What if George Akerlof had written about Lethal “Lemons?”

By William K. Black
(Cross Posted at Benzinga.com)

If you have studied economics at the university level in the last 35 years it is likely you were introduced to the concept of “asymmetrical information” and George Akerlof’s famous 1970 article on markets for “lemons” (American slang for an automobile of terrible quality).  The Nobel committee that awards the prize in economics singled out that article for special praise in deciding to make him a Nobel Laureate in 2001.  The article discusses the implications of asymmetrical information in a number of contexts, but at least two of the contexts involved what criminologists call “control fraud” and a third involves the risk of fraud by borrowers.  Most of the examples Akerlof discussed involved fraud.  The frauds he analyzes concern deceit about the quality of goods being sold or the borrowers’ ability or willingness to repay a loan.   

I have noted in many articles that the clan of economists has a primitive tribal taboo against saying the mystic “f” word out loud or even putting it in print, so Akerlof’s article does not contain the word “fraud.”  His language, however, makes it clear that he is discussing fraud and how it can create what we now call a “Gresham’s dynamic” in which bad ethics drives good ethics out of the market.

The theme of my article is to alert the reader to other variants of anti-purchaser control fraud in which the deception about the quality of the goods sold (or rented) affects safety, not simply the appropriate price of the bad quality goods.  I use as my example the recent deaths of nearly 400, and over 1,000 injured, Bangladeshis when the building they were working in collapsed.  I show that the same case is also an example of anti-employee control fraud.

The nature of the survivors’ injuries is often horrific.

“[T]he director of Enam Hospital, Dr. Mohammed Anawarul Quader Nazim, said that more than 650 survivors had been brought in since the Wednesday morning disaster. The scope of injuries was horrifying: fractured skulls, crushed rib cages, severed livers, ruptured spleens. One survivor lost both legs. So many people suffered crushed limbs that his hospital sent a medical team to the wreckage to help handle on-site amputations.”

I make three points that criminologists stress that supplement Akerlof’s discussion of what “represents the major costs of dishonesty.”  First, the costs of anti-purchaser control fraud include hundreds of thousands of people who are sickened, maimed, and killed by the frauds.  Second, the cost can include the erosion of trust and morality in ways that can cause broader and deeper injuries than Akerlof identifies.  Third, the Bangladeshi case illustrates the lethal intersection of anti-purchaser control fraud and anti-employee control fraud.

I also ask the question whether Akerlof’s famous article on “lemons” might have had even greater impact and might have led to broader and more effective policies if he had discussed the lethal nature of “lemons” rather than examples in which the only loss he discussed was economic value.  Here are the key passages in Akerlof’s article in which he describes examples of anti-purchaser control fraud and discusses why he believes to be the costs of such frauds and why he believes they are more common in less developed nations.

C. The Costs of Dishonesty

“The Lemons model can be used to make some comments on the costs of dishonesty. Consider a market in which goods are sold honestly or dishonestly; quality may be represented, or it may be misrepresented. The purchaser’s problem, of course, is to identify quality. The presence of people in the market who are willing to offer inferior goods tends to drive the market out of existence –as in the case of our automobile “lemons.” It is this possibility that represents the major costs of dishonesty – for dishonest dealings tend to drive honest dealings out of the market. There may be potential buyers of good quality products and there may be potential sellers of such products in the appropriate price range; however, the presence of people who wish to pawn bad wares as good wares tends to drive out the legitimate business. The cost of dishonesty, therefore, lies not only in the amount by which the purchaser is cheated; the cost also must include the loss incurred from driving legitimate business out of existence.

Dishonesty in business is a serious problem in underdeveloped countries. Our model gives a possible structure to this statement and delineates the nature of the “external” economies involved. 

There is considerable evidence that quality variation is greater in underdeveloped than in developed areas. 

Indian housewives must carefully glean the rice of the local bazaar to sort out stones of the same color and shape which have been intentionally added to the rice” (pp. 495-496).

The Market for “Lemons”: Quality Uncertainty and the Market Mechanism

The Quarterly Journal of Economics, Vol. 84, No. 3. (Aug., 1970), pp. 488-500.

One should always pay particular attention to the “Conclusion” section of an Akerlof paper because he uses it to convey his key message.  This is the full text of the conclusion of the “lemons” paper.


“We have been discussing economic models in which “trust” is important. Informal unwritten guarantees are preconditions for trade and production. Where these guarantees are indefinite, business will suffer – as indicated by our generalized Gresham’s law.  This aspect of uncertainty has been explored by game theorists, as in the Prisoner’s Dilemma, but usually it has not been incorporated in the more traditional Arrow-Debreu approach to uncertainty. But the difficulty of distinguishing good quality from bad is inherent in the business world; this may indeed explain many economic institutions and may in fact be one of the more important aspects of uncertainty” (pp. 500).

Akerlof’s conclusion puts together three powerful ideas that interact, but perhaps because of the context of the fraud examples he chose to discuss his article does not develop the implications of the interplay of trust, the Gresham’s dynamic, and the “inherent” perverse incentive firms have to engage in fraud that must be countered if we are to avoid severe losses.  If we take these three concepts and place them in context of the most destructive current control frauds we can develop a more comprehensive understanding of fraud and the interplay of the factors that Akerlof emphasized in his conclusion.

Akerlof discussed two examples of anti-purchaser control fraud in the longer passage I quoted – bad quality cars and rice intermixed with “stones” of the same color and shape.  The defects in exceptionally bad cars can include a wide range of components that pose a safety concern (e.g., bad brakes, steering, and tires).  Each of these defects can maim and kill.

Stones in the rice will not kill the consumer (quickly), but they can easily break the consumer’s teeth.  To my readers, that probably sounds very painful, expensive to remedy, and inconvenient.  In the time and place Akerlof was discussing (India in the 1960s) it was actually much worse for an Indian peasant.  The tooth would likely never be repaired and would be lost.  There would likely be no bridge or dentures.  The victim’s risk of infections would grow considerably.  Gum disease does not simply threaten the loss of the remaining teeth; it increases the risk of heart disease.

As soon as one takes the risks of sickness, injury, and death into account it becomes clear that a Gresham’s dynamic causes injury far greater than driving honest sellers out of business.  Like corruption, many variants of control fraud maim and kill.  When a Gresham’s dynamic develops because of these forms of control fraud the primary consequence is that many purchasers are maimed and killed.

Morality and ethics are always an issue when fraud is present, but they become even more important when a seemingly legitimate business becomes profitable by maiming and killing its purchasers.  A CEO who has such pathetic ethical standards that he will maim and kill the firm’s customers may well commit many other forms of crime, including violence against journalists and government investigators and corruption.

Many forms of control fraud involve suborning politicians, regulators, and professionals.  This can cause harm in other firms and industries.  A politician or a regulator who is bribed is far more likely to be ineffective in honestly representing the public interest in future cases.  If a particular CEO convinces a governmental body to end effective regulation or supervision the resultant regulatory “black hole” can be exploited by every firm – and attract new entrants to the industry.  If a control fraud is able to create a regulatory “race to the bottom” (a regulatory Gresham’s dynamic), the result can be a regulatory black hole in many nations.  This is one of the factors that drove the current financial crisis in which the City of London “won” the race to have the weakest financial regulation.

Criminologists have greatly supplemented what Akerlof viewed as “the major costs of dishonesty.”  We have also confirmed and supplemented Akerlof’s insight about the critical harm that control fraud can do to “trust.”  The essence of fraud is that the perpetrator gets the victim to trust him and then betrays that trust in order to steal from the victim.  As a result, there is no more effective acid in destroying trust than fraud – particularly elite fraud.  Trust is vital to many aspects of life – personal relationships, social bonds, effective democracy, honest businesses, and effective markets.  Long before fraud becomes endemic it can cause markets to cease to function.  In economics jargon, control frauds can cause exceptionally damaging negative externalities.

The Collapse of the Building in Bangladesh

The collapse of the building in Bangladesh represents the intersection of two forms of control fraud – anti-purchaser and anti-employee.  (The other two forms of control fraud, as classified by the primary intended victims, are accounting control fraud, which drive our recurrent, intensifying financial crises, and anti-public control fraud (e.g., tax fraud and the illegal disposal of toxic waste)).

The facts are, of course, incomplete about the Bangladesh building collapse.  What is being reported is consistent with anti-purchaser and anti-employee control fraud.  Here are key passages from the Wall Street Journal article announcing the arrest of the building’s owner as he tried to flee to India.

“Mr. Rana allegedly didn’t obtain mandatory permits from the government agency that oversees building safety in the greater Dhaka area, and he allegedly built the eight-story building on the site of a pond without proper precautions, according to authorities.

Authorities ordered the arrests of the owners of factories in the building, following allegations that they forced workers to return to the building on Wednesday despite safety concerns after a crack emerged on an exterior wall.”

Reports also claim that public authorities ordered the building closed when the cracks appeared.

“Cracks had been discovered in the structure a day earlier, and police officials and industry leaders say they had asked the factory bosses to stop work until the building had been inspected.

‘I wouldn’t call it an accident,’ the government’s information minister, Hasanul Haque Inu, told Bangladeshi journalists. ‘I would say it’s a murder.’”

Bangladesh has roughly 4000 murders annually, so the building collapse represents about 10% of its annual murder rate.  Deaths due to control fraud are generally not treated as murders, but that is a significant aspect of the reason we often fail to deter elite white-collar crimes or even understand their prevalence.

What if Akerlof had written about Lethal Lemons?

If you ask an economist or a doctoral candidate in economics about Akerlof’s article on lemons s(he) will almost always tell you that it discusses “asymmetrical information.”  It does, but it largely discusses control fraud and not one economist or doctoral student in a thousand will even mention fraud.  I have never known an economist or doctoral candidate who expresses concern that frauds deliberately maximize the asymmetry of information while purporting to minimize it and that the resultant frauds maim and kill tens of thousands of people.

Textbooks frequently introduce the literature on asymmetrical information as a story of triumph.  They explain how markets participants have evolved practices and institutions to provide the purchaser with reliable assurances of obtaining high quality goods.  I am not aware of any textbook discussing how asymmetrical information leads to lethal markets for lemons and how control frauds act dynamically to mimic the practices (and suborn the institutions) that purportedly provide the purchaser with reliable assurances of high quality goods.

Akerlof discussed market mechanisms to counter the problems of asymmetrical information, but he did not posit that these mechanisms were invariably successful.  If he had discussed lethal lemons and control frauds explicitly it would have been far harder for economists to ignore these subjects.  It is time for economists to take fraud seriously and the Bangladeshi building collapse provides yet another example of how lethal lemons can be and why it is essential that our theories and policies address them as a top priority.


Bill Black is the author of The Best Way to Rob a Bank is to Own One and an associate professor of economics and law at the University of Missouri-Kansas City. He spent years working on regulatory policy and fraud prevention as Executive Director of the Institute for Fraud Prevention, Litigation Director of the Federal Home Loan Bank Board and Deputy Director of the National Commission on Financial Institution Reform, Recovery and Enforcement, among other positions.

Bill writes a column for Benzinga every Monday. His other academic articles, congressional testimony, and musings about the financial crisis can be found at his Social Science Research Network author page and at the blog New Economic Perspectives.

Follow him on Twitter: @williamkblack