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Literature Review on Analytical Frameworks
Background Paper to Creating Confident
Consumers
May 2003
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Frameworks
for Consumer Protection Policy
Duggan (1991) says that there are three frameworks (or "sets
of values") that underlies nearly all consumer protection
measures. This section adapts the frameworks presented by Duggan,
so as to help define the goals of consumer policy. The frameworks
centre on:
- welfare considerations. However, we prefer the
phrase "efficiency" to "welfare" and will use it from here on.
Under the efficiency approach, the objective of consumer policy
is to help consumers meet their preferences in order to achieve
an efficient allocation of society's resources. A consumer's
preferences are not to be questioned and any intervention which
interferes with a consumer's pursuit of these preferences is
prima facie inefficient and undesirable
- equity considerations. Under an equity framework
the objective of consumer policy may relate to a "fair"
distribution of losses or resources, or to the power
relationship between supplier and consumer (inequality of
bargaining power)
- an eclectic mix of concerns grouped together under the
heading "paternalism". An information-based framework is
derived from the efficiency framework. However, it is less
wedded to certain premises, such as the premise that consumers
will always act rationally in a self-interested manner. It also
defines a broader agenda for consumer protection, which is
concerned with the process of preference formation. The
objective of the information-based framework is to protect
consumers from the "bad deal": the transaction where what the
consumer gets is not what they intended or expected.
Further frameworks include:
- a libertarian framework
- an information-based framework
- a "rights" framework.
The Efficiency Framework
The fundamental goal of the efficiency framework is that
"people should get what they want"; in other words, that
consumers' individual preferences should be satisfied. Underlying
this goal are the following premises:
- individual consumers know better than anyone else what
their preferences are
- although they are not infallible, consumers are less likely
to make a mistake about what is wanted than a third party (such
as the state)
- the only externally valid indication of a preference held
by consumers is their willingness to pay.
From an economic perspective, allowing consumers to pursue
their own preferences is the most efficient way to allocate
society's resources. It therefore follows that there is only
limited scope for consumer protection intervention by the
government. Any intervention that takes place must enhance the
ability of consumers to meet their individual preferences and
therefore must also enhance economic efficiency.
The grounds for intervention under this framework are slim.
For example, Hynes and Posner (2001) state that a proper defence
of consumer protection regulation must explain why the market
would not supply its benefits if consumers were willing to pay
for them. [1]
Theorists in this vein seek to demonstrate that there are a
number of seemingly unfair contractual outcomes that in fact
perform a valuable signalling and informational function between
supplier and consumer, and help consumers meet their preferences.
For example, consumers who agree in a credit contract to offer
all personal belongings as security for a loan may be signalling
that they consider that they are unlikely to default-given the
inconvenience that would be caused by repossession-and are
therefore a good credit risk. The creditor may respond by
offering a lower interest rate. In contrast, debtors who are
reluctant to put all their personal belongings on the line may be
signalling that they think they are likely to default and this
risk will be reflected in the interest rate. Regulation
[2] may interfere with
these informational outcomes and lead to cross-subsidisation (for
example, the creditor may charge all debtors the same interest
rate (good credit risks therefore subsidise the bad) and other
inefficient outcomes.
The efficiency framework does leave room for intervention if
it will enhance efficiency or, in other words, resolve market
failures. Imperfect information is the most common barrier to
consumers meeting their individual preferences and cause of
market failure. Imperfect information has a number of
manifestations:
- information may be costly to acquire and interpret
- there may be information asymmetries between supplier and
consumer, allowing scope for the supplier to take advantage of
the consumer, including through fraud
- consumers may underestimate the value of information about
a particular product or service.
The consequence of this is that consumers face information
barriers to the satisfaction of their preferences, and the result
is that in particular transactions the outcome may not be what
they expected. This is sometimes referred to as the "bad deal" (Hadfield
et al, 1998).
Consumer protection measures, to the extent that they are
justified by the efficiency framework, generally focus on
mitigating imperfect information. However, to be efficient the
benefit of such measures must outweigh the cost and, if there is
a choice of measures, the least costly must prevail. On this
basis, the efficiency framework favours measures such as
mandatory disclosure of information over alternatives such as
occupational regulation or prohibition of particular contractual
terms.
The grounds for intervention on the basis of imperfect
information remain limited. For example, in an influential
formulation, Schwartz and Wilde (1979) argue that intervention,
whether to regulate terms or require information disclosure, is
not justified because a number of consumers are ill-informed-"...
rather, the normative question should be whether the existence of
imperfect information has produced noncompetitive prices and
terms" (p631). The same authors (1983) also state that "supracompetitive
pricing ... is often the only problem serious enough to justify
regulatory concern" (p1391).
Schwartz and Wilde (ibid.) also succinctly describe
the underlying premise of the efficiency framework (pp1392-93):
... we assume that competitive outcomes in
markets for contract terms are normatively desirable ... When a
market is in competitive equilibrium, firms provide goods and
contract terms at the lowest possible cost consistent with the
continued existence of these firms. Thus, assuming a given
distribution of wealth, consumers cannot do better than purchase
in competitive markets.
The efficiency framework does not concern itself
with goals such as equality or the fair distribution of
resources. The argument is that such goals should not be achieved
by consumer protection regulation that restricts the contracting
process and thereby interferes with consumers pursuing their
preferences. Rather, they should be achieved through instruments
such as the taxation and social welfare system.
The Libertarian Framework
This framework shares many of the assumptions of the
efficiency framework. The difference is that the fundamental goal
is not efficiency but individual autonomy and freedom. Thus,
government intervention that subverts individuals pursuing their
preferences is not objectionable on the grounds that it threatens
a misallocation of society's resources, but is prima facie bad
because it infringes individual freedom. "Freedom of contract" is
a moral imperative of the libertarian framework.
Much of "law and economics" scholarship, particularly the
"Chicago School", demonstrates a libertarian bent. It is
generally unsympathetic to consumer protection measures.
The grounds for intervention to protect consumers are limited
and restricted to aspects of a transaction that call into
question the voluntariness of the parties to the transaction-e g.
physical coercion or serious externalities.
The Equity Framework
The overriding goal of the equity framework is fairness.
However, Duggan points out that there is no universally accepted
standard of fairness. He highlights three theories of justice
based on equity considerations that have relevance in the
consumer protection context:
- commutative justice
- loss-shifting
- distributive justice.
Also discussed is a more general standard of fairness based on
inequality of bargaining power.
Commutative Justice
Duggan states that (p257):
Commutative justice is concerned with preserving
each citizen's share of the prevailing distribution. It is
complementary to the notion of distributive justice which is
concerned with how society's wealth is divided among its citizens
in the first place.
Redistribution of wealth should be carried out according to
societal standards of fairness and not as a result of ad hoc
interactions between parties.
Duggan points to a number of legal doctrines that appear to be
based on commutative justice principles, for example the concept
of unjust enrichment, the doctrine of penalties and tort rules on
damages. All of these doctrines are designed to restore the
respective positions of parties to a transaction following a
breach of some legal standard by one party against the other, and
also to prevent parties from making windfalls from the breach.
In the consumer context, an example might be a rule that sets
aside a contract because it is unduly one-sided, such as in the
credit context where the Court has the power to reopen credit
contracts. [3]
Loss Shifting
This is a legal rule that shifts a loss from a party that
might normally be expected to bear it to some other party.
An example arises under the Consumer Guarantees Act 1993 (and
the Hire Purchase Act 1971). If a consumer purchases a good on
hire purchase and the good is deficient, the consumer may claim
various remedies from the supplier. If the supplier is insolvent,
normally the consumer must bear the loss. However, the Consumer
Guarantees Act gives the consumer the right to sue the financier.
The rationale for this rule is that it is fair that
the loss should be borne by the creditor because it is more
likely than the consumer to be able to absorb it (i.e. the
creditor has "deeper pockets").
Distributive Justice
This relates to the distribution of resources in society, and
notions of equality. A distributive justice framework sees
consumer protection policy as a vehicle for achieving greater
equality in society.
Measures considered to fall within this framework include
interest rate controls and restrictions on creditors' remedies
following a debtor's default. Such measures have the economic
effect of transferring resources from creditors to debtors.
Proponents of a distributive justice framework reject the
efficiency framework on a number of grounds:
- The efficiency framework overlooks the "detailed complex of
legal, social and economic factors, which constitute the
institutional framework of the transactions in these markets
and which structure the exercise of power within these
relationships" (Ramsay, 1995 p189). For instance, it ignores
the existing distributional impact of judicially created
"ground rules" of the common law, and power inequalities
between suppliers and low-income consumers (in particular). It
is therefore wrong to think of market transactions as "simply a
consequence of voluntary and mutually beneficial exchanges" (ibid.).
- Distributional goals are not necessarily achieved more
efficiently through the tax system than through contract
regulation (Kronman, 1980).
[4] Similarly, the
taxation and social system are under pressure and less able to
deliver on distributional goals (Ramsay, 2000).
Proponents of the distributive justice framework argue that
the goals of consumer law are aligned to the goals of the welfare
state. Ramsay (1995) cites an argument by Wilhemsson for a
general principle of social force majeure where
individuals have been unable to maintain payments on a credit
contract because of illness, unemployment or changes in family
circumstances. Here, consumer law shares one of the goals of the
welfare state, "that of security against consequences of
unemployment and illness" (Ramsay, 1995 p195). Ramsay states
"this new principle might influence the development of the law,
injecting discussion of unemployment and social divisions into
the world of contract doctrine and texts" (ibid.).
While the efficiency framework is dominant in North American
scholarship, a distributive framework has more support in Europe.
Brownsword, Howells and Wilhemsson (1996) discuss three
conceptions of "welfarism" which expand on the point above made
by Ramsay:
- minimal welfarism
- personal welfarism
- maximal welfarism.
Minimal Welfarism
Brownsword et al (1996) write:
Contract being viewed as a competitive activity,
it follows that the regulatory objectives of minimal welfarism
are twofold: to provide contractors who deal from below a
notional line of minimal wellbeing; and to adjust outcomes that
are liable to push a contractor below the line. In other words,
the most adverse effects of social inequality and of contractual
exchange are cushioned. Where transactions produce cases of
severe individual hardship (need) the law should be willing to
protect the party in need.
Personal Welfarism
This system abandons the competitive model of contracting and
seeks to introduce a regime of co-operative contracting such that
contractors assume responsibility for one another's welfare.
Co-operative dealing thus replaces a purely self-interested
contractual ethic (in which each side acts with a view to
maximising its own utility) and seeks to protect the interest of
the weaker party (ibid.).
Maximal Welfarism
This framework is based on inequality of bargaining power.
This is not discussed by Duggan as a distinct "set of values"-his
equity frameworks are more concerned with distributive aspects of
equity. However, it is a commonly cited rationale for consumer
protection. For instance, Tokely (2000) in her text on consumer
law in New Zealand says the basis of justification for consumer
laws is "the unequal bargaining power between consumers and
traders".
The distinction between distributive concerns and the more
general equity framework based on fairness is usefully summarised
by Brownsword et al (1996) under the concept of maximum
welfarism:
Rather than looking at the contractor's position
in the overall social order (or hierarchy), maximum welfarism
focuses specifically on the power relationship between the
particular contracting parties. If one side has greater
bargaining strength than the other, then the weaker party will be
protected against abuses of contractual power ... The general
regulatory objective is to act against inequality of bargaining
strength and unfair contractual outcomes that can be generated
from such inequality.
This approach underlies a lot of the consumer literature that
attacks standard-form contracts, broad security terms and
contracts that are substantively unfair. The principal
assumptions seem to be that consumers have few options but to
purchase and contract on terms set by increasingly large and
powerful sellers: disparity in size and resources between sellers
and buyers was often thought to equate to bargaining power.
Sellers were also able to exploit significant information and
sophistication asymmetries in their favour (Hadfield et al,
1998).
Paternalism
As noted above, the efficiency framework does not question
that consumers themselves know what their best interests are. An
alternative argument is that we cannot always be confident that
transactions that reflect parties' present preferences are really
in their long-term interests. Intervention that runs counter to
the preferences formed by consumers themselves is pejoratively
called "paternalism".
There are a number of examples of paternalistic interventions,
particularly with respect to children-for example, the Minors
Contracts Act and various product safety laws. Duggan (1991)
argues there are three shades of paternalism, the distinction
being based on whether the intervention was intended to correct
perceived deficiencies in:
- the way a choice was exercised in favour of a particular
preference
- the way a preference was formed
- the outcome of the choice.
However, as the first two points above do not aim to limit
consumer choice, or try to exercise it for them, it is not
necessarily appropriate to label it as "paternalistic". Secondly,
it is hard to determine whether there is any real distinction
between those points-for example, the way a preference was formed
may involve a choice on the part of the consumer. On that basis
these two points are not treated as "paternalism".
The third type of paternalism is what Duggan calls "true"
paternalism and is based on substantive judgements about the
validity of particular preferences. Choices are prohibited
because the outcome is considered not to be in the consumer's
best interest and people are assumed to need "saving from
themselves". A number of consumer protection measures,
particularly those designed to prevent over-indebtedness, seem to
be motivated by this form of paternalism.
[5]
In another context, a paternalistic motivation would be to
attempt to bring consumer preference-forming into line with
scientific "objectivity" when consumers perceive a risk that
science does not (Hadfield and Thomson, 1998). This is
highlighted in the debate over Genetically Engineered food.
Hadfield and Thomson point out that if consumers perceive a risk
that science does not, a non-paternalistic approach to
consumer protection will set as its goal to convey to consumers
the information they need to act on their perception. The fact
that consumer perceptions are not scientific is not a basis for
substituting a principle that those transactions that science
would make are those that should guide policy.
On the other hand, where the consumer is underestimating or
unaware of a risk that a scientific approach would reveal, it
would still be paternalistic to close the gap in favour of the
scientific approach-in this case, however, such paternalism is
appropriate (ibid.).
An Information Framework
A strict efficiency approach does not question a consumer's
preferences and sees no role in the law in shaping preferences.
This is because preferences are presumed to be subjective, so
there is no basis for enquiring into whether they were validly
formed or not, and no way of distinguishing qualitatively between
one set of preferences and another (Duggan, 1991).
However, the way consumers form preferences is not inviolable,
for example:
- Preferences may be formed on the basis of social
conditioning (e.g. sex and race discrimination), lack of
opportunity or habit (ibid.).
- Consumers operate under conditions of "bounded
rationality"-they use heuristics to simplify complex decisions
(Korobkin and Ulen, 2000). Hadfield et al (1998)
discuss how an "important and durable" heuristic device is the
general expectation consumers have that products are safe,
aside from risks that are obvious. In the case of hidden
defects, reliance on this heuristic leads to detriment.
- Consumers often underestimate the value of information,
that is, the benefit information is likely to bring to the
consumer in terms of making a different choice about what goods
and services to buy and on what terms (ibid.).
These considerations may go some way towards justifying an
agenda for consumer protection that is broader than traditional
efficiency considerations would allow-while sharing the same goal
that consumers should get what they want.
This appears to be the approach of Hadfield et al
(1998) in their recommendation of an information-based framework.
Emerging theories in the area of law and behavioural science,
with its emphasis on the consumer decision-making process, are
likely to add weight to this framework.
Hadfield et al (ibid.) begin their
discussion with a review of the economic theory that underlies
early consumer protection initiatives. This theory was based on
simplistic assumptions about market power and inequality of
bargaining power. The paper then covers a wide range of modern
theories relating to market structure, bargaining and game
theory, transaction costs and comparative institutional analysis
to arrive at a modern approach for analysing consumer protection
problems.
The central concept is that of the "bad deal", namely consumer
transactions in which what the consumers get out of the
transactions deviate from what they intended and expected to get.
The concept captures the essential way in which the analysis of
consumer protection is grounded in consumers' expectations and
desires.
This follows the basic principle of the market economy: that
consumers assess for themselves the costs and benefits of various
transactions. The fact that consumer perceptions are not
scientific or fully rational is not a basis for substituting a
principle that those transactions that science would make should
guide policy. It is the divergence between what consumers expect,
in fact, and what they get, in fact, that drives policy.
That basic approach highlights two important characteristics
of the market setting-the value of information and the cost of
information. Having established these premises, a framework would
follow the steps common to policy analysis, with the following
emphasis:
- In defining a public policy problem, the focus should be on
the quality and cost of consumer information.
- In deciding whether regulation is a necessary and feasible
response, it is suggested that consumer protection regulation
is only likely to make consumers better off if it either
improves consumers' estimates of the value of information or
reduces the cost of information to consumers (or both). In
trying to improve consumers' estimates of the value of
information, regulation is most likely to be effective where it
is addresses:
- hidden risks or hazards that create a gap between
consumers' general expectations and reality
- certain demonstrative cognitive failures to appreciate
certain kinds of risk.
- In choosing a regulatory instrument, an instrument should
not generate information that is costly for consumers to
interpret or access. Nor should the instrument have the effect
of increasing the gap between expectations and reality.
[6] There may be
trade-offs with respect to instruments which restrict consumer
choice (and freedom of contract) but are more successful in
reducing information costs (e.g. in respect of product safety),
and instruments that lower information costs but also restrict
competition or trade.
A Rights-Based Framework
Consumer policy is sometimes framed in terms of "consumer
rights". It is most common for the consumer movement to
articulate consumer policy in this way. For instance, Consumers
International state:
Consumer policy promotes the establishment of
legislation, institutions and information that improve quality of
life and empower people to make changes in their own lives. It
seeks to ensure that basic human rights are recognised, and
promotes understanding of people's rights and responsibilities as
consumers. These are:
- the right to satisfaction of basic needs
- the right to safety
- the right to be informed
- the right to choose
- the right to be heard
- the right to redress
- the right to consumer education
- the right to a healthy environment.
Consumers also have responsibilities to use
their power in the market to drive out abuses, to encourage
ethical practices and to support sustainable consumption and
production.
(www.consumersinternational.org:
accessed 10 October 2002)
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