phishingforphoolscoverIn an important new book, Phishing for Phools, George A. Akerlof and Robert J. Shiller demonstrate, through a series of examples, the prevalence of manipulation (“phishing”) in consumer markets and in society more broadly. Manipulation is inevitable, they argue. It is the equilibrium outcome. High-road sellers will soon lose out to their low-road competitors and disappear from the market. You must manipulate to survive: phish or perish.

As Akerlof and Shiller recognize, their book builds on a now rich literature in behavioral economics. Their contribution lies in the generality of their claims and in their ambition to present market failure – the bad phishing equilibrium – as the rule, rather than the exception. This short post does two things: First, it discusses consumer contracts as an example of phishing. Second, it considers different policy responses to the unhappy picture that Akerlof and Shiller so vividly paint.

In a recent book, titled Seduction by Contract: Law, Economics and Psychology in Consumer Markets, I studied consumer contracts and argued that the design of these contracts can be explained, in large part, as a response by sophisticated sellers to the imperfect rationality of consumers. In the terminology of Akerlof and Shiller, I was looking at contractual design as a phishing strategy. Of course, contractual design in consumer markets is but one example of the pervasive phishing that Akerlof and Shiller document. But it is an important example, so I will discuss it briefly.

Consumers routinely enter into contracts with providers of goods and services—from credit cards, mortgages, cell phones, insurance, cable TV, and Internet services to household appliances, theater and sports events, health clubs, magazine subscriptions, transportation and more. Consumer contracts are the product of an interaction between market forces and consumer psychology. They provide short-term benefits, while imposing long-term costs (think credit card teaser rates) – because consumers are myopic and optimistic. They are excessively complex (with multi-dimensional pricing structures, not to mention endless fine print) – because complexity allows sellers to hide the true cost of the product or service from the imperfectly rational consumer. Consumers are seduced by contracts that increase perceived benefits, without actually providing more benefits, and decrease perceived costs, without actually reducing the costs that consumers bear.

Like Akerloff and Shiller, I found that competition does not always alleviate this behavioral market failure. Indeed, competition may even exacerbate the problem. Sellers, operating in a competitive market, have no choice but to align contract design with the psychology of consumers. A high-road seller who offers what she knows to be the best contract will lose business to the low-road seller who offers what the consumer mistakenly believes to be the best contract. Put bluntly, competition forces sellers to exploit the biases and misperceptions of their customers.

Of course, Akerlof and Shiller discuss consumer markets as a central arena where phishing takes place. Contractual design, however, plays a less central role in their story. As noted above, Seduction by Contract, with its focus on contractual design, can be viewed as one example (or one category of examples) of the phishing that Akerlof and Shiller emphasize. But Seduction by Contract is not only narrower than Phishing for Phools in its focus on consumer contracts, it is also narrower in its definition of phools. Seduction by Contract considers consumer misperceptions and how they are exploited by sophisticated sellers. This corresponds to “information phishing” in Akerloff and Shiller’s taxonomy.

My analysis in Seduction stays away from preferences and emotions. Like many economists, I felt uneasy or unsure about going down that treacherous road, second-guessing people’s preferences. My phools knew their preferences but failed to satisfy them, because their perception of the relevant environment was distorted or biased. Akerloff and Shiller are braver. They do not shy away from preferences. Their phools don’t know what they want. Their preferences and emotions are manipulated in the phishing equilibrium. I view this as a strength of Phishing for Phools. On that view, health conscious consumers are drawn to the Cinnabon® store by the smell of freshly baked cinnamon buns. A person who never considered buying a dog, walks into a pet store after seeing the irresistible puppy in the window. Our “monkey-on-the-shoulder tastes," as Akerloff and Shiller call them, overrule our well-considered tastes.

Now on to policy. Can the law help us avoid the bad phishing equilibrium or, at least, reduce the incidence of and harm from phishing? Seduction by Contract, with its focus on information phishing, answers in the affirmative. Akerloff and Shiller agree that law can effectively combat information phishing. They are much less optimistic about the ability to prevent the manipulation of preferences and emotions – what they call psychological phishing. The reason and extent of this pessimism are not entirely clear, but I believe that it rests on two pillars: (1) psychological phishing is inherently harder to defeat, and (2) the American anti-regulation ethos makes it difficult to muster the stronger medicine that is needed to fight psychological phishing. In other words, while soft interventions like mandated disclosure may be sufficient to combat information phishing, we need more intrusive interventions, e.g., banning certain products and practices, to fight psychological phishing; and we cannot muster the political will to employ these intrusive interventions.

I am perhaps a bit more optimistic than Akerloff and Shiller, at least about our ability to use strong medicine in the fight against phishing. The Dodd-Frank Act is an example on point – an example that Akerloff and Shiller discuss. More specifically, the Consumer Financial Protection Bureau (CFPB), established by the Dodd-Frank Act, seems to be doing a good job policing phishing in the consumer finance space. Of course, the CFPB and other regulators could benefit from a larger budget. And they will always be a step behind the phishers; it is hard to deny that the market usually moves faster than its policemen who need to vigilantly watch for new phishing techniques. Still, there is reason for optimism. The failures of the market system should not overshadow its great success (which Akerloff and Shiller acknowledge). This success, which is enabled by effective regulation, leaves me hopeful. But perhaps I am just a phool.

Oren Bar-Gill
Oren Bar-Gill is Professor of Law and Economics at Harvard Law School. He is the author of Seduction by Contract: Law, Economics and Psychology in Consumer Markets (OUP, 2012).