The Nobel Prize

A. Michael Spence (b. 1943)

Michael Spence was born in Montclair, New Jersey, USA in 1943 while his mother was visiting friends there. He grew up in Canada, mostly in Toronto where he went to school, but received his college education in the United States and the United Kingdom. Spence was awarded a BA in philosophy by Princeton University in 1966. In 1968, as a Rhodes Scholar at Oxford University, he obtained a BA–MA in mathematics. Spence completed his college education at Harvard University and was awarded a PhD in economics in 1972.

Spence’s academic career has been split between the universities of Harvard and Stanford. He began teaching at Harvard in 1971 and remained there as assistant professor until 1973 when he moved to Stanford University to take up a post as associate professor. In 1975 he returned to Harvard, first as an honorary research fellow and then visiting professor. In 1977 he became Professor of Economics at Harvard and in 1984, Dean of the university’s Faculty of Arts and Sciences. In 1990 Spence moved once again to Stanford University as Dean of the Graduate School of Business, a post he relinquished in 1999. He is presently Professor Emeritus of Management in the Graduate School of Business at Stanford, and a partner in Oak Hill Capital Partners and Oak Hill Venture Partners.

Spence’s awards and distinctions include an Honours Thesis Prize in Philosophy from Princeton University. In 1972 he received the David A. Wells Prize for outstanding doctoral dissertation at Harvard University. He has also been awarded the John Kenneth Galbraith Prize for excellence in teaching at Harvard (1978). In 1981, Spence received the John Bates Clark Medal from the American Economic Association, and in 1983 he was elected a fellow of the American Academy of Arts and Sciences. From 1991 to 1997 he was chairman of the United States’ National Research Council Board on Science, Technology and Economic Policy. In 2001 Spence, together with George Akerlof and Joseph Stiglitz, was jointly awarded the Nobel Memorial Prize in Economics ‘for their analyses of markets with asymmetric information’ (Nobel Foundation, 2004).

Spence’s Nobel citation makes reference to his pioneering work in the economics of signalling. Spence (1973; 1974) demonstrated that, in markets with incomplete information, there exist incentives for those with more information to signal it to those with less information. The result is the attainment of market equilibria advantageous to the signallers and which would otherwise not occur.

As a graduate student working on the implications of the incompleteness of information in markets, Spence was advised to read fellow Laureate George Akerlof’s then recently published ‘Market for “Lemons”’ paper. Spence reports that he found the paper ‘quite electrifying’ (Spence, 2002). Akerlof’s central contention in the paper was that in a market with asymmetric information, such as that for used cars, buyers have no means of distinguishing the goodquality cars from the bad (the ‘lemons’). This presents the sellers of ‘lemons’ with an opportunity to pass off their cars as better products than they in fact are. The overall effect is that the potentially separate markets for ‘lemons’ and high-quality cars fuse into a single market but because the equilibrium price in this market may be too low for the sellers of high-quality cars, they consequently withdraw from the market leaving it with only an adverse selection of ‘lemons’. The central point here is that the presence of informational uncertainty means that trading opportunities are lost and the market does not perform as well as conventional economic theory suggests (see also the entry on Akerlof in this volume).

Spence’s response to Akerlof’s paper was to identify how potential employees in the labour market can use signals to convey information to employers about their inherent productivity. In the absence of such signals, poorly informed employers are unable to distinguish between the productivity potential of different employees. In the event that employers fail to offer adequate rewards to potentially higher-productivity employees, the latter exit the market and the result is analogous to Akerlof’s adverse selection problem (Spence, 2002). Spence published this work in what Blaug (1998, p. 271) has called ‘a brilliant and provocative book’ (see Spence, 1974). This was a revised version of Spence’s prize-winning Harvard doctoral dissertation and made an important contribution to the economics of information (see entry on Stigler in this volume).

Spence supposed that educational attainment could be used by potential employees to signal information about their ability to prospective employers. Moreover, he assumed that for different groups of workers in the labour market, the costs of education differed; in particular, for high-productivity workers, educational costs – measured in terms of effort, time or expense – were lower than for lowproductivity workers. In such circumstances, high-productivity workers have both the necessary cost and reward incentives to make the effort to signal their distinctiveness to potential employers. Low-productivity workers on the other hand have neither.

Spence (2002) points out that it is important that employers’ beliefs about the relationship between educational attainment and productivity are ‘self-confirming’. So long as employers’ faith in the reliability of the signals they receive is maintained, they have an incentive to operate a system of differential reward – in effect to not underpay workers who have invested in their own education. This means that, overall, signalling acts to preserve what Spence calls ‘multiple equilibria’. In other words, the presence of reliable market signals overcomes the adverse selection problem by preventing effectively separate labour markets from collapsing into one another.

In subsequent work, Spence has made important contributions to the theory of industrial organisation; see, in particular, Spence (1976; 1977). Some of the approaches he has developed have subsequently been taken up in, for example, international trade theory; see Spence (1981).

Main Published Works
(1973), ‘Job Market Signalling’, Quarterly Journal of Economics, 87, August, pp. 355–74.
(1974), Market Signalling: Informational Transfer in Hiring and Related Screening Processes, Cambridge, MA: Harvard University Press.
(1976), ‘Product Selection, Fixed Costs and Monopolistic Competition’, Review of Economic Studies, 43, June, pp. 217–35.
(1977), ‘Entry Capacity, Investment and Oligopolistic Pricing’, Bell Journal of Economics, 8, Autumn, pp. 534–44.
(1981), ‘The Learning Curve and Competition’, Bell Journal of Economics, 12, Spring, pp. 49– 70.
(2002), ‘Signaling in Retrospect and the Informational Structure of Markets’, American Economic Review, 92, June, pp. 434–59.

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.

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