Consumer Protection in a Free Market

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An article in the latest issue of the Undercurrent examines the cultural vilification of Big Pharma. The piece argues that pharmaceutical companies deserve their profits because they invest a tremendous amount of time and energy researching and developing their products. In this post, we look at the oft-made criticism that the only reason pharmaceutical companies engage in R&D, and more generally the only reason corporations engage in honest practices, is that the government requires them to do so.

Many people believe that without government regulation, pharmaceutical companies will dupe consumers and cut corners in order to make a quick dollar. They believe that the regulatory restrictions imposed by the Food and Drug Administration (FDA) are necessary to reign in companies whose greed would otherwise lead them to engage in a range of unscrupulous practices.

This view fails to recognize that the free market already has a means of rewarding integrity—the profitability of a good reputation.

Reputation is a crucial business asset. Companies work for years, sometimes, decades, to earn a reputation for providing quality products, impeccable service, customer care, timely delivery. The hint of a bad reputation—that a software company’s programs are liable to crash, that a delivery company damages fragile goods, that a bank overcharges on service fees, or that a pharmaceutical company releases medication hastily—can be fatal for a company. In a free market, a competitor is ever ready to exploit such weakness.

Alan Greenspan [writing in Ayn Rand’s essay collection Captialism: The Unknown Ideal] notes: “[I]t is in the self-interest of every businessman to have a reputation for honest dealings and a quality product. Since the market value of a going business is measured by its money-making potential, reputation or ‘good will’ is as much an asset as its physical plant and equipment…“

The idea that profit could incentivize moral behavior sometimes strikes people as counter-intuitive. What about all the cases in which it would be more profitable for a company to deceive customers, distort earnings, cut corners? Without government regulation, what would check a pharmaceutical company seeking profit in situations where profit required immorality?

These questions equivocate short-term and long-term gain. It is possible for a company to benefit short-term from unscrupulous practices. A company can misrepresent its product or service to generate some immediate interest or revenue. But then what will happen? Dissatisfied customers will take their business elsewhere; the media will criticize; affiliates will distance themselves; honest employees will seek out other employers. The price for that immediate gain was real damage to the company’s reputation, and thus to its long-term gain.

The fact that short-term deceit is possible is an argument for, not against, the role of the profit motive in protecting consumers in the marketplace. It is precisely the fact that companies can be motivated by earning a quick dollar, rather than providing a real value, that makes reputation such an important asset. How many of us invest in the Nigerian businessmen contacting us via spam? How many of us buy medical products from infomercials? We don’t do these things because the seller has not earned a reputation with us.

As Greenspan puts it: “[I]t requires years of consistently excellent performance to acquire a reputation and to establish it as a financial asset. Thereafter, a still greater effort is required to maintain it: a company cannot afford to risk its years of investment by letting down its standards of quality for one moment or for one inferior product; nor would it be tempted by any potential ‘quick killing’…””

Over the long term, the only way for a company to achieve success is honesty and integrity. Deceiving customers to make money simply isn’t practical. As historical example after example shows, sooner or later, one way or another, such deception comes back to haunt a company.

[In this post we’ve presented, in brief, the positive argument that the free market rewards integrity and honest practices, and therefore serves consumer interests. For more on this argument, and also the negative argument that government regulation does not protect consumers, see the aforementioned Greenspan article, “The Assault on Integrity”, in Rand’s Book “Capitalism: The Unknown Ideal”.]

Posted by on April 11, 2008. Filed under Business & Economics, Government & Law, Spring 2008. You can follow any responses to this entry through the RSS 2.0. You can leave a response or trackback to this entry