Might the age of asymmetric information – for better or worse – be over?  Market institutions are rapidly evolving to a situation where very often the buyer and the seller have roughly equal knowledge. Technological developments are giving everyone who wants it access to the very best information when it comes to product quality, worker performance, matches to friends and partners, and the nature of financial transactions, among many other areas.

These developments will have implications for how markets work, how much consumers benefit, and also economic policy and the law. As we will see, there may be some problematic sides to these new arrangements, specifically when it comes to privacy. Still, a large amount of economic regulation seems directed at a set of problems which, in large part, no longer exist.

 

Used Cars

Let’s start with a simple and classic illustration from the economics literature, namely George Akerlof’s pioneering paper from 1970 about asymmetric information and the market for used cars. In the core version of this model, sellers have better information than buyers: sellers know the value of their car but buyers know only the value of used cars on average. Since buyers don’t know the quality of a seller’s car they will be willing to pay only the average value. But if buyers are only willing to pay for average quality, why would anyone want to sell a car that is of above average quality, a plum? When the plums exit the market, the average value of the used cars for sale falls even further and buyers are willing to pay even less. Following the logic, we end up with a situation where only a few lemons are bought and sold, thus the moniker “the market for lemons.”

The market for used cars, however, has been one of the earlier examples where market institutions largely (albeit not completely) solved the problem of asymmetric information. Even in 1970, the market for used cars was extensive, and some institutions existed to make information more symmetric. Perhaps the most important of these was the odometer. First used by Alexander the Great to measure distances between cities, modern odometers were standard on almost all cars by 1925. The odometer reading is the single most important piece of information about a specific car that determines its value, and that is why used car prices are adjusted for mileage. The law contributes to this solution by making odometer tampering illegal and successive state and federal laws have increased the penalties and enforcement over time. In 1972, for example, the Federal Odometer Act made tampering a federal felony. As with other crimes, punishment doesn’t eliminate tampering but it does reduce it quantity thus making odometer readings more trustworthy and quality information more symmetric. Even more importantly, the Truth in Mileage Act of 1986 requires that sellers disclose and record the odometer reading on the title at every transfer of title. The 1986 Act greatly reduced the benefits of tampering because the odometer could not be rolled back prior to the reading from a previously recorded sale.

Since the 1986 Act, odometer readings and recordings have become more frequent. Odometer readings, for example, are now made at emission inspections and safety inspections. In many states such readings are made once per year. Services such as CarFax collect and report odometer readings from title transfers and inspections, making the information easily available for a small fee. In the future, states or the private sector could provide this information online for free. In addition to odometer readings, services such as CarFax collect information from service stations and insurance companies about repairs and accidents. The information collected is incomplete but it can be very useful in the important cases, such as when a car has been flooded or totaled.[1]

Perhaps the most telling fact is that the market for used cars is already some three times larger than the market for new cars (as measured by unit sales, see Bureau of Transportation Statistics). In 2012, for example, there were 40.5 million used car sales compared to 14.5 million new car sales (NIDIA 2013). On average, used cars sell for about a third the price of new cars, so the total size of the two markets is similar with both around $330 billion in sales. There just aren’t that many lemons to sustain such a high transactions volume. In fact both high-quality and low-quality used cars are available in fairly liquid, fairly transparent markets.

Information symmetry about the quality of automobiles is very likely to increase. Almost all vehicles today have “event data recorders” aka “black boxes,” similar to those found in airplanes. Event data recorders record data on vehicle performance and diagnostic checks but also speed, braking, seatbelt use and other information relevant to safety and car crashes. Some car companies, most notably Tesla, can collect such information remotely or stream it in real time. Tesla, for example, collects information on a vehicle’s odometer, service history, speed, location, battery use, charging time, braking, starting and stopping times, air bag deployment—even radio and horn use.[2] When a vehicle is sold the data transfers with the vehicle. It is now possible to prove that a used car really was driven by a grandma just on Sundays.[3]

Asymmetric information is no longer a plausible description of the used car market and, as a result, we should not be surprised that these markets are thriving, whether in terms of volume, diversity of product, or their ability to deliver a reliable purchase at a reasonable price.

What about the adverse selection argument as it applies to health insurance?  There too it seems that we are seeing a rapidly increasing symmetry of information.

Black boxes for people are not yet standard, but wearable sensors can monitor movement, heart rate, and heart rhythm, blood pressure and blood-oxygen levels, and glucose levels and other health-related statistics. Such information can be recorded and reported through smartphone apps, watches, and other wearable devices. Life insurance firms already have enough information from actuarial tables to make a good guess about an individual’s health. In the data we see that life insurance rates decline with the purchase of larger policies, which is the opposite of the prediction of the adverse selection model, namely that rates should increase with purchases (Cawley and Philipson 1999).

The actual problems with health insurance markets have less to do with information asymmetry and adverse selection than with too much information. That can make some people’s insurance very expensive at actuarially sound rates. For instance if you have a cancer of a given kind, this is verifiable to the outside world, and if the treatment costs are $200,000, the cost of an insurance policy will in turn be about $200,000. Buying the policy won’t be cheaper than buying the treatments, and in that sense the market for insurance is not always present. That is a very real public policy problem, but it is not well understood by invoking standard theories of asymmetric information.

The cheap sequencing of the genome may accelerate and intensify these issues. Science still is not able to infer so much from a sequenced genome, but to the extent this changes medical information and indeed information about the person more generally will become more public. Even if privacy legislation is in place, the market equilibrium may induce a lot of disclosure, because employers and others (potential dating partners?) will infer negative information from a lack of disclosure (Tabarrok 1994). In the limiting case we can imagine that each person will carry indicators of genetic information and also of environmental upbringing, allowing other parties to evaluate that individual much more accurately than before.

 

Moral Hazard

Moral hazard is another kind of asymmetric information problem which very often can be tolerably overcome with cheap, ubiquitous information. By moral hazard we mean the tendency of a better informed party to exploit its information advantage in an undesirable or dishonest way; for instance it is moral hazard when a worker shirks on the job or when a business enterprise takes too much risk at the possible expense of its bondholders.

Let’s again consider the example of cars. A typical moral hazard problem might be that consumers insure their cars, but then drive recklessly, knowing that the insurance company will pick up the bill for any resulting damage. Deductibles have helped with this problem, but these days there are better remedies yet. For instance consumers can use the type of data collected by Tesla and other manufactures not only when selling their cars, but also to share with insurance companies in return for lower rates. A consumer who is a good and responsible driver can prove it to the outside world, or at least give a good indication that this is likely the case.

Since 1996 all cars manufactured and sold in the United States must have a standardized On Board Diagnostic (OBD) port. A similar requirement exists for Europe and China and for heavy duty vehicles (HDOBD). Today, Progressive Insurance offers “Snapshot,” a simple device that connects to the OBD port. The Snapshot device continuously streams vehicle data such as speed, time, VIN number, and G force to Progressive. Consumers who drive fewer miles, drive during daylight or early evening and without sharp braking typically receive lower rates. Snapshot in part allows Progressive to better select safer drivers, but it also reduces moral hazard. One user, for example, reported:

After my six month use of Snapshot, I’ve concluded that it’s most effective at helping drivers become more aware of their vehicle, driving conditions and slowing gracefully to a stop. It took me roughly a couple of months to retrain my driving behavior.

An interesting feature of Snapshot is that the user doesn’t have to be a current Progressive customer. Anyone can install Snapshot for 30 days and at the end of the 30 days receive an insurance quote. Allstate offers a similar system, as does GMAC insurance for customers using GM’s OnStar system. It is now possible in some states to buy insurance by the mile, a logical extension of these systems. That will reward drivers who put their vehicles less at risk, and of course those same drivers are putting other vehicles and pedestrians less at risk too.

The extensive information available through the OBD port can be used to control not just drivers’ behavior but also that of the  repair shops. Keep in mind that most people today have the power of a 1990 Cray-II supercomputer in their pocket. With a Bluetooth connector to the OBD port a smartphone app can report fault codes, coolant temperature, fuel pressure, and many other performance characteristics in addition to speed, distance, location, and so forth. The extensive information from the car can be used to analyze and diagnose problems exactly as a mechanic would do. Once again, the information doesn’t have to be perfect or perfectly understood to alleviate the most serious moral hazard problems. If the mechanic says the car needs a new Johnson rod and the smartphone reports no problems, the consumer knows that it’s at least time to seek a second opinion.

 

Reputation Mechanisms

Reputation is one very general way to think about solutions to moral hazard problems. A mechanic with a reputation for honest dealing can earn more business at a higher price. Cheating becomes less valuable when the price is a loss of reputation.

In recent times, information technology has made it easier to observe a seller’s reputation and to contribute to the formation of a seller’s reputation at low cost. Yelp, Angie’s List, and Amazon Reviews all make it easy for past buyers to report their observations on seller quality and for future buyers to observe a seller’s accumulated reputation. And of course it is not just sellers who are rated but workers too are evaluated in a variety of ways; for instance many employers check a worker’s credit rating, or on-line history, before making a hire. We may be creating some privacy problems with these techniques, but the old school issues of asymmetric information are drying up rapidly.

Early reputation mechanisms were one-way, namely that buyers would generate reputations for sellers, but now the ratings often go both ways. Many of the exchanges in the sharing economy, including Uber (transportation), Airbnb (accommodations), and Feastly (cooks) use two-way reputational systems. That is the customer rates the Uber driver, but in turn the Uber driver rates the customer. Dual reputation systems can support a remarkable amount of exchange even in the absence of law or regulation. The Silk Road marketplace for illegal goods, for example, supported millions of dollars of exchange through a dual reputation system. On the Silk Road it was possible to pay for goods in advance of delivery or to buy goods which were delivered before payment was made. In each case, honesty was maintained through reputation even without legal recourse for contract breach.[4] Thus, in these cases reputation maintained quality even when theories of information asymmetry would have predicted the problematic nature of any exchange at all.

From these examples, however, we can see one major problem of the new information economy, namely a lack of privacy. For instance in the case of cars, it is easy to track where a driver goes, how long he stays there, and perhaps what his or her mood was along the way. Our cellphones track our personal movements, as does Facebook. More generally, online information often gives a fairly complete portrait of who we are, who are friends are, what we do, and many of our views and personal inclinations, including our previous infractions and perhaps also our personality defects. By no means is this all bad, because in large part we are able to project an image out into the world and match better with friends, partners, and jobs. Still, by no means does everyone feel privacy limits are set in the right place, and ours may become a world where second chances are harder to come by.

If you have a criminal record, or have behaved badly in the past, it is hard to create a new social identity when so much information is available online. Conceivably this could mean too few chances to recover from mistakes. In theory, rational actors can always discount low-quality information, but most people aren’t Bayesian. It’s telling that the legal system often prevents juries from hearing relevant information about both criminal defendants and victims. In a Bayesian world this makes no sense, but if people overreact to certain types of information, less information may result in better decisions.

Private and social returns to information may also differ. Each employer may find it cheap to discriminate against potential employees with an arrest record, for example, but when all employers discriminate in this way, a large class of people may find it difficult to find employment, and that in turn may increase recidivism.

Even for people who have done nothing wrong there will be greater risk aversion ex ante. We will all work too hard to avoid the perception of having done something wrong. If there are no second chances then second thoughts become ever more important. Perhaps we shouldn’t send that tweet, write that blog post, or contribute to Cato Unbound! Even if there are no repercussions today, we don’t know how the future will judge our past.

Even when a privacy “opt out” is allowed, a problem remains. Those individuals who wish to keep more privacy often have to forsake the benefits of modern technology and return to the earlier, more costly world of asymmetric information. We can all think the trade-offs are worth it, “all things considered,” and still see problems with how part of those trade-offs are working out.

It’s possible that advances in cryptology may create reputation mechanisms that  are compatible with the demand for privacy. One of the most remarkable discoveries in computer science and cryptological research, for example, has been that reputation is compatible with anonymity and can be leveraged across markets with different pseudonyms (Camenisch & Lysyanskaya 2001, Androulaki et. al. 2008). You can buy and sell on eBay for instance, without having a publicly known name, and yet still reap the benefits of the modern reputation economy. One frontier set of issues is what the demand for such systems might be like and how far such mechanisms might be extended. At the moment this remains an open question.

 

Principal-Agent Problems

These problems have a common structure, namely that principals hire agents to produce output. Output is a function of agent actions and also noise. Agents know their actions but principals do not, and so principals must infer agent actions from output and the structure of noise. Incentive design theory provides lessons on how principals can optimally infer agent actions and how rewards should be structured to best navigate the tradeoffs between putting too much or too little risk on the agents (Prendergast 1999).

One simple solution to principal-agent problems is to reduce the information asymmetry so that principals better observe agent actions. Consider the parcel delivery firm UPS. UPS monitors the mechanical performance of all of its trucks and their location, speed, and braking behavior. UPS also knows every time a truck starts or stops, when a door is opened and closed, and whether a driver is wearing his or her seatbelt, among other pieces of information. UPS uses this information to optimize production routes. The number of stops and starts required to deliver packages is minimized. Routes are matched to the vehicles that get better mileage at the speeds the routes require, and so forth. Driver actions on the same routes are also compared to ensure that all drivers are behaving with maximum efficiency.[5] UPS estimates that a savings of one minute per day per driver increases profit by $14.5 million over the course of a year.[6] As a result of its technology, UPS, the principal, knows more about the actions of its agents than the agents themselves. That is a reversal of principal-agent theory, and that state of affairs is characteristic of the new information revolution.

Even simple information can be used to overcome many principal-agent problems, even in lower technology settings. A random sample of teachers in India found that about a quarter are absent on any given day (Kremer et al. 2005). In a field experiment, Duflo, Hanna, and Ryan (2012) showed that requiring the teachers to take a picture at the start and end of each day showing themselves and their students reduced absentee rates by over 50%, with resulting significant improvements in child learning and achievement. Systems like this are so cheap they are being moved from field experiment to practice. In 2014, India introduced a system that logs the entry and exit times of government workers. The system uses cheap fingerprint scanners to avoid cheating, and all of the information is publicly available in real time at http://attendance.gov.in/. Currently, over 80,000 government workers in New Delhi are logged and another 35,000 are logged by similar system in the state of Jharkhand (http://attendance.jharkhand.gov.in/). The system only logs entry and exit time, but failure to show up for work is likely the most important principal-agent problem in this setting.

Government workers in the United States are also coming under greater monitoring, most notably police officers. Inconsistencies between police reports and later discovered cell phone video recordings indicate that often the police behave worse than they let on. Many localities are now debating whether to require police to wear body cameras. A randomized controlled trial found that after body cameras were put into place, reports of use of force fell by more than half as did the number of complaints against police officers (Ariel, Farrar, Sutherland 2014).

Many “public choice” problems are really problems of asymmetric information. In William Niskanen’s (1974) model of bureaucracy, government workers usually benefit from larger bureaus, and they are able to expand their bureaus to inefficient size because they are the primary providers of information to politicians. Some bureaus, such as the NSA and the CIA, may still be able to use secrecy to benefit from information asymmetry. For instance they can claim to politicians that they need more resources to deter or prevent threats, and it is hard for the politicians to have well-informed responses on the other side of the argument. Timely, rich information about most other bureaucracies, however, is easily available to politicians and increasingly to the public as well. As information becomes more symmetric, Niskanen’s (1974) model becomes less applicable, and this may help check the growth of unneeded bureaucracy.

Cheap sensors are greatly extending how much information can be economically gathered and analyzed. It’s not uncommon for office workers to have every key stroke logged. When calling customer service, who has not been told “this call may be monitored for quality control purposes?” Service-call workers have their location tracked through cell phones. Even information that once was thought to be purely subjective can now be collected and analyzed, often with the aid of smart software or artificial intelligence. One firm, for example, uses badges equipped with microphones, accelerometers, and location sensors to measure tone of voice, posture, and body language, as well as who spoke to whom and for how long (Lohr 2014). The purpose is not only to monitor workers but to deduce when, where and why workers are the most productive. We are again seeing trade-offs which bring greater productivity, and limit asymmetric information, albeit at the expense of some privacy.

As information becomes more prevalent and symmetric, earlier solutions to asymmetric problems will become less necessary. When employers do not easily observe workers, for example, employers may pay workers unusually high wages, generating a rent. Workers will then work at high levels despite infrequent employer observation, to maintain their future rents (Shapiro and Stiglitz 1984). But those higher wages involved a cost, namely that fewer workers were hired, and the hires that were made often were directed to people who were already known to the firm. Better monitoring of workers will mean that employers will hire more people and furthermore they may be more willing to take chances on risky outsiders, rather than those applicants who come with impeccable pedigree. If the outsider does not work out and produce at an acceptable level, it is easy enough to figure this out and fire them later on.

 

Escrow Systems, Artificial Agents and Malleable Memory

When two parties do not trust one another, they may be reluctant to trade if information about the quality of the merchandise or payment cannot be quickly observed. An escrow system increases trade by introducing a trusted third party. The traders convey the merchandise and payment to a third party who makes the transfer if and only if the merchandise and resources satisfy the conditions of the traders.

Trusted third parties may themselves be difficult to find or expensive. It’s possible, however, to create trusted third parties in software. Using a blockchain based system of decentralized money, for example, contracts can be created which execute only when certain conditions are met; for example the S&P 500 rises by 4% or more on a day when the Nikkei falls by 5% or more. Moreover, such trustworthy contracts can be created with neither of the parties knowing the identity of the corresponding party.

Traders are sometimes reluctant to trade because even a bid or ask can reveal information the trader doesn’t want revealed. Escrow systems using software can solve many of these problems. A simple but telling example is the expression of interest in dating another person. Revelation of interest can be uncomfortable, especially as it may not be reciprocated. Phone apps like Tinder allow users to express interest in other users, but the users are not able to contact unless both express an interest in each other. In this case, the double coincidence of wants is not a problem but a feature. The usefulness of the Tinder app in overcoming the information asymmetry problem is indicated by its user base of 50 million, who together make millions of connections a year (Bilton 2014).

The evolution of artificial intelligence suggests yet further ways of overcoming information asymmetries. Arrow (1963) argues that one problem with the market for information is that it is difficult for the buyer to know the value of the information without knowing the information itself. Once the information is known, however, the potential buyer need no longer purchase it.[7]

A third party escrow system can solve this problem by making the exchange if and only if the third party judges that the buyer would value the information at more than its price if only the buyer knew the information. Two difficulties with the third party escrow system are, first,  that the third party must be trusted by both not to use the information that it has acquired for its own purposes, and second, the third party must be trusted to accurately represent the buyer when judging whether the buyer would value the information at its price. Both of these problems can be solved by making the third party an artificial intelligence.

An artificial intelligence can be trained to evaluate information on behalf of the buyer (or seller). Some such systems have already been noted, such as a bitcoin system that makes a financial exchange only when certain conditions have been met. In this case, the artificial intelligence need only consult publicly observable information. Much more is possible, however, as A.I. systems grow in power. In a potential buyout, for example, a buyer’s A.I. system might be given access to a corporation’s internal financial reports. It would then report back to the buyer whether the corporation was a good buy at the proposed price, and if necessary the memory of the A.I. could be wiped. In this way, the A.I. would report back only a yes or no, easing the transaction but keeping the core information confidential.

 

Conclusion

A lot of economic theories about asymmetric information, while logically correct, have been rendered empirically obsolete. We are not suggesting that this new world is perfect in every way, and indeed privacy is one of the major concerns. Still, the passing of many information asymmetries will lead easier trade, higher productivity, and better matches of people to jobs and to each other.

These changes also cast new light on the costs of a political system that  produces many new regulations but repeals very few old ones. The American regulatory apparatus is increasingly out of date. It is geared to problems that peaked in the previous generation or even earlier. We should revisit the topic of regulatory reform, with an eye toward making more regulations temporary, or having automatic sunset provisions, unless they are consciously and intentionally renewed for reasons of their continuing usefulness.

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Tyler Cowen and Alex Tabarrok argue that technological developments — most notably advances in digital technology — have reduced and in some cases eliminated asymmetric information in certain markets. According to now-standard economics, we can therefore expect markets to operate more efficiently if left to their own devices. Importantly, regulations that were justified on the basis of the existence of asymmetric information may no longer be required.

There are two aspects to their claim. First, does the elimination of asymmetric information reduce the need for certain regulations? Second, is it the case that technologies are eliminating information asymmetries, or are there other forces at play? I will deal with each in turn.

 

Information and Market Failure

As is typical, the first hurdle for promoting government regulation is the identification of a market failure. Alongside externalities and missing markets, information asymmetries have been used to justify many interventions. This comes up most strongly in consumer protection laws; that is, are firms supplying the products that consumers thought they were buying? We have many situations when a product’s quality — while it might be known to a seller — might be hard for a buyer to assess without experience, sometimes over a long time frame, with the product itself. If, for example, your front-load washing machine is designed so that with normal use over a number of years mold arises internally, it is hard to know that at the point of sale. Sales of such machines may harm consumers but, equally, fear of them may constrain prices for new products.

The fundamental issue is that product quality could itself depend on price. For instance, in Akerlof’s famous lemons paper, the reason used cars for sale were of low quality was because no consumer was willing to pay a high enough price to encourage high quality used cars to be put up for sale. The end result was not direct harm to consumers — they expected lemons and got them — but instead, harm to high quality sellers. That is, the existence of bad products was driving out the good.

Cowen and Tabarrok demonstrate that information on car quality, for example, is now more readily available. But does that mean that government sanctions against tampering with odometers play no role? Even if we could imagine that odometer readings of cars were transmitted and made available publicly (ignoring for the moment whether that would be a good idea for privacy reasons), the creation of a distribution of prices based on those readings will create a large incentive to hack odometers. While it may operate in the background, a potential government sanction can give buyers some recourse and high quality seller’s a better return. Thus we need to be cautious about jumping to conclusions, as regulation may still underpin the more reliable information that has come to exist.

 

Technology and Information Asymmetries

The second part of the Cowen-Tabarrok thesis is that technologies are eliminating information asymmetries. In particular, better and more public reporting allows consumers to more readily benefit from the experience of others. Importantly, one can imagine that having open ratings and reviews has assisted greatly in the emergence of e-commerce, whereby consumers must purchase without a physical presence. We also know from HBS’s Michael Luca that ratings for restaurants through Yelp have allowed more traffic to be driven to higher quality outlets, especially when those outlets do not have an independent reputation (such as being part of a chain).^[1]

How far can we push this? Consider the association between better information regarding used car quality and used car sales. Government regulations may have assisted in this, and technologies may assist further. But over the same time period, the cars themselves have become more durable and hence more likely to have multiple owners. In addition, overall wealth has increased, which may have led to a greater intrinsic desire to turn over cars more quickly. These factors may have increased the value of a market for used car sales above and beyond changes in information asymmetries. This, in turn, in the absence of regulation may have given rise to intermediaries who resolved the informational issues. Once again, we have difficulty inferring the precise role of regulation here.

But with all of this additional monitoring — and that is essentially what it is — we should also be concerned about the use to which the new information is put. For instance, we have seen an explosion in surveillance cameras as they have become cheaper. Some of these are for law enforcement. Some of these are for private security, including the monitoring of customers and employees. In relation to employees, Cowen and Tabarrok claim that the improved monitoring could reduce the informational rents earned by workers and hence reduce their cost to employers. That is surely true. However, there may be other inefficiencies and concerns that arise.

Surveillance is owned by the surveyor.  In consequence an employer can use the information they gather selectively; for example, they may sanction an employee who cannot prove they were working rather than shirking. The employee becomes vulnerable to rent extraction based on selective information the employer can gather in a more powerful situation. To be sure, I am constructing a theoretical possibility, but what is fundamental is that increased monitoring may not reduce informational asymmetries but may increase them in certain ways.

This issue has emerged most strongly in recent times when it comes to video and other digital monitoring of police actions.  The way in which this is being proposed — namely, police dashboard and body cameras — means that, in some sense, the monitor is doing their own monitoring. Such measures won’t protect anyone if the camera might fail at a convenient moment.

To counter surveillance’s potential lack of integrity, my University of Toronto colleague Steve Mann has invented the term sousveillance, in which the surveyed monitors the surveyor. Our idea, following from this, is that when both parties have their own digital record of an event, those records have integrity that makes them useful in contracting. Without this, there is a fundamental limit to monitoring.^[2]

 

Conclusion

The use of technologies to monitor product (both physical and human) quality is something that is generally welcome. It certainly challenges rationales for regulation (e.g., that licensing is required for taxis or hotels) but it is far from giving us confidence that regulations designed to preserve the integrity of monitoring technologies (after all, that is what an odometer is), can be abandoned. I suspect that these technologies will raise more issues and distinct regulatory roles than we appreciate right at the moment.

 

Cowen and Tabarrok are on target with this piece on the “end of asymmetric information.” It is an especially relevant point for policymakers concerned with innovation and competition in medical practice. For decades, asymmetric information—the inability of consumers to judge medical professionals—has been the go-to defense for state-level licensing activities.[1] However, rather than protecting consumers, state-level regulation has served as a vehicle for politically powerful physician groups to limit both the supply of physicians and the scope of practice of non-physician clinicians.[2] This has protected physicians from competition, limited access to care, and stifled efficiency-enhancing structural innovations in the provision of medical care.[3]

 

Access to Information

As in the other cases mentioned by Cowen and Tabarrok, some of the credit for retiring the asymmetric information defense for state medical professional licensing must go to improved technology. Information has been gathered in a more systematic fashion and it is more accessible to market participants. In particular, this has improved medical malpractice underwriting. One of the most significant consequences is that medical professional liability insurance is now experience rated.[4] In the past, doctors paid premiums based on impersonal factors—their location and specialty. Now they pay premiums that reflect their past performance and personal practice characteristics. Poorly managed practice risk can increase premiums by 500%. In addition, malpractice insurance contracts may require a physician to take specific actions to improve patient outcomes. In severe cases, individual physicians are denied malpractice insurance altogether. This creates strong incentives for risk management on the part of physicians.

Access to information has benefited consumers in other ways. Information available online has made it easier for individuals to select a doctor. Digital data sources have lowered the costs to hospitals, managed care organizations, health maintenance organizations, and health care insurance companies of evaluating the physicians with whom they contract or associate. Armed with information, these organizations can make better quality decisions. As a result, they may deny or limit hospital privileges or pull problem physicians from their panels or practices. These private enterprises are in a good position to evaluate and detect abnormalities in practice patterns or outcomes.

With so much access to data, it has become nearly impossible for physicians to hide their past questionable practices by moving across state lines.  Hospitals have access to the federal government’s National Practitioner Database. The public can go to the Federation of State Medical Boards’ DocInfo site for information one could not glean from a state license, such as disciplinary actions and medical specialty board certification. Also, individual states are increasingly making detailed information about medical professionals available online.[5]

Ironically, access to information has allowed researchers to examine the record of the state licensing boards. The evidence suggests the state boards have done a poor job; they have failed to identify the majority of risky physicians.[6] In addition, information that might help consumers make choices – for example, when a physician is taking part in a drug rehab program – is not made public.

 

Beyond Technology

Certification and Brand Name: In addition to the technology-related advances in access to information, there have been other relevant developments that weaken the case for state regulation. The first is the substantial growth in private certification of all types of medical professionals. Today it is estimated that over 80 percent of U.S. physicians and almost all newly minted physicians are medical-specialty-board certified.[7] State licensing is not specialty-specific, but knowing a physician’s specialty is a key component of consumer choice. Medical specialty board certification is so valuable as a measure of specialty-specific competence that it is advertised by physicians practicing medicine abroad (as in Thailand). And there has been a significant increase in the use of brand name in health care, as well-respected providers (Cleveland Clinic, Kaiser Permanente, and the Mayo Clinic, among others) are leveraging their reputations across the country. The addition of certification and brand name make it easier for consumers to assess physician competence, further reducing information asymmetries.

Liability: Perhaps the most critical development when it comes to consumer protection in health care markets has been the expansion of liability for medical malpractice. Liability initially rested with independent physicians. It has been expanded by the courts to include the providers who hire physicians, hospitals that credential and privilege physicians, and even, to some extent, the managed care organizations and insurance providers who include physicians in their networks or panels. Not only are their reputations at risk, but legal liability works to align their incentives with those of the patients they serve. Combined with the recent dramatic shift away from independent practice to direct employment of physicians by health care providers, growing institutional liability creates a strong incentive for oversight, a level of oversight it would be unrealistic to expect from a state agency.

 

Doctors Benefit from Restrictions to Entry

The state medical professional licensing apparatus has grown to be an important tool for the physician lobby, one which can be used it to reduce competition for physician services by limiting the scope of practice of non-physician clinicians (advanced practice nurses, physician assistants, podiatrists, pharmacists, etc.).[8] The variation across states in the influence of physicians has led to differences in what non-physician clinicians are allowed to do. Researchers have found that in states where clinicians are permitted to work up to the limit of their certification, non-physician clinicians provide a level of care equal to that of physicians. However, many states continue to limit the scope of practice of non-physician clinicians (for example, advanced practice nurses may not be allowed to prescribe drugs) to protect physician interests.

All states defer to the Liaison Committee on Medical Education (LCME), jointly managed by the American Medical Association and the Association of American Medical Colleges, to determine which medical education programs are acceptable. Only graduates of LCME-accredited programs qualify for state licenses. This gives these organizations veto power over innovations in medical education in the United States. It also gives them control over the number of seats in medical schools and, therefore,  control over the supply of physicians.[9]

State licensing laws have gotten in the way of innovations such as retail clinics and telemedicine, both of which have the potential to lower health care costs and improve access to care. State licensing laws preclude charitable organizations from bringing physicians across state lines to serve indigent populations.[10]

 

Conclusion

Cowen and Tabarrok are exactly right that asymmetric information is less of a problem given today’s technology. When it comes to health care, improvements in technology, along with changes in liability, certification, medical malpractice underwriting, and increased use of brand name offer protection against inept or malfeasant practitioners. But don’t expect the American Medical Association or other physician-funded lobbying groups to renounce state licensing of medical professionals. After all, the state regulatory structure has allowed physicians to maintain a position of inordinate power and influence in medical labor markets.

Hayek conceived of a market economy as a sort of decentralized calculator. Participation by consumers and firms allows private information about technology and preferences to be communicated to the market which then summarizes the data in the form of prices. Transactions at these prices then allow goods and services to flow to their most efficient use.

Viewed from this perspective, information is a crucial input in an efficient allocation of resources. Asymmetric information is a friction on the system because it creates pockets of informational monopoly. Just as classical monopoly rents flow to an agent with exclusive ownership of a productive asset, when information is exclusive its holder can extract information rents from the market, typically by inefficiently distorting the terms of trade in her favor.

Alex Tabarrok and Tyler Cowen argue persuasively that advances in information technology are changing this equation. Let me discuss several caveats to their conclusions.

 

The End of Asymmetric Information?

There is no disputing the premise that technological advances are resulting in better information. But better information doesn’t imply more symmetric information. This is true even if the information is available to all parties. Consider genetic testing. A test that is highly predictive of a future disease creates symmetric information about health outcomes but at the same time probably creates asymmetric information about what really matters for market outcomes: the patient’s future health care costs. Indeed, health insurance companies will have exclusive access to a wealth of data that predicts the future costs of an applicant with a given array of genetic markers. Thus what would appear at first glance to level the informational playing field in fact will likely only shift information rents from patients to providers. There is no telling if this will lead to better or worse market outcomes overall.

 

The End of Market Failure?

There is however a far more sobering caveat to the apparent benefits of improved information technology. First, let’s remind ourselves why health insurance markets exist in the first place. Its not because we have any fundamental need or desire to accurately price health risk. A market price for risk is just one way of approaching the true fundamental objective of any insurance institution: to share risk.

Everybody has some chance of suffering an economic loss due to poor health or other risks. The uncertainty that creates is intrinsically undesirable. Insurance is how we smooth out those fluctuations. It involves transfers to those who suffer a loss from those who don’t. The feasibility of such transfers reduces risk and improves overall welfare for everyone.

Were we to actually see the end of asymmetric information then for sure the efficiency of markets for health insurance contracts will improve dramatically. With improved testing and symmetric information about the future health outcomes of the insured, contracts will be negotiated to reflect as accurately as possible the likely costs. Adverse selection will no longer be a source of market failure.

However, as a direct result of this, health insurance markets will cease to be a useful institution for actually providing insurance, i.e. sharing risk. That’s because every patient will be fully exposed to 100% of their health care risk in the form of the price they pay for their customized policy. This is called classification risk and there is a sort of conservation law that binds on any market-based insurance institution: you can eliminate classification risk, or you can eliminate adverse selection, but you can’t eliminate both.[i]

 

Markets for Information

Besides, information doesn’t come for free. It must be produced like any other good or service. If we expect dramatic changes in economic institutions due to the availability of information, then a lot is riding on the proper functioning of markets that incentivize its production. These markets are riddled with their own failures.

To begin with, information wants to be a public good (to correct a phrase). Like all public goods we can’t expect markets to provide the socially efficient amount of public information. But for information to be symmetric it must be public at least to some degree. To make profits, information providers will find a way to lessen the free-rider problem by selling exclusive access to information. In other words we should expect market incentives to frustrate rather than facilitate The Great Symmetrization.

Indeed the net effect of improved information technology could very well be more overall regulation rather than less once we account for all the new regulation of information markets that will be necessary to reap the benefits—and avoid the pitfalls—of improved information. To be convinced of this it’s enough to think of all the information-based regulation of lending markets intended to constrain lenders who are presumed to be using their informational advantage to prey on unsuspecting borrowers. Imagine those sentiments applied to futuristic insurance providers who have sequenced their clients’ genomes to forecast their health status.

To see the kinds of market failures caused by decentralized production of information look no further than the current hand-wringing over the “higher-education bubble.” Tremendous resources spent on providing a college education appear (to some) to be little more than a massive over-production of information (“signaling”) incentivized by market forces.  Indeed as a general principle the mere availability of high-quality certification creates a kind of informational rat race which compels all suppliers to invest in certification. The overall welfare effects are ambiguous.[ii]

 

The End of Markets?

Fortunately we are in fact very far from the end of asymmetric information. But it’s a fun exercise to think about how we will know when we’ve truly reached that stage. Might I suggest that Hayek again has the answer? According to Hayek the superiority of a decentralized market economy – the main reason to live with all of the classical failures of market power, externalities, and public goods – is that it’s the most efficient system of collecting and aggregating asymmetric information.

So the way we’ll really know that the age of asymmetric information is over is that the age of markets will be over too. That’s probably a long way off.

 

Notes

Shortly after our Cato Unbound article appeared, The New York Times ran two stories about the end of asymmetric information. The first discussed a new form of insurance now being offered in the United States:

Andrew Thomas’s life insurer knows exactly when he arrives at his local gym. The company is notified when he swipes his membership card, and 30 minutes later, it checks that he is still there, tracking his location through his smartphone.

The insurance company has a vested interest in keeping Mr. Thomas alive and well. In return for sharing his exercise habits, his cholesterol level and other medical information, Mr. Thomas, a 51-year-old medical publisher who lives in Johannesburg, earns points, which translate into premium savings and other perks.

That is yet another example of the evolution of private information into common knowledge, in this case knowledge about Mr. Thomas’s proclivities for exercise.

The second example was the killing of Walter Scott by a police officer. After a cell phone video of the shooting surfaced, the claims of the officer were quickly shown to be false. Not long ago this major injustice would probably have been a neglected police report. Today it is a national scandal likely leading to greater adoption of police body cameras.

None of the commentators either at Cato Unbound or on the web appear to dispute the thrust of our argument that information about buyers and sellers, workers and firms, principals and agents is becoming more easily available and more evenly divided. Much more, in fact. Some wish to dispute the conclusions we draw or the conclusions they think that we draw from this phenomenon, but our actual central message stands unscathed.

We first clarify a few confusions evident in some readers’ comments on our paper.

It is important to remember that the opposite of asymmetric information is symmetric information, not perfect information. That is a simple distinction, yet it’s one that many commentators, such as David Auerbach writing at Slate, fail to recognize. Information will always be imperfect. Uncertainty and risk will never be banished. Uncertainty and risk, however, do not in general create market failure (indeed in the case of insurance and gambling, uncertainty and risk create markets).

We don’t even have perfect information about our own tastes. In this setting, when one of us orders a product that does not meet our expectations, what do we do? Most of the time, we return it. Rather than living in a world dominated by moral hazard, we live in a world dominated by firms so eager to sell quality products that they will often guarantee our satisfaction or take the product back for any reason with full refund (sometimes less postage).

Of course, some products such as durables may not develop observable problems until well into their lifetimes and so are not easy to return. Yet it’s important to realize that in a competitive marketplace this is a problem for firms as much as for consumers. Our model of reduced information asymmetry, however, predicts that durables will increasingly be provided with greater guarantees and bundled service plans. In the past, firms did not offer such plans because they feared our moral hazard. A firm that can monitor the use of the durable, however, will willingly offer more guarantees and return plans. Rolls-Royce, the British manufacture of jet engines, for example knows so much about how and when its engines are being used that it makes most of its money not by selling engines but by renting them by the hour, along with a promise to maintain and replace any engine that breaks down. Similar rental contracts already exist for consumer durables such as automobiles, and we predict they will become more attractive as the renting firms can monitor the use of the vehicle with greater ease.

A number of commentators pointed to extensive price discrimination as contradicting our argument. It’s true that more information and search capabilities on the consumer side are likely to lead to more competition, but more information on the seller side can lead to more price discrimination, such as personalized pricing. The latter effect is just another implication of the decline of privacy, as we discussed. There is no necessary contradiction, however, between greater competition and more price discrimination. Indeed, when fixed costs are high and marginal costs are low, personalized pricing will tend to increase output, consumer surplus, and welfare (Varian 2005, 2010).

Joshua Gans and a number of others suggest that we are predicting or promoting the end of regulation. But that is a misreading. In fact, government regulation has sometimes helped to overcome problems of asymmetric information. Our example was the Truth in Mileage Act of 1986, which requires that sellers disclose and record the odometer reading on the car’s title at every transfer. We would support further efforts to make odometer readings collected at inspections easily available online by Vehicle Identification Number. As another example, we think that calorie counts and ingredient labeling have had benefits, albeit small ones. How about requiring that firms provide the same labeling information tied to a barcode or QR code that consumers could easily scan with a cell phone? That would allow shoppers to easily access information via algorithm to create personalized recommendations (eat this, not that). Weight Watchers already offers a phone app with similar capabilities, but regulation could make this information more easily and universally available at lower cost.

More generally, our belief is that government regulation which helps buyers and sellers to make better choices is superior to government regulation that prevents choices. As another example of a government regulation ripe for improvement in the information age, consider the Food and Drug Administration’s (FDA) regulation of pharmaceuticals. Rather than following the old paternalism model of banning products unless they pass a one-size-fits-none rule, it may be better to think of a Consumer Reports model for the FDA. Consumer Reports rates and recommends but it doesn’t ban. An FDA that focused on information provision would collect, analyze and make information more easily available but it would leave more treatment choices to be made by patients and their physicians.

We agree with Shirley Svorny, by the way, that the asymmetric information argument has been used far too often to protect rents, including the protection of physicians and dentists from greater competition from nurse practitioners and dental hygienists.

The government also has access to a wealth of information about education and health from administrative records on school children and Medicare recipients. Making this information more easily available—in suitably anonymized form—could similarly improve market efficiency, education and health. Chetty, Friedman, and Rockoff (2014), for example, use school district and tax records from more than one million children and their families to show that value added scores for teachers do a good job measuring teacher quality and that high quality teachers increase the earnings of their classrooms by hundreds of thousands of dollars in present value.

We pointed to reviews, ratings and recommendation systems as new sources of information to overcome moral hazard problems. It’s true that these systems are themselves subject to attack and manipulation and signal jamming. Unlike physics, however, there is no theorem in economics that says that every action creates an equal and opposite reaction. The advance of information symmetry is a case of daily progress averaging 3 steps forward and 1 step back. If reviews were so gamed as to be useless, for example, people would stop using them and services like Airbnb would shut down as markets reverted to the old equilibrium. Yet we don’t expect services such as those offered by Airbnb, Yelp, and Angie’s List to shut down anytime soon. In fact those companies and others providing similar information services have high market valuations.

Jeff Ely writes about genetic tests and how the information advantage may shift to insurers. Tabarrok (1994) long ago discussed potential problems for insurance with genetic information and suggested a solution, genetic insurance. Let’s assume this isn’t possible. Ely’s argument is that instead of asymmetry on the buyer side, the superior information will be held on the insurer side: “health insurance companies will have exclusive access to a wealth of data that predicts the future costs of an applicant with a given array of genetic markers.” That outcome is not obvious, as consumers will be able to access information about their own genes from services like 23andMe, again assuming the government doesn’t prevent such markets.  Furthermore it may be possible to provide basic information about costs based on genes in an intelligible form.

But still, let’s assume Ely’s premise is correct. If insurance buyers have greater information than sellers, markets may fail to exist, a negative outcome. But if, as in this hypothesized case, insurance sellers have more information than buyers, the result is not usually so grim. Indeed, contra Ely, with competition in insurance the insurers won’t even earn an information rent. Honda knows much more about the cost of building a car than we do, but they don’t earn a significant information rent from that knowledge. Even with some degree of monopoly, information rents on the sell side won’t cause markets to shut down. As long as prices are free to adjust, something close to actuarially fair insurance still should be available, albeit with segmented rates for different classes of buyers according to risk. There will be less pooling, and some welfare losses as a result, but note we discussed that shortcoming in our initial essay.

Ely also suggests, or seems to suggest, that the end of asymmetric information will mean the end of markets and thus should be rued (we are not quite sure how to read him here). We should keep in mind a distinction between asymmetric information and dispersed knowledge. Dispersed knowledge is the broader concept, and it includes knowledge of particular circumstances of time and place, such as tradeoffs in local production possibilities or knowledge of local demands and consumer preferences. As Hayek emphasized, the market does not require perfect knowledge to function, rather it is the means by which imperfect knowledge is made to function in the social interest. The case for the market in minimizing production costs, incentivizing the satisfaction of consumer demands and spurring innovation remains robust. But when it comes to dealing with the very specific problem of systematically asymmetric information, there we see the informational playing field leveling in many sectors. That blend of developments won’t render a market economy obsolete anytime soon, though it should change the proper scope of regulation.

Ask yourself the following question. If the amazing proliferation of information, monitoring, and quality evaluation in recent times does not render at least some regulation obsolete, or in need of revision, than what kind of information developments might do so? Once the question is phrased in such terms, it becomes obvious that a) information asymmetries are diminishing significantly, and b) the nature and extent of government regulation really does need to change.

 

References

Chetty, R., Friedman, J. N., & Rockoff, J. E. 2014. Measuring the Impacts of Teachers II: Teacher Value-Added and Student Outcomes in Adulthood. American Economic Review, 104(9): 2633–79.

Varian, H. R. 2004. Competition and market power. In H. R. Varian, J. Farrell, & C. Shapiro (Eds.), The Economics of Information Technology: An Introduction (pp. 1–47).

Varian, H. R. 2010. Computer Mediated Transactions. The American Economic Review, 100(2): 1–10. Retrieved from http://www.jstor.org/stable/27804953

Tabarrok, A. 1994. Genetic testing: An economic and contractarian analysis. Journal of Health Economics, 13(1): 75–91.

 

I’ve enjoyed this discussion, and it raises two issues I’d like to address. First, Joshua Gans says “it’s not the end of regulation.” But it is important to distinguish between the category of regulation and that of laws that are designed to facilitate market exchange, such as legal penalties to protect market participants when fraud occurs. Increasing penalties for changing a car’s odometer reading fall in the latter category. Market participants benefit from laws that protect them in transactions. These laws reduce the costs of engaging in transactions. Market participants know that they have some legal protection and recourse to court awards that reduce the size of the loss if they trade with a partner who engages in fraud. This reduces the costs of market transactions (such as buying a used car) and facilitates trade. These remedies are not in the same category as government interventions to protect consumers.

Gans seems to have more faith in a government agency when it comes to consumer protection than the market, despite the incentive problems associated with getting government agencies to act in the public interest. He talks about the need for government evaluation of front-loading washing machines, “designed so that with normal use over a number of years mold arises internally.” It is not clear that a government agency would be able to say much about those machines at their introduction, and the market consequences for firms that introduce shoddy products are severe. The evidence from the regulation of physicians is that agencies hide information from the public and fail to identify the majority of malfeasant physicians. Regulatory capture is a well-recognized phenomenon.

Gans suggests employees “who cannot prove they were working rather than shirking” will be sanctioned by a firm, making the workers “vulnerable to rent extraction.” I have to ask why it would be in the interest of the firm to adopt a policy that would tarnish its reputation in the labor market and subject it to potential law suits (for engaging in fraud) to try to extract rents from its employees? That can’t be good for morale, productivity, and profitability over time.

The second issue I’d like to address is Jeff Ely’s statement that, if “the age of asymmetric information is over…the age of markets will be over too.” The market is not simply, as Ely writes, “the most efficient system of collecting and aggregating asymmetric information,” it is much more. In their response, Cowen and Tabarrok point out that the end of asymmetric information is not the end of information costs which, of course, is true. What Ely is missing is that markets do much more than provide information to participants.

Cowen and Tabarrok aptly describe the role of the market’s price mechanism in their microeconomics principles text: “A price is a signal wrapped in an incentive.” In a free market, the price mechanism allocates resources by signaling participants (with prices) and encouraging them to move resources (with market incentives—profits and losses) to shift resources to their highest-valued use (as determined by consumers.) So the age of markets can’t be over unless there is some other, less costly, means to signal and motivate market participants to shift resources in response to changes in consumers’ tastes and preferences.