Screening in economics refers to a strategy of combating adverse selection – one of the potential decision-making complications in cases of asymmetric information – by the agent(s) with less information. For the purposes of screening, asymmetric information cases assume two economic agents, with agents attempting to engage in some sort of transaction. There often exists a long-term relationship between the two agents, though that qualifier is not necessary. Fundamentally, the strategy involved with screening comprises the “screener” (the agent with less information) attempting to gain further insight or knowledge into private information that the other economic agent possesses which is initially unknown to the screener before the transaction takes place. In gathering such information, the information asymmetry between the two agents is reduced, meaning that the screening agent can then make more informed decisions when partaking in the transaction. Industries that utilise screening are able to filter out useful information from false information in order to get a clearer picture of the informed party. This is important when addressing problems such as adverse selection and moral hazard. Moreover, screening allows for efficiency as it enhances the flow of information between agents as typically asymmetric information causes inefficiency. Screening is applied in a number of industries and markets. The exact type of information intended to be revealed by the screener ranges widely; the actual screening process implemented depends on the nature of the transaction taking place. Often it is closely connected with the future relationship between the two agents. Both economic agents can benefit through the notion of screening, for example in job markets, when employers screen future employees through the job interview, they are able to identify the areas the employee needs further training on. This benefits both parties as it allows for the employer to maximise from employing the individual and the individual benefits from furthering their skill set. The concept of screening was first developed by Michael Spence (1973). It should be distinguished from signalling – a strategy of combating adverse selection undertaken by the agent(s) with more information.
Examples
Labour market Screening techniques are employed within the labour market during the hiring and recruitment stage of a job application process. In brief, the hiring party (agent with less information) attempts to reveal more about the characteristics of potential job candidates (agents with more information) so as to make the most optimal choice in recruiting a worker for the role.
Screening techniques include:
Application review – the hiring party initially screens applicants by undertaking a review of their application submission and any responses received, including an evaluation of their resume and cover letter to reveal education, experience and fit for the role Aptitude testing and assessment – the hiring party may require applicants to undertake a range of testing exercises (either online or in-person) to reveal academic or practical abilities Interviews – candidates are often required to undertake an interview with a representative(s) from the hiring party to reveal a range of factors such as personality traits, verbal communication ability and confidence level
Insurance market The process of screening customers is highly applicable in the market for insurance. In general, parties providing insurance perform such activities to reveal the overall risk level of a customer, and as such, the likelihood that they will file for a claim. When in possession of this information, the insuring party can ensure a suitable form of cover (i.e. commensurate with the customer’s risk level) is provided. In particular, Michael Rothschild and Joseph Stiglitz conducted research on the insurance market and how individuals can improve their position in the market when presented with asymmetric information. Rothschild and Stiglitz found that individuals (uninformed party) are able to initiate action by extracting information through screening in order to better position themselves in the market. Insurance companies (uninformed party) had lacked information on the risk level of consumers (informed party). Through screening, insurance companies were able to gain information on the risk level of their consumers, this had been done by offering incentives to policyholders in order to disclose such information on customers. This allowed insurance companies to create a range of risk classes in which their consumers were allocated. Moreover, this allowed insurance companies to create policy contracts for higher deductibles in exchange for lower premiums. Screening techniques include:
Background check – the party providing insurance obtains information about the customer such as their criminal history, credit rating and previous employment to reveal past behaviors Provision of demographic information – the party providing insurance obtains information about the customer such as their age, gender and ethnicity to reveal their type. For example, a young male has a higher risk of being in a car accident than a middle-aged woman Other information gathered by insurance parties during a screening process is usually specific to the type of insurance the customer is seeking. For example, car insurance will require provision of accident history, health insurance will require provision of health condition and previous illnesses, and so on.
Moral hazard: Moral hazard take place when one party engages in actions that harm the other party. The chance of moral hazard can occur especially in insurance companies, in which one party takes part in risky behaviour as they have insurance coverage and therefore will benefit from being compensated by the insurance company. In this case, the insurance company is the uninformed party, however, through screening processes such as historic behaviour, therefore, insurance companies are able to identify those individuals in order to offer a different insurance plan.
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