Some of you may remember Al Gore’s claim he had invented the Internet. Well, the claim was never made that way, and Al Gore’s role in commercializing the Internet made out of a government playground what we know today, so he may have had a little to boast about.
The other thing he was talking about, though, never really came to be. That’s the Information Superhighway. It was supposed to deliver information at your fingertips, and for some things (like cheap watches) it works even too well. For others, though, it doesn’t work at all, and that’s a real shame.
You see, a lot of the biggest corporations in the world deal with nothing but information. They sell it to you at an outlandish profit, but you should be able to get that information for free, or almost. I am talking about financial services and insurance companies. In a real Information Superhighway economy, there is no need for either of them, and the fact both are still alive and well is puzzling.
Let’s start with insurance companies, since the math is easier. Basically, an insurance company asks you a bunch of questions, figures out how much money you are likely going to want back, add marketing, fraud prevention, administration, and (huge) profits on top, and charges you that much.
Assume you are getting car insurance. What the insurance company wants to figure out is how much money you are going to cost them in damages. So they look up people just like you and decide you will cost them, on average, $500 a year. So they will charge you $1,000 a year, make a nice profit, and end of story.
Now, the question is: if the information was freely available, why would anyone want to pay $1,000 if they are only likely to need $500? In particular, why would anyone want to pay for marketing and profits, when all you want is coverage in case of catastrophe?
There are other cases in which we don’t deal with aggregates, but with single people. HOA fees are an example, where a home-owners association charges a certain amount and uses that to pay for common repairs and expenses. We wouldn’t go to an escrow company and have them manage our HOA fees, would we? So why do we allow that with insurance?
The other example, financial services companies, are situated similarly, but the information is of different kind. Instead of knowing about risk, financial services companies know about available money and about people that need it. What a bank does, in essence, is connecting people that have money with people that need money. Same is true for your hedge fund, or investment bank.
There is a little more complexity to that: the financial services company needs to have an idea of whom to give money, and at what cost. Banks are notoriously atrocious at that (see the recent financial meltdown), and the reason they survive is that the difference between what they hand out to investors and what they take from debtors is enormous. Just as is the case for insurance companies.
Here, too, the question is clear: why wouldn’t people with money give it to people that need money, cutting out the middlemen? Well, people with money don’t know people that need money (in general), and they can’t easily assess the reward that would make their risk worth it.
In other words, it’s a matter of information.
If we had a web site (say, since we are talking about the Internet) that had all that information, we wouldn’t need a bank. But wait! There are tons of such web sites – micro-lending is a good idea that is coming of age as I type.
So, the web of the future might have sites that collect information about people that want to pool their risk for mutual insurance, or people that have a project in mind and need money for it.
And what would banks and insurance companies do?
Well, nothing, of course.