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Disclosure as a regulatory tool: how we make decisions

Inspired by this article about the ineffectiveness of disclosure as a regulatory tool, some questions:

When you sign up for an online service like iTunes or Facebook, do you read the terms and conditions before you click the “I agree to these terms and conditions” button?  When you rent a car, and the clerk asks you to put your “initials here, here, and here, and sign at the bottom,” do you read the form before you initial and sign your name?

I don’t.  I have a law degree, but reading the contract would be a waste of time because I wouldn’t fully understand all of the fine print.  Instead, I sign the contract because a) I can’t rent the car otherwise, and b) I trust that if I act reasonably and don’t damage the car, the car-rental company won’t try to screw me over.  I trust that they won’t because they want my repeat business, and/or because there are laws that prevent them from doing so.

Another question: if you’ve gone to the ER because you’re feeling sick, or you thought you were having a heart attack, did you read the forms that they asked you to sign purporting to provide your “informed consent” to examination and treatment?

I wouldn’t.  I’m a doctor, and I wouldn’t have time to read those forms when I was feeling well, let alone when I was feeling sick or worried that I might be suffering from a heart attack.  Instead, I would sign because a) I would think it was the only way for me to get the treatment I need, and b) because I trust that the hospital staff will act in my best medical interests because medical professionals act this way, and c) because I trust that there are laws and regulations preventing the medical staff from behaving otherwise.

Most of us, I think, sign long contracts all the time, without reading them.  There is evidence for this.

Last month 7,500 online shoppers agreed to provide the British retailer Gamestation with more than just cash. They signed over their rights to eternal life. Gamestation added an “immortal soul clause” to its terms and conditions as part of an April Fool’s Day experiment. (Notice of the transfer would be announced in 6-foot-high letters of fire.) Customers who read the clause and chose to opt out received a £5 discount on their next videogame purchase. Only 12% did, proving Gamestation’s point that most people agree to terms and conditions without reading them.

Carl Schneider

Carl Schneider

Professors Omri Ben-Shahar and Carl Schneider emphasize an unsurprising and almost self-evident fact: disclosure frequently doesn’t work as we’re told it does.  If we say, as most lawmakers do, that mandatory disclosure is meant to help people make better choices, then the evidence that it doesn’t should make us wary of relying on disclosure to solve problems like predatory lending, violation of arrested people’s constitutional rights, and the mistreatment of sick people by doctors and hospitals.

The contrary view of disclosure is one that’s been incredibly popular, of course.  Telling people about their options and about their rights has been a ubiquitous solution to various social problems over the past few decades.  This has coincided with the ubiquity and popularity of the belief that lightly-regulated free markets maximize individual freedom and, consequentially, their individual well-being and happiness.  In fact, both of these ideas stem from the same belief that we are all autonomous and rational self-interested welfare maximizers who thrive best when government “gets out of the way.”  This is the conventional wisdom of our age, and I surely do not have to remind anyone of it.  But sometimes it helps.

It helps, because many lawmakers are eager to turn to the same regulatory tool — mandated disclosure — as a way of preventing the next financial crisis (and of preventing the establishment of new regulations).  Stopping short of simply breaking up the big banks or taxing speculative trading, the financial reform bill will probably require more disclosures and transparency.  In many cases, such as derivatives trading, this would probably be a good thing.  But, at least when it comes to disclosures made to average consumers, we should be skeptical that this transparency alone will prevent rapacious behavior by big banks in the future.  We shouldn’t think that it will prevent future bubbles like the real-estate bubble, which are driven in part by consumer behavior.

Omri Ben-Shahar

Omri Ben-Shahar

Sure, disclosure is almost never a bad thing.  It is cheap, compared with many other regulatory tools.  But it frequently doesn’t work.  The theory that underlies it — that we’re all autonomous self-interested utility maximizers — is a woefully inadequate description of human beings.  This underlying theory is recognized as inadequate by virtually every honest and non-senile economist, but as popular conventional wisdom it has been much more difficult to cut down to size.  Continuing faith in this incomplete model of humanity is the reason why we remain vulnerable to market bubbles, why we still have to sign long forms when we’re sick in the hospital, and why real reform of the financial sector seems so slow in coming.

I’m in favor of an independent consumer financial protection agency because I believe Ben-Shahar and Schneider when they say that disclosure frequently doesn’t work.

In law school, I took a class from Carl Schneider that considered how patients make medical decisions.  We considered a lot of evidence that they do not simply decide based on the disclosure of information.  As a physician, I know that patients don’t demand to be told all the options and then inform me what it is that they’ve decided to do.  Instead, they expect me to listen to their description of what’s bothering them, and then make a recommendation about how to make them feel better.  The vast majority of the time, they decide to do what I recommend.  They’re still making a choice, but it’s a choice that relies overwhelmingly on the advice of an expert (me) advising them to do one thing and not to do something else.  Their choice, really, is to trust the doctor, and not to get a monospot test or to check a serum potassium level.

I make decisions the same way in areas in which I’m not an expert.  When my car breaks down, I take it to a mechanic and ask for his recommendation about how to fix my car.  Ninety-nine times out of a hundred, I’ll decide to follow the mechanic’s recommendation.  I’m still an “autonomous” decision-maker, but I’m not making my decisions based on extensive disclosures of data and facts.  I’m deciding to defer to someone else whom I believe has more expertise about the subject of my decision than I do.

I’m not a financial expert either.  When I’m about to make a big financial decision, I seek out experts and generally defer to their recommendations.  The problem is, because I’m not a financial expert, I can’t always know what decisions are “big” financial decisions.  A consumer financial protection agency could warn me about unrecognized financial traps that I wouldn’t see otherwise.  Or it could simply outlaw them.  Either approach is much more likely to protect me from nefarious purveyors of dubious financial products than a long and detailed prospectus alone.

People must have the freedom to make their own decisions about much of what they do in life.  That’s not the same as saying that people can only exercise freedom of choice when they’re given long lists of raw data about the pros and cons of each decision they’re asked to make.  Nor is this the same as saying that people’s autonomy is infringed when other people and institutions are prevented by law from offering certain “options” to others.  If, for example, we outlaw a rental-car form contract with a buried clause stating that I have to pay $1000 per day if I park in a McDonald’s parking lot, and otherwise I have the car for $49.95 per day, my autonomy is not infringed.  My autonomy certainly isn’t adequately protected by requiring the disclosure of such a term in Paragraph 14 of a form contract with 48 paragraphs.

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