The title of this post is a reference to an excellent book edited by Dan Klein and Fred Foldvary, The Half-Life of Policy Rationales: How New Technology Affects Old Policy Issues.
The book looks at how many of the arguments given to justify state intervention – such as public goods arguments – are not intrinsic realities. They can quite often be down to little more than technological limitations. As new technology develops, the issues associated with public goods or common-pool resources can be eliminated, and the justification for state intervention eliminated along with it.
One example of this I recently experienced relates to asymmetric information. When there is asymmetric information in a market, one party has more information relevant to a transaction than another party. This can lead to suboptimal outcomes. Probably the most famous statement of this issue is the famous paper by George Akerlof, The Market for Lemons. To quickly recap, this paper considers the used car market. There is asymmetric information between prospective buyers and sellers of used vehicles. If I’m selling my used car, I know more about the condition of that car that you, the prospective buyer. You might naturally suspect my car is a lemon – that is, a car with significant issues. The risk that I might be trying to sell you a lemon will tend to make you push for a lower price. This, in turn, can lead to an adverse selection problem. When buyers of used cars want to push prices down to offset the risk of lemons, prospective sellers who have the highest quality used cars will pull their cars from the market. This in turn makes the used car market more concentrated with lemons, which further pushes down the price people are willing to offer, leading those with the highest quality cars remaining to pull out of the market as well, and so on. Enough iterations of this process, and the used car market will consist of nothing but overpriced junk. Or so the argument goes.
There is also an asymmetric problem with insurance markets. I know more about my life, health, and habits than insurance companies do. Of course, they can attempt to use broad statistical regularities to account for this. For example, auto insurance companies know that teenage boys are riskier to insure than middle aged women, and will tend to charge higher rates for the former than the latter. But this doesn’t fully offset the issue – auto insurance policies are issued on an individual basis. Maybe I am a reckless driver, and the fact that I haven’t been in any accidents lately is down to sheer luck on my part. This is something I can know about myself, but the auto insurance company doesn’t know – there’s asymmetric information here. But, like most things in life, it turns out there’s an app for that.
I get my auto insurance through my bank, USAA. And I discovered a few months back that there’s an app called USAA SafePilot that you can use to impact your auto insurance rates. If you download the app and sign up for the program, the auto insurance company can gain additional information about your driving habits. So USAA can get a sense of how I drive, how often I stomp on the brakes, whether I’m unlocking and using my phone while driving, and so on. And, as a result of reducing the information asymmetry between myself and USAA, my auto insurance rates were reduced by 18%. Not bad at all.
In fact, simply knowing that I have this app downloaded on my phone itself nudges me to act differently when I drive. The other day I was on my way home in the morning from the gym and stopped at a red light, when I saw that there was a particularly striking sunrise in progress. I was tempted to take my phone out and snap a picture of it – but then I realized that if I did, the app would ding me for unlocking and using my phone while driving, so I kept my phone away.
The more general lesson is that the market itself has a tendency to find ways to address market imperfections. There is asymmetric information between myself and a life insurance company – but that can be accounted for with a requirement that approval for a given life insurance policy requires undergoing a medical exam for the insurance company to review. The prospect of a market for lemons creates an opportunity for companies like Carfax to emerge to help reduce information asymmetries about used cars. And the advent of new technologies like smartphones can reduce the information asymmetries in the auto insurance market in ways that were unavailable not all that long ago.
As Arnold Kling would say – markets fail, use markets. Where you see a market failure, some entrepreneur out there sees a market opportunity. The more competition and innovation there is being put to use to take advantage of those opportunities, the better. And as the pace of technological innovation increases, the half-life of market imperfections correspondingly decreases.
READER COMMENTS
nobody.really
Sep 6 2024 at 4:42pm
Any research on whether cars in the used-car market have become better since the advent of Carfax? I’ll be they have–but mostly because cars are ALWAYS getting better, for reasons that likely have nothing to do with Carfax. So I guess the question is whether we can show that cars in the used-car market have improved more than we would have expected them to improve in the absence of Carfax.
Richard W. Fulmer
Sep 7 2024 at 3:00pm
That’s a great point. Cause and effect are devilishly hard to tease out when so many things are changing at once.
Perhaps the best proof we have that Carfax is making things better is that it’s still in business. Consumers, car dealers, lenders, and insurance companies are unlikely to keep paying for the company’s services if they didn’t believe that they were getting value for their money.
That seems to me to be another good reason to trust the market. Companies that don’t provide value tend to fail. That’s not necessarily true of government programs. Senator Smith is unlikely to admit that his signature policy is a failure, assuming (to take your point) that we can trust studies that suggest that it’s not working. Smith is far more likely to declare that the problem is that things would have been even worse had his policy not been implemented and that additional funding is needed.
Knut P. Heen
Sep 9 2024 at 10:17am
Market for Lemons is a great story rejected by data. The price of used cars drop almost immediately after you have bought it. Asymmetric information increases with experience with the car. Moreover, the car’s service record may eliminate most of the value relevant asymmetric information.
The immediate drop in price may be explained by option theory. A new car comes with many options for customization (color, seats, tech options, etc.). The buyer often exercise these options based on own current preferences rather than future market preferences (resell value). If your brand new pink car sell at a big discount, don’t trick yourself into thinking it is because of your special knowledge of the car.
MarkW
Sep 10 2024 at 8:12am
Another good example of a dramatic decline in asymmetric information is the explosion in online reviews of lodging, restaurants, entertainment, books, cars, and products available on Amazon (which is to say almost everything). This has made life much harder for unscrupulous sellers trying to sell substandard goods and services to one-time purchasers (like tourists), and has reduced the need for both government oversight and expert reviewers — both of which are vulnerable to ‘regulatory capture’. Of course review systems are not perfect, and there are problems with those attempting to game the system with fake reviews, but still, the situation is dramatically better than it was 30 years ago.
A related matter is DIY. It is so much easier to acquire how-to situation specific information that the functional knowledge gap between experts and the general public is much lower than it once was.
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