The title of this post is a reference to a wonderful book edited by Dan Klein and Fred Foldvalle. The half-life of policy evidence: How new technologies affect old policy issues.
In this book, we examine some of the arguments presented to justify state intervention, such as Public Goods The argument is not about fundamental reality; it is often merely about technological limitations. As new technologies are developed, the problems associated with public goods and shared resources disappear, and with them the justification for state intervention.
One example of this that I’ve come across recently concerns information asymmetry. When there is information asymmetry in a market, one party has more information relevant to the transaction than the other party. This can lead to suboptimal outcomes. Perhaps the most famous assertion of this issue is in George Akerlof’s famous paper: Lemon market. To briefly summarize, this paper considers the used car market. There is asymmetric information between prospective buyers and sellers of used cars. If I am selling a used car, I know more about the condition of the car than you, the prospective buyer. Naturally, you will suspect that my car is defective, i.e., a car with serious problems. The risk that I may be selling you a defective car will lead you to ask for a lower price. This, in turn, can lead to an adverse selection problem. If used car buyers want to lower their prices to offset the risk of defects, prospects with the best quality used cars will pull their cars out of the market. This, in turn, will make the used car market even more concentrated with defects, further lowering the prices people are willing to offer, and causing the remaining top quality cars to also withdraw from the market. If this process is repeated enough times, the used car market will consist entirely of overpriced junk. At least, that is the argument.
There is also an asymmetric problem in the insurance market: I know more about my life, health, and habits than the insurance companies do. Of course, the insurance companies can try to use broad statistical regularities to explain this. For example, car insurance companies know that teenage boys are a higher risk to insure than middle-aged women, and they tend to charge the former higher premiums than the latter. But this doesn’t completely offset the problem. Car insurance is issued on an individual basis. Perhaps I’m a reckless driver and have just been lucky that I haven’t had an accident recently. This is what I know about myself, but the car insurance companies don’t know. There is asymmetric information here. But like most things in life, it turns out there’s an app for that.
I get my car insurance through my bank, USAA, and a few months ago I found out about an app called USAA SafePilot that can help me influence my car insurance premiums. If I download the app and sign up for the program, my car insurance company gets additional information about my driving habits. That means USAA knows how I drive, how often I brake, and if I use my unlocked phone while driving. And as a result of reducing the information asymmetry between me and USAA, my car insurance premiums went down by 18%. Not bad at all.
In fact, just having this app on my phone changes my behavior while driving. The other day, I was driving home from the gym and stopped at a red light when I saw a particularly impressive sunrise. I was tempted to pull out my phone to take a photo, but then I realized the app would warn me if I was using my phone unlocked while driving, so I put my phone away.
The more general lesson is that markets themselves tend to find ways to deal with market imperfections. There is an information asymmetry between me and the life insurance company, which can be explained by the requirement that approval for a particular life insurance policy requires that I submit to a medical exam for the insurance company to review. The prospect of a market for distressed goods creates an opportunity for companies like Carfax to emerge that help reduce information asymmetry about used cars. And the advent of new technologies such as smartphones can reduce information asymmetry in the auto insurance market in ways that were not available not so long ago.
Arnold Kling said, “When markets fail, exploit them.” Wherever there is a market failure, some entrepreneur sees a market opportunity. The more competition and innovation there is, the better off we are when we can take advantage of that opportunity. And as the pace of innovation increases, the half-life of market imperfections shortens accordingly.
