It’s Not the End of Regulation

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.