Knowing and Making

Robert Peston's article today isn't a bad summary of the last twenty years of economic theory. Information asymmetry is the term for markets that don't work because proper information is not available to both parties - e.g. the broadband speed example that Robert gives. Adverse selection is a related problem which causes credit to be mispriced. It works like this: companies know more about their business prospects than banks, thus banks will charge a premium on loans to account for the risk they run. This premium puts off creditworthy businesses, whose owners will prefer to invest their own money or raise it in the markets. This leaves only businesses which are middling or downright bad risks still willing to borrow. As the best businesses have left the market, this affects the average risk profile for the banks, who put the rates up again... discouraging the borderline cases and leaving only the really bad risks. Rates then go up again, and... you can see where this lea...

Robert Peston discusses the difficulties that retailers (or their suppliers) are having getting trade credit insurance. Fundamentally, information asymmetry combined with efficient use of capital causes this problem. The reason suppliers want insurance is because the economy is shrinking and a (small but significant) percentage of retailers and wholesalers are going to go under. Even though the number is small (I'd estimate 3 to 5 per cent), the problem is that nobody knows which ones. Therefore unless suppliers stop trading altogether, they want to be covered for the risk. I read a nice analogy recently: if someone gave you ten bottles of water and you knew one was poisoned, you probably wouldn't drink any of them. Even if you were really thirsty. This combines with the (quite correct) desire of retailers to minimise the amount of working capital tied up in their supply chain in order to be price competitive and profitable. Therefore they extend payment terms to the degree th...