Adverse Selection, Gresham's Law and State Regulation

Abstract

Regulation is often justified as a response to adverse selection caused by poorly informed buyers and as a means of preventing a ‘race to the bottom’ in competitive markets. This paper argues that competitive markets respond with a variety of institutional mechanisms to problems of adverse selection and that these are often subverted by regulation. Far from Gresham's Law being associated with competitive market processes, it is actually more correctly viewed as the outcome of regulatory intervention that weakens the quality‐protecting incentives that economic agents would otherwise face.

Keywords: adverse selection, educational certification, Gresham's Law, public choice, quality standards, regulation

JEL Classification: B53, D70