Screening (economics)

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.^[1] 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.^[2]

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.^[1] Both economic agents can benefit through the notion of screening,^[3] 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).^[4] It should be distinguished from signalling – a strategy of combating adverse selection undertaken by the agent(s) with more information.