The Political Business of addressing Information Asymmetries

          A political business model commonly financed by the parliament is a political firm, tasked with addressing supposed market information asymmetries. These agencies often serve as gatekeepers, suffering from distorted incentives that arise from inappropriate sources of funding. Competitive markets have faced information asymmetries since the dawn of human trade because it is inevitable that one of the parties to a transaction will have an information advantage over the other. Sometimes the problem is addressed through pricing mechanisms and perhaps more often with reliance on reputation effects. A seller on eBay, with no ratings history, will have to post a significantly lower price to overcome the risk a buyer sees in dealing with a first-time seller. In comparison, a long-time seller with hundreds of positive ratings can expect to receive a premium price. Market-based business models that successfully address the risk of information asymmetries include objective third-party ratings firms earning fees by providing buyers with independently generated ratings (i.e. Consumer Reports), and market makers that collect and present crowd-sourced ratings (i.e. eBay). In both of these cases, the information generated is objectively produced and helps to reduce transaction costs.

          If a market-based ratings firm chooses to generate revenue from producers instead of consumers, the information provided to the consumer becomes tainted, as shown by the once highly respected financial instrument ratings agencies. For many years, the earnings of these firms came from investors seeking to overcome the information asymmetries inherent in complex financial transactions. When new government ratings requirements were imposed for investments made by certain money market funds, pensions, and government agencies, the ratings firms made the tragic decision to move to the more lucrative model of charging the issuers and providing their services free to investors (McLean and Nocera 2010). This shift in the business model forced the issuers, desperate to satisfy the new rating requirements, to negotiate with the four government-anointed rating firms as “paying customers.” With revenue and profit on the line, investment ratings suffered severe inflation. The inflation began when the ratings agencies chose to generate revenues from the source of the information asymmetries.

          Political firms created to address information asymmetries receive funding from the parliament and often additionally from user fees paid by the producers being rated. For example, it is the mission of the Food and Drug Administration (FDA), as an “objective” third party, to act as a gatekeeper and as the primary source of essential healthcare information for the public. While two-thirds of the funding for the FDA comes from Congress, the third part is collected from pharmaceutical and medical device companies in the form of user fees (Fontanarosa, Drummond and DeAngelis 2004). There is ongoing pressure from Congress to increase the revenues from these fees, thus reducing the dependency on taxpayer funding (Food and Drug Administration 2012). Since there are numerous FDA employees tasked with assessing new medical breakthroughs, it is likely that producers will expend significant resources to determine the smoothest path through the approval process. Mid-level bureaucrats are afraid of garnering negative attention from supervisors and are therefore motivated to be reasonable in their treatment of what are essentially “paying” customers. An obstructive bureaucrat, with a reputation for being heavy-handed, will be avoided or will receive numerous complaints.

          In opposition to the revenue incentive is the fear of making a rating error that results in deaths or other catastrophes and once again drawing unwanted negative attention. Since the primary funding source of most political firms is the parliament, the bureaucratic prime directive of self-preservation is the highest priority. This risk can be mitigated by creating a mountain of well-documented procedures that, if followed, protect the individual worker from the wrath of a supervisor and provide documentation if it becomes necessary to defend the actions of the agency. The "red tape" mechanism addresses the fear that failure will lead to inevitable funding and job cuts. In the case of the Food and Drug Administration, we see a political firm that responds to these incentives by making the navigation of the bureaucratic process very costly—smaller firms and orphan drugs need not apply—while providing an expensive but almost inevitable approval for the innovations of larger health-care providers.

          In conclusion, in a competitive market, without the entanglement of the polity, the asymmetric information problem is usually addressed with an objective business model, ensuring consumers receive the information required to reduce transaction costs. In contrast, the political firm operates on funds from the parliament and the producers to provide consumers with what is perceived as free information, but is in fact costly, incomplete, and suspect.

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Works Cited

Fontanarosa, Phil B, Rennie Drummond, and Catherine D DeAngelis. "Postmarketing  
          Surveillance—Lack of Vigilance, Lack of Trust." The Journal of the American Medical 
          Association 292, no. 21 (December 2004): 2647-2650.

Food and Drug Administration. "FY 2013 Budget Overview." www.fda.gov. May 21, 2012. 

          http://www.fda.gov/downloads/AboutFDA/ReportsManualsForms/Reports/
          BudgetReports/UCM301719.pdf (accessed October 5, 2013).

McLean, Bethany, and Joseph Nocera. All The Devils Are Here. New York, NY: 
          Penguin Books, 2010.