The power of information

Dr. Terry Cutler

Originally published: Business Review WeeklyMay 2002

The economic texts gathering dust on my bookshelves talk a lot about perfect markets. Perfect markets presume perfect information. Regrettably, we live in a very imperfect world, and nowhere is this more evident than in the markets for information about what is happening in markets. A lot of the trouble we have with competition policy in Australia can be traced back to information asymmetries. Information is power.

A key cost factor in markets is the cost of information discovery, that is, the cost of discovering information about the true cost of market transactions.

There is a battle between the private commercial interests in the non-disclosure of information and the public interest in transparent disclosure and the nurturing of a public "information commons". The theorists of market economics assume informed markets but, everywhere, market power and market distortions are based on information asymmetry and market dis-information.

In the United States, the Enron Corporation saga is exposing the failure of audit regimes to assure the credibility of corporate reporting to investors. Critics of Wall Street point to conflicts of interest in the behaviour of investment banks using their analysts to push in-house transactions. I will never forget the collective intake of breath at a Silicon Valley talk-fest when a former industry analyst committed the unforgivable sin of stating the obvious with his anguished confession: "Now I don't have to lie any more!". I wonder whether we will hear similar mea cuplas at the HIH Royal Commission.

The imperfections of information markets are a serious problem for innovation and competition policy, particularly in small, isolated country economies such as Australia. Being a small economy with thin markets means that the discovery costs of information about Australia are simply too high for most global analysts to bother.

Consider the place of the Australian Stock Exchange in the operations of global financial markets. Australia is not only a long way from Wall Street, but also suffers the disadvantages of being the same scale as Texas and having roughly the same gross domestic product as Taiwan or the Netherlands. For most Wall Street analysts, there is little incentive to specialise in Australian stocks. The alternative is for Wall Street to rely on local analysts in Australia, a bit like the use of local stringers for newspapers.

Locally, the coverage of stocks and sectors is uneven. Brokers and financial houses tend to specialise in stocks or sectors in which they are active as market makers, creating potential conflicts of interest.

Another problem is that a lot of crucial market information is locked behind the firewalls of commercial secrecy. If one or two firms dominate a sector, as is often the case in Australia, a lot of key data about a sector will never trickle out into the public domain. When this happens, there are three consequences:

How big a problem is this? Well, it matters a great deal in the technology arena, and in markets going through a lot of change. A recent paper from the Federal Trade Commission in the US makes the obvious point that "technology markets are characterised by business, technical and market risk". Uncertainty and risk are the enemy of new investment. Good information reduces risk and builds bridges between supply and demand.

How do we get access to better information? Before the deregulation of the telecommunications industry in 1991, there was more information about the sector in the public domain than there is now. Even when there is the backing of a Government mandate, as in the national bandwith inquiry I chaired in 1999, we had huge problems extracting real data from the carriers. Try to get the real facts on broadband penetration and usage today and you run into the same brickwalls.

There are some solutions. First, follow the lead of the US in the aftermath of the Enron debacle and start looking at increasing the mandated public reporting by companies. The US Securities and Exchange Commission's filing requirements already ensure a level of disclosure and a quality of information we lack in Australia. In the US, company fillings are placed in the public domain, in full.

Second, follow the lead of Federal and State regulatory agencies in the US and mandate the Government collection - and publication - of key market data. A recent example of how useful this can be is the US Federal Communications Commission's requirement for all telecommunication companies to lodge regular reports, in detail, on their broadband activities.

Third, both Commonwealth and State governments are key generators or repositories of massive amounts of data about the Australia market. Make this available to the market, for free.

More informed markets will be more competitive markets, making this a core issue for competition policy. Informed markets are less risky markets for new investment and innovation. By addressing the systemic failures in the markets for information, governments and regulators can actually deliver real national investment attraction and innovation outcomes.

© Terry Cutler. May 2002