Markets: A Mixed Verdict

Markets: A Mixed Verdict

People may most need a good nudge when choices require memory, have delayed effects, are difficult or infrequent, offer poor feedback, or have an unclear relationship to the experience that follows. A natural question is whether free markets can solve people’s problems, even under such circumstances. Often market competition will do a lot of good. But can markets perform miracles? We should always be suspicious of miracles.

A colorful and illustrative example is the sale of bogus medical treatments, a practice that can be found in various forms around the world. In movies depicting the American Wild West, the magic elixir was often called “snake oil,” perhaps to discourage competitors from entering the market. Snake oil was said to cure many ailments, ranging from acne to arthritis to impotence. Modern versions still exist in the “natural health” sector (which is, in many countries, only lightly regulated), but for the sake of this brief discussion let’s focus on snake oil, because the marketing strategy often employed helps make a more general point about markets and their limitations.

The setup in the classic western movie version shares features of many scams and swindles that regularly reemerge in slightly different forms over the years. A “doctor” in a covered wagon comes into town and opens for business somewhere near the local saloon. He offers to sell bottles of his special brew of snake oil, which can cure whatever ails you. As it happens, someone in the crowd on crutches soon emerges and challenges the doctor, calling him a fraud. Pointing to his gimpy leg that prevents him from walking, he says, “I bet you can’t cure this, doc!” The doctor generously offers the poor man a free sample, and miraculously, the next night his leg is healed! Many bottles are sold and early the next morning, the doctor and his partner, who played the part of the man on crutches, head out of town to their next destination. Some version of the same scam can still be seen in crowded city locations popular with tourists, though instead of snake oil they may be peddling the chance to win some easy money playing three-card monte or spot the pea. (The accomplice wins some early money in this variation.)

Although these sorts of scams seem extreme, they are just a few examples of the many products that appeal to Humans but not Econs. You can find a whole bunch of them on the internet, and if you watch late-night television in some countries, there’s a lot of snake oil for sale. Our advice on one common insurance purchase is simple: just say no to extended warranties. But the question we want to discuss here is larger: whether competitive markets protect consumers from such scams. Sadly, the answer is no.

Entry into the snake oil business, though not free, was nevertheless unregulated. Any two people with a wagon, some bottles, and a gift for fast talking could enter this business. It would help to have a knack for brazen lying, and no qualms about taking money from innocent bystanders. To be sure, there was always the risk that someone would recognize them and they would get in trouble with the local sheriff. But here is the key point. No one could make any money telling people not to buy snake oil! Few of us are in such perfect health that we wouldn’t be happy to spend a few dollars for a bottle of a magic elixir. Does it cure COVID-19? Tennis elbow? Bad back? Writer’s block (or sore fingers)?

Snake oil is just an extreme version of any ill-advised purchase. Many people become addicted to gambling, and for them casinos can be as dangerous as heroin or crack. And although they are regulated and entry can be limited, casinos do compete with one another as well as with other forms of gambling, such as sports betting or do-it-yourself options trading. They compete by offering enticing environments, free drinks, and sometimes better odds. But no one has gotten rich by convincing people not to gamble. Advice can help Humans avoid financial mistakes, but we do not expect our writing to eliminate the extended warranty business.

In the modern era, it’s easier than ever to sell snake oil. People can go online and sell products that are said to reduce the risk of cancer, to cure diabetes, to save you money, to make your skin clear, and to fight anxiety and depression. We are fans of the actress Gwyneth Paltrow (check out the underrated Country Strong), but her website, Goop, was selling products that might actually contain small amounts of snake oil. With respect to health, romance, and money, it is not at all hard to exploit people’s lack of information. If one of those things is at stake, companies have a strong incentive to exploit behavioral biases, including availability, unrealistic optimism, and anchoring. And they certainly try to create informational cascades. Sometimes they succeed.

There is a general lesson here. Much of the time, more money can be made by catering to human frailties than by helping people to avoid them. Bars make a lot more money than Alcoholics Anonymous. So, if Humans have problems, they might benefit from a well-chosen nudge.