 A matter of our speaker, Glenn Fox is an agricultural and natural resource economist. He has been a member of the Department of Food, Agriculture and Resource Economics at the University of Guelph since 1985 and served as acting department chair from 2001 to 2002. His research interests are incredibly broad. They include methodology, property rights and natural resource stewardship, regulatory takings, trade and environment, technological change and Austrian economics. He's also a senior fellow at Canada's Fraser Institute. Professor Fox previously taught economics at the University of Western Ontario. He received his PhD in agricultural economics at the University of Minnesota and his bachelor's degree from the University of Guelph. Among his academic publications, he has co-edited and contributed several chapters to a book entitled The Economics of Regulation in Agriculture, Compliance with Public and Private Standards. This was published by CABI Publishing in the UK. Professor Fox will lecture on Asymmetric Information and Market Failure, a Market Process Perspective. Well, I'd like to express my thanks and gratitude to the conference organizing committee and to John for inviting me to present this lecture. It is a singular honor to be invited to give the Ludwig von Mises Memorial Lecture at the Ludwig von Mises Institute at this conference. And that's honor with a U because that's the way we spell it where I come from. I bring greetings from the Austrian scholars of Canada. When we get together we don't need a room quite this big, but it's a very enthusiastic and committed group. Any other Canadian Austrians here? Very good. We'll meet in the phone booth later for our social. Let me give you a little bit of information on my background. My involvement in Austrian economics really was sort of, well, it was accidental. My first exposure to Austrian thinking was reading a copy of The Road to Serfdom, which I think is the opening act for many of us. My second opening act was a little bit different. I came across a copy of Epistemological Problems of Economics in the university bookstore when I was doing my PhD program. And so that's the second step in my Austrian economics education. That was in about 1981 or 1982. About a decade later I met Walter Block when he was at the Fraser Institute in Vancouver. And then I took a short course in Austrian economics from the Foundation for Economic Education and Roger Garrison was one of the lecturers as well as others. When I was in graduate school, there were two factions among my professors and among my classmates. And the one faction I used to refer to as the Chicago Perfect Market School. And the other faction I later came to refer to as the Cambridge Market Failure School. And much to the chagrin of both sides, I used to disagree with both of them. And I infuriated them more than they infuriated each other. And the position was, okay, you don't have to be one of us, but you can't not be one of us and not be one of them because there only are two teams. And I was clearly not part of those two teams. But I didn't realize that until some years later when I read essentially at one sitting human action. And I can remember to this day, even though that was probably 25 years ago, the intellectual thrill that I felt when I read the last page of that book and close the cover and how awestruck I was at the intellectual achievement that is represented in that book. And at that point, I realized there's a third team that I don't have to be one of the two teams. Joe and his introduction mentioned that I'm an agricultural economist. That may seem odd to you to have an agricultural economist talking, giving the Mises lecture. But I did check in the fourth edition of human action, Mises makes reference to agriculture and agricultural almost 60 times. So I'm going to claim him as a founding member of agricultural economics. Anybody in one book can talk about agriculture 60 times if that doesn't qualify you as an agricultural economist. I don't know what does. Okay, so I want to talk to you today about some work on what might strike you as an esoteric topic from economic theory, particularly modern welfare economics for the students in the audience. You may have come across some of these ideas. Typically these are things that get that students get exposed to at the PhD level. And in fact, my my talk today really is the out is the outgrowth of a conversation that I had in one of our PhD students dissertation defenses when he was talking about asymmetric information and market failure. And so he and I engaged in a dialogue which we've been doing ever since. And and so part of my remarks today are a reflection of of that. So anyway, I want to talk to you about this concept of asymmetric information, which is an idea from contemporary what's called welfare economics theory. You don't have to know a lot of welfare economics to understand what I'm going to talk about. I want to contrast what I call the Valrasian-Javonsian neoclassical perspective with the Hungarian neoclassical perspective. And this is a reflection, this awkward language is a reflection of a problem that I've had over the years. I've often heard people make a distinction between neoclassical economics and Austrian economics. And when I was new to Austrian economics, I used to make that distinction myself. But then I came to I realized that of all the three neoclassical revolutionaries, Manger has the greatest claim to neoclassical. And so I don't think that Austrians should abandon the neoclassical name because Manger was the most quintessential neoclassical. And so that's why I use this somewhat awkward nomenclature of Valrasian-Javonsian neoclassical versus the Hungarian. I want to talk about particularly some work by George Akerlof, who is the the author that PhD students study when they study welfare economics and they study, they learn about asymmetric information in a paper called The Market for Lemons. And again, I'm an agricultural economist, so you think the market for lemons, it's about demand and supply conditions in the market for citrus fruit? No, it's not. It's a metaphor. The market for lemons is the metaphor that people used to describe a defective automobile. So I want to review how the concept of asymmetric information is used in the context of Akerlof's paper, but then also illustrate how the concept of basic information is pervasive, and I think treated much more insightfully in the Hungarian neoclassical tradition. And then I want to talk just briefly and get down to what I think Akerlof really had in mind, what Valrasian neoclassicals really have in mind with this problem of asymmetric information and how we can help them, essentially. So asymmetric information is a somewhat new category in what's called market failure theory in modern welfare economics. It didn't originate, but sort of the singular contribution here is a paper by Akerlof published in 1970 called The Market for Lemons, and it was motivated by a number of phenomenon, not the least of which is if you buy a new car and then drive it off the lot and then want to sell it. I don't know why you would ever do this, but if you wanted to sell it like an hour after you drove it off the lot, would you get back all your money? And generally the experience is no, you wouldn't. Well, why is that? It also has to do with use cars with defects. Why would anybody sell a used car unless there was something wrong with it? Why would you buy a used car knowing that the only reason that anybody would sell a used car is that there's something wrong with it? Why would you want to buy somebody else's problem? So this is the general motivation. Sellers know the defect buyers don't, and this is called asymmetric information, and it's been applied more broadly just than in the market for used cars. So, and the prediction is that there in fact would either be very few transactions or there would be no transactions at all for used cars or products associated with this. So the generalization is that asymmetric information leads to an efficiency. That's a market failure, and that government policy needs to be implemented in order to fix that, okay? I have some quotations. Akerlof received the Nobel Prize for this paper, and there was kind of a review paper published the next year or contemporaneously with his Nobel Prize award, and the authors of that paper, describing Akerlof's paper, said that it is probably the single most important contribution to the literature on the economics of information, which is not a small honor, and that along, and there were co-recipients Michael Spence and Joseph Stiglitz at the same time transform the way economists think about the functioning of markets, which I think is a factually correct statement if we think about most economists, whether it is a normative statement, whether it's an ought to be statement, I'm going to quarrel with that in a little bit. I want to talk about what I call a market process perspective on asymmetric information or a mangarian neoclassical perspective. The Javonsian-Valrasian perspective is really built on a foundation of perfect competition theory, and any departure from perfect competition represents a problem of efficiency. One of the requirements of perfect competition is that everyone involved, everyone in the world be completely and perfectly informed about everything, and that any departures from that constitute market failures, and so, of course, if a buyer knows different things than a seller, that's a departure from this assumption, and that triggers the diagnosis of some sort of policy response. Even within this tradition, however, there is a recognition in public choice theory, for example, that market failure is a necessary but not a sufficient condition to justify government action. Typically, that condition is sort of glossed over, but even in that tradition it's recognized. However, when we look at this problem from a market process perspective, here we have not an equilibrium model but a disequilibrium model. With distributed knowledge, the nature of the situation is that we have distributed knowledge among individuals and that we don't all know the same thing, and some of the things that we know can't all be right because I might know something and you might know the opposite, so we can't both be right, and in that context, impediments to voluntary cooperation, impediments to voluntary exchange are what constitute failures. They might be market failures or they might be non-market failures. Akerlof makes four assumptions, which turn out to be pivotal in illustrating the difference between the Valrazian-Givonzian approach and the Mengerian approach. The first assumption is that there are variations in quality for a category of goods or services under consideration. I don't think that that's a controversial assumption. I think that everybody in this room could accept that for any category of goods you might want to think of, there are variations in quality. Second assumption, however, turns out to be more important and is a clearer indication of how the market process differs from the perspective that Akerlof took. First, he assumes that buyers cannot assess the quality of units of the good or service in question, but sellers can. Sellers can know whether it's high quality, low quality, mediocre quality, but buyers cannot. Third assumption is that all units of the good or service must be sold at the same price. Fourth assumption, and this is really related to the second one, is that any services that might arise in what I would call independent verification of quality services, that they can't arise because they are what Akerlof calls non-atomistic. That is a competitive service for third party verification can't happen. So these are the four assumptions and the three of which I think are critical from our point of view. I don't think that the market process approach would in any way quarrel with assumption number one. So the prediction is, as I said earlier, either a sharply reduced or zero, a sharply reduced number or zero transactions would take place because buyers would never want to buy somebody else's problem. Roderick Long has differentiated between two types of abstraction and I think applying his distinction to this situation really is helpful to illustrate how the market process perspective is different. Three of the assumptions, two, three and four, are examples of what Long calls Precisive Abstraction and Long's a philosopher and I'm not and I always get these words between this distinction between Precisive and Non-Precisive Abstraction. I have trouble keeping it straight in my mind but Precisive Abstraction means specifying that something has some characteristic or more particularly does not have some characteristics. So the Precisive Abstraction in assumption number two is that buyers cannot learn or discover the quality of the thing it is that they're thinking of purchasing. And he goes on to say that those who criticize abstraction in the Valrazian Givonzian tradition on the grounds of lack of realism aren't asking for more Precisive Abstractions, they're asking for Non-Precisive Abstraction. He talks about Non-Precisive Abstractions are things that apply in the same way to every single example of the thing in question. So the use of abstraction in market process theory tends to be Non-Precisive Abstraction whereas Akerlof's assumptions are examples of Precisive Abstractions. It turns out that asymmetric information has a very well developed history in the Mangarian Valrazian tradition going right back to Manger's theory of exchange but asymmetric information is not a category of market failure. In fact it's probably better seen as a market function rather than a market failure. Manger's theory of exchange the theory of entrepreneurial alertness is another example where the market process perspective emphasizes asymmetric information. The economic calculation debate was a debate about asymmetric information. Austrian business cycle theory is another example of asymmetric information and Tom Dolorenzo a few years ago I'll pay homage to Tom's contribution in essentially international relations. He pointed out that US foreign policy is an example of a situation of asymmetric information that the voters really don't know what their government is doing for their benefit and on their behalf. Am I getting it roughly correct Tom? That quotation. So Manger's theory of exchange going back to the putative founder of the market process perspective Manger's theory of bilateral exchange is a theory based on an assumption of asymmetric information. Just to read you a brief quotation from Manger the benefits of a mutual transfer of goods depend on three conditions. A, one economizing individual must have command of the quantities of goods which have a smaller value to him than other quantities of goods at the disposal of another economizing individual who evaluates the goods in reverse fashion. Voluntary change doesn't take place unless there is this asymmetric valuation. I want what you have more than what I have and you want what I have more than what you have. That's asymmetric information. Without asymmetric information there would never be a market exchange and that was one of the breakthroughs because for hundreds if not thousands of years social theorists seem to believe that what happened in market exchange was people exchange things of equal value. Volunt came Manger and said that doesn't make any sense people exchange things of unequal value. The conditions that Manger lays out he says the absence of one of these conditions means that an essential prerequisite for an economic exchange is missing i.e. no asymmetric information no asymmetric valuation no exchange. So asymmetric information is at the very heart the very origin of the market process perspective on the market on market exchange. The theory of entrepreneurial alertness developed by Mises and also Kersner and others the definition of entrepreneurial alertness is that one individual notices something that no one else has noticed maybe even that same person 10 minutes ago. So entrepreneurial alertness is another example of asymmetric information. The entrepreneur perceives something that nobody else perceives. So by definition that's asymmetric information the entrepreneur knows something that other people don't. Of course not all entrepreneurial perceptions prove to be valid prove to be accurate. There are a lot of things that we believe might happen that don't turn out to be the case. So people have to act on their entrepreneurial perceptions in order to test their their validity and this is why Hayek's essay competition is a discovery procedure is so insightful and so important because in that he explains that no one can know a priori whether these entrepreneurial perceptions are valid or not and it's only through this rivalrous competitive process that this testing takes place and then when the testing takes place then other people get to to know so competition is the process that tests these asymmetrical perceptions that in the inner perceptions of entrepreneurs. The economic calculation debate is another context in which the market process perspective has has investigated and applied the concept of asymmetric information. Hayek in 1945 differentiated between scientific knowledge and what he called the knowledge of the particular circumstances of time and place. I really wish she'd had a more compact way to say that it takes a long time in class to get students to remember that category but the point is that that a lot of knowledge a lot of information in society is distributed in human heads and it's not necessarily even things that we can express but knowledge of the particular circumstances of time and place are behind a lot of what we do as people. They animate quite a bit if not the substantial share of human action but this second category of knowledge is fragmented it's conflicted it's subjective and it may even be something that we can't articulate to ourselves or others and the price system according to Hayek mobilizes this distributed fragmented inconsistent knowledge in and allows people to and it resolves conflicts over the differences in the knowledge of the particular circumstances of time and place. In the economic calculation debate pity the poor central planning board. Wonder if we could just pause and be sorry for the person or persons that are charged with somehow figuring out what the best use of all the means of production happened to be in a society when they can't access so they face an asymmetric information problem that the people know stuff that the central planning board doesn't know and no one can't know. Now we don't think of that as a market failure obviously the market process says that that's a non-market failure that's a policy failure that the central planning board faces a problem of asymmetric information that impedes its ability to allocate goods particularly goods of higher order among their competing employment. Another area where market process theory deals with problems of asymmetric information is in Austrian business cycle theory. Mises and others in the Austrian tradition articulated a business cycle theory which is in some respect a monetary phenomenon that it's disturbances in the money and credit system that and it's based on a theory of asymmetric information. Rothbard characterizes the bust portion of the business cycle as a situation the downturn as it is as a clustering of entrepreneurial errors. Now bunching up about that that an above normal rate of entrepreneurial error happens in the downturn part of the business cycle. Now in the normal operation of the price system we expect some entrepreneurial perceptions to be correct but it's normal for some of them to be incorrect. So entrepreneurial failure is a normal part of the price system sometimes we get a little bit blinded and emphasize the entrepreneurial success but the entrepreneurial failure is another important and necessary part of the price system but in the downturn portion of a business cycle for some reason a higher number a higher rate an above average number of entrepreneurial perceptions turn out to be wrong. So why is that? Well the theory essentially appeals to to a problem of asymmetric information. Okay that under particular circumstances particularly disturbances in the money and credit system the rate of entrepreneurial error rises. Well why does it rise? Well entrepreneurs are not able to distinguish between what the price system at its sort of fundamental level is trying to tell them and what the distortions introduced by the disturbance in money and credit are telling them which are in a sense false signals. Okay now this is a little bit difficult to characterize as an asymmetric information problem because it may be that even the people doing the disturbance of the of the money and credit system they may not know either what they're doing particularly if they think that expanding the money supply works through a helicopter money model then then even the people doing the expansion of credit may not understand the distributed effects on different prices at different rates at different places and times might have but certainly we can see that the entrepreneurs have faced a problem of asymmetric information that they're looking at these things called price signals and they trust them but in a sense they shouldn't trust them. Again it's a problem of asymmetric information but it's not a problem of market failure typically we think of that as some interference with the market process that creates the problem of market failure which leads to this above normal rate of entrepreneurial failure. A few years ago I came across a paper by a professor Eric Bond. Now I don't know Eric I've read this paper and I've taught it to my students and I think it's a very useful paper it's an empirical study of the United States used pickup truck market and I don't know Eric's background and so I don't know what the origins of this were but I can picture Eric as a PhD student thinking well here's this paper that's come out on the market for lemons and it makes predictions about used vehicle sales but it's a theoretical paper and nobody's done an empirical study and one thing that PhD students kind of gravitate toward doing is let's take a theoretical paper and I'll do an empirical study and see if I can measure whatever the effect is so I don't know whether this was Eric's thought process or not but it very well could have been I'm speculating and of course if there is a place where one might consider going to look for a lemon's effect it you'd be hard-pressed to find a better location than the used pickup truck market now you may not have any first-hand experience with used pickup trucks I do and if you're going to search for lemons here's where my pictures come in and their pictures of used pickup trucks and in the vernacular of in the rural vernacular pickup trucks are a vehicle which are often road hard and put away wet these are not mine now I drive a pickup truck but it's a professorial pickup truck it has a bit of a pampered life but non-professorial pickup trucks don't have quite the pampered life that my pampered little Tacoma does and so I have some pictures of used pickup trucks and they're supposed to scare you so I'd like you all to pretend to be scared right now at the pictures of these used pickup trucks maybe I should have had a trigger warning that then I'm going to show you pictures of used pickup trucks and sensitive viewers may may be offended at this so what did what did Eric Bond find in his search for lemons well he found that there is thank you a very active and robust market in used pickup trucks in the United States if you're not again if you're not involved in the market for used pickup trucks this may or may not surprise you it didn't surprise me given my personal experience well how can this be and this is where I think the really valuable a part of his research applies and he said that well first owners can in fact acquire their own personal knowledge from their own experience about how to judge the quality of a pickup truck this may not surprise any of you but given the background you know it is contrary to one of these one of the assumptions he also observed that there was a well developed market in a secondary market in verification services people can check and of course this is more well developed now than it was when Eric did his research in the in the 80s now there are all kinds of resources that you can get you can access as a potential buyer to learn about the history of a vehicle there are independent mechanical inspections that can be obtained competitively at relatively low cost you can examine service records there's the reputation of the seller there are now car dealerships that specialize in selling used vehicles that's all they sell and they offer warranties and inspections and and so forth so in other words social adaptations have emerged to address this this lemon's problem and seem to be quite quite effective the most an important part of this is that they are not non-atomistic that is that they are very competitive and access to these services is not anyway difficult for someone thinking about thinking about purchasing a used pickup truck okay so the ironing is that Professor Akerlof got the Nobel Prize and Eric Bond was not named as a co-recipient of the Nobel Prize of course this is the complaint of empirical economists from time immemorial right that the theory guys get all the glory and the empirical guys that actually go out and test and measure are doing the grunt work that doesn't get the recognition but if I were on the Nobel committee I would certainly want to put in a vote for for Eric Bond for for doing this this work but I don't want to be dismissive of what the Valrasian, Javonsian economists are worrying about I think that they have a valid worry but it's not expressed very well and I think here's where we can help them I think what they're really worried about is not asymmetric information I think they use that term and it's overly broad it's an over generalization what they're really worried about is fraud okay and it turns out market process economists are also worried about fraud I think we all agree that fraud is a bad thing I don't know about Walter maybe Walter I can't remember if Walter's got a chapter about defending the undefendable defending the fraudster I forgot to check that chapter before I before I came so I could in the Q&A maybe I'll be corrected okay I worry about fraud let me say that I won't generalize for any of you and I'm worried about a situation where the seller maintains that a good is of a particular quality and the buyer takes that at good faith and then finds out that it's not the case so it's a misrepresentation okay and what do we do about that because I think that's what the market for lemons was really about and and it was just too broadly expressed well one of the things that I think that we can that we should recognize as economists and it doesn't matter whether we're in the Valrazian-Javonsian tradition or the Mangarian tradition is let's not assume when we identify a problem that we're the first people on the planet who've ever thought about that problem I think that's just a good practice of modesty maybe other professionals maybe other disciplines have thought about this before let's go see if we can learn from what they've learned and and and then build build on that okay so the economic research program to study fraud I'm going to say that there's two broad options that could be pursued if fraud is the focus of our investigation one will be to construct a hypothetical situation in which fraud exists and then compare the efficiency properties in some perfect competition sense of that situation to a parallel hypothetical situation where fraud doesn't exist okay that'd be one one approach kind of a thought experiment if you will and essentially I think that's what Akrolov was doing and others but the problem is that they assumed that they were the first people that ever stumbled across this problem right and as a result they were not able to avail themselves of the wisdom and experience of others it also could be seen as what Harold Dempsey that's called the Nirvana approach let's compare an actual situation to an ideal perfect situation and see which one's better right Dempsey that's called that the Nirvana approach I call it the ideal husband approach and I realized there was a movie I used this in class and none of the students that even heard of this movie but this is an older crowd so maybe you've heard of the movie the ideal husband I've not seen the movie myself yes see everybody you know of a younger generation like I never heard of this movie anyway there's a movie called the ideal husband when this movie came out I was friends with a couple that I'd met shortly after I arrived in Guelph an older couple that had probably the best relationship that I'd ever seen I aspired to have a relationship half as good as their relationship and one day Jim the husband came to me and he said my wife and I have rented a movie we're gonna watch it tonight and I said oh what's the movie Jim it's he said it's the ideal husband I said Jim don't watch that movie and Jim said well what I mean is it a bad movie have you seen the movie I said Jim I haven't seen the movie but don't watch it he said well what do you mean you haven't even seen the movie and you're telling me don't watch the movie that's crazy why should I say Jim just don't take it from me I know I'm younger than you or I don't have your experience just don't watch the movie and uh and and Jim just kind of scoffed and went off and he watched the movie okay and what I observed over the next month is that Jim couldn't dress himself properly uh Jim couldn't back the car out of the garage properly Jim could not put a pair of sunglasses on his face properly and so a little while later I took him aside and I said Jim you know what happened I don't I understand that the husband and the ideal husband is not in fact an ideal husband there's a certain irony in the title but the problem is somebody got an idea that there is something called an ideal husband and guess what Jim you're not him well I think we have an ideal husband problem or a nirvana approach problem in the problem of asymmetric information uh in this uh uh this approach another option which I call the modesty option is let's think let's try and figure out what other disciplines have learned about this problem of tackling uh fraud what are some of the other disciplines well accounting uh accountants spend apparently uh all their waking hours thinking about problems of fraud particularly auditors okay so there are principles and procedures in auditing and we all know that they're not perfect you know we can all cite the big business failure problems when that was not perfect but anyway they've thought about it a long time and they've set up situations to deal with it in law contract law again a body of practice in which people have dealt with problems of asymmetric information for hundreds of years if not more than that sociology and anthropology have dealt with kinship and ethnic trading communities in particular and how those communities have set up relationships have evolved practices to deal with fraudulent behavior and in particular the sanctions that they've developed in those contexts to deal with people who don't abide by the accepted code of ethics or practice and then elsewhere in economics there are people and here's where I think the market process perspective has been most helpful uh is uh people who've done studies on the economics of uh trust and reputation um and there's been a lot of contributions in the Austrian tradition in the Hungarian tradition on that so option number two would be let's look at what these other disciplines would look at what these other scholars have learned when they've tackled this problem uh and see but this is not generally what's happened uh this is not what my phd students come back to me and talk about after they've taken their welfare economics courses they don't come back and say hey we had a stimulating lecture on on contract law today and I don't worry so much about asymmetric information as I uh used to okay so just to wrap up with some concluding comments uh I think that the existing literature which is not dominated by the market process perspective is excessively broad in when it talks about this problem of asymmetric information um a better understanding of the price system is that the price system rests foundationally on a condition of asymmetric information without asymmetric information we would not have any exchanges we wouldn't have any prices and we wouldn't be able to get this indirect information that we get from prices about these subjective values that people carry around uh in their heads okay the price system mobilizes and tests this asymmetric information uh as part of the ongoing dynamics of the exchange process what most economists outside the market process tradition I think really have in mind is fraud as I've said earlier and that that it would be better for them to use that term and then focus their inquiry specifically on tackling that but the literature that I'm referring to today has largely limited its attention to this perfect competition ideal husband nirvana approach which um and it has ignored non-market failure problems that give rise give rise to asymmetric information problems okay at a deeper level I think that this topic is an illustration of some of the fundamental differences between what I've been referring to as the javonsian valrazian approach in neoclassical economics to the mangarian approach that if we look at the problem of asymmetric information from a market process perspective we really see it quite differently we have a different understanding of the phenomenon they're different methodological differences what's the nature of how we do scientific economics that comes to bear here and what normative criteria do we apply uh to uh to a situation um dishonesty or fraud and market exchanges I think is a valid concern uh I worry about it I suspect some of you worry about it as well but more productive avenues and inquiry are available and I think a market process perspective uh can can actually help quite a bit in understanding this uh this problem so that's my uh those are my remarks thank you