The Question of Consumer Competence—Posner

When is it proper for government to try to protect people, in their capacity as consumers of goods and services, from themselves? And not just children or people with serious mental problems, but normal adults. Can’t normal adults protect themselves? And if they can’t, won’t competition among sellers protect them?

 

These questions are acutely raised by the proposal, now before Congress, to create a Consumer Financial Protection Agency that would protect consumers of financial products such as mortgages and credit cards and payday loans not only from misrepresentations by sellers of these products, but also from their own ignorance or poor judgment. The proposal draws on behavioral economics, which teaches that cognitive and psychological limitations frequently lead consumers to make mistakes, even when there is no fraud by sellers.

 

The specific proposal seems to me misconceived. Its premise is that the housing bubble and ensuing financial collapse were due in significant part to reckless borrowing to finance home purchases or borrow against home equity in order to obtain cash to buy other goods and services. The argument is that people didn’t realize the risk involved in buying a house with very little (sometimes zero) equity, especially if they financed it by an adjustable-rate mortgage, which might become unaffordable by them if interest rates rose.

 

No doubt some people didn’t realize they were taking a risk, but I don’t think that that is the explanation for the housing bubble. Almost no one, including sophisticated economists and financiers, realized that the steep increase in housing prices that ended in 2006 was a bubble phenomenon. If it was not, then homebuying wasn’t really risky, because one could anticipate that the market value of one’s house would grow, and this would create sufficient equity to be able to refinance one’s mortgage on attractive terms. There was a speculative element but it did not seem extreme because so few experts believed there was a housing bubble. Among these experts notoriously was Ben Bernanke.

 

I want to contrast with the proposal to curtail risky borrowing by consumers two types of consumer protection that seem to me justifiable, and this regardless of the insights of behavioral economics. One is requiring cigarette labeling and advertising to carry warnings of the health hazards of smoking. This regulation is not very important today because everyone knows about these hazards, but it was important in the 1960s when the existence and gravity of the hazards were first confirmed. Obviously individual consumers were not in a position to study the health effects of smoking—which cigarette manufacturers were busy denying—but one might think that advertisers of competing products would have had an incentive to frighten consumers away from smoking. But this would not be a realistic expectation. What would consumers think if a manufacturer of chewing gum advertised that chewing gum, unlike smoking cigarettes, does not cause lung cancer? Nor would cigarette manufacturers whose cigarettes contained less tar and nicotine than the average be strongly motivated to advertise the fact, because they would be telling the world that cigarettes are hazardous, at a time when this was not generally realized. Automobile manufacturers were slow to offer seatbelts, perhaps fearing they would be advertising the dangers of driving—and charging a higher price (to cover the cost of the seatbelts) at the same time.

 

My second example is inspections of restaurants and food processors by government inspectors, to prevent food poisoning. One can imagine leaving food safety to the market, reinforced by tort remedies against the sale of unsafe products. But solvency limitations would make market and tort remedies ineffectual against many sellers, especially small and new ones—so the inspection regime actually facilitates new entry, which is a dominant feature of the restaurant industry. Food poisoning can cause death, indeed multiple deaths, and when the consequences of a market failure are very grave, there is an argument for preventive regulation.

 

Now I want to discuss an important intermediate case, where the argument for consumer protection seems to me stronger than the case for consumer financial protection (other than against fraud), but not so strong as in the cases I just gave. That is the case of obesity. According to the Weight Control Information Network, which is part of the National Institutes of Health in the Department of Health and Human Services—and I believe reputable—two-thirds of American adults are overweight and one-third—an astonishing percentage—are obese, defined as having a Body Mass Index (the ratio of a person’s weight in kilograms to the square of his height in meters) of more than 30. So, for example, a woman 5 foot 6 inches tall would be deemed obese if she weighed 180 pounds, and a man 6 foot 1 inch tall would be deemed obese if he weighed 227 pounds.

 

Obesity is measured differently for non-adults, but 17 percent of young children and 17.5 percent of adolescents are estimated to be obese.

 

These are startling figures, and considerably higher than in virtually any other country in the world. My esteemed colleague Becker has argued, however, that American obesity is not excessive in an economic sense. Obese people may simply have traded off the pleasures (and economy) of eating cheap, tasty, and nutritious food against the costs in disagreeable appearance, impaired mobility, the greater danger of and longer recovery time from surgery, and the much greater incidence of Type II diabetes and joint problems; there is also a greater risk of heart disease and possibly of dementia. Becker believes that the long-run expected costs of obesity may be small if continued advances in medical technology eliminate or greatly reduce the health problems that obesity creates, and that the realization of this possibility is one of the factors that people consider in deciding whether to allow themselves to become obese.

 

I am skeptical. The problem of obesity is concentrated in the poorer segment of the population, among people with limited education who may be unable to assess the health risks of obesity and as a result are unwilling to incur the slight added expense (or cost in diminished eating enjoyment of a diet less rich in sugar and butter). They may also be imperfect agents of their children; and a person who becomes obese as a child will find it more difficult to avoid obesity than people who were thin children. Governmental paternalism when directed to children is less problematic than paternalism toward adults.

 

There is also an externality, which is a nonpaternalistic justification for government intervention. The government, meaning ultimately the taxpayer, now pays for half of total U.S. medical expenses. The average medical expenses incurred by obese people are substantially greater than those of the nonobese, even after allowance for the shorter life spans of obese people. (It has been responsibly estimated that obesity and overweight add $150 billion a year to the nation’s medical bill. This is somewhat too high because it ignores the effect of obesity in reducing longevity. On the other hand it excludes the $40 billion a year that people spend on diet programs.) Much of the additional cost to Medicare, Medicaid, and other public programs is borne by taxpayers who are not obese. Private health insurers are forbidden to “discriminate” against the obese by charging higher premiums to them, which is an unsound policy that should be changed (it won't be). But probably many obese people are not insured, and their medical expenses are paid by charity or government, for example when they seek medical care in hospital emergency rooms and cannot pay the price they are billed for that care. Failure to pay the full medical costs imposed by obesity distorts the decision of a person to become or remain obese; it is a subsidy for obesity. I find it difficult to imagine a more grotesque subsidy.

 

But whether it would be desirable for the government to try to reduce obesity depends on the cost and efficacy of the measures it might take. Some of the common proposals are likely to have only modest effects, such as requiring restaurant menus to disclose calories. People who are motivated to avoid obesity know or can easily discover the approximate caloric content of the various foods, and people have most of their meals at home rather than in restaurants.

 

Somewhat more promising measures are: instruction in nutrition and the dangers of obesity in elementary and high schools; healthful school-lunch programs; expanded compulsory physical education in schools; restrictions on foods that can be purchased with food stamps; a tax on advertising fast food; a tax on video games; a ban on food advertisements aimed at children; a relaxation of regulations of health insurance that discourage charging higher premiums to the obese (and that thus subsidize obesity); a tax on soft drinks that contain sugar; and a calorie tax. All would be relatively inexpensive measures that would have a good chance of paying for themselves. The last, the calorie tax, which would probably be the most effective measure, would be a Pigouvian tax—a tax designed to internalize an externality, and, as such, defensible on standard economic grounds if I am correct that obesity creates an externality.

 

Still, such a tax can be criticized on two grounds. One is that it would be strongly regressive. But its regressive effect could be offset by a more generous food-stamp program. The second objection, emphasized by Becker, is that a tax on calories penalizes people who are not obese, and they are the majority. It is the same objection that can be made to alcohol taxes as a means of curtailing drunk driving: most of the people taxed are not drunk drivers. A more efficient anti-obesity tax, in principle, but utterly infeasible politically, would be a head tax measured by weight.

 

I am not much impressed by “fairness” objections to taxes. Taxation is inherently arbitrary, because it doesn’t match the taxes paid by a person to the services he receives from government or the costs he imposes on society. A calorie tax would raise considerable revenue, because like most Pigouvian taxes it would result in only limited substitution away from the taxed good, and the government at present is in desperate need of additional revenue.

 

A more efficient tax would be a tax on producers of food, based on the difference between the cost of the ingredients before processing and the price for the finished product. The tax would therefore fall more heavily on highly processed foods, which tend to be higher in calories, than on lightly processed ones.

 

More study is necessary, however, before the costs and benefits of a well-designed program of obesity reduction can be responsibly assesssed.

Comments

[GK Scott]

I think subsidizing consumer decisions results in greater and greater subsidies, which sink the economy. The underlying problem is lack of transparency, encouraged by the worst culprit, the law, which ensures that system errors are assigned to individuals, so the system is never corrected, and losses are assigned to the taxpayer.

[sesli chat]

This sounds like the arguments used against the creation of the Food & Drug Administraion and other consumer protection groups like the Dep't. of Agriculture. "Why do we need an Agency that regulates Food and Drugs? Can't people determine for themselves when food is rotten or contaminted and drugs like Laudanum or Dr. John's Miracle Medical Elixr are worthless or downright dangerous?"

As for regulating and controlling the Financial and Commercial Industries in the interest of the Public Welfare; the Creators of those toxic Finacial Instruments and other obtuse, exotic, and downright bizarre Financial instruments
which have been the bane of the American and World Economy as of late; the creators, even have no idea of what they are, how they work (if they work at all) and their impact on the Public Welfare. And you want the general public to fend for themselves? Talk about legitimizing "pigs in a poke", "shell games", "ponzi schemes" and other bizzare business practices as the Hallmark of World Economic Order and Enterprise.

No wonder we have economic problems we can't seem to get straightened out.

[Max Furniture]

This scenario disputes the Posner-Becker “state of the world” which implies there was only one rational thing for everyone to do, and into this state of the world we put the homeowners. They are also heterogeneous. The “flippers” for example are another type of investor, some made money and other did not, some hedged and some did not. A CFPA is not for them.

[GK Scott]

If an obesity solution is to be developed, the solution must solve both prongs of the problem, Caloric intake and Caloric expenditure. Driving food costs up will drive down consumption. The other solution that must be incorporated is the increase of Caloric Expenditure and that can only be achieved by a dramatic increase in physical activity. In other words, get the kids out of in front of the TV, Videos, Computers, Game boys and other sedentary activites and outside where they can walk, run, jump, swim, bicycle and participate in any and all types of physical activity.

[Cardy Ugg Boots]

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[Baby Nursery Accessories]

I think the American health-care expenditure example is analogous. We drive our bodies more recklessly on average, of which our obesity rate is a symptom, and a lot of our "extra" spending may be what it medically cost to preserve the longevity of people with unhealthy lifestyles.

[work from home opportunities]

Life can be extremely unfair in the short term, but it is extremely fair over the long term, because life is a distribution of unpredictable events. Don’t get hung up on the extremes. Set yourself up to be patient; that is the key to investing, at every level.

[Internet Marketing Company]

Once the bubble burst, the number of first-time aspiring home-flippers in high-default states like FL and CA plummeted, which reduced the pool of prospective homebuyers lacking the necessary competence.

[Panerai Watches]

It will be easier to enforce good habits than to tax bad ones. We need to be proactive and stop children from getting fat in the first place. Mandatory physical exercise should extend through all four years of high school. However, I prefer a solution that puts the burden on the individuals to improve themselves, rather than a more paternalistic option.

[oil paintings]

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[earth4energy]

since a plethora of deadly and debilitating diseases are transmitted by them as well. Unlike genetic and environmental illnesses, they can be easily avoided by an educated public.

[how to grow taller 4 idiots]

But that statement contains a logical error because "longevity" is not the proper measure of what one gets out of health-care spending. "Maintenance costs" are a more apt analogy. Imagine two individuals who buy identical automobiles. One drives sensibly and conducts routine oil changes, while the other drives recklessly, and perform no regular care on the vehicle, crashes often, and occasionally has to spend significant amounts in repairs.

[den]

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[den]

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[lower back pain]

Nothing is more non-sensical than those. Indeed, sex (kissing) and owning pets like cats and dogs would be proper subjects of advisories as well, since a plethora of deadly and debilitating diseases are transmitted by them as well. Unlike genetic and environmental illnesses, they can be easily avoided by an educated public.

[Emma]

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[Online Payday Loans]

Yes, the entire blow-up debts are caused by the borrowers who are very irresponsible in their act. They purchase things through credit card and become very reluctant when it comes to payments. They always point the blame to the loan companies and then whine about the interest where in the first place they agreed upon the terms before having that card in their wallet. They always don't want to take responsible to their act and leave everything to the government that they keep on bringing down. The government is doing its part for the people. But are these people doing the same?

[Mitchel]

Thanks for the info!

[online payday loans]

I guess what I loved most about it was the common sense, no nonsense way leadership is viewed. Simple statements (not simplisitic) such as "We will work harder and more effectively for people we like. And we will like them in direct proportion to how they make us feel." As they point out we don't need to read mountains of studies on emotional intelligence to understand the truth of these words.

[Rosetta Stone]

These questions are acutely raised by the proposal, now before Congress, to create a Consumer Financial Protection Agency that would protect consumers of financial products such as mortgages and credit cards and payday loans not only from misrepresentations by sellers of these products, but also from their own ignorance or poor judgment. The proposal draws on behavioral economics, which teaches that cognitive and psychological limitations frequently lead consumers to make mistakes, even when there is no fraud by sellers.

[Umbrella manufacturers in China]

Very true. Those men, as well as some icons who have already left, were symbols of a world in which we grew up and felt safer more powerful and capable of success simply by following the rules of decency and good. It did work for a while, even if it might have been an illusion. ?R

[Advertising umbrella]

Thanks for the tips, Scott. Beyond spelling and grammar I spend most of my arts/lit blog time checking info and tracking down links -- and hope that even then I don't mangle them.

[Mini umbrella]

Well deserved EP! This was a fascinating post. I used to hook rugs and remember how much fun it was.

[crystal-gift-clock]

Wonderful piece! I've definitely had moments of fear of taking both my kids places when I thought they could run off.