Another Argument Against Free Market Economics in Consumer Protection: James Kwak’s Economism

by Jeff Sovern

For years, fans of economics have attempted to convert judges and lawyers to their mode of analyzing legal problems.  For example, George Mason's Scalia Law School's Law & Economics Center has offered programs for judges for nearly four decades, and thus far has attracted more than 4,000 judges to its programs. It also offers programs for state attorneys general, and law professors. It even offers a consumer credit academy for regulators. I have never attended one of these programs, and so can't say what's covered (though I wish they would webcast at least the consumer credit academy), but I imagine that they devote some attention to free market economics. That, of course, is a perfectly appropriate subject for such instruction.  

But those who are interested in the application of economics to law–a group in which I include myself–should also know about critiques of what James Kwak calls "economism" in his valuable book of the same name. In recent years, free market economics has been under attack from at least two directions. One avenue of attack, which has surfaced often on this blog, is behavioral economics. Behavioral economics, spearheaded by Nobel-prize winner Daniel Kahneman and his deceased collaborator Amos Tversky, argues that people consistently make certain errors in thinking with the result that markets reach inefficient outcomes. For example, the optimism bias causes consumers to believe erroneously that they will never make a late payment and so to ignore penalty fees and interest rates for late payments when incurring debts.  Consequently, if we depend solely on markets lenders can charge as much as they wish with late fees and consumers will not avoid loans with excessive late fees because consumers will just assume they will never incur such fees–despite the fact that many do.  My impression is that the CFPB and other Obama-era regulators tend to accept these errors as affecting decision-making and so seek to regulate transactions to protect consumers from them.  So to continue the late fee example, when Congress enacted the Credit CARD Act of 2009, it provided that regulators would cap late fees. 

Though Kwak’s Eonomism discusses behavioral economics, it also mounts another attack on classical economics. Kwak argues that Economics 101 is based on unrealistic assumptions which causes it to make incorrect predictions about the effectiveness of markets. He shows that empirical evidence is often at odds with what classical economics suggests should happen. Among the unrealistic assumptions are that we have perfect competition, all market participants have perfect information, and all products in the same class are identical.  But Kwak argues that the lessons of Economics 101 still have considerable influence among policy-makers and others, and so they overlook those unrealistic assumptions in drawing conclusions about what the law should be (For a recent example of how the free market works, or more precisely doesn't always work to protect consumers see my blog post about the Wells Fargo scandal). 

Kwak argues that Econonism has become a religion-like ideology. In the academy, among economists, according to Richard Thaler’s book, Misbehaving, behavioral economics is winning the battle over classical economics. Similarly, most law professors writing about these issues these days use behavioral economics, though some professors at George Mason and elsewhere are fighting on behalf of classical economics.  It remains to be seen what happens with policy-makers. Free market economics suffered a setback in the election of 2008, but it appears to be in the ascendency at present.  Maybe those who argue that law should take account of real people rather than the econs of free market economics should consider their own educational programs. 

Leave a Reply

Your email address will not be published. Required fields are marked *