The lemons problem

An economist explained why some markets quietly rot, using the example of used cars. Imagine buyers cannot tell a good used car from a bad one, a lemon, before buying. Since they cannot distinguish them, buyers will only pay an average price, somewhere between what a good car and a bad car are worth. But that average price is an insult to anyone selling a genuinely good car, so those sellers leave the market. Now only worse cars remain, the average quality drops, buyers notice and lower their offers further, and more decent sellers exit. The market spirals down until mostly lemons are left. It won a Nobel prize, and it describes far more than cars. It describes any market where quality is hidden and cannot be verified in advance.

When people cannot tell good from bad before committing, the good quietly leaves and you are left with the worst. This is exactly what happens in hiring when your process cannot recognise strong candidates. The strong ones, who have better options, will not wait through a process that treats them the same as everyone else, so they go elsewhere, and the pool that remains is the pool that could not get a better offer. Beyond making weaker picks, a hiring process that cannot tell good from bad actively drives away the people you most want, until the only ones left are the ones nobody else wanted either.

The Undercover Economist

Tim Harford, 2005

The chapter on information gaps walks through Akerlof's used car market, peaches and lemons, and why hidden quality quietly drives the good sellers out.