Unbundling Information Asymmetry To Improve Governance

Unbundling Information Asymmetry To Improve Governance

Governments around the world regulate everything – from how firms carry out their business to the manner in which public agencies are expected to deliver services. In doing so, however, there is reliance on the concept of information, both its stock and its flow. Thus, understanding the notion of asymmetry is important to understand why governments do what they do, and hence why their performance varies.

What then is ‘information asymmetry’? Access to—and capability to process—information is varied across the board, leading to an imbalance. Differences in existing information and access to it lead to limited and incomplete information across groups.

Indeed, inefficient institutions result from imperfect and costly information, so we need to tackle information asymmetry to improve governance.

We can identify three specific components of imperfect information. First, there is lack of information across time, or in other words, we know more at time T-1 (what happened yesterday) than at T+1 (what will happen tomorrow). Second, there is also information asymmetry across space, as different institutions have unequal access to information depending upon where they are located; a company in a capital city is likely to have more access to information on government policies than a company located outside of the capital. Third, we can talk of asymmetry in terms of capacity to interpret; even when two institutions have access to the same information, they will probably respond differently to it because they may not possess equal amounts of resources or capacity to process the ramifications of the information. Economists argue that these three asymmetries lead to what is known as ‘bounded rationality’ – there are limits to how rational institutions can be.

But why is this important for instituting good governance? The above implies clearly that some institutions are more able to reconfigure their work to benefit from the information they have. All of them, though, incur what are known as ‘transaction costs,’ which can be divided into search and information costs (gathering, monitoring, and validating information); bargaining costs (those incurred in arriving at an acceptable arrangement with the other party); and policing and enforcing costs (to make sure that the other party honors the agreement, and take appropriate action if otherwise).

Transaction costs can be measurable or not. For instance, the costs of enforcing contracts are quite tangible. On the other hand, costs that cannot be directly measured include those for the time it takes to acquire information, waiting in line for services, bribery, or imperfect monitoring.

Since there are transaction costs to institutions and governments need to have a level playing field for all institutions, another relevant concept is ‘credible commitment’ and its corollary, ‘credible threat’. Parties that are in a contract—including the government and the private sector—must commit to each other as part of the contract, for example to facilitate access to credit or provide an enabling environment for investments.

The expectation in the contract is that each party will credibly commit to it; in other words, each party can assume the other will adhere to the same principle. Thus, a situation of credible commitment arises when all parties to the contract assume that everyone will adhere to the rules of the game on how they hold up their side of the deal. Policy reversals—or more aptly, the threat (or perception) of such reversals—lead to a failure to commit credibly. Inherently, credible commitment should reduce transaction costs. In reality, parties to the contract or game do not tend, for whatever reason, to exhibit such commitment – so transaction costs tend to rise.

So what does all this mean for governance? Unequal access to information—or variations in the ability to analyze available information—does indeed eventually lead to rent-seeking behavior, scope for leakages in the system, and eventually to governance failure. Information asymmetry is also at the core of ‘binding constraints’ such as political interferences in the work of state-owned enterprises, weaknesses in the regulatory system, or inherent capacity gaps in public service delivery by governments. For instance, ADB recently identified weaknesses in the regulatory system, deficient infrastructure provision, uneven access to productive assets and lack of good job opportunities as binding constraints to inclusive growth in Fiji.

In developing countries, where the state tends to be all-pervasive in the market, the government’s overriding and continuing goal is to attain increases in welfare without anyone losing out. The ultimate goal would be to attain Pareto Optimality, when even a single player benefits in the market without anyone else losing. Reaching this optimal situation by ensuring a clear flow of the full stock of information is critical, as it in turn facilitates good governance, which eventually aids the development process.


This article was previously published in the Asian Development Blog and is being republished here with permission.

The views expressed in this article are those of the author and do not necessarily represent the views of CourtingTheLaw.com or any organization with which he might be associated.

Gambhir Bhatta

Author: Gambhir Bhatta

The writer is Technical Advisor on Governance for the Asian Development Bank’s Sustainable Development and Climate Change Department. He has been involved with advisory, programmatic, academic and operational work on governance and public sector management issues for more than 25 years. Before joining ADB in 2005, he was a Senior Advisor in the New Zealand public service.