Does Information on the Internet Weaken the Case for Consumer Protection Regulation?

Journal of Private Enterprise, Spring 2001 by Moorhouse, John C

. . . the real issue is whether [consumer] protection is best provided by 'regulation' or by 'free competition.'

Manuel F. Cohen

(Stigler and Cohen, 1971,21)

Just about everything we've ever done that has to do with communication and information has been digitized, and now we're going to start tackling stuff that hasn't been done because you can do it only with the Internet.

(Levy, et al, 1999, 41)

From apples to Z-cars, the regulation of consumer products abounds. The justification for such regulation is the same everywhere-consumer ignorance. Consumers do not and cannot know enough to make decisions that are in their own best interest, properly understood.1 Numerous federal and state agencies promulgate consumer protection rules, regulations, and standards. At the national level these administrative agencies include the Consumer Products Safety Commission, the Environmental Protection Agency, the Food and Drug Administration, the Federal Trade Commission, and the National Highway Traffic Safety Administration.

The asserted inability or unwillingness of the market to provide sufficient information justifies extensive government regulation of consumer products. But with few exceptions government provides not information, but restrictions on what can be sold, how it is to be sold, and how it is to be used. As Walter Oi (1977, 21) observes, "The [government] agency charged with reducing risk and accident costs ... can produce and disseminate information.... Governments have almost universally rejected this informational approach. The National Commission on Product Safety asserted that consumer education has little if any impact on the accident toll." One result is that consumers make fewer choices about the products they purchase.

But if a lack of information is a major justification for consumer protection, the case for government intervention may be seriously weakened by the dramatic increase in the availability of consumer information on the Internet. This technology makes low cost, up-todate information readily available to consumers. The purpose of this paper is to explore how technological advancements affect the ability of free markets to deal effectively with consumer demand for product information and quality assurance. The paper discusses the alleged market failure to provide adequate consumer information, the multiplicity of ways consumers obtain and use information, market devices employed to generate and distribute information, and the role that the Internet increasingly is playing in the dissemination of product and service information.

Justification for government intervention

To some, the necessity of government regulation of consumer products is obvious. For example the former director of the NHTSA, Joan claybrook (1978,14), writes, "In regulating for health and safety, government assumes what I believe to be one of its most basic functions, promoting the general welfare. Too many companies and industries refuse to recognize the multiple hazards of their technology and the government's legitimate interest in the public's health and safety ...." Others develop careful theoretical arguments about the market's failure to provide the information necessary to assure optimal consumer product quality and safety.

One of the more influential analyses of market failure was offered by Kenneth Arrow in 1962 (1972). In the essay, he argues that the market cannot be relied on to provide information because producers cannot appropriate a return and, even if they could, the allocation of information would be non-optimal. The former follows because of the low cost of reconveying information. Once someone has the information, the original producer can no longer charge a price sufficient to cover the cost of generating and disseminating it. The misallocation effect follows because charging a positive price for information that once produced could be distributed at close to zero marginal cost is sub-optimal. Arrow's solution is to separate the reward for production of information from the charge to the users of information. This is accomplished by letting the government subsidize the production and dissemination of information.2 Writing nearly two decades later, Leland (1980, 268) observes, "As is well known, information on quality has many of the characteristics of a public good.... Under such circumstances inadequate resources will be channeled to providing information."

Building on Arrow's thesis, Akerlof (1970), Stiglitz (1979), and Carlton and Perloff (1994) offer models based on the assumption that markets fail to provide adequate consumer information. Given that assumption, Akerlof argues that, in the absence of government regulation, low quality products displace high quality products and Stiglitz predicts that prices will be higher than is compatible with competition. Akerlof s "lemons problem" has become standard fare in undergraduate microeconomic theory texts.3 Stiglitz demonstrates, under a set of restrictive assumptions, that incomplete information can lead to monopoly pricing even when there are a number of independent vendors selling the same product.