Doug writes > I've just been wrestling with some of Stiglitz & Co.'s stuff on info > asymmetries. It seems that it takes arguments that could be made in no more > than a paragraph of Robinson-clear English and puts them into pages of > formulas. Am I missing something? Didn't Ricardo make the argument about > adverse selection and high interest rates in a sentence or two? As someone who has also struggled through a lot of Stiglitz's stuff, I have a certain amount of sympathy with these sentiments. However, I also think there is much more there than Doug suggests. To take Doug's example, if I'm correct in guessing what passage in Ricardo he's referring to, then no, Ricardo didn't make the argument about adverse selection and high interest rates. That is, if this is the passage in question (correct me if it isn't!): "To the question, 'who would lend money to farmers, manufacturers, and merchants, at 5 per cent per annum, when another borrower, having little credit, would give 7 or 8?' I reply, that every prudent and reasonable man would. Because the rate of interest is 7 or 8 per cent there, where the lender runs extraordinary risk, is this any reason that it should be equally high in those places where they are secured from such risks?" , then it need not be read as invoking adverse selection at all. If adverse selection is in fact invoked here, the argument is at best ambiguous. One possible interpretation is that Ricardo is simply stating that interest rate differentials must reflect risk differentials. Other things equal, and independent of strategic issues, a collateralized loan involves less risk than an unsecured one, so its risk premium is lower. A second interpretation involves "moral hazard" (i.e., a strategic problem related to unobserved actions) rather than adverse selection (a strategic problem related to unobserved characteristics): collateral is one known solution to the canonical "moral hazard" problem. [Can you tell that this term was invented by the insurance industry?] Finally, one could stretch it and read Ricardo as talking about adverse selection in a manner which parallels that of Stiglitz, but a passage necessary to confirm this interpretation is missing: namely, the argument that raising the interest rate *increases the pool* of loan applicants who have poorer prospects of repaying the interest. Taking the broad view, what Stiglitz has done is to force the mainstream to take issues related to asymmetric information seriously. While one could say that this is the mainstream's problem, not ours, I think it is fair to say that radical economists also need to have a more coherent understanding of the economic implications of informational problems. Gil Skillman
