In this chapter, and again with the invaluable help of Wheelan's book, I will analyze how the markets struggle to solve the problems that the lack of information or the unfair distribution of this among the parties (asymmetric or imperfect information) brings about. “Information matters and the market tends to favor the party that knows more. If the imbalance or asymmetry of information becomes too large then markets can break down entirely”
The Royal Swedish Academy of Sciences recognized the importance of the insights and studies about the problems derived from asymmetric information by granting George Akerlof, Michael Spence and Joseph Stiglitz the Nobel prize in 2001.
Common examples of asymmetric information markets are the second-hand car market, the labor market, the insurance business... When one of the parties infers that she doesn´t have full knowledge of the details under negotiation, the biased decisions taken may result in:
- A rational discrimination issue. I.e: in a job interview where the employer doesn´t know the applicant, a female candidate can be easily dismissed because there high probabilities that women get pregnant and take maternity leaves. Moreover, statistics prove that women are more prone than men to take care of child-rearing responsibilities and even leave jobs. In cases where race, sex or minorities show a statistical disadvantage, the more information available the better.
- Inefficiency and vested interests that lead to undesirable outcomes. For instance, in private health care, neither individuals or the doctor pay for the final costs of a specific treatment. The doctors can be tempted to ask for expensive, “not always necessary” tests “just to be sure” and avoiding a future lawsuit, not being challenged by patients that not have better information about their illnesses than such doctor´s diagnosis. When I broke my leg, the first X-ray they took in Urgency care was fairly enough to know that I needed a surgery but when I went to the regular orthopedic surgeon, he asked for an expensive CAT scan “just to be sure”. How did I guess it? He wasn´t finally in charge of my surgery and the final surgeon didn´t even have a slightly sight at the CAT result, he just looked at the first and simple X-ray output to make his final and definitive diagnosis.
Health maintenance organizations have been designed to control costs and many times (at least in USA) patients end up fighting with bureaucrats about a treatment (bureaucrats may have to decide whether to approve or deny a lifesaving treatment!)
“The fundamental challenge of any health care reform should be paying for the “right” treatment – the “product” that makes the most sense relative to what it costs”. Quality and coverage are the basis of Obama´s health care bill recently passed.
- Adverse selection problems or a “Market of Lemons” as Akerlof called it. This is what happens in the second-hand cars market. The asymmetry of information would lead to a market full of low quality used cars, the so-called lemons. The buyer assumes that if the car is high quality, the owner would not sell it so he anticipates the bad quality/shape of the vehicle and demands for a lower price that dissuades high quality cars owners to enter the market.
We can also find it in health care. People with presumable long-term health problems would be more interested in opt in for a health insurance than healthy people. The costs of the former would not be compensated by the costs of the later and the insurance business will fail.
How could this failure be avoided? Via group policies (company benefits packages) with no possibility of opt out (for healthy ones); via thoroughly analysis of the individual cases to get as much information as possible or via “screening” mechanism like price deductibles that would provide incentives to opt out when individuals expect to perform better than average or to opt in otherwise.
A moral dilemma arises. How much information should the insurance companies know? With science advances, any person/company could know the predisposition of an individual to suffer one or another illness just by a simple DNA analysis. If genetic information is fully available, it will become very difficult to get coverage for those prone to illness. Otherwise, laws forbidding to insurance companies to gather individuals past/future information, leave them vulnerable to adverse selection. Doesn´t the state-financed universal health care make sense in those cases?
Any law that enforces a health insurance for everyone, would lead to adverse selection problems only offset in the case that each individual is forced to pay for an insurance. The healthy people would partially cover the high costs of less healthy people. This is called the “personal mandate” and it is in the roots of any state-financed health care.
In all realms of our daily lives, consumers and firms make decisions based on partial or missing information so they create their own mechanisms to solve the problems. The brand/product recognition “is at the heart of the company's success” (I.e.: You know what your are going to eat each time you come into a McDonald's. McDonald's hamburgers are the same in any different country and all McDonald´s restaurants offer equivalent facilities). That is why the firms spend huge amounts of money to build a known brand, an identity for their products, for predictability and for better differentiation from the competition. On the other hand, “branding helps to provide an element of trust that is necessary for a complex economy to function”. We have to trade with people we don´t know and the brand is the tool that smooths the pace and help a party to recognize the other.
Some other examples of tools or mechanisms used to offset the lack of information could be: the message of trust that is inferred out of signs in billboards like “Since 1900” (the business wouldn´t still be there if they would not have build customers confidence); by gathering information from outsiders that certify quality” (I.e. - real-state appraisal or consumers reports); via quality messages such as pleasant, comfortable, nice and elegant offices (in Asia a freezing refrigerated office is a sign of extreme luxury), degrees from high prestige schools, expensive certifications; via a discriminatory racial profiling (“race, age, ethnicity, and/or country of origin can convey information in some circumstances”. It could be against civil liberties but the economists focus on pros and cons, i.e. in a terrorism situation).
Economists study what to do with information but also and not least, what to do with the lack of it.
Time to close this chapter, please, don´t forget to watch The Alternate Side, where Jerry acknowledges for a car insurance.
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