George Akerlof’s classic 1970s paper The Market for Lemons introduced the world to the threat that asymmetric information poses to market economics. Taking the used car business as an example, he argued that since buyers of used cars will only pay the average price quoted for cars of a particular vintage, there is no incentive for sellers to place the cars in the market if they know that the value of their car is higher than the average. Since sellers have better information about their cars than buyers, sellers with good cars will always stay out of the market. This will drive the average price of the market ever southwards until eventually the market will be populated, solely, by sellers of lemons.
The impact of imperfect knowledge on market economics is well understood among regulators and many commercial statutes are specifically designed to counteract the effect of knowledge asymmetry. One of the best examples of this type of regulatory intervention is the disclosure obligations placed on companies that seek to raise money in public markets. This requirement to provide information persists in various forms, throughout the life of public companies that generally have higher compliance obligations compared to their unlisted counterparts.
In more traditional markets, the information asymmetry between manufacturers and consumers has long been the subject of regulatory focus. Packaged commodities regulations require manufacturers or packers who sell commodities in packaged form to print detailed disclosures as to the contents of the package (since the buyer will not be able to verify, for himself, the contents of the package before buying it). Depending on the nature of the product sold, various regulations require testing and certification by independent testing agencies before the product can be offered for sale. This applies to chemicals (drug control regulations) and food products (food safety regulations), vehicles (for emission and crash standards) and mobile phones (in relation to specific absorption rates of radiation).
In the services industry, registration of purveyors of public services operates, at least in part, as a mechanism by which the effect of the information asymmetry between service providers and service recipients can be mitigated. Providers of transportation services, such as buses and taxis, are required to be registered with the motor vehicles authority, just as boarding and lodging facilities, restaurants and other food services businesses cannot operate without first being duly registered.
Regulators impose various obligations on registered services providers designed to ensure that they provide their services at minimum levels of quality that offer some measure of assurance to consumers as to the standards of service that they can expect. Thus, even though we rarely venture into its kitchen and have no knowledge about its standards of hygiene, we have no hesitation in eating in a restaurant since we can rely on the fact that it cannot remain in business without a health certificate.
The thing we often lose sight of is that all these regulations were either written before, or were at least drafted using principles and concepts that hail from a time that predates the Internet. In that context, data asymmetry applied such significant pressure on the free market that governments were forced to intervene in order to safeguard the interests of the consumers they were obliged to protect.
But this is no longer the case. If there is one thing the Internet and other modern technologies like the Internet of Things (IoT) and wearable computing has given us, it is an over-abundance of widely available data. As a result, the asymmetry of data between buyers and sellers stands at historic lows.
If we were to re-examine Akerlof’s used car market of lemons in today’s context, it is obvious that buyers are far more well informed today than they were in 1970. Electric cars like the Mahindra e2o and Tesla are designed to record extensive telemetry data, offering buyers unprecedented information about their prospective purchase. In many jurisdictions, on-board black boxes record a wide variety of data for insurance purposes, all of which can easily be re-purposed as inputs for valuation.
In the services industry, on-demand services have had a significant impact on the level of asymmetry of data in that market. Businesses such as AirBnB and Uber depend heavily on data and technology and offer dual feedback loops along with rich data analytics that could effectively operate as a substitute for much of the objectives that the government seeks to achieve through regulation.
To the extent that information imbalance was the reason behind many of the regulations in force today, legislators should pay attention to the increasingly potent role that modern technologies can play. If we are to achieve “minimum governance”, we’d do well to use technology, instead of regulation, to ensure data symmetry.
Rahul Matthan is a partner at Trilegal. Ex Machina is a column on the intersection of technology and law.
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