Disclosure vs. Bans: Reply to Robin Hanson
A little while back I wrote a post arguing that the existence of abusive terms in credit card contracts (such as huge jumps in interest rates for being one day late with a payment) do not satisfy the conditions for standard economic models of asymmetric information between rational agents, but rather are trickery, pure and simple. If this is right, then the standard remedy of mandating the provision of more information to the less-informed party, but not otherwise interfering in the market (the idea being that any voluntary agreement must make both parties better off, no matter how strange or one-sided the terms may appear, so any interference in contracts beyond providing information will reduce welfare), is not the right one. There is no decent argument that those terms would appear in any contract where both parties knew what they were doing, so if you see terms like that, the appropriate conclusion is that someone has been screwed, not that Goddess of Capitalism, in her infinite-but-inscrutable wisdom, has uncovered the only terms that, strange as they may seem to mere mortals, make a mutually beneficial contract possible. The goal is to get rid of those terms, and the most direct way to do that is simply to prohibit them. There are some good reasons to be reluctant to have the government go around prohibiting things, so mandatory disclosure might still be a good policy (though the Federal Reserve has investigated this and concluded that it isn’t), but the goal would be to use the disclosures to eliminate the abusive terms. There is no justification for the standard economist’s agnosticism about whether the terms are good or not: they’re bad and the only question is how best to get rid of them.
Robin Hanson left some comments to that post, in which he made the point that since people voluntarily choose these terms, they must like them and so prohibiting them would have to mean protecting people against their will. I answered that while I’m enough of a paternalist to be willing, under some circumstances, to impose limited protections on people even if those people would oppose them, that I didn’t think that was an issue here, as I would guess (though I have no proof), that the Federal Reserve’s recent decision to ban certain credit card practices was probably very popular, even (especially?) among the people who are harmed by those practices. Robin’s reply, as I understand it, is that this may be true, but since people can’t simultaneously want to accept credit cards with those terms and at the same time favor banning those terms, it must be the case that they either don’t understand the terms of the credit card contracts or they don’t understand the effects of the ban. Somewhere there must just be some missing information, and therefore we must be back where we started, with the problem being a lack of information that could be resolved by providing more information.
So I take Robin to be saying that bans such as those instituted by the Fed cannot be shown to be non-coercive to credit card customers simply by recourse to the hypothesized “fact” that the bans are popular, because anyone who voluntarily chooses those terms and also supports the ban must be being inconsistent somehow. He also seems to be saying that this inconsistency means that we’re just back in the world of standard economic models where one side is ignorant.
On the second point, either I am misunderstanding Robin or I think he’s simply wrong. As I understand them, standard models of asymmetric information do not result in the ignorant party just getting screwed. Rather, they result in otherwise beneficial exchanges not happening, or in the terms being distorted in ways that come from the fact that one party is not informed (Robin, let me know if I misunderstand you or if you disagree). So even if everything else Robin says is right, it’s still not the case that we’re in a world where the problem is plain-vanilla asymmetric information, and where the solution is clearly to provide more information but not to ban. Robin might argue that people are in fact getting screwed but that the cure of banning is worse than the disease, but I don’t see how he can argue that the central problem here is asymmetric information.
As for the first point, a couple of commenters pointed out that the inconsistency of preferences that Robin points to are not more irrational than the kinds of preferences that we see people have all the time. I think they’re right about this, but I think there’s a more direct way to square the apparent inconsistency. People today “voluntarily” accept those provisions because that’s the way to get a credit card. In the world as it currently exists, it’s those terms or nothing (with the limited exception of cards issued by credit unions and the like, which avoid such trickery)* and so people “choose” those terms. But they’d be happier in a world whether the equilibrium credit card terms are better, and they would prefer to be able to “choose” those. I don’t want to overstate this point, as I think what’s really going on is that people are badly confused and also (justifiably) hostile to credit card companies. But there is a perfectly sound story in which people would choose the terms and also approve of the ban.
BTW, for a neat example of how people trick and make no bones about the fact that that’s what they’re doing, see here.
*I would be very interested to know what fraction of people who have access to such alternatives use them.