Wednesday, May 16, 2007

Information and Consumer Behavior

My five year old son is very particular about what he will have for breakfast. One of the few things he is willing to eat is a certain breakfast item from Kellogg's. A while back when the FDA mandated the inclusion of information about trans fats on consumer food packing, I noticed that this product contained a small but significant amount of trans fats. At that point, I would have stopped buying the product, however my son would not hear of this. We kept buying the product, but a few weeks ago I noticed that all of a sudden trans fats are missing from the list of ingredients on the product. Interestingly, many companies moved to eliminate trans fats from their products once disclosure became mandatory. Take a look at this story.

In an unrelated story, a few months ago I had a quick bite at McDonalds. I noticed that my tray mat contained nutritional information about the food I was eating, and when I read it I was shocked to discover that the order of fries I was eating contained 8 grams (!!) of trans fats. I haven't ordered McDonald's fries since, and never will again.

The change in the ingredients of my son's favorite breakfast food and the change in my own behavior following the McDonald's incident got me thinking. Had the FDA not mandated the disclosure of trans fat content to consumers, it is likely that Kellogg's would have kept the trans fat content in the product indefinitely. It is also likely that while I knew they were bad for me, I would have continued to order McDonald's fries indefinitely. However, once that information became publicly available, Kellogg's quickly and quietly got rid of this harmful ingredient and I changed my own purchasing behavior. Once again, this is proof positive, if you ever needed one, that daylight is the best kind of antiseptic.

The same logic holds true for financial market regulation and pretty much every other form of human activity. People need complete information to make rational decisions. The markets can only function optimally if information is symmetrically shared by all. This is why I will always be in favor of ever tougher SEC disclosure requirements, ever tighter FDA disclosure rules and pretty much any other regulation that places more information in the hands of the public.

That is also why insiders are always objecting to tighter disclosure regulation. Your lack of knowledge puts money in their pockets. Your money. This is why, for example, analysts and CFOs alike were fighting SEC regulations requiring information to be released to the public at the same time it is released to analysts.

However, being that these groups of insiders are sophisticated, you will always hear them objecting to tighter regulation using such arguments as: (a) the public doesn't need, want or is unable to handle large quantities of information; or (b) the cost of disclosure will be too high and will place a disastrous burden on business; or (c) tighter regulation is not necessary, because industry is policing itself.

When they use these arguments and many others like them, you should only be hearing one thing: "give us your money".

4 comments:

plonkee said...

To me, this demonstrates that knowledge really is power. And I may have to stop eating McDonalds fries.

S. B. said...

Information disclosure often does seem like it's the easiest and most cost effective way to regulate a lot of things. I imagine the cost to outright ban trans fat might be fairly significant -- e.g. sampling, testing, enforcement, legal, waivers, etc. If you have an educated population, disclosure will sometimes accomplish much of the same thing. This obviously doesn't work for everything, but I'm amazed at how well it does work in many cases.

And by the way, yes, I've been asked for my AAA card at several places before, but you didn't enable comments on that post!

Shadox said...

S.B. I agree with your comment completely. I believe that the government generally screws up everything it touches. It should focus on regulation, and only interfere in the free market where a market failure is known to exist.

Consumer behavior is frequently one such area of market failure. The main cause of this is that information and power are not symetrically shared between consumer and vendor. The vendor holds all the information and has no incentive to share it. As in the example of trans fats, once consumers become aware of the information that was hidden from them, the market tends to self correct pretty quickly. Objective achieved, without a cumbersome and corrupt government bureaucracy.

S. B. said...

A classic "externality" is pollution -- the costs of pollution are borne by society, but yet these costs are (often) not captured in costs of goods and services. If the costs were fully captured in prices, the market might well correct a lot of pollution. Hence, for decades there have been attempts to essentially tax pollution by various methods -- none of which have worked all that well, in my opinion.

Is there a parallel here? Might there be some way to more effectively regulate certain kinds of pollution via simple disclosure -- rather than banning, taxing, inspecting, etc -- and then let the market correct? I don't know. Just an early morning thought to throw out there...