Information Asymmetry in the Information Age

Why the impact of new technologies on markets requires governments to revise their regulatory policies

In their interesting article, Alex Tabarrok and Tyer Cowen discuss the declining relevance of asymmetric information. Information asymmetry occurs when one party has more knowledge about the transaction than the other. Usually this grants that party an undue advantage in the transaction whereas the other faces a higher risk. Taborrok and Cowen explain how various new technologies have provided enough avenues to minimise information asymmetry within the economy. They go on to conclude that this change deserves a re-examination of regulatory policy as most of the theories relating to information asymmetry are now obsolete. This post shows how this conclusion is equally relevant in the Indian context through the following scenarios.

 The Ordeals of a Family Vacation

Till recently, a typical middle income family in India would spend lots of time, effort and money planning their itinerary for their yearly holiday. Better off families would opt for travel agents who could reduce the amount of time and effort required, i.e. the transaction cost. However, the monetary cost would probably increase considerably as travel agents often exploit their customers’ poor knowledge of ticket prices and regulations to increase their profits.

This entire set-up changed dramatically with the advent of online travel booking sites. The entry of sites such as Yatra, TravelGuru, and MakeMyTrip into the market reduced the transaction costs of travel as booking a ticket was now just a click away. Furthermore, these sites supplied travellers with data they could use to make more informed choices. Such data would range from information about weather conditions and popular tourist sites to customer reviews containing user-uploaded photos. The most important contribution of these sites was to reduce the information asymmetry by removing the middle men. By providing limitless options for travel and accommodation, and the option of online payment they enabled middle income families to plan their holidays in hours.

 The Maid Market in India

Information asymmetry can increase the risk of buyers making uneconomic decisions because it often leads to a decline in the quality of products offered in the market. This decline induces buyers to reduce the amount they are willing to pay for the product and can eventually force sellers of costlier and higher quality products out of the market. This creates a market which is dominated by sellers of low quality goods. In economics this is referred to as adverse selection; a good everyday example would be house maids.

With the rise in the incomes and aspirations of middle income India, a larger number of families have started looking for house maids who comply with their living standards. Such families are increasingly looking for maids who understand English, care for hygiene, can cook continental food, handle hi-tech home appliances and are neatly dressed. However, the market for house maids suffers from an asymmetry of information. Households are usually at the losing end of the bargain as each maid has more knowledge of her expertise than the house owner. House owners would try to reduce their risk by initially paying a low wage to the maids. This would price out higher quality maids who value their service at a higher rate and would leave only low quality maids in the market.

This problem has been solved by home maid agencies. These agencies recruit domestic workers or people interested in domestic work and train them according to changing demands within the market. These agencies help domestic workers in finding better opportunities by guaranteeing a higher quality of service provision to house owners.

 The GPS Tracking of Garbage

The principal-agent problem occurs when a person (the principal) hires someone (the agent) to perform certain tasks. However, in most cases the incentives of the agent differ significantly from the principal as the costs incurred are borne only by the principal. The textbook solution is to create incentives for the agent such that it is in his or her self interest to follow the principal’s directions. One such incentive is to share the risk. For example, companies like Infosys pay their CEOs with stock options as a compensation for relatively low salaries. Another method would be to increase the cost of disobedience by monitoring the agents more. An example of the latter method is the use of GPS fitted garbage trucks in Delhi.

Garbage trucks are owned by private garbage disposal services or by municipal corporations. These trucks collect garbage from all across the city and dump it at a particular location. However, the drivers of the trucks have various incentives that interfere with this role. These include profits from reselling the garbage or alternate uses of the truck. In 2013, the Delhi government fitted GPS devices to garbage trucks to track their movements and monitor their work performance. These monitoring systems reduced the information asymmetry between the drivers of garbage trucks and owner of the garbage disposal services.

 Uber: the Escrow Agent

Asymmetry of information can often create distrust between the parties to a transaction. In such cases, escrow agents act as a trusted third party that ensure that parties maintain the standards of performance set by the contract. A simple example of this would be Uber, an international company which operates a mobile app that allows customers to book taxis.

Uber’s legal page describes the company as an intermediary for taxi drivers and people interested in availing their services. This role allows Uber to guarantee that there will be no bargains over fares for customers as well as a regular stream of income for drivers. In doing this, Uber reduces the information asymmetry by providing details about the driver ranging from his current location to his basic profile. This has helped in reducing the transaction costs of cab rides and has empowered customers trying to narrow the information gap.

 In Conclusion

The advent of new technologies has mended multiple market failures by narrowing the information gaps in various economic exchanges. In doing so they have also changed the very fabric of transactions and have thus rendered many theories from the past obsolete. As many regulatory policies were designed on the basis of those theories the onus is on political systems to revise these regulations. When they do so, they must keep in mind the ways in which new technologies have affected information asymmetries. In order to maintain pace with innovations, these policies would have to be time bound and adaptable to the needs of the time.

Tabarrok and Cowen succinctly summarise the challenges of such reforms in their piece:

 These changes cast new light on the costs of a political system that produces many new regulations but repeals very few old ones.

Devika Kher is a Research Associate at Takshashila Institution. Her twitter handle is @DevikaKher

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