The free market has many remarkable benefits. It also has an oft-ignored negative feature, say two Nobel Prize winning economists who wrote this book. That negative is the ubiquitous “phishing for phools.” That means marketing designed to benefit the seller (the phisher), not necessarily the customer (the phool). This feature is inherent in how competitive markets work, they assert, as business people behave in the self-serving way economic theory assumes.
The simple model of the free market is that everyone operates in their own self-interest. The reality is that trickery and deception sometimes persuade us to make decisions contrary to our interest. Phishermen inevitably arise to profitably exploit our cognitive biases and lack of information about certain goods and services. Entrepreneurs pursue profits, and taking advantage of customer’s naiveté is part of the free market’s double-edged sword. The free market creates a strong incentive to make profits, but does not reward those who refrain from manipulative tactics used by their competitors.
We regularly make decisions that aren’t good for us, whether it is saving too little for retirement, foregoing medical checkups, overusing credit cards, and so on. Marketing influences our decisions. Advertising often contains misleading, if not downright false, claims, so long as those claims elicit sales. Advertising is based upon what works, even when the targets are children. “Let the buyer beware” is still alive and well.
Phishing for Phools provides dozens of examples of practices and scams, some legal and some not, that manipulate the unwary into acting contrary to their interests. One example is the slot machine, which was invented in 1893. Exploiting human weakness, the new machines were soon found to be addictive to some of their users. One writer says they were “addictive by design.”
Another example was the savings and loan and junk bond crises of the 1980s. Next came the rise of Enron, which was based upon bogus accounting. Then the Bernie Madoff pyramid scheme. The 2007 bursting of the housing bubble stemmed from undeserved high ratings for mortgage-related securities.
Government regulation is either a needless drag on the economy, or an essential protection of the public interest. Akerlof and Schiller make the case for the latter, and do so by describing how “our free market system tends to spawn manipulation and deception.” They recognize the influence that regulated industries have upon regulators. Big Pharma, for example, spends more on lobbying than any other industry. The authors nonetheless maintain that regulation protects the public interest, even if that protection is inconsistent and less than it should be.
When Reagan declared that government is the problem not the solution, he led an era of deregulation. There has also been diminished funding for regulatory agencies, which limits their effectiveness. Fewer IRS agents means that hundreds of billions of dollars are uncollected each year because there aren’t enough people to collect them. When it comes to financial crimes, the regulators today typically fine the companies rather than prosecute individuals. One reason is that individual prosecution is more expensive. On the other hand, company fines are seen as a cost of doing business, and are a weaker deterrent than the threat of prison.
This book’s main point is that, “Free markets make people free to choose, but they also make them free to phish, and free to be phished.” The market is a double-edged sword. When the public recognizes that reality, there will be more support for government regulators to protect the public from phishing. ###
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