The costs and benefits of Identity
First published on worldbank.org here. By Roumeen Islam. | March 02, 2021
Image: Chhor Sokunthea / World Bank
Identity is defined in various ways, depending on who is doing it. It may be used to denote association with a given social, economic or political group. It may refer to the digital username and password that one uses to get access to a site or services online. It is generally the response to the question: who are you?
How does identity matter in economics and which definition of identity matters? Identity matters because people (their ability, endowments and preferences) are heterogenous. Ackerlof and Kranton (2000) in their seminal article, contend that choice of identity is critical in economics, as identity is an important determinant of behavior and because there are externalities associated with peoples’ identity choices. For purposes of this blog, Identity is that marker which corresponds to one particular individual/entity for a specific purpose and is used in transactions among people or between people and agencies or other bodies.
Policy. Policies addressing distribution, for example—of wealth, income, or skills, look to identity to understand the economic reasons for and, consequences of, economic heterogeneity. There are at least as many identities as there are people; in practice, there are many more, as every person has a number of different identities. There are many areas of policy relevance where policymakers desire to remove heterogeneity: for example, in access to job opportunities.
Usually policy targets focus on a limited set of possible heterogeneity—such as targeting groups of people above or below a certain income level for a tax. It is prohibitively costly to design a different policy for each unique individual. However, proper implementation requires universal identification, even if the eventual policy is targeted to a subgroup, say—the poor. Unless all the poor are identified, only a subset of targets will be reached. At the same time, the desire to be identified will depend on the costs and benefits of being so for each individual or entity.
Markets. Even if distributional issues did not concern the policymaker, knowing identity would still matter for economic outcomes. This is because markets face high transactions costs when identity cannot be established. But which concept of identity matters? Market transactions depend on identity being established uniquely for the transaction at hand—though not all aspects of a person’s identity are needed. Governments have identity too—usually several. There are at least as many relevant separate identities as there are agents transacting in the market or policy sphere.
What are the transactions costs? The first one is information asymmetry. I may know who I am, but my banker may not. The simplest Identity for a transaction could be provided by those who “know’ you physically, by reason of association. However, these Identities are not trusted outside the network. For any arms-length transaction to occur, an identity—based on a set of identifiers—(proof of identity) is necessary. My banker does not need to know my family or social network to believe that it is I standing in front of her trying to get access to my funds. She needs an identifier. However, to the village moneylender, my family may be the identifier. Another cost relates to assignment and enforcement of property rights/contracts. Ownership of an asset, the right to a resource or even the right to carry out an activity (such as polluting a river) must be assigned on the basis of identity. In some cases, the identity may not be a personal identity but a third-party one (such as a business).
Yet, in all countries, there are people who do not have formal Identities. This means that there are many transactions in which they cannot take part. They cannot register a business, open a bank account, or get social transfers. For many, Identity to mitigate information asymmetries and assign property rights, could confer substantial benefits. But, there are costs too; thus “informal” activities remain integral to all markets.
An obvious question is what sort of identifiers should be used to create Identity—name, height, weight, ethnicity, religion, fingerprints, DNA or all of the above? The answer varies according to the purpose. Tourism in Italy requires me to have a passport, not an employee identification number. No matter how an identity is derived, the key to an effective system is to minimize exclusion for the purpose at hand while managing costs and to maximize ease of use.
Countries and companies are increasingly using digital means for unique identity—biometrics are an example, but there are numerous others; public and private. The digital world has spawned a world of alternate identities that are privately created and managed and allow arms-length transactions. However, all these private Identities cannot replace that provided by government—the final arbiter, reflecting the externalities associated with identity.
In sum, establishing Identity has benefits for policy, markets and thus people; both the supply of and demand for an identity depend on the benefits conferred and costs incurred.