A twist of lemon
Profile of George Akerlof, winner of the Nobel Prize for Economics. Published in California Monthly magazine.
When George Akerlof first joined the Berkeley faculty in 1966 as an assistant professor of economics, he admits he was at sea, unable to decide which of the dozen or so research ideas buzzing around his head to focus on. But Tom Rothenberg, an older and wiser colleague, took him under his wing and helped narrow the field to Akerlof’s best idea—one involving the used car market. It was sage advice. That work launched Akerlof’s career, along with an entire new field of economics; and now, thirty-five years down the road, it has earned him the Nobel Prize for Economics.
The call from Stockholm came at 6:17 a.m. on October 10. Akerlof’s wife, Janet Yellen, grabbed the phone and was surprised to hear a Swedish voice at the other end. (Yellen, also a professor at Berkeley, is best known as former chair of President Clinton’s Council of Economic Advisers.) “As soon as it actually sunk in that this was real, we grabbed one another and had a huge hug,” she says.
One of the first people at Akerlof’s door that morning was colleague Daniel McFadden, who won the same prize last year. He was there to offer his congratulations as well as advice on how to cope with the onslaught of reporters already making their way to Akerlof’s home. McFadden isn’t surprised that the Nobel Committee would award the prize to Berkeley professors in the same department two years in a row. “George has been on everyone’s list for a long time,” says McFadden. “His work is recognized as one of the really pioneering developments that has defined the way people think in economics.”
As the day drew on, and Akerlof was herded from press conference to photo shoot and from one reception to another, one thing became abundantly clear—Berkeley’s most recent Nobel laureate, its 18th overall, is also its most dedicated fan. That evening he spoke to a large audience that had (by happy coincidence) gathered at the Lawrence Hall of Science to celebrate the Nobel tradition at Berkeley. “It is a thrill to win the Nobel Prize,” he said. “But most of all it has been a thrill to have been here at Berkeley for 35 years.” During the morning’s press conference, Akerlof also told reporters: “Berkeley has always been a wonderful place for students and faculty and a real resource for the state. Ever since it was founded, Berkeley has set the agenda for California.” Colleagues call Akerlof’s commitment to the University “legendary.” Yellen says her husband even intends to donate his prize money to Cal. “His basic plan is to give gifts to institutions that have supported him over the years in his research, and Berkeley heads the list,” she says.
Born in Pittsburgh, Pennsylvania, the son of Swedish-born chemist Gosta C. Akerlof, he attended Yale, but proudly notes that his great-grandfather, Joseph Hirschfelder, was in Berkeley’s very first Class of 1873, and that his grandfather, Arthur Hirschfelder, graduated with the Class of 1897. Although his own son Robert has followed him to Yale, Akerlof’s allegiance is clearly to Cal.
“Berkeley is a great community with many wonderful ideals. And at Berkeley you’re supposed to live up to those ideals,” says Akerlof. “For example, we believe in the acceptance of the person as a person. Everybody respects everybody else and listens to their views. There’s just a wonderful intellectual exchange here.” Such an environment, Akerlof says, allows people to be much more daring and willing to pursue ideas “at the margins.”
More than anything, says Akerlof, this makes Berkeley a great place for students and young faculty. “I was really honored, when I came here as an assistant professor, that people listened to my ideas; it helped me develop and grow,” he recalls. “We’re just very, very careful to listen to the ideas of our younger people—that’s where we have our special advantage. The best place to be a young professor anywhere in the country is automatically Berkeley.”
That may be in no small part thanks to people like Akerlof himself. In his department, where he has been Goldman Professor of Economics since 1980, Akerlof is known as an exceptionally devoted teacher. “He is generally considered to be one of the most accessible people on our faculty,” says department head Alan Auerbach. “Certainly, he must be one of the most accessible people among Nobel Prize winners.” His students agree: “This year’s prize could not have gone to a more deserving economist and a nicer person,” says former student Wei Kang Wong, Ph.D. ’01, who now teaches at the University of Singapore. “George is one of the best advisers you can imagine. He always has time for his students—he spends hours with them. I often wonder how he manages to find time for his own research.” Wong adds that Akerlof genuinely cares about his students’ well-being, and fondly remembers the time he brought his students cookies (“good cookies, too”) during an exam held at dinner time.
Another doctoral student, Rebecca Hellerstein, says that she chose to come to Berkeley in part because she had been told that Akerlof was “one of the best people to train a young economist.” She also praises the dedication and time he gives to his students. “The week before the prize was announced, he spent four hours with me over two days discussing my dissertation project. And I don’t think my experience was unique.”
Akerlof shares the Nobel Prize with two other economists, Joseph Stiglitz of Columbia University and Michael Spence of Stanford, for their work studying the effects on markets of “asymmetric information”—where one party, the buyer or seller, has more or less information than the other. Akerlof was recognized by the Nobel Committee as the person who kicked off the field with his analysis of the used car market. His paper, “The Market for Lemons,” was first written in 1966—the year he came to Berkeley. Although the shady world of used car deals may seem remote from the lofty world of the Nobel Prize, Akerlof says it helped prove a principle: “Everybody knows what it means to buy or sell a used car. You clearly understand what the issues are, so you can think concretely about it. But asymmetric information applies to every single market.”
Starting with Adam Smith in the eighteenth century, economic theorists had worked on the assumption that buyers and sellers are always in possession of “perfect information,” which enables markets to operate with perfect efficiency. But Akerlof showed that even theorists cannot ignore the asymmetric information that exists in the real world.
In his example, used car buyers can’t possibly know as much about the true value of a car as the seller, and worry that they might get stuck with a lemon. That wariness among buyers has the effect of lowering the average price of all used vehicles on the market, even those of better quality, so sellers with good cars are deterred from putting them up for sale. This in turn drives down the average quality of vehicles in the used car market, further lowering buyers’ expectations.
This analysis of the detrimental effects of asymmetric information has since been extended to all kinds of markets, in particular the insurance, employment, and credit markets. While some markets are able to correct their own imbalances with mechanisms like warranties, brand names, and business reputations—all of which signal good quality to buyers—others are not. One of the more controversial implications of the work on asymmetric information is the idea that (Adam Smith notwithstanding) markets do not always operate efficiently; sometimes the “invisible hand” needs a nudge in the right direction.
“There are special cases where the problems of asymmetric information can be so great that you need governmental intervention,” says Akerlof. “There’s at least one leading example of that—medicare.” He explains that asymmetric information caused the health insurance market for people over 65 to collapse in the early 1960s, making it impossible for older people even to buy health insurance. Not all economists agree that the government should do the nudging; Akerlof says he is “in the middle” between those who argue for a completely free market and those who say there should be more government intervention.
Even as a young child in Pittsburgh, Akerlof was interested in economic problems. Growing up not long after the Great Depression, he says he was acutely aware of the problems of poverty and unemployment. “In second grade they asked me what I wanted from Santa Claus for Christmas, and I said, ‘A steel mill,’” he chuckles. (That way he wouldn’t ever have to ask Santa Claus for anything else, he explains.) It was his concern about poverty that made him become an economist in the first place. “Economists study why there is poverty. We figure out why people are poor and try to cure that,” says Akerlof.
His most extreme encounter with poverty came in 1967, when he worked in India for a year. “My first reaction was utter shock,” he recalls. The experience had a profound impact on the young economist, but was also helpful to his work. At that time, he had already submitted his first draft of “The Market for Lemons”to a number of economics journals, but all had rejected it, saying effectively, “If this is economics, then anything is economics.” Akerlof revised the paper, adding examples from India, including an analysis
of its credit market that made it “a better, richer paper,” he says. The paper that would eventually win him the Nobel Prize was finally published in The Quarterly Journal of Economics in 1970.
It was while on his way back from India that Akerlof says he read his first social science book—Ruth Benedict’s The Chrysanthemum and the Sword, an anthropological account of life in Japan. Since then, he has taken an interest in all the social sciences and how they can be incorporated into economics, a field which has traditionally stood on its own. In his 1984 book, An Economic Theorist’s Book of Tales, Akerlof sets out what might be called his “fusion cuisine” approach to economics. “Economic theorists, like French chefs in regard to food, have developed stylized models whose ingredients are limited by some unwritten rules,” he wrote. “Just as traditional French cooking does not use seaweed or raw fish, so neoclassical models do not make assumptions derived from psychology, anthropology, or sociology. I disagree with any rules that limit the nature of the ingredients in economic models.”
For more than two decades now, interdisciplinary work has been the trademark of his approach to economics, and he has filled in the gaps in his knowledge by sitting in on graduate social science classes taught by such faculty members as Laura Nader and Nancy Scheper-Hughes. (He has also taken undergraduate classes in Urdu and Hindi.)
The opportunity for collaboration with people from other departments is just one more thing that Akerlof cherishes about Berkeley. He and his wife Janet often collaborate, not just with each other but with scholars in many of the social sciences. “Just this morning I had an e-mail from [sociologist] Martín Sanchez-Jankowski. Janet and I did some work on gangs, and Martín [an expert on gangs] was right there in our building,” says Akerlof. “Anything that you care to work on, there are just wonderful people all over campus who are working on it.”