Civil Engineering Reference
In-Depth Information
Asymmetric Information
Most economic texts identify the problems created by a dominant firm, or a group
of colluding firms, as typical causes of market failure. As an example, reflect on the
market structures that typify firms in construction and the possible opportunities for
them to enter into agreements on joint profits (or at least review
Key Points 8.4)
. In
this text we have chosen to emphasise that
any
contractual agreement that is loaded
in favour of one party can contribute to market failure. There is a general problem
of one-sided information. In
Chapter 6
(see page 86), we introduced the idea of
asymmetric information.
A situation in which some of the parties involved in an economic transaction
have more information than others is defined as asymmetrical.
Markets may not achieve efficient outcomes when the consumer has to defer to
a more informed producer. Let us develop this idea a little further with a simple
example. When most consumers go into a music shop to buy a CD, they have
enough information to make a rational decision. When they purchase services from
a builder, the situation is often very different. In this situation, purchasers know
roughly what they want to achieve - but they must rely on the experience and advice
of the builder to specify what precisely needs to be done.
This situation - in which one party holds most of the cards - is a common
cause of market failure. A new academic approach to market analysis is emerging
that focuses on the contractual agreement between the 'principal' - that is,
the client - and the 'agent' - the contractor. This focus on the
principal-agent
relationship questions the balance of power between the less informed client and
the knowledgeable agent. The debate is around the extent to which the agent acts
in the best interests of the client. This analysis of the principal-agent relationship
demonstrates how the skills and experience of the agent could lead to a situation
in which a trusting client may be misinformed. The initial discussions on principal-
agent relationships appeared in health economics: in health contexts, it is clear that
the doctor - the agent - has far more medical information than the patient - the
principal. Consequently, we are very reliant on doctors to act in our best interests.
Principal-agent analysis can equally be applied in construction contexts - to
project managers, engineers and architects. Many large-scale construction projects
are technically complex and not easily understood by non-professionals. Although
the costs of a mistaken choice may not appear as dire as in medical cases, they are
equally difficult to reverse. For example, if the clients or purchasers of a major
building development wish to reduce the environmental impact of the construction
process, they are completely dependent on the expertise of contractors to achieve
these outcomes. It is quite possible that energy usage may not be as efficient as it
could be or that waste may not be minimised as requested. The hired 'agent' may
not always act in the client's best interest, and they might be able to get away with it
because of the 'principal's' incomplete knowledge.
