This Christmas season does not offer much scope for cheer. The economic situation is glum. Growth has slowed, inflation is still high, the rupee has dived and fiscal stress is evident. Yet, the government seems set to go ahead with a food Bill that could wreck national finances. It seems there could be more trouble ahead in 2012.
So in this last column of the year, I thought it would be a better idea to revisit another Christmas tale—The Gift of the Magi, the wonderful story of love and disappointment penned by O. Henry. It is a tale of a young and impoverished couple deeply in love with one another. Each wants to secretly buy a Christmas gift for the other. James sells his watch so that he can buy Della, expensive combs for her long hair. Della meanwhile sells her beautiful hair so that she can buy a platinum chain for the watch James so loves.
The inability of the two young people to share information makes for a poignant story. Economists too have applied their minds to what can happen if there is inadequate information between two sides of an exchange. Tangentially, a year-end question: is the end of the O. Henry story Pareto optimal?
Take a simple example of why information is important. A young woman applies for a management job in your company. You have no clear idea about her abilities. She does. There is information asymmetry. One solution is that she has the means to signal to you that she is worth employing. One common signal is a degree certificate from a reputed university. What she learnt there may have no direct relevance for the job on offer, but it does tell you that she is bright enough to finish the course. Educational certificates are often a signal to overcome inadequate information, and such signals can be expensive.
There are cheaper alternatives as well. Game theorists use the concept of cheap talk. It is useful in a well-known game called The Battle of the Sexes. The husband wants to go to the baseball game that weekend. The wife prefers the opera. They need to agree on a plan. It would be better if they revealed their preferences rather than keep them secret. Even a little marital row would help.
Would James and Della have been better off if they had indulged in some cheap talk? They would, though O. Henry would not have had much of a story to write.
However, information is passionless. One of the most intriguing papers I read in 2011 was written by Deirdre N. McCloskey, who has moved beyond standard textbook economics to study fascinating subjects such as the rhetoric of economics, feminist economics, and the role of ethics in an economy and the cult of statistical significance. She also changed her gender in 1995.
McCloskey was one among many of the best American economists who was asked by the US National Science Foundation on what the big research ideas over the next 10 years would be. Her answer: “A worrying feature of economics as presently constituted is that it ignores language working in the economy... A large part of economic talk is not merely informational or commanding, but persuasive.” The economy is not just an information exchange; it is a conversation.
McCloskey calls these impassioned conversations as sweet talk, a clear derivation from cheap talk. I had written about her idea in an online column on the day the new iPhone was to be launched in October. The entire iPhone cult that Steve Jobs built up could be said to have been a variant of sweet talk, with all the excitable buzz and hyperbolic adjectives. More mundanely, your regular bargaining with the fish vendor is rarely impersonal exchanges of cold information. Nor are the annual appraisals that your boss does. Rich language is central to most interactions in an economy.
In her paper, McCloskey estimates that the value of sweet talk is around a quarter of the income in a modern economy, a claim that pleases a columnist who is in the business of persuasion but, which has not been backed by any statistical evidence. “Formal maximum-utility economics cannot explain the sweet talk. The research would need to establish the fact beyond doubt, bringing together for example mathematical economists and rhetorical theorists. It can be treated mathematically by showing the cooperative equilibria (for example) cannot be achieved without trust created by earnest talk. In a way it is the oldest and most obvious finding of game theory that games have of course always a context of rules and customs and relationships, all of them affected by language,” she says.
Trust, language, sharing: all these are factors that rarely enter standard economic discourse. But they are worth remembering in a year of mistrust, haircuts and ticking debt clocks. James and Della are still worth remembering!
Niranjan Rajadhyaksha is executive editor of Mint. Comments are welcome at firstname.lastname@example.org
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