The title of this post is a reference to an excellent book edited by Dan Klein and Fred Foldvary, The half-life of policy foundations: How new technology affects old policy issues.
The book examines how many of the arguments put forward to justify state intervention – such as public goods arguments – are not intrinsically reality. They can often face little more than technological limitations. As new technology develops, the problems associated with public goods or common resources can be eliminated, and with them the justification for state intervention.
An example of this I recently experienced involves asymmetric information. When there is asymmetric information in a market, one party has more information relevant to a transaction than the other party. This can lead to suboptimal outcomes. Probably the most famous quote in this issue is George Akerlof’s famous article, The market for lemons. To summarize, this article considers the used car market. There is asymmetric information between potential buyers and sellers of used vehicles. When I sell my used car, I know more about the condition of that car than you, the potential buyer. Of course, you might suspect that my car is a lemon, that is, a car with significant problems. The risk of me trying to sell you a lemon will lead you to insist on a lower price. This in turn can lead to an adverse selection problem. When used car buyers want to lower prices to offset the risk of lemons, potential sellers who have the highest quality used cars will take their cars off 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, causing those with the highest quality cars to also withdraw from the market, and so on. If there are enough iterations of this process, the used car market will be nothing but overpriced junk. Or so the reasoning 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 try to use broad statistical regularities to explain this. For example, car insurance companies know that it is riskier to insure teenage boys than middle-aged women, and will tend to charge higher rates for the former than for the latter. But this does not fully compensate for the problem: car insurance policies are issued on an individual basis. Maybe I’m a reckless driver, and the fact that I haven’t had any accidents lately is down to pure luck on my part. This is something I could know about myself, but the car insurance company doesn’t know – there is asymmetric information here. But like most things in life, it turns out there is an app for that.
I get my car insurance through my bank, USAA. And I discovered a few months ago that there is an app called USAA SafePilot that you can use to influence your car insurance rates. If you download the app and register for the program, the car insurer can obtain additional information about your driving behavior. So USAA can get an idea of how I drive, how often I hit the brakes, whether I unlock and use 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.
Just knowing that I downloaded this app on my phone makes me behave differently while driving. The other morning I was walking home from the gym and stopped at a red light, when I noticed a particularly striking sunrise happening. I was tempted to take my phone out and take a picture of it, but then I realized that if I did, the app would warn me for unlocking and using my phone while driving, so I kept my phone from the neighborhood.
The more general lesson is that the market itself tends to find ways to address market imperfections. There is asymmetric information between myself and a life insurance company, but this can be taken into account with the requirement that approval of a particular life insurance policy requires a medical examination so that the insurance company can assess it. The prospect of a market for lemons creates an opportunity for companies like Carfax to help reduce information asymmetry about used cars. And the advent of new technologies like smartphones can reduce information asymmetries in the auto insurance market in ways that weren’t available not so long ago.
As Arnold Kling would say: markets fail, use markets. Where you see a market failure, an entrepreneur sees a market opportunity. The more competition and innovation used to take advantage of those opportunities, the better. And as the pace of technological innovation increases, the half-life of market imperfections decreases accordingly.