May 18, 2008
Consumer Protection--Posner
The subprime mortgage debacle, efforts by New York City to ban trans fats in restaurants, the discovery of lead in toys manufactured in China, and concerns about safety inspections of airplanes and laxity in regulation of new drugs have brought to the fore the issue of the optimal scope and methods of regulation designed to protect consumers.
There are two reasons to think that consumers might need more protection than is provided by competition among sellers, even as backed up by court-enforced law. Few opponents of regulation doubt the appropriateness of such judicially enforced rules as the implied warranty of fitness and safety that accompanies the sale of products.
The first reason for thinking that it might make economic sense to add a layer of regulation to competition plus court-enforced law is the high costs to consumers of obtaining information about products and services (but I will confine my attention to products). The busier people are and hence the higher their costs of time, and the more complex that products are, the higher consumer information costs will be. Product information could be thought a product in itself that a competitive market would generate in optimal quantities, but that is far from certain. The problem is what might be called "fouling one’s nest." If a cigarette producer advertises its cigarettes as "safer," it is implying that cigarettes are unsafe, and this could reduce consumption. Now in fact everyone knows about the dangers of smoking, so that is not a serious problem; but it is a problem when the hazards of a product are not widely known. A restaurant that advertises that its food contains less trans fat or less salt than other restaurants is telling consumers that there are bad things in restaurant food. Moreover, and probably more important, it is very difficult for an advertiser to explain why trans fat or salt or butter is bad for one. I believe that the obesity epidemic must be due in in part to the ignorance of many consumers, especially if they are poorly educated, of the causes and consequences of obesity.
There are three possible responses to the problem created by consumer information costs. The first is to require producers to provide more information; the second is to ban products upon on the basis of a judgment that if consumers knew the score they would not buy the product in question; and the third is to leave the burden of information on the consumer, thereby increasing the incentive of a consumer to inform himself about the products he buys. Often the preferred ranking will be 2, 1, and 3. Banning the product eliminates information costs, though to justify so drastic a measure requires a high degree of confidence that informed consumers would not buy the product if they knew the facts about it. If as I believe trans fats have close and much more healthful substitutes that cost little more than trans fats, the attempt to ban trans fats in New York City restaurants made sense.
Forcing sellers to provide more information to consumers can paradoxically raise consumer information costs by requiring consumers to sort through more warnings and interpret and evaluate them. There is also a lulling effect: required warnings create the impression that the government is protecting consumers by regulating sellers, which it may not in fact be doing; or may create resentment because consumers feel overloaded with unnecessary warnings: a "crying wolf" problem. A related problem is that consumers have very different stocks of information, making it difficult or even impossible to draft a warning that will provide a significant net increment in consumer knowledge.
Finally, encouraging consumers to become better informed about products on their own, in lieu of relying on government regulation, might be excessively costly. It would force consumers with high time costs to reallocate high-value time to the study of consumer products, at a cost and a cost of this reallocation that might exceed the cost of regulation. Take the case of health inspections of restaurants. My guess is that those inspections add little to the cost of restaurant food (I am assuming the inspections are financed by a restaurant tax). In their absence a consumer could not just drop in on a new restaurant with confidence that he would not get sick because of unsanitary conditions. (So such regulation may encourage entry into the restaurant industry.) No doubt services would spring up to rate the healthfulness of different restaurants, just as services like Zagat rate the quality of the food and service offered in different restaurants. But the inspectors employed by a private service would not have the powers of public inspectors--to inspect without notice and shut down a restaurant found to have unhealthful conditions. Perhaps some restaurants would consent to grant such powers to a private service, but then the consumer in evaluating the private inspection services might be faced with a formidable search cost to determine the best service.
Apart from costs of obaining information, there is the distinct problem of evaluating or processing information. This is the domain of the cognitive quirks that have been illuminated by the recent literature (increasingly influential in economics) in cognitive psychology. An example is the seeming inability of many consumers to appreciate the practical identity between an item priced at $9.99 and the identical item priced at $10.00. Merchants' unquestionably sound conviction that consumers exaggerate the difference between these two prices is the only thing keeping the penny in circulation, as it costs more than a penny for the U.S. Mint to produce a penny.
I do not think these quirks provide a compelling reason for additional regulation of consumer products and services. Such regulation would amount to telling consumers that they can't think straight, and would reduce consumer utility, at least in the short run, by denying them $9.99 "bargains." I would however favor incorporating into the curricula of high schools, and perhaps even elementary schools, courses in cognitive psychology that would make students alert to the pitfalls that await them as a result of cognitive defects that, though hard-wired in the brain, are avoidable if one is alert to their existence.
The existence of cognitive deficiencies may have been a factor in the subprime mortgage debacle, though on the consumer rather than the producer side. Many consumers may have been incapable of properly evaluating the risks of heavy borrowing; cognitive psychologists have found that average and even very intelligent people have difficulty handling probabilities. On the producer side of markets, however, there are forces for minimizing the effect of cognitive deficiencies. People who don't handle probabilities well are not going to thrive in the insurance business or other financial businesses. They will be selected out by competition; the analogy is to natural selection in biological evolution. I suspect that the housing bubble and ensuing credit crunch reflect, on the business side of the market, not so much irrational optimism as risk taking that was rational given asymmetries of loss and gain. Generous severance benefits truncate downside risk for the top management of large companies, and speculation in the face of a known bubble can be rational because until the bubble bursts values are rising very rapidly; the trick is to jump off the hurtling train just before it crashes.
Posted by Richard Posner at 09:40 PM | Comments (22) | TrackBack (2)
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Posted by warming to global Fight at May 19, 2008 03:29 AM | direct link
Fight global warming how fund Fight global warming
Posted by warming to global Fight at May 19, 2008 03:29 AM | direct link
Judge Posner:
Have you completely forgotten about trademark law, which effectively requires sellers to incorporate the consequences of negative externalities into their pricing? Wouldn't that be just as or more effective than any other regulations you suggest?
Also, I have been working on the problem lately, and I believe that bubbles can be explained without resort to any theory of psychology by taking into account dynamic price fluctuations that are the result of Schumpeterian creative destruction in the market for an older good. With slowly varying price, liquidity, external money supply, and transactions costs, one can produce a "resonance" effect equivalent to a bubble. No psychology needed.
http://brokensymmetry.typepad.com/broken_symmetry/2008/05/schumpeterian-c.html
This reminds me also of why Law, Pragmatism & Democracy was the most compelling of your books: it was the only one to incorporate a dynamic equilibrium theory of the markets it described. Too much of your analysis (including your analysis of consumer goods here) is trapped in a static world in my humble opinion.
Posted by Michael F. Martin at May 19, 2008 03:52 AM | direct link
Mortgage payment protection insurance is increasing in popularity in the UK. This is mainly because monthly mortgage payments are very high, because of the high cost of housing in the UK.
Posted by whatmortgage at May 19, 2008 04:58 AM | direct link
Government must act as a vein for the of information to the public?
Two words Dr. Posner: Consumer Reports.
Posted by YoungActuary at May 19, 2008 07:16 AM | direct link
Since food is one example used, consider this. Purveyors could label produce "organic." Produce cannot be inorganic, so labeling it "organic" is not false. Then, one criticism was the latent presence of inorganic or synthetic substances on some produce, for example, residues of pesticides, fertilizers, or washing/waxing. So, regulations are imposed that allow the label "organic" to be applied only to produce from farming done without the use of inorganic or synthentic substances.
This regulation clearly increases the cost to the consumer for the "organic" produce. That consumer does know the regulations or how far its requirements go, and may not know anything about "organic" farming. In other words, the regulation does not make for "more informed" consumers. All it does is give the consumer a choice, to buy and pay more for "organic" produce, or to buy something else. Regulation does not always equate to information, but standardized labeling is desirable to consumers, even if it adds costs.
Posted by Thomason at May 19, 2008 12:22 PM | direct link
You appear to be ignoring the possibility that the authorities making the rules might themselves be in error, either because they are subject to the same cognitive deficits as the rest of us or because their incentives are not consistent with our interests. For the obvious historical example of the latter, consider the past pattern of state regulation of margarine sales, motivated not by considerations of health but by the political influence of dairy farmers.
For the former, you might remember that for a very long time, the official wisdom held that one ought to substitute margarine for butter. We now know that this wisdom was wrong, that the margarine being substituted contained transfats and was much more dangerous than butter. If your solution 2 had been applied in that case the result would have been a very large number of unnecessary deaths--I'm guessing in the hundreds of thousands.
Or in other words, your arguments as given are about forty years out of date, so far as economic thought is concerned. You are committing the old fallacy of implicitly assuming the government will make the right decisions, instead of applying the same assumptions of self-interest, imperfect information, cognitive deficits, and the like to the political system that you apply to the market.
Finally, I would like to offer a much simpler explanation for the increase in obesity. Humans evolved in and are thus "designed" for an environment where food was often scarce. We have a pattern of tastes and behavior adapted to such an environment. We are now in an environment where calories are almost costless and where what used to be particularly scarce forms of nutrition, in particular fats, are readily available.
I suggest that your alternative explanation is subject to a very simple empirical test. Ask people who are very much overweight whether they know that being very much overweight has adverse effects on their health. If a substantial number reply that they do, you have good evidence that ignorance is an inadequate explanation.
Posted by David Friedman at May 19, 2008 01:05 PM | direct link
Hayek has observed that if you assume that outside experts can always make the best decisions for people, then there really is no rationale for freedom. The arguments for banning X, Y, and Z founder on the understanding that each individual is the world's best expert on his own tastes and desires. The nanny state is a crude instrument to use to deal with the idiosyncratic desires of hundreds of millions of individuals.
Posted by Scott Wood at May 19, 2008 02:23 PM | direct link
Judge, I'm perfectly willing to live with Option 3 - enlightened caveat emptor. Just reopen the common-law courthouses of America, rebuke federal administrative agency pre-emption of State injury compensation law, and protect trial by jury, class actions where they make sense, and punitive damages where the defendant has earned them. Able trial lawyers, thoughtful courts, and a few State attorneys general on the cutting edge back in the '60's and '70's gave us the foundation of the considerable improvements in consumer product/service safety improvements we've seen since. Unfortunately, we couldn't get to everything that deserved an uprooting - e.g., over-the-counter sale of nicotine delivery devices. "Rule of law" has to mean as much for ordinary people as it does for wealthy interests. That's where we've gone off track and we need to do better.
Posted by Brian Davis at May 19, 2008 02:30 PM | direct link
Judge Posner,
You have probably met more successful bankers than I have; but very few of my banking acquaintances would be likely to make good bookmakers. I suspect that one of the underlying factors leading to recurring financial crisis is that many people in charge of financial institutions are rather poor at getting their minds round probabilities. Judges, as a class, seem much better at sorting out the odds.
More fundamentally, is not the proper role of consumer protection regulation preventing rogue traders (those who are not looking for repeat business and are therefore unconcerned with loss of reputation) from making routine commerce impossibly burdensome? To be fit for purpose and therefore acceptable in routine trade, goods and services must at least meet known minimum specifications.
The vagaries of consumer protection legislation over the last five centuries seem to demonstrate that the temptation to over-detailed regulation is always present; and generally leads to back-tracking. The general direction of the resolution of this question in the nineteenth and twentieth centuries has been to combine minimum specification regulations with reinforced rights of redress for buyers who do not receive what they paid for.
The advance of science has lead to more and more of the minimum specifications being evidence-based. The increasing flood of scientific findings (including those of the "social sciences") provides justification for almost infinite possible elaboration of minimum specifications. The costs of meeting complex specifications have so far proved prohibitive in very few cases; but those costs are on an increasing trend. The costs will have to be contained in due course by some general rule of not regulating when the cost may outweigh the benefits. Properly incorporating that in legislation and practice should keep quite a number of our successors occupied over the coming decades.
The more urgent issue is that the odds are that a substantial proportion of the scientific findings on which new arguments for consumer regulation are likely to be based will be demonstrated later to be wrong or misleading. (This may be even more true in the social sciences than in the biological sciences.) We have the choice of regulating now and chancing both the costs of regulation if our assumptions prove right and the costs of mis-adventure if our evidence for regulation is later proved wrong; all as against the damage that may be allowed if we do not regulate. My guess is that our need to protect confidence in the overall regulatory system will result in some form of presumption against regulating until the evidence on which the proposed regulation is based has been thoroughly tested; but it looks like an interesting time until we get there.
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Posted by Mike at May 20, 2008 03:51 AM | direct link
頑張って下さい。
名古屋 風俗
Posted by 名古屋 風俗 at May 20, 2008 08:26 PM | direct link
"I believe that the obesity epidemic must be due in in part to the ignorance of many consumers, especially if they are poorly educated, of the causes and consequences of obesity." I love your writing but wonder about the use of 'of'-- could 'about' be used here as well ('too' or instead of, ha ha). How come you chose New York restaurants? You may have superior knowledge about whether NYC is the restaurant capital of the world and therefore their behavior would be the benchmark for other citys wishing to emulate a sophisticated, in-the-know and in-the-swing of things cachet. Spending habits correlate to one's overall daily existence and are closely related to one's emotional health (Economist Kenneth Galbraith talked about this)...buying houses with no down and working 3 jobs could be very attractive to someone who has always lived in substandard apartments even if they only get to live there for a little while (like a vacation for their person, mind and spirit)...but anyway, great post...you always attract interesting readers with interesting commentary! How about that long list of web sites to check out products!
Posted by Saint Darwin Assissi's cat at May 21, 2008 12:20 AM | direct link
thanks for you !
Posted by ivan at May 21, 2008 01:21 PM | direct link
In need of greater information to form a better decision? Certainly not! Just look at all the current drug ads on television these days. I really like the disclaimers about side effects at the end. Some of them are worse than the conditions they are trying to cure. No wonder my Doctor won't prescribe them! As graphically portrayed by Mike above, this is a phenomenon I call "Information Overload". I won't go into the psychological details of how it works, but it's just one technique to implement the "Big Lie".
Information is not not going to solve the problem of protecting the public's health, safety, or even the environment. Direct regulation of industry has had it's beneficial results. Look at the development of the FDA or the USDA (although their having some problems today in regards to meat inspection and prescription drug control). Perhaps we ought to rescind the Pure Food and Drug Act or the Meat Inspection Act. (I hear the Drug Companies have a cure for Human Mad Cow disease that they would love to bring to market).
Or better yet, let's just return to the good old days of "The Jungle", where anything goes that can be sold. Perhaps we'll see the return of Laudanum or the original recipe Coca-Cola. Just one concern, I wonder how many people will end up as opium addicts or how many kids will end up as "Coke Heads"? Oh well, sorry about that minor ethical sentiment, we must keep our eye on profit above all else.
Posted by neilehat at May 21, 2008 07:17 PM | direct link
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Posted by Fight global warming help at May 22, 2008 07:29 PM | direct link
Appreciate this particular blog post...Thank you Mr Posner.
Posted by Hillblogger at May 22, 2008 07:30 PM | direct link
Appreciated this blog post... Thank you Mr Posner.
Posted by Hillblogger at May 22, 2008 07:32 PM | direct link
Appreciated this blog post... Thank you Mr Posner.
Posted by Hillblogger at May 22, 2008 07:35 PM | direct link
Your discussion about the possibility of a private venture sanitary inspection business can be taken further. If there are multiple such enterprises they will compete for fees from the consumers and the restaurants. Those organizations taking lower fees will succeed in garnering the larger number of clients in a classic network effect. Restaurants would probably be happier doing business with an organization that gave mostly 'A's and consumers would want to give their money to the business that provided information on the largest number of restaurants. Unfortunately the lower fees would require faster, and less complete, inspections. Only at some very low level of quality would restaurants feel they were being harmed by association with a too easy firm, a level where consumers would avoid an information firm that did not warn of a restaurant that had rats running through the dining room. So we have an optimum level of information quality as against cost. If this optimum level is too low to ensure consumer health (as I suspect it would be) the only option I can see is government regulation that raises the costs of everyone but forces the least efficient information producers from the market.
Posted by verisimilidude at May 23, 2008 02:01 PM | direct link
versi, Did you know that "If" is the middle word of "Life"? All analyses begin with, "What if this ..." or "What if that ...", meanwhile the public health and safety is held for ransom. Shall we put health and safety at risk while we wait to see whether "What if this/that" really works? Sometimes direct action and regulation pays unforseen dividends.
Posted by neilehat at May 24, 2008 06:40 AM | direct link
