Creating Confident Consumers

The Role of the Ministry of Consumer Affairs in a Dynamic Modern Economy

May 2003

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5. The Role of Consumer Policy in a Dynamic Modern Economy

• The Role of Consumers in Competitive Markets
• A Framework for Consumer Policy
• The Information Interface between Competition and Consumer Policy
• Choosing the Right Mix of Policy Tools

The Ministry's functions are relatively wide ranging within the "traditional" domain of consumer policy. This section now develops more fully the relationship between this traditional role of a consumer policy organisation and the broader perspective of economic development - a particular emphasis is on the role that consumers play in competitive markets and how this stimulates economic efficiency and innovation.

The Role of Consumers in Competitive Markets

Successive governments have been concerned with improving New Zealand's economic growth rate in a way that leads to improved well-being for all New Zealanders. Improved economic growth is partly underpinned by the existence of dynamic and competitive markets, which stimulate the innovative potential of firms and set the stage for improved productivity that will lead to a higher growth rate.

Consumers have a vital part to play in the development of dynamic and competitive markets through their purchasing decisions. First, they satisfy their own needs as individuals. Second, their collective decisions ensure competition amongst suppliers. [4] Consumers who use information to make sophisticated choices and demand high-quality products and standards of service will stimulate providers of goods and services to innovate as a means of improving their quality and efficiency.

As the proposed outcome framework set out in Section 4 below will suggest, the Review Team considered that if consumers are to participate actively and fully in the economy they need to be able to transact with confidence. The fundamental principles underlying this concept are described in further detail below.

A Framework for Consumer Policy

From a traditional economic perspective, allowing consumers to pursue their own preferences is the most efficient way to allocate society's resources. A strict efficiency framework does not question a consumer's preferences and sees no role for the law in shaping preference; the grounds for government intervention are slim. But while the economic efficiency of any particular intervention must be considered, efficiency is not necessarily the most appropriate overriding goal. [5]

The way consumers form preferences is far from perfect. For example:

• Preferences may be formed on the basis of social conditioning, lack of opportunity, or habit
• Consumers' ability to obtain and process information is limited and so they often use mental short cuts of various kinds to simplify complex decisions - for example, consumers generally expect that products are safe if they do not have obvious visible risks. In the case of hidden defects, this may be a faulty expectation that leads to consumer detriment
• Consumers often underestimate the value of information, that is, the benefit that information may bring in terms of making a different choice about what to buy and on what terms.

These constraints on how consumers form preferences provide some justification, therefore, for a different and broader agenda for consumer protection, while sharing the same goal that consumers should get what they want. The thrust of consumer law in New Zealand and elsewhere is consistent with this approach. It is also consistent with the bulk of theoretical literature on consumer policy.

This broader approach may be found in an information-based framework: that consumers are generally in the best position to form their own preferences and decide whether or not to enter into a transaction. [6] The central concept is that of the bad deal (that is, consumers did not get what they intended or expected out of a transaction).

Information is central to this approach. Within such a framework, consumer policy is aimed at reducing the gap between consumers' expectations and reality by ensuring that:

• consumers can get the information they need to make decisions
• consumers understand and value accurately that information (so they are more likely to seek it out and use it)
• consumers are not exposed to hidden risks or hazards
• consumers have access to redress in the event of failed transactions.

It also means that consideration has to be given to the quantity and quality of information consumers need in order to transact with confidence. A flood of information can be as much of a problem as not enough information. Regulatory frameworks may assist consumers by creating an environment where rules under which traders behave free consumers from having to make judgements about whether, for example, a product weight is as stated by a manufacturer or whether an electrical appliance is safe.

The Review Team considers that an information-based framework is the most appropriate for use in New Zealand. Inevitably, issues will emerge that require a solution based on a different framework. In these cases it will be necessary to articulate the reasons for preferring an alternative framework, which would involve stating why the information framework is not appropriate in the circumstances.

The Information Interface between Competition and Consumer Policy

The proposed information framework highlights the connection between competition policy and consumer policy. In a theoretically perfectly competitive market, consumers have perfect information and zero search costs. This means they can assess the prices of all suppliers in the market, which ensures effective competition and results in optimum pricing. But if there is imperfect information, this can lead to imperfect competition because:

• There may be too few searchers in a market - too few consumers searching for information will reduce suppliers' incentives to compete effectively (and optimally) on price. [7]
• Information is not discrete - for instance, information may apply to a whole product type (such as wholemeal bread) rather than a particular brand of product. Suppliers advertising the benefits of their product type cannot effectively prevent competing suppliers from "free-riding" on this advertising. [8]
• Suppliers may have a common incentive not to disclose information - for instance, cigarette manufacturers compete among themselves for market share but have a common incentive not to disclose information about the risks of smoking. [9]
• Transaction costs - information may appear too costly for consumers to access in relation to the perceived benefit of the information.

Both consumer and competition policy have a shared objective - improved consumer well-being. Competition policy aims to achieve this objective by ensuring that consumers have a meaningful range of options and that prices reflect competition between suppliers. Consumer policy, on the other hand, aims to achieve the objective by ensuring that consumers' reasonable expectations of transactions are met, and is primarily concerned with reducing the gap between their expectations and the outcome of the transaction. The point of overlap between competition and consumer policy is in ensuring that consumers have effective access to information.

Choosing the Right Mix of Policy Tools

Where a consumer issue or problem is information based, the analysis undertaken may suggest the use of competition policy tools, or consumer policy tools, or a combination of both.

This has important implications for MED as the home of both consumer policy and competition policy, because the interaction between the two areas means that each must be informed by the other. There needs to be a close relationship between the Ministry's Policy Unit and those branches of MED responsible for competition policy - that is, the Regulatory and Competition Policy Branch and the Resources and Networks Branch.

It must also be recognised that the two policy areas do come from different perspectives, which means they might approach problems differently. This makes it important to retain expertise and an independent voice for both, so differences can be resolved in such a way that the policy objectives are achieved and adverse impacts on markets and consumers are minimised. It seems clear from the interviews with SLT members that MED relies on the Ministry to have a different perspective, which is clearly distinct from that of competition policy.

[4] Mitchell J, Kutin B and Macgeorge A (2001) "Guidelines for Consumer Policy in Central and Eastern Europe" Journal of Consumer Policy 24: 83-109 p94.

[5] See the background paper Literature Review on Analytical Frameworks for further discussion of these frameworks.

[6] It is acknowledged, however, that there is a role for government policy in seeking to change consumer behaviour where that behaviour is contrary to broader social interests.

[7] Schwartz A and Wilde L L (1979) "Intervening in Markets on the Basis of Imperfect Information: A Legal and Economic Analysis" University of Pennsylvania Law Review 127: 630 p638.

[8] Golan E, Kuchler F and Mitchell L. (2001) "Economics of Food Labelling" Journal of Consumer Policy 24: 117-184 p130.

[9] Hadfield G K, Howse R, and Trebilcock M J (1998) "Information-based Principles for Rethinking Consumer Protection Policy" Journal of Consumer Policy 4: 131-169 p153.

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