The Human Face of Economics

• Position: an Advisor in the IMF's Research Department.

People in Economics

IN 1984, economics Nobel Laureate George Stigler predicted that economics was on its way to becoming the queen of the social sciences. He called economics “an imperial science,” one that was clearing a path through the academic thickets for other social disciplines. He applauded the work of “economist-missionaries . . . often against apprehensive and hostile natives.”

Well a funny thing happened on the way to the coronation. Over the quarter-century since Stigler’s article, it has become clear that economics has as much to learn from other disciplines as it has to teach them. Today, the field of behavioral finance uses insights from psychology and sociology to understand financial markets. Corporate scandals and greed-driven financial crises have led to calls for blending ethics into economics. And Nobel Prizes in economics over the past decade have gone to a psychologist, Daniel Kahneman (see F&D, September 2009), and a political scientist, Elinor Ostrom.

These developments might have upset George Stigler but not his namesake, George Akerlof, a 2001 economics Nobel laureate. He says it has long been his “dream” to have a macroeconomics grounded in the “full range of human emotions and actions: fairness, confidence, greed, identity, procrastination.” (Procrastination? We’ll get back to that . . . later.)

“It’s not fair!”

Akerlof says the topic that has motivated him the most over his 40-year career is unemployment. “I have always thought of unemployment as a terrible thing. In fact that has been the motivation for almost everything I have ever written. A person without a job loses not just his income but often the sense that he is fulfilling the duties expected of him as a human being.”

Why does unemployment arise? Akerlof, in joint work with noted economist Janet Yellen (who also happens to be his wife), has argued that the notion of fairness plays a key role. Akerlof and Yellen draw on sociology to enrich the description of how exchange takes place in markets, including the labor market. In economic theory, the price at which an exchange takes place is determined by supply and demand. If more sellers bring fruit to a farmers’ market than there are buyers that day, the price at which fruit is sold drops. If there is an unexpected snowstorm, a hardware store, according to the economic theory, will raise the price of shovels and is justified in doing so to reflect their sudden scarcity.

But “human beings don’t always think this way,” says Akerlof. Surveys have shown that people regard it as unfair if hardware stores raise prices in the middle of a snowstorm. And prices may not always fall in the farmers’ market when supply outstrips demand. People who shop in farmers’ markets are often “making a statement,” Akerlof says. Some buyers may buy a bit more than they had planned if they see the sellers they are trying to support not doing too well. And some sellers may have too much “pride in the quality [of their product]” to lower the price and may hold out for a price they regard as “fair.”

When applied to the labor market, considerations of fairness play an even more important role. The price at which labor is exchanged—the wage rate—does not depend solely on the demand and supply of labor. The employer has to factor in the impact of paying a low wage on the morale and efficiency of the worker. It does no good for an employer to drive down a worker’s wage if that would cause the worker to be resentful and to figuratively “spit in the soup.” Hence employers offer something higher than the wage that would equate demand and supply. Akerlof and Yellen call this the “efficiency wage” to capture the notion that higher wages motivate workers to be more effective or efficient at their jobs.

The aggregate consequence of employers doing the right thing is that there will always be some unemployment in the economy, because wages will be set higher than the rate at which everyone who seeks a job would be employed. “The market for jobs is then like a game of musical chairs, with more people on the dance floor than there are chairs. When the music stops, some people...