Chapter 8 delves into the complexities introduced by asymmetric information, where some contestants possess more information than others, or neither of the contestants has complete information about the characteristics of the others. The chapter examines contests in which the true common value of the prize may be unknown to certain contestants, such as an incumbent having a better understanding of the value of office than a challenger, or a current resource owner having more information about its true value than potential entrants. It also examines situations where no contestant has complete information about the value assigned for each contestant to the prize, such as companies competing to develop a new product or technology. Each company knows its own valuation of the potential market but does not know the competitor’s valuation. The chapter also analyzes the existence and properties of equilibrium and other related questions, such as the following: How do outcomes in complete and incomplete information scenarios compare? Should a well-informed planner disclose information to maximize total effort in a contest involving both informed and uninformed contestants?

Human minds are particularly biased when processing information in digital environments. Behavioral economics has highlighted many cognitive biases that afflict our economic decision making. We may choose people like ourselves for important jobs or we may focus on irrelevant characteristics. We may also focus on recent, available information because our brains interpret that as more relevant for the current situation, whereas, optimally, we might benefit from a deeper dive into collecting more representative or comprehensive data and analyzing it appropriately. Even the way information is presented influences whether we believe it. Designers of digital content and experiences need to be aware of and account for such biases when engaging users.

Online marketplaces have permeated many aspects of our lives, as we use them to procure goods and services of all sorts, and many have relied on them during the COVID-19 lockdowns. Both sides of the market must feel comfortable trusting each other for online marketplaces to thrive, and for that, they need to have safeguards that alleviate the problems caused by asymmetric information. In this chapter I explain how feedback and reputation systems work in practice, and how they support ecommerce in online marketplaces. It starts by covering the theory behind reputation mechanisms and how they support more efficient trade, followed by descriptions of the actual working of typical online feedback and reputation systems. A survey of empirical findings from a host of papers is presented that explore how reputation works in actual online marketplaces, and how these relate to the theory. I then highlight some of the shortcomings of feedback systems and offer some suggestions and considerations for the future design of feedback and reputation systems that can augment their effectiveness.

Chapter 3 lays out the book’s central theory as well as the theory’s observable implications. It argues that powerful producers seek to use their privileged knowledge of the risks and benefits of their products (and regulators’ dependence on that knowledge) to systematically push their own out-of-patent products and those of generic sellers off the market via regulation, in favor of more expensive, patented alternatives. Producers accomplish this first by strategically revealing negative information about out-of-patent products as a means of convincing regulators that these products require stricter regulations. Second, producers support regulatory institutions that require existing products to be reevaluated under a precautionary standard, meaning that failure to prove an existing product is safe leads to the assumption it is dangerous. These precautionary institutions help innovative producers eliminate out-of-patent products more systematically, allowing them to acquire stricter standards not via the provision of damaging information, which carries some reputational risks, but through the withholding of favorable information. This chapter also lays out expectations for where we might expect these precautionary institutions to be adopted, given the distribution of preferences across countries, and it shows why such precautionary institutions should tend to be supported by developed countries and opposed by developing ones. Finally, the chapter argues that because international standard-setters ought to be susceptible to the same sorts of information problems as domestic regulators, and given the distribution of national power within these organizations, we can expect international standard-setters to replicate the precautionary institutional preferences of their wealthier members. We can additionally expect this to create the same tendency on the part of international standard-setters to arbitrarily impose stricter standards on more affordable products, despite the fact that this creates trade barriers that disadvantage poorer members and that directly conflict with these standard-setters’ stated mission.

Chapter 1 provides an introduction to the book. Motivating the book with examples of various regulatory barriers to agricultural trade that have proven particularly contentious, this chapter asks what might explain these barriers and whether we should expect current international solutions to resolve them. The chapter provides a brief overview of the book’s argument regarding how producers leverage private information to acquire the sorts of regulatory barriers that the opening examples describe. In addition, it previews the book’s main contribution and gives a brief chapter outline.

This chapter sets the stage for the remainder of the book by providing a broad overview of the sorts of information asymmetries that exist between producers of potentially dangerous products and those who are tasked with regulating them. Leveraging insights from a diverse set of industries -- aerospace, direct-to-consumer products, pharmaceuticals, and industrial chemicals -- and spanning a wide range of countries, this chapter establishes the surprising degree to which regulators not only are at a disadvantage relative to firms when it comes to acquiring information about product risk but also, as a result, depend on firms to be the primary source of information required to regulate. The chapter then investigates the conditions under which this might allow producers to influence the timing and direction of regulatory change. After establishing the pervasiveness of information asymmetries and dependencies at the domestic level, as well as the resulting opportunities for regulatory bias, the chapter demonstrates why we should expect the very same information asymmetries and biases to be replicated and even exacerbated at the international level.

After establishing why people migrate, in this chapter we turn to an investigation of how migrants economically re-engage with their homeland. Specifically, we explore how migrants facilitate flows of international financial capital. We argue that migrants, because they possess critical knowledge about investment opportunities in their homelands, help international investors overcome information asymmetries which drives both portfolio and foreign direct investment into their homelands. Our empirical analyses leverage a wide range of data on migrant stocks and portfolio and foreign direct investment to test our argument. We find that migrants are key to explaining international capital flows, especially in environments where formal political institutions that protect property rights are absent or weak.

Chapter 4 chronicles the status quo and innovations in underwriting practices in the life insurance domain and shows how private markets deal with information problems and how they eagerly capitalize on novel ways – such as tracking devices – to mitigate asymmetric information. Using quantitative analysis, the chapter also shows that private life insurance markets are more developed in country-years with better information, but that partisanship mediates this relationship. Life insurance is an interesting domain to study because it has many parallels to health insurance, yet the former is mostly private, while the latter is mostly public. The chapter discusses the emergence of a supplementary private health insurance market, but it also documents the continued popularity of public solutions in areas where the time-inconsistency problem cannot be overcome by private actors.

Chapter 2 presents the (formal) theoretical framework and advances four arguments. First, whether or not majority support for public provision of insurance exists depends on the distribution of information. Second, some insurance is best provided via pay-as-you-go systems, but these involve a difficult time-inconsistency problem that private markets cannot solve. Some social insurance is therefore bound to remain almost entirely within the purview of the state. Third, people’s preferences regarding social insurance are also a function of the availability of private options. If social insurance is the only game in town, even those subsidizing the system will support it, leading to broad cross-class majorities. With private alternatives, the better-off will lower their support for public spending, which erodes the broad support public social policy programs traditionally enjoy. Fourth, parties continue to matter because they represent different risk groups, and we expect that partisan conflicts will extend into new areas, most importantly the regulation of information and how it may be used.

In this chapter, we analyze the economics behind the use of big data and, in particular, ratings, reviews, and recommendations that have become mainstream on digital platforms. We start in Section 2.1 by analyzing rating and review systems. These systems provide platform users with information about either products or their counterparties to a transaction. Of crucial importance is, of course, the informativeness of these systems, which depends on the users’ actions. We then turn, in Section 2.2, to recommender systems, which aim to reduce users’ search cost by pointing them towards transactions that may better match their tastes. Besides the ability of such systems to generate network effects, we also discuss their effects on the distribution of sales between “mass-market” and “niche” products. Finally, in Section 2.3, we complement the analysis of ratings and recommender systems by uncovering additional channels through which big data may generate network effects and other self-reinforcing processes on platform.

In practice, the regulator generally has access to less information than the regulated firm on costs. In Baron– Myerson (1982) the regulated firm has private information on cost characteristics it cannot modify. In Laffont– Tirole (1986) the firm has private information on its endogenous effort to decrease cost. Regulators must pay information rent to access the information required for designing the contracts and must credibly commit to pay it to avoid a ratchet effect. The issue is politically sensitive because the ‘fee’ for information increases the operator’s profit whereas it is paid either by the consumers or the taxpayers, that is, by voters. Under adverse selection, to reduce the cost of the information rent, which is highest for the most efficient firm that is induced to produce the first-best level, less efficient firm production is distorted downward. The optimal regulation mechanism to address moral hazard risks impacting costs offers a menu of contracts where efficient firms choose a high fixed payment and produce the optimal effort while inefficient firms are constrained to choose cost-plus contracts, which again implies no rent and no effort for them.

The function of insurance is to protect individuals and firms from adverse events by pooling risks. Life insurance protects against the financial consequences of premature death, disability, and retirement. Non-life insurance protects against risks such as accidents, illness, theft, and fire. Insurance is a risky business, as insurance companies collect premiums and provide cover for adverse events that may or may not arise. The insurance business is plagued by asymmetric information problems. There is a moral hazard problem when the behaviour of the insured, which can be only partly observed by the insurer, may increase the likelihood that the insurer has to pay. After signing the contract, the insured may behave less cautiously because of the insurance. Another problem is adverse selection: high-risk individuals (for instance, ill people) may seek out more (health) insurance than low-risk persons. The final section of chapter describes the variation in insurance systems across Europe and analyses financial conglomerates that combine banking and insurance

Having a well-functioning financial system in place that directs funds to their most productive uses is a crucial prerequisite for economic development. The financial system consists of the financial infrastructure and all financial intermediaries and financial markets, and their relationships with respect to the flow of funds to and from households, governments, business firms, and foreigners. The main task of the financial system is to channel funds from those with a surplus to sectors that have a shortage of funds. In doing so, the financial sector performs two main functions: (1) reducing information and transaction costs and (2) facilitating the trading, diversification, and management of risk. This chapter discusses both of these functions at length. The importance of financial markets and financial intermediaries differs across Member States of the European Union. An important question is how these differences affect macroeconomic outcomes.

This chapter reviews the reasons for regulating and supervising the financial services industry. Regulation refers to the process of rule making and the legislation underlying the supervisory framework, while supervision involves monitoring the behaviour of individual firms and enforcing legislation. The case for government intervention is based on market failures. The chapter distinguishes between prudential supervision and conduct-of-business supervision. Prudential supervision aims to protect consumers by ensuring the safety and soundness of financial institutions. Conduct-of-business supervision focuses on how financial institutions deal with their customers and how financial institutions behave in markets. Conduct-of-business rules also promote fair and orderly markets. Finally, the chapter discusses financial supervision in the EU, including whether national-based supervision is appropriate in an integrating market.