Edmund S. Phelps

My recent book, Inflation Policy and Unemployment Theory, introduces what is called the statistical theory of racial (and sexual) discrimination in the labor market.' The theory fell naturally out of the non-Walrasian treatment there of the labor market as operating imperfectly because of the scarcity of information about the existence and characteristics of workers and jobs. A paradigm for the theory is the traveller in a strange town faced with choosing between dinner at the hotel and dinner somewhere in the town. If he makes it a rule to dine outside the hotel without any prior investigation, he is said to be discriminating against the hotel. Though there will be instances where the hotel cuisine would have been preferable, the rule represents rational behavior it maximizes expected utilityif the cost of acquiring evaluations of restaurants is sufficiently high and if the hotel restaurant is believed to be inferior at least half the time. In the same way, the employer who seeks to maximize expected profit will discriminate against blacks or women if he believes them to be less qualified, reliable, long-term, etc. on the average than whites and men, respectively, and if the cost of gaining information about the individual applicants is excessive. Skin color or sex is taken as a proxy for relevant data not sampled. The a priori belief in the probable preferability of a white or a male over a black or female candidate who is not known to differ in other respects might stem from the employer's previous statistical experience with the two groups (members from the less favored groups might have been, and continue to be, hired at less favorable terms); or it might stem from prevailing sociological beliefs that blacks and women grow up disadvantaged due to racial hostility or at least prejudices toward them in the society (in which latter case the discrimination is self-perpetuating). The theory is applicable to the class of liberal employers and workers who have no distaste for hiring and working alongside black or female workers. By contrast, the theory of discrimination originated by Gary Becker is based on the factor of racial taste. The pioneering work of Gunnar Myrdal et al. also appears to center on racial (and, in an appendix, sexual) antagonism. Some indications of interest in the new theory, and the independent discovery of the same statistical theoryby Kenneth Arrow, convince me that it is time for a formalization of the theory in terms of an exact statistical model. Though what follows is very simple, it may be useful to those who like exact models and it may stimulate others to develop the theory further. An employer samples from a population of job applicants. The employer is able to measure the performance of each applicant in some kind of test, yi, which, after suitable scaling, may be said to measure the applicant's promise or degree of qualification, qi, plus an error term, ps.

Readers of my article on optimal over time1 will recognize its principal theme to be the following. Among all alternative equilibrium states of steady anticipated or deflation, all with the same steady unemployment rate, there exists a state with an algebraic anticipated rate that is optimal. But, by virtue of the immediate postulated gains from over-employment-from employment in excess of the equilibrium level-and the immediate postulated losses from under-employment, social time preference plays a critical role in determining each day's optimal level of aggregate demand and thereby the ultimate steady rate of algebraic that society will asymptotically settle for. The higher the rate of time preference, the more does this asymptotic algebraic rate exceed the statically optimal rate and the greater is the present optimal level of aggregate demand. If the current rate of inflation exceeds the asymptotic rate of algebraic inflation, then the optimal aggregate demand policy will produce transient (vanishing) underemployment and thus a rate of below expectations. If the current expected rate of is below the asymptotic rate of algebraic inflation, then the optimal fiscal policy aims for transient overemployment and algebraic in excess of expectations. It is odd that Mr. Williamson, in his Comment, 2 should find a deflationist moral in this even-handed theme. My article rejected the conventional approach to the choice of aggregate demand, which takes expectations as exogenous or irrelevant, not any conventional conclusion about the merits of inflationary policies. One conclusion of the model is that a society with the requisite time preference can rationally opt for over-employment, unexpectedly high and its aftermath of high steady in the eventual future equilibrium. Even the statically optimal rate of algebraic inflation-in my formulation this is the maximum rate of algebraic consistent with full liquidity or monetary efficiency-might be one of mild if the real rate of interest is small enough. The interesting variation on this dynamic model that Williamson proposes would, loosely speaking, make more deflation worse than less deflation on the other side of the static optimum. There are

Journal Article On Second-Best National Saving and Game-Equilibrium Growth Get access E. S. Phelps, E. S. Phelps University of Pennsylvania Search for other works by this author on: Oxford Academic Google Scholar R. A. Pollak R. A. Pollak University of Pennsylvania Search for other works by this author on: Oxford Academic Google Scholar The Review of Economic Studies, Volume 35, Issue 2, April 1968, Pages 185–199, https://doi.org/10.2307/2296547 Published: 01 April 1968