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ACS Blog Debate on Google: Putting Consumer Welfare First in Antitrust Analysis of Google

Posted by Josh Wright on October 6, 2011

[I am participating in an online “debate” at the American Constitution Society with Professor Ben Edelman.  The debate consists of an opening statement and concluding responses to be posted later in the week.  Professor Edelman’s opening statement is here.  I am cross-posting my opening statement here at TOTM.  This is my closing statement]

Professor Edelman’s opening post does little to support his case.  Instead, it reflects the same retrograde antitrust I criticized in my first post.

Edelman’s understanding of antitrust law and economics appears firmly rooted in the 1960s approach to antitrust in which enforcement agencies, courts, and economists vigorously attacked novel business arrangements without regard to their impact on consumers.  Judge Learned Hand’s infamous passage in the Alcoa decision comes to mind as an exemplar of antitrust’s bad old days when the antitrust laws demanded that successful firms forego opportunities to satisfy consumer demand.  Hand wrote:

we can think of no more effective exclusion than progressively to embrace each new opportunity as it opened, and to face every newcomer with new capacity already geared into a great organization, having the advantage of experience, trade connections and the elite of personnel.

Antitrust has come a long way since then.  By way of contrast, today’s antitrust analysis of alleged exclusionary conduct begins with (ironically enough) the U.S. v. Microsoft decision.  Microsoft emphasizes the difficulty of distinguishing effective competition from exclusionary conduct; but it also firmly places “consumer welfare” as the lodestar of the modern approach to antitrust:

Whether any particular act of a monopolist is exclusionary, rather than merely a form of vigorous competition, can be difficult to discern: the means of illicit exclusion, like the means of legitimate competition, are myriad.  The challenge for an antitrust court lies in stating a general rule for distinguishing between exclusionary acts, which reduce social welfare, and competitive acts, which increase it.  From a century of case law on monopolization under § 2, however, several principles do emerge.  First, to be condemned as exclusionary, a monopolist’s act must have an “anticompetitive effect.”  That is, it must harm the competitive process and thereby harm consumers.  In contrast, harm to one or more competitors will not suffice.

Nearly all antitrust commentators agree that the shift to consumer-welfare focused analysis has been a boon for consumers.  Unfortunately, Edelman’s analysis consists largely of complaints that would have satisfied courts and agencies in the 1960s but would not do so now that the focus has turned to consumer welfare rather than indirect complaints about market structure or the fortunes of individual rivals.

From the start, in laying out his basic case against Google, Edelman invokes antitrust concepts that are simply inapt for the facts and then goes on to apply them in a manner inconsistent with the modern consumer-welfare-oriented framework described above:

In antitrust parlance, this is tying: A user who wants only Google Search, but not Google’s other services, will be disappointed.  Instead, any user who wants Google Search is forced to receive Google’s other services too.  Google’s approach also forecloses competition: Other sites cannot compete on their merits for a substantial portion of the market – consumers who use Google to find information – because Google has kept those consumers for itself.

There are two significant errors here.  First, Edelman claims to be interested in protecting users who want only Google Search but not its other services will be disappointed.  I have no doubt such consumers exist.  Some proof that they exist is that a service has already been developed to serve them.  Professor Edelman, meet Googleminusgoogle.com.  Across the top the page reads: “Search with Google without getting results from Google sites such as Knol, Blogger and YouTube.”  In antitrust parlance, this is not tying after all.  The critical point, however, is that user preferences are being satisfied as one would expect to arise from competition.

The second error, as I noted in my first post, is to condemn vertical integration as inherently anticompetitive.  It is here that the retrograde character of Professor Edelman’s analysis (and other critics of Google, to be fair) shines brightest.  It reflects a true disconnect between the 1960s approach to antitrust which focused exclusively upon market structure and impact upon rival websites; impact upon consumers was nowhere to be found.  That Google not only produces search results but also owns some of the results that are searched is not a problem cognizable by modern antitrust.  Edelman himself—appropriately—describes Google and its competitors as “information services.”  Google is not merely a URL finder.  Consumers demand more than that and competition forces search engines to deliver.  It offers value to users (and thus it can offer users to advertisers) by helping them find information in increasingly useful ways.  Most users “want Google Search” to the exclusion of Google’s “other services” (and, if they do, all they need do is navigate over to http://googleminusgoogle.com/ (even in a Chrome browser) and they can have exactly that).  But the critical point is that Google’s “other services” are methods of presenting information to consumers, just like search.  As the web and its users have evolved, and as Google has innovated to keep up with the evolving demands of consumers, it has devised or employed other means than simply providing links to a set of URLs to provide the most relevant information to its users.  The 1960s approach to antitrust condemns this as anticompetitive foreclosure; the modern version recognizes it as innovation, a form of competition that benefits consumers.

Edelman (and other critics, including a number of Senators at last month’s hearing) hearken back to the good old days and suggest that any deviation from Google’s technology or business model of the past is an indication of anticompetitive conduct:

The Google of 2004 promised to help users “leave its website as quickly as possible” while showing, initially, zero ads.  But times have changed.  Google has modified its site design to encourage users to linger on other Google properties, even when competing services have more or better information.  And Google now shows as many fourteen ads on a page.

It is hard to take seriously an argument that turns on criticizing a company simply for looking different than it did seven years ago.  Does anybody remember what search results looked like 7 years ago?  A theory of antitrust liability that would condemn a firm for investing billions of dollars in research and product development, constantly evolving its product to meet consumer demand, taking advantage of new technology, and developing its business model to increase profitability should not be taken seriously.  This is particularly true where, as here, every firm in the industry has followed a similar course, adopting the same or similar innovations.  I encourage readers to try a few queries on http://www.bing-vs-google.com/– where you can get side by side comparisons – in order to test whether the evolution of search results and innovation to meet consumer preferences is really a Google-specific thing or an industry wide phenomenon consistent with competition.  Conventional antitrust analysis holds that when conduct is engaged in not only by allegedly dominant firms, but also by every other firm in an industry, that conduct is presumptively efficient, not anticompetitive.

The main thrust of my critique is that Edelman and other Google critics rely on an outdated antitrust framework in which consumers play little or no role.  Rather than a consumer-welfare based economic critique consistent with the modern approach, these critics (as Edelman does in his opening statement) turn to a collection of anecdotes and “gotcha” statements from company executives.  It is worth correcting a few of those items here, although when we’ve reached the point where identifying a firm’s alleged abuse is a function of defining what a “confirmed” fax is, we’ve probably reached the point of decreasing marginal returns.  Rest assured that a series of (largely inaccurate) anecdotes about Google’s treatment of particular websites or insignificant contract terms is wholly insufficient to meet the standard of proof required to make a case against the company under the Sherman Act or even the looser Federal Trade Commission Act.

  • It appears to be completely inaccurate to say that “[a]n unsatisfied advertiser must complain to Google by ‘first class mail or air mail or overnight courier’ with a copy by ‘confirmed facsimile.’”  A quick search, even on Bing, leads one to this page, indicating that complaints may be submitted via web form.
  • It is likewise inaccurate to claim that “advertisers are compelled to accept whatever terms Google chooses to impose.  For example, an advertiser seeking placement through Google’s premium Search Network partners (like AOL and The New York Times) must also accept placement through the entire Google Search Network which includes all manner . . . undesirable placements.”  In actuality, Google offers a “Site and Category Exclusion Tool” that seems to permit advertisers to tailor their placements to exclude exactly these “undesirable placements.”
  • “Meanwhile, a user searching for restaurants, hotels, or other local merchants sees Google Places results with similar prominence, pushing other information services to locations users are unlikely to notice.”  I have strived in vain to enter a search for a restaurant, hotel, or the like into Google that yielded results that effectively hid “other information services” from my notice, but for some of my searches, Google Places did come up first or second (and for others it showed up further down the page).
  • Edelman has noted elsewhere that, sometimes, for some of the searches he has tested, the most popular result on Google (as well, I should add, on other, non-“dominant” sites) is not the first, Google-owned result, but instead the second.  He cites this as evidence that Google is cooking the books, favoring its own properties when users actually prefer another option.  It actually doesn’t demonstrate that, but let’s accept the claim for the sake of argument.  Notice what his example also demonstrates: that users who prefer the second result to the first are perfectly capable of finding it and clicking on it.  If this is foreclosure, Google is exceptionally bad at it.

The crux of Edelman’s complaint seems to be that Google is competing in ways that respond to consumer preferences.  This is precisely what antitrust seeks to encourage, and we would not want a set of standards that chilled competition because of a competitor’s success.  Having been remarkably successful in serving consumers’ search demands in a quickly evolving market, it would be perverse for the antitrust laws to then turn upon Google without serious evidence that it had, in fact, actually harmed consumers.

Untethered from consumer welfare analysis, antitrust threatens to re-orient itself to the days when it was used primarily as a weapon against rivals and thus imposed a costly tax on consumers.  It is perhaps telling that Microsoft, Expedia, and a few other Google competitors are the primary movers behind the effort to convict the company.  But modern antitrust, shunning its inglorious past, requires actual evidence of anticompetitive effect before condemning conduct, particularly in fast-moving, innovative industries.  Neither Edelman nor any of Google’s other critics, offer any.

During the heady days of the Microsoft antitrust case, the big question was whether modern antitrust would be able to keep up with quickly evolving markets.  The treatment of the proferred case against Google is an important test of the proposition (endorsed by the Antitrust Modernization Commission and others) that today’s antitrust is capable of consistent and coherent application in innovative, high-tech markets.  An enormous amount is at stake.  Faced with the high stakes and ever-evolving novelty of high-tech markets, antitrust will only meet this expectation if it remains grounded and focused on the core principle of competitive effects and consumer harm.  Without it, antitrust will devolve back into the laughable and anti-consumer state of affairs of the 1960s—and we will all pay for it.

Posted in antitrust, consumer protection, economics, error costs, exclusionary conduct, federal trade commission, google, monopolization, technology, tying | 6 Comments »

Zywicki on the Unintended Consequences of the Durbin Bank Fees

Posted by Josh Wright on October 1, 2011

Here’s Professor Zywicki in the WSJ on the debit card interchange price controls going into effect, and their unintended but entirely predictable consequences:

Faced with a dramatic cut in revenues (estimated to be $6.6 billion by Javelin Strategy & Research, a global financial services consultancy), banks have already imposed new monthly maintenance fees—usually from $36 to $60 per year—on standard checking and debit-card accounts, as well as new or higher fees on particular bank services. While wealthier consumers have avoided many of these new fees—for example, by maintaining a sufficiently high minimum balance—a Bankrate survey released this week reported that only 45% of traditional checking accounts are free, down from 75% in two years.

Some consumers who previously banked for free will be unable or unwilling to pay these fees merely for the privilege of a bank account. As many as one million individuals will drop out of the mainstream banking system and turn to check cashers, pawn shops and high-fee prepaid cards, according to an estimate earlier this year by economists David Evans, Robert Litan and Richard Schmalensee. (Their study was supported by banks.)

Consumers will also be encouraged to shift from debit cards to more profitable alternatives such as credit cards, which remain outside the Durbin amendment’s price controls. According to news reports, Bank of America has made a concerted effort to shift customers from debit to credit cards, including plans to charge a $5 monthly fee for debit-card purchases. Citibank has increased its direct mail efforts to recruit new credit card customers frustrated by the increased cost and decreased benefits of debit cards.

This substitution will offset the hemorrhaging of debit-card revenues for banks. But it is also likely to eat into the financial windfall expected by big box retailers and their lobbyists. They likely will return to Washington seeking to extend price controls to credit cards. …

Todd closes with a nice point about where the impact of these regulations will be felt most:

Conceived of as a narrow special-interest giveaway to large retailers, the Durbin amendment will have long-term consequences for the consumer banking system. Wealthier consumers will be able to avoid the pinch of higher banking fees by increasing their use of credit cards. Many low-income consumers will not.

Read the whole thing.

 

Posted in banking, business, consumer protection, credit cards, economics | 2 Comments »

My Reflections on The Senate CFPB Hearing

Posted by Josh Wright on September 9, 2011

[Cross-posted at PYMNTS.COM]

Richard Cordray’s nomination hearing provided an opportunity to learn something new about the substantive policies of the new Consumer Financial Protection Bureau.  Unfortunately, that opportunity came and went without answering many of the key questions that remain concerning the impact of the CFPB’s enforcement and regulatory agenda on the availability of consumer credit, economic growth, and jobs.

The Consumer Financial Protection Bureau’s critics, including myself, [1] have expressed concerns that the CFPB— through enforcement and regulation—could harm consumers and small businesses by reducing the availability of credit.  The intellectual blueprint for the CFPB is founded on the insight, from behavioral economics, that “[m]any consumers are uninformed and irrational,” that “consumers make systematic mistakes in their choice of credit products,” and that the CFPB should play a central role in determining which and to what extent these products are used. [2] The CFPB’s recent appointment of Sendhil Mullainathan as its Assistant Director for Research confirms its commitment to the behaviorist approach to regulation of consumer credit.  Mullainathan, in work co-authored with Professor Michael S. Barr, provided the intellectual basis for the much debated “plain vanilla” provision in the original legislation and advocated a whole host of new consumer credit regulations ranging from improved disclosures to “harder” forms of paternalism.  The concern, in short, is that the CFPB is hard-wired to take a myopic view of the tried-and-true benefits of consumer credit markets and runs the risk of harming many (and especially the socially and economically disadvantaged groups in the greatest need of access to consumer credit) in the name of protecting the few.

To be sure, there is absolutely no doubt that there are unscrupulous and unsavory characters in lending markets engaging in bad acts ranging from fraud to preying upon vulnerable borrowers.  Nonetheless, it is critical to recognize the positive role that lending markets and the availability of consumer credit has played in the American economy, especially in facilitating entrepreneurial activity and small business growth.  Taking into account these important benefits is fundamental to developing sound consumer credit policy.  I had hoped that the hearings might focus upon Mr. Cordray’s underlying philosophical approach to weighing the costs and benefits of credit regulation and how that balance might be struck at his CFPB.  They did not, instead focusing largely upon another important issue: the precise contours of CFPB authority and oversight.

Currently, the unemployment rate is over 9 percent and all of the available evidence suggests the CFPB’s approach will run a significant risk of overregulation that will reduce the availability of consumer credit to small businesses and thus further depress the economy.  Therefore, getting hard answers concerning how the CFPB views and will account for these risks in its enforcement and regulatory decisions is critical.  Certainly, the nomination hearing offered small hints toward this end.  We learned that under Mr. Cordray’s watch, CFPB enforcement will involve not only lawsuits but also a “more flexible toolbox” that includes “research reports, rulemaking guidance, consumer education and empowerment, and the ability to supervise and examine both large banks and many nonbank institutions.”

The job of protecting consumers in financial products markets—the domain of the new CFPB—extends to all such consumers.  The benefits of healthy markets and competition in consumer credit products has generated tremendous economic benefits to the most disadvantaged as well as to small businesses.  If the CFPB agenda were limited to educating consumers about the costs and benefits of various products and improving disclosures, there would be far less need for concern that it will be a drag on consumers, entrepreneurial activity, and economic growth.  However, the CFPB’s intellectual blueprint suggests a more aggressive and dangerous agenda, and the authority it has been granted renders that agenda feasible.  The CFPB must account for the benefits from lending markets and balance them against its laudable objective of preventing deceptive practices when crafting its enforcement and regulatory agenda.  Unfortunately, after Tuesday’s nomination hearing, the CFPB’s approach to this complex and delicate balance remains an open question.

—–

[1] David S. Evans & Joshua D. Wright, The Effect of the Consumer Financial Protection Agency Act of 2009 on Consumer Credit, 22(3) Loyola Consumer L. Rev. 277 (2010).

[2] Oren Bar-Gill & Elizabeth Warren, Making Credit Safer, 157 U. Pa. L. Rev. 1, 39 (2008).

Posted in consumer financial protection bureau, consumer protection, cost-benefit analysis, credit cards, economics, politics | 8 Comments »

Natural Disasters and Payday Lending

Posted by Josh Wright on August 28, 2011

There has been plenty of Hurricane Irene blogging, and some posts linking natural disasters to various aspects of law and policy (see, e.g. my colleague Ilya Somin discussing property rights and falling trees).   Often, post-natural disaster economic discussion at TOTM turns to the perverse consequences of price gouging laws.  This time around, the damage from the hurricane got me thinking about the issue of availability of credit.  In policy debates in and around the new CFPB and its likely agenda — which is often reported to include restrictions on payday lending — I often take up the unpopular (at least in the rooms in which these debates often occur) position that while payday lenders can abuse consumers, one should think very carefully about incentives before going about restricting access to any form of consumer credit.  In the case of payday lending, for example, proponents of restrictions or outright bans generally have in mind a counterfactual world in which consumers who are choosing payday loans are simply “missing out” on other forms of credit with superior terms.  Often, proponents of this position rely upon a theory involving particular behavioral biases of at least some substantial fraction of borrowers who, for example, over estimate their future ability to pay off the loan.  Skeptics of government-imposed restrictions on access to consumer credit (whether it be credit cards or payday lending) often argue that such restrictions do not change the underlying demand for consumer credit.  Consumer demand for credit — whether for consumption smoothing purposes or in response to a natural disaster or personal income “shock” or another reason — is an important lubricant for economic growth.  Restrictions do not reduce this demand at all — in fact, critics of these restrictions point out, consumers are likely to switch to the closest substitute forms of credit available to them if access to one source is foreclosed.  Of course, these stories are not necessarily mutually exclusive: that is, some payday loan customers might irrationally use payday lending while better options are available while at the same time, it is the best source of credit available to other customers.

In any event, one important testable implication for the economic theories of payday lending relied upon by critics of such restrictions (including myself) is that restrictions on their use will have a negative impact on access to credit for payday lending customers (i.e. they will not be able to simply turn to better sources of credit).  While most critics of government restrictions on access to consumer credit appear to recognize the potential for abuse and favor disclosure regimes and significant efforts to police and punish fraud, the idea that payday loans might generate serious economic benefits for society often appears repugnant to supporters.  All of this takes me to an excellent paper that lies at the intersection of these two issues: natural disasters and the economic effects of restrictions on payday lending.  The paper is Adair Morse’s Payday Lenders: Heroes or Villians.    From the abstract:

I ask whether access to high-interest credit (payday loans) exacerbates or mitigates individual financial distress. Using natural disasters as an exogenous shock, I apply a propensity score matched, triple difference specification to identify a causal relationship between access-to-credit and welfare. I find that California foreclosures increase by 4.5 units per 1,000 homes in the year after a natural disaster, but the existence of payday lenders mitigates 1.0-1.3 of these foreclosures. In a placebo test for natural disasters covered by homeowner insurance, I find no payday lending mitigation effect. Lenders also mitigate larcenies, but have no effect on burglaries or vehicle thefts. My methodology demonstrates that my results apply to ordinary personal emergencies, with the caveat that not all payday loan customers borrow for emergencies.

To be sure, there are other papers with different designs that identify economic benefits from payday lending and other otherwise “disfavored” credit products.  Similarly, there papers out there that use different data and a variety of research designs and identify social harms from payday lending (see here for links to a handful, and here for a recent attempt).  A literature survey is available here.  Nonetheless, Morse’s results remind me that consumer credit institutions — even non-traditional ones — can generate serious economic benefits in times of need and policy analysts must be careful in evaluating and weighing those benefits against potential costs when thinking about and designing restrictions that will change incentives in consumer credit markets.

Posted in behavioral economics, behavioral economics, consumer financial protection bureau, consumer protection, contracts, cost-benefit analysis, credit cards, economics, regulation | 2 Comments »

Cooper and Kovacic on Behavioral Economics and Regulatory Agencies

Posted by Josh Wright on July 26, 2011

There is an embarrassing blind spot in the behavioral law and economics literature with respect to implementation of policy whether via legislation or administrative agency.  James Cooper and William Kovacic — both currently at the Federal Trade Commission as Attorney Advisor Commissioner, respectively — aim to fill this gap with a recent working paper entitled “Behavioral Economics: Implications for Regulatory Behavior.”  The basic idea is to combine the insights of public choice economics and behavioral economics to explore the implications for behavioral regulation at administrative agencies and, in particular given their experiences, a competition and consumer protection regulator.

Here is the abstract:

Behavioral economics (BE) examines the implications for decision-making when actors suffer from biases documented in the psychological literature. These scholars replace the assumption of rationality with one of “bounded rationality,” in which consumers’ actions are affected by their initial endowments, their tastes for fairness, their inability to appreciate the future costs, their lack of self-control, and general use of flawed heuristics. We posit a simple model of a competition regulator who serves as an agent to a political overseer. The regulator chooses a policy that accounts for the rewards she gets from the political overseer – whose optimal policy is one that focuses on short-run outputs that garner political support, rather than on long-term effective policy solutions – and the weight she puts on the optimal long run policy. We use this model to explore the effects of bounded rationality on policymaking, with an emphasis on competition and consumer protection policy. We find that flawed heuristics (e.g., availability, representativeness, optimism, and hindsight) and present bias are likely to lead regulators to adopt policies closer to those preferred by political overseers than they otherwise would. We argue that unlike the case of firms, which face competition, the incentive structure for regulators is likely to reward regulators who adopt politically expedient policies, either intentionally (due to a desire to please the political overseer) or accidentally (due to bounded rationality). This sample selection process is likely to lead to a cadre of regulators who focus on maximizing outputs rather than outcomes.

Here is a little snippet from the conclusion, but please go do read the whole thing:

The model we present shows that political pressure will cause rational regulators to choose policies that are not optimal from a consumer standpoint, and that in a large number of circumstances regulatory bias will exacerbate this tendency. Our analysis also suggests special caution when attempting to correct firm behavior as regulatory bias appears likely more durable than firm bias because the market provides a much stronger feedback mechanism than exists in the regulatory environment. To the extent that we can de-bias regulators – either through a greater use of internal and external adversarial review or by making a closer nexus between outcomes and rewards – they will become more effective at welfare-enhancing interventions designed to correct biases.

Thinking about the implications of behavioral economics at the regulatory level is incredibly important for competition and consumer protection policy (think CFPB, for example).  And I’m very happy to see scholars of Cooper and Kovacic’s caliber — not to mention real world agency experience to bring to bear on the problem — tackling it.   For full disclosure purposes, I should note that I have or am currently co-authoring with each of them.  But don’t hold that against them!  Its a thought provoking paper upon which I will have some more thoughts later on, as well as tying it in to some of the work I’ve done on behavioral economics.  For example, Judd Stone and I explore a related problem of the implications of firm level irrationality — both for incumbents and entrants — in this piece, and find the implications for antitrust policy less clear (and in some cases, absent) than have behavioral antitrust proponents.  See also Stone’s post during the TOTM Free to Choose Symposium on BE and Administrative Agencies.

Posted in antitrust, behavioral economics, consumer financial protection bureau, consumer protection, federal trade commission | 1 Comment »

Cassandra, the Fear of Overregulation, and the CFPB

Posted by Josh Wright on June 22, 2011

In the Huffington Post, Marcus Baram warns against those who claim to be concerned about over-regulation on Wall Street and in the consumer protection sphere.  Baram writes:

Today, Wall Street is again on the attack against a regulatory overhaul that includes more stringent investor and consumer protections. Though the financial landscape is far different and the details of the proposals have changed since 1912, the industry is using much of the same alarmist rhetoric to oppose new regulations and rules.

JPMorgan chairman Jamie Dimon recently complained that proposed rules on derivatives, capital buffers and too-big-to-fail banks are bad for America. Wall Street could lose customers to European banks, he said.

Baram includes economist, and my co-author, David S. Evans in his list of those “crying wolf” over over-regulation:

At a congressional hearing on the Consumer Financial Protection Bureau, banking consultant David S. Evans attacked the “hard paternalism” of its interim director Elizabeth Warren. He cautioned that the bureau “could make it harder and more expensive for consumers to borrow money.”

Such Cassandra-like warnings are common in the history of financial regulation.

I think Baram might want to have this one back if given the chance.  His point is that the Dimon and David Evans and others are concerned about imposing an enormous regulatory burden are wrong.  Of course, I am no scholar of Greek mythology, but I seem to recall that Cassandra was right!  Her curse was that nobody believed her accurate predictions about the future.  Baram may have stumbled upon something here.

But more seriously, at a time when the unemployment rate is over 9%, when the intellectual architects of the CFPB were quite frank about favoring a regulatory approach that would restrict access to consumer credit (see here), and when the flow of credit is critical to economic growth and recovery, one has to be pretty deeply committed to the cause to so brazenly ignore predictions that massive regulatory structure just might hold the economy back.

Evans’ testimony at the House Hearing on the CFPB is available here.

Posted in consumer financial protection bureau, consumer protection, economics, regulation | 1 Comment »

Debiasing: Firms Versus Administrative Agencies

Posted by Josh Wright on June 21, 2011

Daniel Kahnemann and co-authors discuss, in the most recent issue of the Harvard Business Review (HT: Brian McCann), various strategies for debiasing individual decisions that impact firm performance.  Much of the advice boils down to more conscious deliberation about decisions, incorporating awareness that individuals can be biased into firm-level decisions, and subjecting decisions to more rigorous cost-benefit analysis.  The authors discuss a handful of examples with executives contemplating this or that decision (a pricing change, a large capital outlay, and a major acquisition) and walk through how thinking harder about recognizing biases of individuals responsible for these decisions or recommendations might be identified and nipped in the bud before a costly error occurs.

Luckily for our HBS heroes they are able to catch these potential decision-making errors in time and correct them:

But in the end, Bob, Lisa, and Devesh all did, and averted serious problems as a result. Bob resisted the temptation to implement the price cut his team was clamoring for at the risk of destroying profitability and triggering a price war. Instead, he challenged the team to propose an alternative, and eventually successful, marketing plan. Lisa refused to approve an investment that, as she discovered, aimed to justify and prop up earlier sunk-cost investments in the same business. Her team later proposed an investment in a new technology that would leapfrog the competition. Finally, Devesh signed off on the deal his team was proposing, but not before additional due diligence had uncovered issues that led to a significant reduction in the acquisition price.

The real challenge for executives who want to implement decision quality control is not time or cost. It is the need to build awareness that even highly experienced, superbly competent, and well intentioned managers are fallible. Organizations need to realize that a disciplined decision-making process, not individual genius, is the key to a sound strategy. And they will have to create a culture of open debate in which such processes can flourish.

But what if they didn’t?  Of course, the result would be a costly mistake.  The sanction from the marketplace would provide a significant incentive for firms to act “as-if” rational over time.  As Judd Stone and I have written (forthcoming in the Cardozo Law Review), the firm itself can be expected to play a critical role in this debiasing:

Economic theory provides another reason for skepticism concerning predictable firm irrationality. As Armen Alchian, Ronald Coase, Harold Demsetz, Benjamin Klein, and Oliver Williamson (amongst others) have reiterated for decades, the firm is not merely a heterogeneous hodgepodge of individuals, but an institution constructed to lower transaction costs relative to making use of the price system (the make or buy decision). Firms thereby facilitate specialization, production, and exchange. Firms must react to the full panoply of economic forces and pressures, responding through innovation and competition. To the extent that cognitive biases operate to deprive individuals of the ability to choose rationally, the firm and the market provide effective mechanisms to at least mitigate these biases when they reduce profits.

A critical battleground for behaviorally-based regulatory intervention, including antitrust but not limited to it, is the question of whether agencies and courts on the one hand, or firms on the other, are the least cost avoiders of social costs associated with cognitive bias.  Stone & Wright argue in the antitrust context — contrary to the claims of Commissioner Rosch and other proponents of the behavioral approach — that the claim that individuals are behaviorally biased, and that because firms are made up of individuals, they too must be biased, simply does not provide intellectual support for behavioral regulation.  The most obvious failure is that it lacks the comparative institutional perspective described above.  Most accounts favoring greater implementation of behavioral regulation at the agency level glide over this question.  Not all, of course.

For example, Commissioner Rosch has offered the following response to the “regulators are irrational-too” critique:

My problem with this criticism is that it ignores the fact that, unlike human beings who make decisions in a vacuum, government regulators have the ability to study over time how individuals behave in certain settings (i.e., whether certain default rules provide adequate disclosure to help them make the most informed decision). Thus, if and to the extent that government regulators are mindful of the human failings discussed above, and their rules are preceded by rigorous and objective tests, it is arguable that they are less likely to get things wrong than one would predict. Of course, it may be the case that the concern with behavioral economics is less that regulators are imperfect and more than they are subject to political biases and that behavioral economics is simply liberalism masquerading as economic thinking.24 My response to that is that political capture is everywhere in Washington and that to the extent behavioral economics supports “hands on” regulation it is no more political than neoclassical economics which generally supports “hands off” regulation. On a more serious note, perhaps the best way behavioral economics could counter this critique over the long run would be to identify ways in which the insights from behavioral economics suggest regulation that one would not expect from a “left-wing” legal theory.

For my money, I find this reply altogether unconvincing.  It amounts to the claim that government agencies can be expected to have a comparative advantage over firms in ameliorating the social costs of errors.  The fact that government regulators might “get things wrong” less often than one might predict is besides the point.  The question is, again, comparing the two relevant institutions: firms in the marketplace and government agencies.  “We’re the government and we’re here to help” isn’t much of an answer to the appropriate question here.  There are further problems with this answer.  As I’ve written in response to the Commissioner’s claims:

But seriously, human beings making decisions “in a vacuum?”  It is individuals and firms who are making decisions insulated from market forces that create profit-motive and other incentives to learn about irrationality and get decisions right — not regulators?   The response to the argument that behavioral economics is simply liberalism masquerading as economic thinking (by the way, the argument is not that, it is that antitrust policy based on behavioral economics has not yet proven to be any more than simply interventionism masquerading as economic thinking — but I quibble) is weak.

As calls for behavioral regulation become more common, administrative agencies are built upon its teachings, or even more aggressive claims that behavioral law and economics can claim intellectual victory over rational choice approaches, it is critical to keep the right question in mind so that we do not fall victim to the Nirvana Fallacy.  The right comparative institutional question is whether courts and agencies or the market is better suited to mitigate the social costs of errors.   The external discipline imposed by the market in mitigating decision-making errors is well documented in the economic literature.  The claim that such discipline can replicated, or exceeded, in agencies is an assertion that remains, thus far, in search of empirical support.

Posted in antitrust, behavioral economics, behavioral economics, consumer financial protection bureau, consumer protection, doj, economics, federal trade commission | Comments Off

Organizing Economists at the CFPB

Posted by Josh Wright on May 13, 2011

With the recent announcement of Sendhil Mullainathan as the Assistant Director for Research at the Consumer Financial Protection Bureau (WSJ profile here), while one turns to the question of how economic input will be incorporated into agency decision-making.

Luke Froeb makes a nice point about the organization of economists in administrative agencies:

The FTC, which enforces identical consumer protection laws, is organized along functional lines, with attorneys and economists each writing memos to a bipartisan Commission. By design, this results in conflict between the economists and attorneys, which allows benefit-cost analysis done by economists to be heard at the highest levels of the organizations.

Watch the organizational design of the new agency. I suspect it will put economists, if it has them at all, under the supervision of attorneys to reduce their influence, as was done during the FTC early years.

For those more interested in how Mullainathan’s economic views will translate to policy, the correct place to start is in his October 2008 piece (co-authored with Michael Barr and Eldar Shafir) on Behaviorally Informed Financial Services Regulation, which includes discussions of at least ten policy ideas, including:

  • Full information disclosure to debias home mortgage borrowers.
  • A new standard for truth in lending.
  • A “sticky” opt-out home mortgage system.
  • Restructuring the relationship between brokers and borrowers.
  • Using framing and salience to improve credit card disclosures.
  • An opt-out payment plan for credit cards.
  • An opt-out credit card.
  • Regulating of credit card late fees.
  • A tax credit for banks offering safe and affordable accounts.
  • An opt-out bank account for tax refunds.

I also believe, but not with great confidence, that this particular paper was the first to propose the well-known “plain vanilla” requirement.

Posted in behavioral economics, behavioral economics, consumer financial protection bureau, consumer protection, economics | Comments Off

Medical Devices

Posted by Paul H. Rubin on April 18, 2011

The GAO has recently issued a report on medical devices.  The thrust of the report is that “high-risk” medical devices do not receive enough scrutiny from the FDA and that recalls are not handled well.  This report and other evidence indicates that the FDA is likely to require more testing of devices.  As of now, most medical devices are approved on a fast track that requires significantly less testing than that required for new drugs.  (As I have discussed in a forthcoming Cato Journal article, medical devices are also subject to more immunity from state produce liability lawsuits.)

The GAO report is remarkable.  The GAO defines its mission as

“Our Mission is to support the Congress in meeting its constitutional responsibilities and to help improve the performance and ensure the accountability of the federal government for the benefit of the American people. We provide Congress with timely information that is objective, fact-based, nonpartisan, nonideological, fair, and balanced.”

But the report on medical devices is entirely unbalanced.  It deals only with procedures for approval and the recall process (both of which are judged inadequate.)  There is no discussion of either costs or benefits.   That is, no evidence is presented that there is any actual harm from the “flawed” approval and recall processes.  Even more importantly, there is no evidence presented about the benefits to consumers from easy and rapid approval of medical devices.

As is well known, virtually all economists who have studied the FDA drug approval process have concluded that it causes serious harm by delaying drugs.  The import of the GAO Report is that we should duplicate that harm with medical devices.  This is an odd and perverse way of providing a “benefit” to the American people.

Posted in consumer protection, cost-benefit analysis, regulation, torts | Tagged: , | 2 Comments »

Medical Billing: A warning

Posted by Paul H. Rubin on April 2, 2011

Recently the Wall Street Journal had an article about medical billing errors.  These can be very costly because they can impact your credit rating.  But there is one billing practice they missed.  Some health care providers (we have found this with two and it is probably more common) begin the billing date as of the date of service but don’t send a bill until insurance has paid their part.  Then when they do send a bill for the coinsurance  it is “late” and they threaten to turn it over to a collection agency.  In other words, the very FIRST bill you may get already has your account as delinquent.

Posted in consumer protection, personal finance | 1 Comment »

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