Thursday, May 14, 2009

How to fix the economy: On Transparency

When people ask my opinion as to what to do about the economy, I mostly punt the question. Arguing that is a macro question, and I gave up on studying it, because I think it is too hard a problem, not only for me to figure out, but even for the profession. I'm not sure anyone knows. But if pressed, one reform that does seem to be pretty easy to advocate is to increase transparency (this is a favorite prescription proposed by my students). Or perhaps not. As Truman famously lamented, there's no such thing as a one handed economist.

On the surface, transparency is good. It increases the free flow of information, and economic theory has told us that more information is almost always good, theory says that perfectly efficient markets depend on perfect information. And when information is hidden (i.e. when there is asymmetric information) you get market failures and inefficiencies. A practical implemenation of this idea in the financial sector that is often tossed around is to make more securities traded openly on exchanges rather than over the counter.

Of course thinking a little more deeply, there are problems with transparency. Partly, is the practical matter of standardizing incredibly complicated securities to put on an exchange. But more fundamentally there is the problem that transparency impedes the firms abilities to maintain trade secrets. Trade secrets, like patents, are another form of intellectual property protection (some argue they are the primary form of intellectual property protection given that the patent system is so broken), and though all intellectual property protection is bad for competition because it creates monopoly power and higher prices, it is good for innovation. So a byproduct of greater transparency could well be less innovation.
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