The Effects of Asymmetric Information on Economic Growth

Abstract

It has been widely recognized that asymmetric information affects investment, and investment is of course in turn important to economic growth. Knowledge of the mechanisms by which asymmetric information affects economic growth, however, appears incomplete. There are two types of asymmetric information, namely, hidden information and hidden action [1]. Although Azariadis and Smith have studied how hidden information (adverse selection) may affect economic growth with a monetary growth model [3] and a non-monetary growth model [2], the effects of hidden action and costly state verification have been ignored. There have been many studies which at least suggest links between asymmetric information and economic growth. Diamond [6], Boyd and Prescott [5], and Williamson [16]' show that asymmetric information between borrowers and lenders gives rise to financial intermediation. Diamond [6] and Williamson [16] show how financial intermediation can promote economic growth by reducing monitoring costs and channeling funds to the most efficient users. Greenwood and Jovanovic [9] show how collection and analysis of information by financial intermediaries can help investors' resources to flow to the place in the economic system where the funds will yield the highest social return. Bencivenga and Smith [4] show how a reduction of the fraction of savings held in the form of unproductive liquid assets is favorable to capital accumulation and economy growth. While contributing to the literatures of financial intermediation and economic growth greatly, these studies, however, do not specifically examine the relationship of asymmetric information to economic growth. This paper attempts to explore how hidden action (moral hazard) and costly state verification affect economic growth. Hidden action is incorporated into a neoclassical growth model, in which people invest for future consumption, and investment leads to capital accumulation and, thus, economic growth. Borrowers have an informational advantage over lenders ex post concerning the outcome of investment project. Though verification can overcome such asymmetry, it is costly. The results of this paper suggest that the effect of hidden action is to alter the path of economic growth. In the neoclassical growth model without asymmetric information, the economy