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HOW TO DEAL WITH ASYMMETRIC INFORMATION IN LABOUR MARKET


Contents
Introduction
1. What the asymmetric information is
2. The behavior of an employer and an employee under conditions of asymmetric information
3. Dealing with asymmetric information

Conclusion
Bibliography

Introduction
The traditional assessment of economic performance is based upon the analysis of the basic production factors such as land, labour and capital. Knowledge assets or intellectual capital may be mentioned as the "hidden" assets of a firm which is based on human capital. Today selection of the human resource is becoming a much more important case that has to be achieved for firms and other agents.
So in this essay I would like to speak about the role of information in labour market and about the consequences that asymmetric information can have both on an employee and on an employer.

What asymmetric information is
Asymmetric information is a factor that can lead to a market failure. Much of the analysis in economics has been undertaken on the critical assumption of economic agents having full information about the goods or services being bought or sold, and full information about each other. These assumptions describe a market where there is perfect information.
Information is an extremely valuable resource and it can determine actions such as where consumers can buy higher quality goods at lower prices, or where government regulation can be more efficient if it has the good scientific information. Therefore information can be seen as a valuable economic factor.
With microeconomic assumptions of perfect information in economic models, economists do not represent real world situations, for example households do not know the price of a particular good at every store that sells it, or firms do not know the actual productivity of every job applicant for a vacant position. Therefore there is imperfect information in individual markets, for reasons such as accurate information being too costly, or impossible to obtain. The lack of information in a market transaction may be only one sided, or take place in respect to both parties. In this case people usually speak about asymmetric information.
Asymmetric information is a situation in which economic agents involved in a transaction have different information, as when for example a private motorcycle seller has more detailed information about its quality than the prospective purchaser, or employees will know more about their ability than their employers.
There are two major forms of asymmetric information. These are the adverse selection and the moral hazard.
Adverse selection is a situation where one party in a transaction knows something about its own characteristic that the other party does not know. Adverse selection is often referred to as a hidden information problem in a market.
Moral hazard refers to the "situations where one side of the market can’t observe the actions of the other and is sometimes referred to as a hidden action problem" . The results of moral hazard are an increased probability of undesired outcomes for one party.
In his Nobel Prize winner lecture Akerlof showed that informational asymmetries can really cause adverse selection on markets. Under certain conditions, well-informed agents can improve their market outcome by signaling their private information to poorly informed agents. On the other hand, firms can also have superior information than the workers. The asymmetry of information in this case may introduce unemployment and wage fluctuations.

The behavior of an employer and an employee under conditions of asymmetric information
The way the employer and the employee behave in the situation of asymmetric information reminds of the “prisoners dilemma” in the game theory, but it is far more complicated. The employer and employee try to make the other party behave as they want, rather than maximizing their own utility. That is why applying for a job not all the employees compose their CVs according to their qualifications. With experience most of the employers discovered that having only skill and knowledge does not guarantee success. So not only the messages occurred by the impressions of candidates' CVs identify whether to like a candidate but also the interviews are very important.
The asymmetric information has certain effects on the behaviour of both the employer and the employee. The quality of workers in a firm is dependent on the wages paid in such a way that reducing the wage would reduce the quality of the workers and the profits of the firm. Therefore the firm will not cut wages even if it was possible to do so to the current workers, or hire from unemployed workers. The reason for this result is the asymmetric information available to firms about workers productivity, both in an adverse selection and moral hazard form.
Adverse selection problems are based on the inability of employers to distinguish between types of workers and the fact that good quality workers will be less willing to take low paid jobs than bad quality workers. Therefore firms will have an incentive to pay higher wages to attract the good quality workers, but good quality workers may choose to remain unemployed because if a job is low paid it may send a signal about their low quality.
These kinds of misunderstandings happen extremely often and may have some really negative consequences. In a global research study conducted by the Future Foundation Organization it was found that the hidden cost of selecting the wrong candidate for a position equals an annual sum of US$23 billion in the UK and US$105 billion in the United States .

Dealing with asymmetric information
One of the ways to get around the problem of asymmetric information is to have one party sending a signal that would reveal some piece of relevant information to the other party. That party would then interpret the signal and adjust his behaviour accordingly.
In the job market, potential employees seek to sell their services to employers for some wage, or price. Generally, employers are willing to pay higher wages to employ better workers. While the individual may know his or her own level of ability, the hiring firm is not able to observe such an intangible trait - thus there is an asymmetry of information between the two parties. Education credentials can be used as a signal to the firm, indicating a certain level of ability that the individual may possess; thereby narrowing the informational gap. This is beneficial to both parties as long as the signal indicates a desirable attribute - a signal such as a criminal record may not be so desirable.
Assuming that there are only two types of employees – a good one and a bad one, there's no real way for employers to tell in advance which employees will be of the good or bad type. Bad employees aren't really upset about this, but good employees know that they deserve to be paid more for their higher productivity, so they desire to invest in the signal — in this case, some amount of education. It is assumed that education does not increase the productivity of an individual. But there is one key assumption: good-type employees pay less for one unit of education than bad-type employees. The cost is not necessarily the cost of tuition and living expenses, sometimes called out of pocket expenses, as one could make the argument that higher ability persons tend to enter "better" (i.e. more expensive) institutions. The cost is the opportunity cost. This is a combination of 'costs', monetary and otherwise, including psychological, time, effort and so on. Of key importance to the value of the signal is the differing cost structure between "good" and "bad" workers. The cost of obtaining identical credentials is strictly lower for the "good" employee than it is for the "bad" employee.
The differing cost structure will stop "bad" workers from obtaining the credential. All that is necessary for the signal to have value (informational or otherwise) is that the group with the signal is positively correlated with the group of "good" workers.
In real life this is not always the way asymmetric information can be escaped. Very often both the employer and the employee remain unsatisfied with the job, working conditions or the situation simply does not live up to their expectations. So in order to prevent this, a more thorough research has to be conducted before taking the vital decision. The point here is that the cost of decision-making and hiring a potential candidate should never exceed the benefits received from hiring the employee.

Conclusion
To sum up, asymmetric information is a problem that economists should always consider in the analysis of labour market, as it tends to create market failures where unqualified employees may drive out qualified ones and, on the opposite, the highly qualified potential workers may be attracted to corporations where their potential will eventually be underestimated. Signaling and research conducting are one of the ways to deal with asymmetrical information. However, in reality it still seems to be not enough and asymmetric information continues to be one of the current problems and characteristics of labour market influencing the behaviour of the employer and the employee.

Bibliography
1. Akerlof, G.A., ‘The Market for "Lemons": Quality Uncertainty and the Market Mechanism, Quarterly Journal of Economics
2. Hillier, B, The Economics of Asymmetric Information, Macmillian Press, Hampshire, UK, 1997
3. Varian, H.R, Intermediate Microeconomics: A Modern Approach, 2nd ed., W.W. Norton & Company, New York, USA, 1992
4. www.wikipedia.org




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