• Jonas S. Müller

Asymmetric Information Between Potential Customers and Vendors in International Trade

Updated: Sep 17

An Economic Examination

– Summary –

Leipzig, September 2018,

edited in Mai 2020

International trade flow is less than expected

There are still puzzles in international trade that have yet not been fully understood. For instance, why is international trade smaller than trade theories predicted?[1] Why is the volume of trade, especially among poorer and richer countries, less than predicted by the Heckscher-Ohlin-Vanek model?[2]

Consumers have a strong preference for domestic products.

In addition to that, it is also not yet quite understood why consumers seem to have such a strong preference for domestic products.[3] Moreover, natural trade barriers (which are not caused by government measures) are still poorly understood even though they have a significant effect.[4]

This paper examines whether a problem of asymmetric (or imperfect) information between potential customers (consumers or companies who are in demand for a product or service) and vendors (supplier who offer or would under perfect market conditions offer this product or service) could partly contribute to these international trade puzzles.

Different than the country of origin effect (which can be negative or positive) asymmetric information in international trade focuses on the difficulty of cross-border trade act and not on the perception of where a product comes from (is produced).

What is asymmetric information?

At economic theory, we learn the principle of demand and supply and how the market works under perfect circumstances. In practice, however, the market does not have perfect circumstances, and its function can fail. One condition is that all market participants have complete information for free. Obviously, this is rarely the case. Due to that, the market is not working as perfectly as if it would in perfect condition. The market is failing due to the lack of information, which is called asymmetric information. Asymmetric, because one side (e.g., vendor) knows more about themselves (e.g., their product quality and their trustworthiness), then the other side (e.g., customer) knows about the first side.[5]

Akerlof's famous "market for lemons"

There are generally two categorize of asymmetric information. One is well explained by Akerlof's famous "market for lemon" paper. He explains that on the second-hand car market, the car dealer (expert) knows more about the car than the consumer (layman) does. The consumer cannot assess whether it is a good car or a bad car (lemon). The consumer can only assume a vehicle is of average quality (if he or she does not see anything obvious) and that the value of the car is average.

Let's assume, there are only two car categories on the market, bad cars with 5,000 EUR value and good cars with 10,000 EUR value, and there would be the same quantity of both types. The consumer could not segregate between which car is good and which bad. He would assess the value of the cars as average with 7,500 EUR value. Now, if one dealer offers a bad car for 7,500 EUR and another dealer offers a good car for 10,000 EUR, the consumer would buy the bad car. The good cars will eventually not be offered anymore. The trade of good cars, which would be beneficial for both sides, does not take place any more. That phenomenon is called adverse selection.[6]

Moral hazard

The other category is the moral hazard. Moral hazard means, as the name implies, a social threat. It refers to the behavior of one side at the cost of the other party. A typical example is the insurance industry. The insured person does not care about the insured good as he would if any damage would be on his costs.

Five supportive economic findings

In research for the state of research of asymmetric information between potential customers and vendors in international trade, it transpired that this topic has not been researched thoroughly in the economic field. Economic research papers that explicitly examine this topic are almost not available, or at least they are not available to the author. However, some existing theories and researches suggest the existence of the problem of asymmetric information in international trade.

1. Discrimination against foreign firms

The theory of liability of foreignness says that foreign companies that operate in another country have a competitive disadvantage over local firms. This has several reasons, e.g. higher communication costs, lack of knowledge about the foreign culture, law, etc., and discrimination by the foreign country's administration.[7] Part of the liability of foreignness is also discrimination from customers towards foreign firms. However, this aspect has been (compared to other economic topics) neglected by scholars as not many papers focusing on that are publicly available.

2. The role of intermediaries and platforms

The share of intermediaries in international trade is quite significant. Blum et al. quantify the percentage of intermediaries in the imports of a country to 25 to 45 percent for each country.[8] That remarkable share of intermediaries at cross-border trade can be caused by better abilities to screen and signal (the two market solutions of asymmetric information). Hence, intermediaries enable a solution to asymmetric information. Therefore, the high share of intermediaries in international trade suggests asymmetric information in international trade. Moreover, Coad and Dach-Brown found out that firms using platforms (third solution: independent third parties) for intra-EU cross-border e-commerce, experience fewer information barriers. This finding also suggests an existing trade obstacle in international trade caused by asymmetric information.[9]

3. Cross-border information flows have a positive effect on the cross-border trade flows.

Cross-border information flows have a positive effect on the cross-border trade flows, which supports the hypothesis of asymmetric information in international trade. Porter and Rey accidentally found out about the correlation between cross-border information flow and cross-border trade flow while examining another topic. For the two economics, the finding indicates an underestimation of the aspect of asymmetric information in international trade.[10]

4. Companies lack information about foreign countries.

Could consumers then lack information about foreign companies, too?

The theory of liability of foreignness includes that foreign firms have costs to get informed about the foreign market they want to expand to.[7] The so-called Uppsala model, which explains the internationalization of businesses as a learning process, explains that companies perceive business activities in foreign countries with risks as they do not know enough about the other country. Moreover, the theory of international management takes also into account the difference in language, and culture, as well as the difference in the systems of economy, education, and law. Meaning the more different (so-called psychic distant), the less the company knows about the other country (or the more difficult it is to learn).[11]

Furthermore, in recent years a new topic at economics has come up, which gained the interest of more and more academics: the theory of information friction.[12] Information friction basically means that companies lack information about foreign markets.[13] However, it does not refer to the asymmetric information between suppliers and foreign demanders. Instead, according to the theory, domestic and foreign companies have asymmetric information about the domestic market.

Companies (who are generally better informed than consumers) have, according to these theories, a lack of information about foreign cultures and systems (Uppsala model) as well as about the market circumstances at other countries (information friction). Thus, a logical conclusion is that consumers must also lack information about foreign companies (and companies about foreign consumers). Moreover, the same argumentation can be made with asymmetric information between governments and firms in international trade.[14]

5. Immigrants increase bilateral trade flows

Another indication lies in the trade creation of immigrants.[15] Immigrants create additional trade between the country of origin and the country of destination. Head and Ries found out that ten percent more immigrants from one country of origin cause three percent more import from this country and one percent more export to this country.[16] The imports of the county of destination from the country of origin are significantly higher than the opposite trade flow, which suggests an information problem, and that it is of relevance since the demand in the country of destination from the country of origin increases significantly. The higher demand (in the country of destination from the country of origin) might be caused by enhanced information of the people in the country of destination about the people of the county of origin due to social contact and connection with people from the country of origin.[17]

Why is asymmetric information an obstacle for international trade?

People know less about people in other countries and their cultures and behaviors. Therefore, consumers can assess foreign vendors not as good and accurate as they can assess their compatriots.

(E.g., German) potential customers do not trust foreign (e.g., Eastern European) vendors

Potential customers know less about the trustworthiness of the business the products and the aspects of the products when offered by a foreign vendor. For example, they do not know how safe a product is and more importantly how honest the foreign vendor is about the safety of the product since they do not know as much about the foreign culture as they know about their native culture. Potential customers (especially consumers and small businesses) perceive a higher risk at the process of the trade itself if the trading partner is in another less familiar country.

As a result, the lack of knowledge, about the other culture and unknown behavior patterns, ultimately leads to a business obstacle. The potential customers cannot determine whether the foreign vendor is good (trustworthy) or bad (not trustworthy), just as with the lemon theory from Akerlof. Moreover, the difference in the standard of living might provoke the concern of consumers in wealthier countries that vendors in poorer countries could try to scam them (that they try to get money desperately).

Unfortunately, Germans have still prejudices against and a negative bias towards Central and Eastern European countries and Central and Eastern Europeans are facing economical discrimination in Germany.[18] Consequently, the problem of asymmetric information in international trade could be a real business obstacle for Central and Eastern European businesses selling to Germany.

Vendors cannot assess the creditworthiness of foreign customers

The same argumentation chain applies the other way around, and the vendor's risk is also higher at cross-border trade since the vendor cannot appraise the foreign customers' creditworthiness accurately. Furthermore, social control is lesser or even not existing, considering the given geographic and social distance.

But who gives the money or product first?

Consequently, we have a situation where the consumer does not trust the vendor and where the vendor does not know whether the consumer is able to and also intents to pay. But in international trade, inevitably, both sides of the deal cannot be exchanged simultaneously. Hence, one party must give his product or money before the other party fulfills his side of the agreement. But who? That is the problem.

Market solutions are more difficult

Screening and signaling, the market solutions for asymmetric information do not work as well as they do nationally. This is not only due to the larger geographic distance and the language barrier but also to the lack of knowledge on how to understand signals and the lack of received credibility. Larger firms, however, have the means and the interest to screen effectively in spite of the extra costs, that is why the extent of the problem of asymmetric information in cross-border trade is lesser when larger companies are in demand of essential (long-term) supply. Another issue is the different legal systems, which makes it harder to enforce a rightful claim of one party.

Empirical examination

The hypothesis was examined with an empiric method. The structure of production and the structure of exports (of produced goods) of the countries of the EU and EFTA is compared. The difference between the structure of production and the structure of export of each country is compared between the countries. This comparison aims to see whether a structural difference among the countries is observable. The data are from 2015, the latest year with fully available data at the time the hypothesis was examined.

The structures are formed by the degree of technology. The higher the degree of technology, the higher the value of the goods must be, and with higher value comes higher risk. Moreover, a higher degree of technology consists of higher knowledge. Consequently, it might be more difficult for potential customers to understand all the aspects of the goods entirely, hence the risk of the transaction is greater. Due to both aspects, the problem of asymmetric information must be more significant at high-tech products then at low-tech products.

The hypothesis says that the evaluation of foreign goods and services, as well as of foreign vendors and potential customers, is less accurate. This assumable leads to an average assessment from the consumers according to the (subjective) reputation of the other, supplying country. The idea is to use the reputation of one country in the rest of the world to compare the countries' production and export structure according to the countries' perceived image in other countries, and thereby to examine whether countries with a worse reputation have a more significant problem of asymmetric information than countries with a good reputation do.

For the determination of the reputation of the countries in the rest of the world, the most adequate available external study Country RepTrack 2015 [19] was used. Unfortunately, not all examined countries were part of the reputation study. However, this was the study that included most countries. Moreover, some countries did not provide sufficient enough data (confidential reasons). That is why only selected countries could be examined.

The results show that countries with a good reputation can increase the share of high-tech at the production to a significantly higher percentage of high-tech at the export (see figure 1). Whereas countries with a bad reputation do have a similar share of high-tech at the production structure, but they can only raise the share of high-tech at the export structure in comparison to the production structure by a little bid (see figure 1).

Figure 1: Comparison of the five countries with the best reputation and the four countries with the worst reputation

Group of the best 5 (left): Norway, Austria, United Kingdom, Germany, Spain

Group of the worst 4 (right): Rumania, Czech Republic, Poland, Portugal

Italic: data are not comparably available (confidential)

Source: own examination; data of 2015 from Eurostat aggregated: “detaillierte jährliche Unternehmensstatistik für die Industrie (NACE Rev. 2, B-E)” and from Eurostat: “Handel nach NACE Rev. 2 Art der Tätigkeit”

The worse the reputation of one country in the rest of the world is, the more difficult it is for that county to sell its produced high-tech goods to the rest of the world, compared to produced low-tech products (see figure 2). The results indicate the existence of the obstacle of asymmetric information between potential customers and suppliers in international trade. More research is necessary.

Figure 2: Increase or decrease from the share at production to the share at export in percent

Quartile 1: Norway, Austria, United Kingdom, Germany

Quartile 2: Spain, Portugal

Quartile 3: Poland, Czech Republic

Quartile 4: Romania

Frame: approximative

Source: own examination; data from Eurostat: “detaillierte jährliche Unternehmensstatistik für die Industrie (NACE Rev. 2, B-E)” and from Eurostat: “Handel nach NACE Rev. 2 Art der Tätigkeit”

What about services?

Services have not been included in the empirical examination because services are not well classified in the degrees of technologies nor any other useable classifications. Furthermore, the data for the production and export of services are less suitable for this examination. That is why asymmetric information at the international trade of services is discussed in this paragraph. Asymmetric information in international trade could have a greater impact on the trade of services than on the trade of goods, which could be due to the characteristics of services. For instance, services can hardly be evaluated before the purchase increases the problem of asymmetric information. Moreover, the foreign potential customer has it more difficult to understand reviews in the foreign country due to cultural differences and the language barrier. Another characteristic of services is that services are made by internal and external factors, meaning that the customer participates in the production of the service, which also increases the problem of asymmetric information due to the cultural difference and language barrier.[20]

German consumer protection organizations are strictly warning German consumers to go to Central and Eastern European dentists.

One example of that is the market of Central and Eastern European dentist services for German patients. Even though the dentist services must be of comparable quality.[21] ICW [22] German consumer protection organizations are strictly warning German consumers to go to Central and Eastern European dentists.[23] This could be a consequence of adverse selection. Extensive empiric research for services is necessary.

Ricardo model (model of international trade)

The hypothesis is not contradictory to the Ricardo model since this hypothesis does not interfere with the Ricardo model. This paper is more a contribution to answer the remaining puzzles at international trade by whether the international market could partly fail due to asymmetric information in international trade.

The international market could partially fail.

Asymmetric information in international trade might antagonize the perfect international allocation of production. It could be possible that one country has a comparative advantage in producing a product (and produces it relatively efficient), but that the people in the rest of the world do not know about it or do not trust the suppliers from this country and buy less of the product than they would with complete information. The international market could partially fail.

[1] Cf. Rivera-Batiz / Olivia (2003) [2] Cf. Caron et al. (2014)

[3] Cf. Obstfeld / Rogoff (2000) [4] Cf. Steinweder (2018) [5] Cf. Pindyck / Rubinfeld (2009) [6] Cf. Akerlof (1970) [7] Cf. Mezias (2002) [8] Cf. Coad / Dach-Brown (2017) [9] Cf. Portes / Rey (2005)

[10] Cf. Blum et al. (2018)

[11] Cf. Holtbrügge / Welge (2015) [12] Cf. Baley et al. (2015) [13] Cf. Steinwemnder (2018) [14] Cf. Bouët / Cassagnard (2013) [15] Cf. Head / Mayer (2013) [16] Cf. Head / Ries (1998) [17] Cf. Gould (1994)

[18] Cf. Federal Anti Discrimination Agency (2015)

[19] Reputation Institute (2015) [20] Cf. Malicha (2000) [21] Cf. Bundeszahnärztekammer (n.d.) [22] Cf. Zahnärztliche Mitteilungen Online (2017) [23] Cf. Braun (n.d.)


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