by Jeff Sovern
My new article is now up on SSRN: Six Scandals: Why We Need Consumer Protection Laws Instead of Just Markets. Here' is the abstract:
Markets are powerful mechanisms for serving consumers. Some critics of regulation have suggested that markets also provide consumer protection: for example, Nobel Prize-winning economist Milton Friedman said “Consumers don’t have to be hemmed in by rules and regulations. They’re protected by the market itself.” This article tests the claim that the market provides consumer protection by examining several recent incidents in which companies mistreated consumers and then exploring how the companies’ sales to consumers fared. The issue also has normative implications because if markets consistently protected consumers, society would need fewer regulations and regulators, as Friedman suggested.
The article finds a more nuanced situation than Friedman and other critics theorized. In three--possibly four--instances, businesses’ sales actually increased after their misconduct became public, despite the fact that, in at least two cases, consumers had told pollsters they would avoid patronizing the company. In two or perhaps three cases discussed in the article, companies suffered declines in sales after their misbehavior became public, and it seems likely that a scandal was at least partly the cause. In those latter cases, the scandal became known only because of laws and those who enforce them, suggesting that it is the very rules that Friedman decried that led to a market response. In other words, laws helped the market achieve a better outcome by enabling consumers to learn of information that they wished to take into account in making purchasing decisions. Though it is impossible to know what would have happened if the problematic conduct had not occurred, the evidence suggests that markets alone are often not enough to protect consumers, or at least that markets are not a reliable consumer protection mechanism. Indeed, in five of the six scandals discussed in the paper, the strong likelihood is that in the absence of rules, regulators, and consumer attorneys, injured consumers would not have been compensated and the troublesome conduct would not have elicited a response that deterred future misconduct. It thus appears that rules and those who enforce them are sometimes the only source of consumer protection.
The Article also offers hypotheses for when consumers will and will not avoid a company that has misbehaved. Factors that may affect consumer response to misconduct include how the choice to patronize the company is presented to consumers; how difficult it is to switch to other providers (e.g., the cost of switching from one bank to another); whether the company has presented itself as catering to consumer values but failed to deliver; and how many consumers are affected.
