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Quantitative Marketing and Economics

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01.09.2006

Privacy, property rights and efficiency: The economics of privacy as secrecy

verfasst von: Benjamin E. Hermalin, Michael L. Katz

Erschienen in: Quantitative Marketing and Economics | Ausgabe 3/2006

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Abstract

There is a long history of governmental efforts to protect personal privacy and strong debates about the merits of such policies. A central element of privacy is the ability to control the dissemination of personally identifiable data to private parties. Posner, Stigler, and others have argued that privacy comes at the expense of allocative efficiency. Others have argued that privacy issues are readily resolved by proper allocation of property rights to control information. Our principal findings challenge both views. We find: (a) privacy can be efficient even when there is no “taste” for privacy per se, and (b) to be effective, a privacy policy may need to ban information transmission or use rather than simply assign individuals control rights to their personally identifiable data.

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A distinct conception of privacy is autonomy, both from the state (e.g., the right to choose to have an abortion) and from annoyance by other private parties (e.g., the ability to be free of telemarketing calls). For an early discussion by an economist of privacy as autonomy, see Hirshleifer (1980).

Even this trend is not new. Concerns about increasing surveillance and data processing led to the amendment of the California State Constitution in the early 1970s to include an explicit right to privacy.

See, e.g. ``Greeting Big Brother with Open Arms,” New York Times, January 17, 2004, B9.

See Smith (2003) for a recent summary of federal legislation.

Another situation in which privacy concerns arise is one in which the individual wishes to prevent a trading partner from intentionally or unintentionally sharing information with a third party (e.g., the sale of mailing lists or the failure to take adequate measures to secure a database of credit card numbers). Of course, the two cases are linked when the third party obtaining the information is also one of the individual's trading partners. For a recent analysis of third-party sharing, see Kahn et al. (2000). See also Calzolari and Pavan (2004), who establish conditions under which privacy is a equilibrium outcome but do not examine whether such outcomes are efficient, and work cited therein.

See Taylor (2004) for a recent analysis along these lines.

This does not, however, imply that protecting privacy will promote efficiency. Depending on the elasticity of demand for information, implementing a privacy policy that raises the cost of collecting information might actually worsen the inefficiency by leading to higher levels of socially unproductive expenditures.

Posner (1981) at 405, and Stigler (1980) at 629.

This effect of privacy is implicit in the lemons model of Akerlof (1970) lemons model of asymmetric information. It can also be viewed as an extreme form of the first mechanism identified by Posner and Stigler.

We observe that, in order to understand the full effects of privacy policies, one must also examine other potential market responses to privacy, such as insurance suppliers' relying on employer-purchased plans to reduce self-selection. Wathieu (2002) examines the roles of intermediaries (e.g., employers) who possess finer information about customers (e.g., insurees) than product or service producers (e.g., insurance companies).

Stigler (1980) at 630–631.

Murphy (1996) at 2382.

For a seminal analysis of the effects of ex post contracting on ex ante incentives, see Williamson (1975).

The structure of the argument is isomorphic to the logic of granting patents and other intellectual property rights.

Curiously, despite reaching his overall conclusion that privacy is harmful, Stigler (1980) also observes that disclosure can discourage efficient investment in obtaining information. He apparently failed to notice that this fact can be construed as an argument that privacy protection can be efficiency enhancing.

For a recent analysis in a related context, see Kahn et al. (2000).

This argument is an application of the general theory of the second best (Lipsey and Lancaster, 1956).

For example, Shapiro and Varian (1997, pp 29 and 30) argue that:

The right way to think about privacy, in our opinion, is that it is an externality problem. I may be adversely affected by the way people use information about me and there may be no way that I can easily convey my preferences to these parties. The solution to this externality problem is to assign property rights in information about individuals to those individuals. They can then contract with other parties, such as direct mail distributors, about how they might use the information.

See, e.g., Hermalin and Katz (2006) for a discussion.

For discussions of the Internet and price discrimination, see Acquisti and Varian (2005) and Odlyzko (2003).

See, e.g., Posner (1981) at 405.

Observe that we are assuming that the value of transacting with a given household is independent of a firm's transactions with other households.

See, for instance, Varian (1997).

In what follows, we could invoke the revelation principle, but the discussion in terms of general mechanisms better shows the logic of the argument.

For an early application of this type of unraveling argument in a monopoly context, see, e.g., Grossman (1981).

Kahn et al. (2000) appear to obtain a conflicting result. However, as they themselves note, the assignment of property rights affects the equilibrium outcome in their model because of restrictions they place on the scope of contracts that can be written.

That is, \(\frac{{f_2 (\theta )}}{{f_0 (\theta )}}\) increasing implies \(\frac{{f_0 (\theta )}}{{f_1 (\theta )}}\) is increasing as well.

See Katz (1983) for an example providing details of the analysis. The fundamental approach to this class of problems was pioneered by Mirrlees (1971) and applied by Spence (1980) to a multi-product monopolist facing discrete types.

This assumption rules out the possibility that marginal information rents fall as x _θ increases. If the marginal rents fell sufficiently fast, the monopolist's problem would not be concave and multiple equilibria might exist, making comparative statics difficult.

The restriction to third-degree price discrimination when individual consumers have downward sloping demand curves is as an example of the price rigidities discussed in the introduction.

For instance, suppose there are three types, with types 1 and 3 plentiful (especially type 1), while type-2 households are relatively rare and have demands close to those of type-1 households. Under privacy, it could be profit-maximizing to bunch types 1 and 2 at the same x > 0. Now consider the partition in which 1 is alone and 2 and 3 are together. Now the monopolist could prefer to shut out type 2. That is, partitioning in this way leads to type 2's consumption going down.

Assumption (c) and condition (ii) are satisfied, for example, by a Poisson distribution with mean less than \(1 + \sqrt 3\).

For example, an e-merchant could require consumers to sign up and provide personal information before being allowed to shop.

The adverse selection structure is similar to a used car market in which workers are the sellers of used cars and employers are potential buyers of used cars as studied in Akerlof's (1970) seminal article.

Levin (2001) has shown that a particular form of improved information (discussed below) can raise or lower efficiency when θ is continuously distributed.

Because vθ₁ < θ₂, there is also a perverse Nash equilibrium in which employers expect workers of ability θ₂ not to seek employment and, thus, employers never bid above νθ₁. However, this is not Bayesian perfect under the market structure assumed here. If an employer deviated and offered a wage of θ₂ + ɛ, ɛ an arbitrarily small positive number, then all workers would be willing to be employed by that firm and the deviating employer would earn positive expected profit for sufficiently small ɛ because νθ_A (g) − θ₂ > 0.

Straightforward calculations reveal that the sign of the change is equal to the sign of 1 − 2g ₂.

If health status is a perfect indicator of ability, then the no-revelation equilibrium doesn't exist.

A well-known necessary condition for efficiency is that total output rises, but this is not easily computed a priori.

One rationale for this approach is that allowing price discrimination weakly raises a producer's profits, and this may generate increased investments in plant or R&D that benefit consumers in the long run. Of course, letting all firms in an industry engage in price discrimination might lower their profits. And there is no general theorem stating that the additional R&D is always worth more to consumers than its cost.

See, for example, Katz (1983) or Spence (1980) for details.

The relevant aspects of Topkis's Monotonicity Theorem can be summarized as follows: Let X be a lattice and Y be a partially ordered set (a property clearly satisfied by the interval [0,1]). Let \(\phi (x,y):X \times Y \to \Re\) be supermodular in x for any given y and let that function exhibit decreasing differences in x and y. Then, if y ≤ y′, the join (pointwise maximum) of the x that maximizes φ(x, y) and the x′ that maximizes φ(x, y′) maximizes φ(x, y).

Calculations for parts (b) and (c) available from the authors upon request.

We ignore the pathological cases in which the largest solution is a tangency or there is no largest solution because there are infinitely many solutions. ν < 2 and F _σ(θ) weakly concave are sufficient to rule out such cases.

Acquisti, A., & Varian, H. R. (2005). Conditioning prices on purchase history. Marketing Science, 24(3), 367–381.

Akerlof, G. A. (1970). The market for ‘Lemons’: Quality uncertainty and the market mechanism. The Quarterly Journal of Economics, 84(3), 488–500.CrossRef

Calzolari, G., & Pavan, A. (2004). On the optimality of privacy in sequential contracting, Unpublished manuscript. Northwestern University.

Coase, R. (1960). The problem of social cost. Journal of Law and Economics, 3(1), 1–44.CrossRef

Grossman, S. J. (1981). The informational role of warranties and private disclosure about product quality. Journal of Law & Economics, 24(3), 461–483.CrossRef

Hermalin, B. E., & Katz, A. W. (2006). The law & economics of contracts. In: A. M. Polinsky and S. Shavell (eds.), The Handbook of law and economics. Amsterdam: North-Holland (in press).

Hirshleifer, J. (1971). The private and social value of information and the reward to inventive activity. The American Economic Review, 61(4), 561–574.

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Titel: Privacy, property rights and efficiency: The economics of privacy as secrecy
verfasst von: Benjamin E. Hermalin
Michael L. Katz
Publikationsdatum: 01.09.2006
Verlag: Springer US
Erschienen in: Quantitative Marketing and Economics / Ausgabe 3/2006
Print ISSN: 1570-7156
Elektronische ISSN: 1573-711X
DOI: https://doi.org/10.1007/s11129-005-9004-7