The Nobel Prize

Joseph E. Stiglitz (b. 1943)

Joseph Stiglitz was born in Gary, Indiana, USA in 1943. Gary harboured the usual mix of difficulties common to industrial cities in postwar America: ‘poverty, periodic unemployment and massive racial discrimination’. Stiglitz reports that he grew up in a household where political discussion was commonplace, moulding him as an ‘inquiring youngster’ who began to wonder about the economic and social problems around him. This background became significant as Stiglitz commenced his studies in economics. He was taught a theoretical canon which predicted outcomes far removed from the reality he had seen growing up: he knew that full employment was not the norm, that poverty was endemic in even the world’s richest society and therefore that there might be reasons to suspect the market-clearing models that were unable to assimilate these and other such phenomena (Nobel Foundation, 2004).

Stiglitz’s concerns about the ‘competitive equilibrium model’ were enormously deepened by a period he spent in Kenya in 1969. If economic theory was in some important respects at variance with what could be observed happening in real markets in the developed world, Stiglitz found models of perfect markets ‘truly inappropriate’ as a means of trying to understand how developing economies functioned. In particular, the developing world exposed the severe limitations of the array of assumptions upon which the competitive model rested. Stiglitz saw that in Kenya the idiosyncrasies of market institutions and inequalities in the distribution of wealth mattered in ways that conventional economics appeared unwilling to acknowledge. For example, agriculture organised around sharecropping happened because of given patterns of land ownership. That this resulted in what amounted to a 50 per cent or more tax on workers’ earnings suggested to Stiglitz that the distribution of income in a society could not be simply assumed away (see Stiglitz, 2002a). Insight and critical reflection of this form were to become hallmarks of Stiglitz’s career as a professional economist.

Stiglitz attributes the development of his capacity to question to both his family’s influence and the kind of schooling he had. From 1960 to 1963 he attended Amherst College in New England, a liberal arts college where he learned ‘that what mattered most was asking the right question – having posed the question well, answering the question was often a relatively easy matter’ (Nobel Foundation, 2004). From a wide range of possibilities Stiglitz eventually decided to major in economics at Amherst. He recollects, ‘I thought it provided an opportunity for me to apply my interests and abilities in mathematics to important social problems, and somehow, I thought it would also enable me to combine my interest in history and writing. I wanted it all and economics seemed to have it all’ (Nobel Foundation, 2004). Amen to that.

Stiglitz actually left Amherst without graduating, although the college awarded him a BA in 1964. He opted for graduate studies at the Massachusetts Institute of Technology (MIT) and his teachers at Amherst thought that he should not complete a senior year with them given that he would repeat the same material at MIT. He was awarded a PhD from MIT in 1966, where his teachers included four subsequent Nobel Laureates: Paul Samuelson, Robert Solow, Franco Modigliani and Kenneth Arrow. After a year at MIT, Stiglitz took up an opportunity to edit Samuelson’s collected papers (Stiglitz, 1966– 77). Stiglitz relates a story that Samuelson once wrote a letter of recommendation on his behalf that included the opinion that he (Stiglitz) was the best economist to come from Gary, Indiana; Samuelson too was from Gary! In 1965–66, having been awarded a Fulbright Fellowship, Stiglitz attended the University of Cambridge, UK where he was tutored by Joan Robinson – with whom he had a ‘tumultuous relationship’ – and subsequently Frank Hahn. He received an MA from Cambridge in 1970. In the same year Stiglitz was awarded an MA by Yale University; in 1976 he was awarded an MA by the University of Oxford, UK.

Stiglitz is presently Professor of Economics at Columbia University, New York, a post held since 2001. His career record is highly distinguished. The academic highlights include: assistant professor at MIT (1966–67); assistant and then associate professor at the Cowles Foundation, Yale University (1967–70); from 1966 to 1970, Stiglitz was also Tapp Research Fellow at Gonville and Caius College, Cambridge, UK. His work in Kenya was undertaken as a senior research fellow at University College, Nairobi from 1969 to 1971. In 1970 he was appointed Professor of Economics at Yale, a post held until 1974. From 1974 to 1976 Stiglitz moved to Stanford University as Professor of Economics. After Stanford he returned to the UK and from 1976 to 1979 was Drummond Professor of Political Economy at All Souls College, University of Oxford. He became Professor of Economics at Princeton University in 1979 and remained there until 1988 when he moved back to Stanford. He left Stanford in 2001 for his present post at Columbia.

Stiglitz has had an equally dazzling career in economic policy making. He was appointed to US President Bill Clinton’s Council of Economic Advisers in 1993 and served as its chairman from 1995 to 1997. From 1997 to 1999 he was chief economist and senior vice president at the World Bank. Stiglitz relinquished his position at the World Bank under somewhat controversial circumstances not unrelated to his capacity to tenaciously question conventions in economics and, in particular, the policy prescriptions that flow from them. We develop this theme below.

Stiglitz’s awards and distinctions include a Guggenheim Fellowship in 1969–70. In 1979 he was awarded the American Economic Association’s John Bates Clark Medal. In 1988 Stiglitz won the International Prize from the Academia Lincei in Italy and in 1989 the Science Prize given by Universal Academic Press. He holds honorary doctorates from a number of universities around the world. He is a member of the American National Academy of Sciences and fellow of: the American Philosophical Society, the American Academy of Arts and Sciences and the Econometric Society. Stiglitz was also founding editor of the Journal of Economic Perspectives. In 2001, he was awarded the Nobel Memorial Prize in Economics jointly with George A. Akerlof and A. Michael Spence ‘for their analyses of markets with asymmetric information’ (Nobel Foundation, 2004).

Stiglitz’s Nobel citation makes reference to a paper with Michael Rothschild (Rothschild and Stiglitz, 1976) that is a ‘natural complement’ to the key works of his fellow Laureates, Akerlof and Spence (see their entries in this volume). In this paper, Rothschild and Stiglitz consider the information asymmetries in insurance markets where, typically, insurance providers have less information about the risks faced by their customers than do these individuals themselves. More specifically, Rothschild and Stiglitz explore ways in which insurance providers condition the choices faced by their customers so that they purchase policies in accordance with providers’ preferences.

In the presence of perfect – and therefore symmetric – information, insurance companies would offer individual customers policies specifically tailored to the level of risk they carry. Riskier customers would pay more; low-risk customers would pay less. But because in reality information is asymmetric, insurance providers offer policy permutations that ‘screen’ the market such that different risk groups reveal themselves and gravitate towards different policies. Thus Rothschild and Stiglitz demonstrate that information asymmetries are fundamental to an understanding of how this kind of market operates. In their model, high-risk individuals are willing to pay a higher premium on the understanding that they will receive full compensation in the event of a loss which they know is more likely. On the other hand, low-risk individuals choose a lower-cost policy but one that carries a deductible or excess charge which, because they know they are low risk, they are willing to accept given the attraction of the lower premium. Rothschild and Stiglitz call the outcome that arises from this self-selection process a ‘separating equilibrium’. They also show that their model has no ‘pooling equilibrium’, that is where all individuals opt for the same policy. The case here is analogous to Akerlof’s ‘lemons’ model. In offering a single policy in the market, insurance providers would set a premium too high for low-risk individuals and thus leave themselves with an adverse selection of high-risk customers. Stiglitz’s Nobel citation states that the identification of separating and pooling equilibria has led to a paradigmatic shift in general microeconomic theory and information economics (see Löfgren et al., 2002).

Stiglitz’s record of publication is prodigious. His Nobel citation suggests that he ‘is probably the most cited researcher within the information economics literature – perhaps also within a wider domain of microeconomics’. One explanation of the sheer scale of his output is his method of working. Stiglitz describes his research style as one that addresses problems from a variety of perspectives, leading to the accumulation of models from which insights and conclusions emerge. The gestation period of his papers is consequently sometimes very long. For example, some material first developed in Kenya in 1969 reached the public domain more than 20 years later.

Stiglitz’s (1974a) work on the egregious economics of sharecropping, in particular understanding this institutional form as the product of an asymmetric information problem, was one of his earliest contributions to information economics. With Andrew Weiss, he has explored the implications of information asymmetries in credit markets and used these to account for the phenomenon of credit rationing (see Stiglitz and Weiss, 1981). Building upon work first begun during his time in Kenya, he has – with Carl Shapiro – developed the ‘shirking’ model explanation of efficiency wages, thereby contributing to an important aspect of new Keynesian macroeconomics (see Shapiro and Stiglitz, 1984). With Sanford Grossman he has demonstrated the significance of informational imperfections in financial markets (see Grossman and Stiglitz, 1980). His work with Bruce Greenwald has illustrated that market failures are pervasive in a way not recognised by the competitive model and that these failures rest on informational imperfections or incomplete markets (see Greenwald and Stiglitz, 1986). Stiglitz’s Nobel citation also acknowledges important work he has published in other areas of economics, in particular: public economics (Stiglitz and Dasgupta, 1971), industrial organisation (Dixit and Stiglitz, 1977) and the economics of natural resources (Stiglitz, 1974b).

As noted, Stiglitz has worked in the highest echelons of US and international policy making. At the World Bank he was strongly critical of the Washington consensus approach to development promoted by the International Monetary Fund (IMF) and, to Stiglitz’s consternation, the US Treasury. In his view, the IMF’s policy prescriptions were ‘based on an incorrect understanding of economic theory’ – one that ignored recent advances, including those in information economics – and ‘an inadequate interpretation of the historical data’. Stiglitz’s views are summarised in his best-selling book, Globalization and Its Discontents (Stiglitz, 2002b).

Main Published Works
(1966–77), Collected Scientific Papers of Paul A. Samuelson (ed.), Cambridge, MA: MIT Press.
(1971), ‘Differential Taxation, Public Goods and Economic Efficiency’ (with P. Dasgupta), Review of Economic Studies, 38, April, pp. 151–74.
(1974a), ‘Incentives and Risk Sharing in Sharecropping’, Review of Economic Studies, 41, April, pp. 219–55.
(1974b), ‘Growth with Exhaustible Natural Resources: Efficient and Optimal Growth Paths’, Review of Economic Studies, 41 (128), Special Issue pp.123–37.
(1976), ‘Equilibrium in Competitive Insurance Markets: An Essay on the Economics of Imperfect Information’ (with M. Rothschild), Quarterly Journal of Economics, 90, November, pp. 629–49.
(1977), ‘Monopolistic Competition and Optimal Product Diversity’ (with A. Dixit), American Economic Review, 67, June, pp. 481–513.
(1980), ‘On the Impossibility of Informationally Efficient Markets’ (with S. Grossman), American Economic Review, 70, June, pp. 393–408.
(1981), ‘Credit Rationing in Markets with Imperfect Information’ (with A. Weiss), American Economic Review, 71, June, pp. 393–410.
(1984), ‘Equilibrium Unemployment as a Worker Discipline Device’ (with C. Shapiro), American Economic Review, 74, June, pp. 433–44.
(1986), ‘Externalities in Economies with Imperfect Information and Incomplete Markets’ (with B. Greenwald), Quarterly Journal of Economics, 101, May, pp. 229–64.
(2002a), ‘Information and the Change in the Paradigm in Economics’, American Economic Review, 92, June, 460–81. (2002b), Globalization and Its Discontents, New York: W.W. Norton.
(January 2010) Freefall: America, Free Markets, and the Sinking of the World Economy: The current global financial crisis carries a made-in-America label. In this forthright and incisive book, Nobel Laureate Joseph E. Stiglitz explains how America exported bad economics, bad policies, and bad behavior to the rest of the world, only to cobble together a haphazard and ineffective response when the markets finally seized up. Drawing on his academic expertise, his years spent shaping policy in the Clinton administration and at the World Bank, and his more recent role as head of a UN commission charged with reforming the global financial system, Stiglitz outlines a way forward building on ideas that he has championed his entire career: restoring the balance between markets and government, addressing the inequalities of the global financial system, and demanding more good ideas (and less ideology) from economists.
Freefall is an instant classic, combining an enthralling whodunit account of the current crisis with a bracing discussion of the broader economic issues at stake.

Secondary Literature
Löfgren, K.-G., T. Persson and J.W. Weibull (2002), ‘Markets With Asymmetric Information: The Contributions of George Akerlof, Michael Spence and Joseph Stiglitz’, Scandinavian Journal of Economics, 104 (2), pp. 195–211.
Rosser, J. Barkley (2003), ‘A Nobel Prize for Asymmetric Information: The Economic Contributions of George Akerlof, Michael Spence and Joseph Stiglitz’, Review of Political Economy, 15 (1), pp. 3–21.
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