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Summary Article: JOSEPH STIGLITZ (1943—) from Routledge Key Guides: Fifty Major Economists

Joseph Stiglitz has been a pioneer in studying the economics of information, which examines individual decisions to obtain information and how the economy is affected when people have insufficient information. One conclusion of his work is that a lack of information generates economic problems which require government policy solutions. This has made Stiglitz a leader of the new Keynesian school of economics, which seeks to explain why economies can experience high unemployment even if people are perfectly rational.

Stiglitz was born and grew up in Gary, Indiana, a mid-western industrial city. His mother came from a long line of New Deal Democrats and worshipped Franklin Delano Roosevelt. His father was a Jeffersonian Democrat, who possessed a deep sense of moral responsibility. Stiglitz (2001) claims his father made Social Security contributions for all household help, and that he followed his father's example when he grew up. For this reason, unlike other Clinton cabinet appointees in 1993, Stiglitz was easily confirmed by the US Senate to serve on the President's Council of Economic Advisors.

After graduating from high school, Stiglitz went to Amherst College. He majored in physics until the spring of his junior year, when he switched to economics because it enabled him to apply his mathematical interests and skills to social problems. His economics professors at Amherst told him that if he was serious about economics he would need a doctorate and that his senior year at Amherst would not be much different from his first year of graduate school. They helped him get into the PhD program at MIT and arranged for the necessary financial assistance.

At MIT Stiglitz studied with some of the top economists at the time — Paul Samuelson, Franco Modigliani, and Robert Solow — all prominent Keynesians and all future Nobel Laureates. After graduating he received a Fulbright Fellowship to study at Cambridge University for a year. There he worked with a number of prominent Post Keynesians. Joan Robinson was his first tutor, but they did not get along well. According to Stiglitz (2001), Robinson “wasn't used to the kind of questioning stance of a brash American student.”

Following his year at Cambridge, Stiglitz returned to MIT to teach. The position was offered only on the condition that he sleep in an apartment rather than in his office, and that he always wear shoes around the office (Chait 1999). This reputation for eccentricity has grown, rather than diminished, over the years. Rosser (2003, p. 7) reports that Stiglitz once showed up at a Clinton cabinet meeting with his tie outside his shirt collar.

Stiglitz left MIT in 1970, and then held a series of academic positions for short periods of time — at Yale, Stanford, Oxford, and Princeton.

From 1993 to 1997 Stiglitz served on President Clinton's Council of Economic Advisors, and was its chair from 1995 to 1997. In this position, he continually fought with the US Treasury Department and the International Monetary Fund (IMF). The IMF was created after World War II to lend money to countries facing economic problems. These loans were supposed to help countries employ expansionary macroeconomic policies (see Keynes). The US has the largest number of votes on the IMF, and the US Treasury is effectively the US representative on the IMF. Stiglitz felt that the Treasury and the IMF furthered the interests of the US financial community rather than the interests of global economic stability or the interests of countries facing economic problems.

Fed up with the political battles, Stiglitz resigned from the Council of Economic Advisors in 1997 and became Chief Economist at the World Bank. Created with the IMF after World War II, the mission of the World Bank is to reduce poverty in the poorest areas of the world.

However, the political battles continued and intensified. Stiglitz complained about the hardships imposed on poor countries by the US Treasury and the IMF, especially the high interest rates that the IMF was charging them to borrow money. This, he felt, increased loan defaults and worsened the problems facing poor nations. When the US Treasury pressured the World Bank to silence him, Stiglitz had had enough of politics. In 2000 he left the World Bank and Washington politics and returned to academia, accepting a teaching position at Columbia University.

In 2001, Stiglitz was awarded the Nobel Prize for Economics, along with George Akerlof and Michael Spence. The Prize Committee singled out his work on the economics of information. To this we can add his role as a leader of one of the main schools of contemporary macroeconomics — new Keynesian economics.

New Keynesian economics begins where Robert Lucas and the rational expectations school begin — with very smart and very rational individuals. But unlike rational expectations macroeconomists, new Keynesians seek to explain why markets fail to work perfectly, thereby resulting in financial crises and high unemployment.

On the standard economic view, people are rational and have all the information they need to make optimal choices. Stiglitz questioned whether rational people would have sufficient information to make good choices. There are two main reasons for his doubt, one coming from the demand side and one coming from the supply side. Getting information is costly — time, effort, and even money are required. As 1978 Nobel Laureate Herbert Simon (1955) pointed out, it is not rational for people to get all the information required to make the best possible choice. Instead, we consider a few reasonable options and then make a choice that seems satisfactory. Because people are not well informed when they make decisions, strong government regulations are necessary to protect consumers and workers.

Stiglitz also recognized that information is different from tangible goods in an important way. When we buy cars and bread we can try them out to see if we like them. We can take a car for a test drive and kick its tires. We can taste a piece of bread, checking its texture and flavor before we buy an entire loaf. But we cannot do this with information. If I am given information to inspect, there would be no reason for me to buy it. When I examine a recipe for a loaf of bread, I do not need to pay to get the recipe for I have it already. Information is therefore a public good (see Pigou) once it becomes available, and so suppliers have an incentive to keep it hidden.

In markets where information is important, some people will lack the information they need to make rational choices. Kenneth Arrow explained how information problems plague the market for medical services and how this results in excessive spending on health care. Similarly, Stiglitz showed how inadequate information in labor and credit markets generates macroeconomic problems.

In labor markets, employers do not know the skills of potential employees and do not know whether any job candidate will work hard or slack off if hired. Job applicants have good incentives to overstate their skills, and job candidates always seek to give a good impression about how they will perform if hired. The only way to know if someone actually will work hard is to hire them and see what happens. But this advice does not help an employer who needs to make a hiring decision. It is also costly for firms to continually hire and train people, and then have to fire them because they are slacking off.

Early in his career Stiglitz (1974) suggested that firms could use education as a screening device, similar to the way that MIT used recommendations from Amherst College to accept him into their PhD program. If employers hire people with more education and who graduate from better schools, firms will likely get harder working, more productive employees. Later Stiglitz recognized that this device is flawed, since firms cannot determine which well-educated applicants will work hard.

A better solution for the firm is to pay higher wages than necessary, or wages above the market-clearing wage. Economists call these efficiency wages. The term is intended to convey the idea that high wages and treating workers well will increase the likelihood that employees work efficiently. Workers will have more to lose if they slack off and get fired, and they will have greater incentives to work hard (Stiglitz 1984). Efficiency wages turn upside down the traditional economic view that wages are based on marginal productivity (see Clark). Rather than worker productivity determining wages, wages now determine worker productivity.

While offering efficiency wages helps the firm get good workers, it does not help the whole economy. High wages will reduce the demand for workers by firms. Since there are good reasons for firms to pay efficiency wages, wages will not tend to fall when unemployment is high. Moreover, even if wages did fall, production costs and prices would likely decline also, and so real wages would not fall and would not eradicate the unemployment. The Keynesian conclusion of this analysis is that we will not reach full employment by just waiting for market forces to do their job (Stiglitz 1995).

What is true of labor markets is also true of credit markets. The problem here is that some borrowers are unlikely to repay their loans. Moreover, lenders cannot tell whether people will try their hardest to repay a loan or will readily look to declare bankruptcy. If banks knew the actual default risk for each borrower, they could charge everyone an interest rate based on their likelihood of not repaying a loan. But informational problems prevent this.

Some useful information about borrowers is available. Home buyers making a large down-payment are more likely to repay their loan, and so they generally receive lower mortgage rates. Putting down a large sum of money plays a role similar to a good education in labor markets — it signals reliability. However, there is also a problem with this solution: most good borrowers cannot make a large down-payment. When borrowers can't make large down-payments, banks must assume the worst and charge high interest rates. Because of this, some people will decide not to purchase a home or car. As a result, borrowing and spending will be lower; so will economic growth and employment (Stiglitz 1981).

From this analysis Stiglitz concludes that inadequate information in labor and credit markets means that there will be too little hiring at efficiency wages, and too little borrowing and spending at high interest rates. Without sufficient spending, the economy will end up in a recession — unless Keynesian macroeconomic policies are used.

Information problems also plague the global economy. According to Stiglitz (2000b), in the early 1980s Ronald Reagan and Margaret Thatcher appointed free market ideologues to head up the World Bank and IMF. These political appointees got rid of all the first-rate economists working at these institutions and made believing in free market economics a condition for employment. As a result, the World Bank would lend money to poor nations for roads and dams only if they made certain changes to their economies; and the IMF became concerned with issues such as reducing protectionism and removing restrictions on capital flows in and out of a country. This worsened the economic problems facing many countries.

Stiglitz (2002) was particularly incensed over how the IMF dealt with the Asian currency crises of the late 1990s, when the exchange value of many national currencies plummeted. This made it more expensive for these countries to import essential items such as oil and capital equipment. In return for aid with these expenditures, the IMF required nations to raise their interest rates. Higher interest rates increased the demand for Asian currencies and helped them maintain their value. But, Stiglitz argued, higher interest rates also increased loan defaults and corporate bankruptcies, thereby reducing confidence in these troubled countries and in their national currencies.

Similarly, by pushing for free markets, the World Bank and IMF made problems worse in some of the poorest areas of the world. Stiglitz (2002, p. 54) provides us with an excellent example of this problem. For many years, women in a poor Moroccan village received week-old chicks from the government and raised them both for food and for sale. Virtually every analyst agreed that the program helped raise the living standard of these villagers. But the World Bank and the IMF told the Moroccan government that it should not be in the business of distributing baby chicks; and it pressured them to stop this practice. As a result, the chicken raising industry disappeared in Morocco — to the detriment of the poor people living there.

The problem, according to Stiglitz, was that the IMF and World Bank believed that the private sector would immediately fill the gap left by the government. In a world of perfect information, private firms would lend chicks to families that were good risks, and the process would continue as before. But in a world plagued with uncertainty and informational gaps, new firms do not start up the moment the government leaves a market. The result can easily be an economic disaster.

Finally, according to Stiglitz (2010), information problems in the financial system are responsible for the current economic and financial crisis. Home buyers did not know that their mortgage brokers really worked for large banks and got kickbacks from them. As a result, they took out mortgages that were too costly and more likely to result in defaults. Bankers did not know the risks they were facing from making loans, and did not care since the loans were being packaged and sold off immediately. And those buying the loan packages did not have sufficient information about the risks associated with them. They only looked at the rating for mortgage-backed securities and thought that security came from the large number of mortgages contained in the package.

The only solution to these problems is a strong regulatory regime that protects the national economy and protects borrowers against predatory lending. Going further, to remedy our current problems Stiglitz (2010, ch. 4) proposes writing down mortgages so that homeowners can make their mortgage payments, and so they have incentives to pay their mortgages and stay in their homes. This has social benefits as well as individual benefits. It maintains property values and keeps neighborhoods from deteriorating as families leave and homes are abandoned. Everyone gains.

The problem in all these cases is that markets are not perfect. They do not move immediately and painlessly to some equilibrium. In the real world, information matters. When information is imperfect, markets do not give us the best possible result and Keynesian economic policies are needed to improve economic outcomes. This is why Stiglitz is a leading new Keynesian economist; his work provides a new justification for Keynesian policies, one based on problems with obtaining sufficient information.

More than anyone else, Stiglitz has been responsible for the resurgence of Keynes and Keynesian economics. For this reason, Stiglitz has been one of the most influential economists of the late twentieth century and early twenty-first century.

Works by Stiglitz
  • The Theory of ‘Screening,’ Education and the Distribution of Income,” American Economic Review, 64 (December 1974), pp. 283-300.
  • Credit Rationing in Markets with Imperfect Information,” American Economic Review, 71 (June 1981), pp. 393-410. Reprinted in New Keynesian Economics, Vol 2, Coordination Failures and Real Rigidities, ed. N. Gregory Mankiw; David Romer MIT Press Cambridge Massachusetts, 1991, pp. 247-76, with Weiss, Andrew .
  • Equilibrium Unemployment as a Worker—Discipline Device,” American Economic Review, 74 (June 1984), pp. 433-44. Reprinted in New Keynesian Economics, Vol 2, Coordination Failures and Real Rigidities, ed. N. Gregory Mankiw; David Romer MIT Press Cambridge Massachusetts, 1991, pp. 123-42, with Shapiro, Carl .
  • Whither Socialism?, MIT Press Cambridge Massachusetts, 1994.
  • Labor-Market Adjustments and the Persistence of Unemployment,” American Economic Review, 85 (May 1995), pp. 219-25, with Greenwald, Bruce .
  • The Contributions of the Economics of Information to Twentieth Century Economics,” Quarterly Journal of Economics, 115 (November 2000a), pp. 1441-78.
  • What I Learned at the World Bank,” New Republic (April 17—24, 2000b), pp. 56-60.
  • Joseph E. Stiglitz Autobiography” 2001 (available online at www.nobel.se/economics/laureates/2001/stiglitz-autobio.html).
  • Globalization and Its Discontents, Norton New York, 2002.
  • The Roaring Nineties, Norton New York, 2003.
  • Freefall, Norton New York, 2010.
  • The Price of Inequality, Norton New York, 2012.
  • Works about Stiglitz
  • Bausor, RandallJoseph E. Stiglitz,” in American Economists of the Late Twentieth Century, ed. Samuels, Warren Edward Elgar Cheltenham, 1996, pp. 323-50.
  • Chait, JonathanShoeless Joe Stiglitz,” The American Prospect, 45 (July—August 1999), pp. 52-56.
  • Chang, Ha-JoonThe Stiglitz Contribution,” Challenge, 45 (March—April 2002), pp. 77-96.
  • Rosser, J. Barkley Jr.A Nobel Prize for Asymmetric Information: The Economic Contributions of George Akerlof, Michael Spence and Joseph Stiglitz,” Review of Political Economy, 15 (January 2003), pp. 3-21.
  • Other references
  • Simon, HerbertA Behavioral Model of Rational Choice,” Quarterly Journal of Economics, 69 (Summer 1955), pp. 99-118.
  • © 1999, 2006, 2014 Steven Pressman

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