials in our democracy destabilizes our economy, polity, and society from a place of positive equilibrium that took over two hundred years to create. I join George Akerlof (who shared the 2001 Nobel prize in economics with Michael Spence and Joseph Stiglitz for the concept of asymmetric information) in calling for civil disobedience to protest what he calls the worst government since the founding of this country. The American media largely refused to carry his rallying call. I found out only from reading German newspapers.


Sincerely,

Abhay