Diagramas y gráficos de los procesos de fabricación

Above, it has been argued that both competition and regulation can protect consumers from abuse by onerous terms.²⁰¹ Regulation however also comes with costs, and might have a negative impact on the effectiveness of competition to counteract the market failure. Heterogeneous consumer preferences can limit the benefits of regulation, and cause detriment to consumers with a preference for low priced low quality standard terms. As consumers feel more protected, their propensity to be vigilant and to take care in transactions may be reduced. The interplay between competition and regulation should therefore be carefully assessed.

a. The costs of regulation

Regulation, correcting a market failure, comes with costs. These costs consist not only of the administrative costs of implementing the regulation itself, but also of the adverse effects that the regulation might have, for instance in hindering competition and error costs. Also, there is a paradox in using costly information measures as a solution to problems that started with the cost of becoming informed being too high. Insight into the issue of transaction costs has taught that information costs are both a part of markets and

200 This reasoning is analogous to Kornhauser (1976: 1180), who argues that court intervention is insufficient because products that have been driven out of the market due to their high quality cannot be reinstated by courts.

201 See also above, section 5.3.3.

of regulatory interventions. The relative costs of the problem and the solution must be understood clearly (Hadfield et al., 1998: 145).

Furthermore, as consumer preferences are heterogeneous, regulatory intervention could benefit some groups of consumers, while harming the interests of others.

Consumers who have a preference for low-quality low price terms could find that their preferences can no longer being fulfilled, as regulation has banned the terms that they prefer. Whether a ban on a low-quality term is welfare enhancing depends on the number of consumers who prefer one-sided terms. The fact that some consumers might be harmed in their interest when the quality of terms is improved, even when this intervention increases social welfare as a whole, should not be overlooked.

b. The cures of competition and reputation

In theory, competition between sellers should make terms less one-sided, as beneficial terms should attract consumers. If consumers can easily observe and evaluate product attributes at the time of the sale, if search costs are not significant, and if most consumers are capable of making reasonably good decisions concerning the product attribute in question, competition on its own can protect consumers very well (Armstrong, 2008: 100).

The one-sided drafting of standard terms is discouraged by various legal institutions, such as unconscionability, fairness tests, the contra proferentem rule et cetera (Kessler, 1943).²⁰² Consumers will be protected from onerous terms by the company’s need to uphold its reputation, and by the protection of legal institutions. Therefore, standard terms in consumer contracts are unlikely to be onerous (Schäfer and Ott, 2004: 370-3).

These competitive cures however can arise only with respect to the terms that the consumers are consciously aware of, not with respect to the ones that information asymmetry relates to. Also, savvy business strategies can mute the effect of competition and the influence of the marginal informed consumer group by giving favours to the smart and complaining consumers. Furthermore, disagreement over terms that are connected to remote risks might not influence reputation. Moreover, short term players are not deterred from onerous practices or terms by the prospect of a bad reputation.

Goldberg argues that the characteristics of contracts correspond more to private regulation on the part of the drafter and that standardised terms cannot be seen as a voluntary agreement. Equilibrium terms could come forward from this market, but harsh and low priced terms could also drive out the good and higher priced ones (Goldberg, 1974: 483-6). Of course, both consumers and producers have an incentive to cure this situation. Market solutions like brand names and advertising could ameliorate the effects of the market failure, but are unlikely to sufficiently counteract it. Gazal-Ayal analyses how consumers could use readily available information such as price and reputation to estimate the quality of products and thereby of standard terms. Both a high reputation and

202 See chapter 6 for a discussion of the common core of the European legal approach towards standard terms in consumer contract.

5. Behaviourally enhancing policy recommendations - standard terms in consumer contracts

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higher prices could signal a higher quality of the terms. Yet Gazal-Ayal also shows that neither reputation nor price can be sufficient indicators for quality (Gazal-Ayal, 1999:

26-39). Both items can be perceived as signals of quality, and have some effect in that sense, but neither can create full knowledge on the quality of contract terms. Government intervention is therefore warranted to counteract the adverse selection of standard terms.

c. The interplay between competition and regulation

When an industry is more regulated, suppliers have less freedom in setting their own terms. Theoretically at least, this hinders competition, and decreases welfare for consumers with heterogeneous preferences. There is a concern that regulation will induce even less reading by consumers. Moral hazard of consumers (or rational apathy, rational ignorance) is reinforced by paternalistic consumer protection (Hatzis, 2008: 11).

Standard contract terms can in most cases be safely ignored by consumers (Baird, 2006:

936). Law protects consumers anyway and might thereby actually stimulate consumer moral hazard. Why would consumers bother reading or comparing terms if they know that the onerous terms will be stricken from the contract anyway?

However, the extent to which competition is in fact hindered by regulation in the context of standard terms is hard to ascertain. The more terms are affected by adverse selection, and the further these terms are removed from the scope of consumer information, the less positive the effect of competition is. When there is no competition with respect to standard terms, sellers cannot distinguish themselves from the competition by offering better terms. Therefore, all sellers will try to offer terms at as low a cost as possible, and all terms will be offered in the same quality: one-sided, harsh terms with a low price. In this scenario, regulation that aims to improving the quality of terms can thereby only improve the market if it can successfully distinguish the terms that have disappeared due to adverse selection. The quality of terms is too low from a social welfare perspective, and should therefore be corrected. Very intrusive forms of regulation could even prescribe terms in consumer contracts. In this situation, consumers still have only one type of standard term to expect, but now these terms will be of higher quality than they would have been in absence of the regulation. As has been argued above, due to adverse selection the efficient level of quality in standard terms is likely to be higher than the quality of terms that is provided by the market. When there is no competition with respect to a large portion of standard terms due to information asymmetry, regulation on these terms could not possibly hinder competition much.

Whether a form of contract provided by regulation should be preferred over the option of non-interference, which means leaving it up to the market, could however also be questioned. It can be doubted whether the regulator retains sufficient information about which standard terms would be efficient. Different policy proposals which aim at improving the quality of terms, including the option of prescribing terms, will be

assessed below.²⁰³ Suffice it to point out for now that a trade-off does exist with respect to competition and regulation.

The interaction between competition and regulation is delicately balanced. In general, regulation should be regarded as the second-best option, as it interferes with the market mechanism. Before regulation is enforced in order to correct the market failure, it should be established that the effects of competition fail to have sufficiently ameliorating effects.²⁰⁴ With respect to standard terms, it should ideally be established which terms are effected by adverse selection, and which terms are subject to sufficient competition between sellers.²⁰⁵ Heterogeneous preferences complicate the question of whether certain terms are actually subject to sufficient competition. In the case of standard terms, due to information asymmetry, a substantial part of the contract might not benefit from the competitive cure of the market mechanism. The costs and benefits of both regulatory interventions and the mechanism of competition, and the interplay between them, should be carefully assessed.

5.3.8 Conclusion: desirability of government intervention by information insights