Information and the change in the paradigm in economics, Part 2

American Economist, Spring, 2004 by Joseph E. Stiglitz

Research

One of the most important determinants of the pace of growth is, for developed countries, the investment in research, and for less developed countries, efforts at closing the knowledge gap between themselves and more developed countries. Knowledge is, of course, a particular form of information, and many of the issues that are central to the economics of information are also key to understanding research--such as the problems of appropriability, the fixed costs associated with investments in research, which give rise to imperfections in competition, and the public good nature of information. It was thus natural that I turned to explore the implications in a series of papers that looked at both industry equilibrium and the consequences for economic growth. (129) While it is not possible to summarize briefly the results, two conclusions do stand out: that market economies in which research and innovation play an important role are not well described by the standard competitive model, and that the market equilibrium, without government intervention, is not, in general, efficient.

POLICY FRAMEWORKS

The fact that when there are asymmetries of information, markets are not, in general, constrained Pareto efficient implies that there is a potentially important role for government. The new paradigm has important implications for policy, going well beyond addressing how to prevent the creation of asymmetries of information and how to overcome them. As we have seen, asymmetries of information give rise to a host of other market failures--such as missing markets, and especially capital market imperfections, leading to firms that are risk averse and cash constrained--and policy has to deal with these indirect consequences as well. An analysis, for instance, of the incidence of taxation which is predicated on perfectly competitive markets with perfectly informed consumers and risk neutral firms, is likely to go astray.

But beyond this, the new information paradigm helps us to think about policy from a new perspective, one which recognizes the pervasiveness of imperfections of information.

Pareto efficient taxation (130)

Information asymmetries, of course, arise among all participants in society--including between citizens and their government. In the final section of this paper, I wish to explore one side: the difficulties citizens have of controlling their government. Here, I want to briefly note the other side: the problems posed to government in the conduct of its "business" that arise from information asymmetries, in three key areas, taxation, regulation, and production.

One of the functions of government is to redistribute income; even if it did not wish to redistribute actively, it has to raise revenues to finance public goods, and there is a concern that the revenue be raised in an equitable manner, e.g. that those who are more able to contribute (or who benefit more) do so. But government has a problem of identifying these individuals. Just as those who a monopolist would like to charge more do not readily disclose that they might be willing to pay more for the product, and just as those who are less able, less likely to pay back a loan, or more likely to have an accident do not readily disclose that information to those with whom they deal, so too in the public sector. And the self-selection mechanisms for information revelation that Rothschild and I had explored in our competitive insurance model or that I had explored in my paper on discriminating monopoly can be used here. (The problem of the government, maximizing social "profit" (welfare) subject to the information constraints, is closely analogous to that of the monopolist, maximizing private profit subject to information constraints. This is why Mirrlees' [1971] paper on optimal taxation, though not couched in information-theoretic terms, was an important precursor to the work described here.)