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The profit model of credit cards, checking accounts, and other types of consumer lending used to look a lot like banks doing what they could to take advantage of information asymmetries. Through various fees and penalties they could charge low rates for well-informed, or sophisticated, borrowers by price discriminating against poorly informed, or naive, borrowers. Another way to look at it is price discriminating against people with high discount rates. In either case, the outcome seems undesirable to many people, since this regime is likely to on average subsidize the economically better off at the expense of the economically worse off. So by popular demand regulators have been pushing the industry away from this model. So what is the new profit model for consumer finance?
One choice is broad and even fees. For example, free checking accounts might go away and be replaced by a fee. This is one way to go, but it may push some low-income people of out checking accounts. It’s desirable for people to have access to credit and banking, and the lower we can make the fixed cost to access these things the better. This is not to say that broad and even fees are worse for low-income people than the previous regime of overdraft fees and other penalties. I’m just saying that, ceterus paribus, it would be preferrable to have lower fixed costs to accessing banking.
So what options does this leave us? Ideally banks could find ways to price discriminate against people with a high willingness to pay who aren’t economically disadvantaged. The Kardashian Kard seems like a step in the right direction. This is a Mastercard prepaid debit card that have pictures of reality TV stars the Kardashians on the front. What makes the cards noteworthy are the fees. Annie Lowery at Slate provides a rundown:
First there are the upfront costs. For a six-month card customers pay $59.95, or $99.95 for a 12-month card. (The median fee for similar, non-Kardashian-festooned products is $10.) After those six or 12 months, there is the $7.95 monthly fee to keep using it. Users pay a $1.50 fee to withdraw cash at an ATM and a $1 fee to check their balance. They pay $1.50 to speak with a customer service representative. If they lose their card, they have to pay $9.95 to replace it. If they want to cancel their card, they have to pay $6.
These fees do seem exorbitant. And Lowery provides an illustrative example of how a teen using the card for a $200 a month allowance could easily pay $80.40 in fees whereas a debit card would have cost them between nothing and $36. But is this a bad thing?
It seems likely to me that parents who are willing pay between $59.95 and $99.95 up-front for a prepaid debit card emblazoned with B-list celebrities for their teen daughters are not going to be predominantely low-income people. Price discriminating against individuals with enough disposable income to pay so much for such frivolous vanities seems both efficient and fair to me.
In addition, I’d wager that a large percent of teenage consumption is just inefficient status signaling like, oh I don’t know, the Kardashian Kard, which seems like desirable consumption to tax in order to subsidize the financial system.
If programs like this allows banks to offer cheaper services like free banking to the rest of us, then I hope they can find more of them.
As I’m sure most are familiar with by now, firefighters in Tennessee recently refused to put out a house fire because the family hadn’t paid the service fees, and despite their offers to pay them, the fire company let the house burn to the ground. While this is a terrible tragedy, there are several important lessons about public policy here, and -as the title to this post suggests- there are several lessons that aren’t here, which people seem to believe are.
Like Paul Krugman I do think that this case presents a somewhat apt example for the moral hazard of health care, and that if you can’t credibly refuse to deny a service to someone it makes sense to force them to pay for it in advance. The question is, can they credibly deny the service?
On the one hand I think the townspeople who hadn’t been paying their service fees probably got up to date pretty quickly after this incident, as the fire company very much demonstrated that they can credibly deny service.
On the other hand, given the public outcry against this and the fact that a neighbor’s house caught on fire as a result, perhaps the fire company has learned that they can’t credibly deny service.
An important question remains for the locals in that area: having watched a neighbor’s house burn down, are you prepared to wager that your other neighbors have learned their lesson? This gets at an underappreciated public goods aspect of the issue that is aside from clear danger externality: nobody likes to watch their neighbor’s house burn down. It is a giant, unignorable, tragic, and heartbreaking spectacle that I’m sure every neighbor of that Tennessee home would have, ex post, willingly paid to avoid. This means that aside from danger externalities, there is an additional reason why fire insurance would be under-provided. It may be that given a level of mortgage debt and risk preferences, the service fee the fire company charged was not worth it even for a rational homeowner. But taking into consideration their neighbor’s desire to not see the house burn, it is likely inefficient for them not to have it. This suggests a mandate or tax.
On the other hand, I strongly disagree with the contention that this tells us anything about libertarianism. Is a voluntary provision of public services more libertarian than a mandatory provision? Yes, on the margin. But saying this is a “failure” of libertarianism, or that libertarian thinking is to blame, is like blaming the huge debts of the U.S. Postal Service on libertarianism because the post office isn’t a completely free service paid for by taxes. It’s also like blaming the failure of Fannie/Freddie on libertarians because they were GSEs rather than fully government run. For many libertarians these may be second, third, or fourth best outcomes, but for far more government optimists they are first or second best outcomes; this is a failure of government optimism.
In addition, I have to believe that the fire company was simply behaving in accordance with the law, and that they weren’t responding to the fire because they weren’t allowed to. At the very least they had no monetary incentive to go put that fire out (one would think they had plenty of moral incentive, but apparently that wasn’t enough). In contrast, had they had been a for profit company free to behave in a profit maximizing way, they would have certainly gone to put out the fire as they could have perfectly price discriminated. This is a “sinking ship” scenario sometimes discussed in price gouging contexts, as discussed here by Richard Posner:
Suppose a ship is sinking, and another ship comes along in time to save the cargo and passengers of the first. The second ship demands, as its price for saving the cargo and passengers of the first ship, that the owner of the ship give it the ship and two-thirds of the rescued cargo, and the captain of the first ship, on behalf of the owner, being desperate agrees.
Clearly, this is a highly profitable and pareto improving scenario. Posner informs us, however, that such contracts are unenforceable under admirality law and common law, so this might limit a private fire company’s ability to profit here.
Nevertheless, unlike a government run fire company, a private one would have plenty of incentive to put out the fire.
There must be something about nail salons that causes them to price discriminate more actively than other businesses. Recently a story made headlines about a nail salon charging higher prices for overweight customers, and now there is another story about a nail salon charging men higher prices. The former is potentially justified on a cost basis, e.g. heavier customers wear out the chair faster, but I can’t see any reason why men would cost more than women to do a manicure for. Since cost does not appear to be the issue, it must be the case that the average willingness to pay is higher for men then for women.
The story is that Jimmy Bell went into a nail salon to get a manicure and was charged $4 extra for being a man. Being that Jimmy Bell is, as the Washing Post put it, a “lawyer with a knack for the headline-making case” he obviously could not tolerate this grievance and is suing the salon for $200,000.
Whether or not Jimmy Bell is a crybaby and a waste of everyone’s time and money is an issue I’ll leave aside, because I’m more interested in where society and the legal system will draw the line on issues like this.
For starters, there appears to be a significant stigma against charging different prices to the obese, and somewhat less of a stigma against charging to different genders, whereas nobody seems to have any objection to senior citizens and children’s discounts. This is somewhat counterintuitive, as you would expect people to be more against charging based upon something upon which we have absolutely no control, such as age or gender, rather than something over which we have some control, like weight.
One explanation for this counterintuitive belief may be that people are more willing to tolerate discriminations that are framed as discounts rather than penalties. Senior citizens and children get discounts, whereas men and the overweight are charged a premium at a nail salon. These are functionally the same, but the framing is different.
People may also be more tolerable of discrimination that is widely shared rather than singling out some minority. So a premium for a man in a nail salon (where men are a minority) is less acceptable than a premium for men at a gym, where the gender mix is more equal.
Intuitively, most people don’t object to Ladies Night discounts at bars, although enough have taken the trouble to bring lawsuits that it is illegal in several states. California’s Unruh Civil Rights Act has been ruled as prohibiting Ladies’ Night at a nightclub and Ladies’ Day at a carwash, and the Gender Tax Repeal Act of 1995 specifically outlawed any gender based price discrimination. Californians, it seems, have something against price discrimination. Other states, like Illinois, Pennsylvania, and Washington have allowed it.
In contrast, there is a generally widespread agreement that businesses should not be allowed to price discriminate against people on the basis of skin color, although some libertarians will dissent (cue Bryan Caplan to defend race based discrimination).
So is there a clear line about what kind of price discrimination is acceptable and which isn’t? Some states like California have taken a very hard-line against price discrimination, putting the burden of proof upon businesses to provide cost based justifications. For example, auto insurance companies are forbidden from setting rates for an individual based on anything other than three factors: their driving record, how many miles they drive, and their years of driving experience. Others states, in contrast, are more lenient.
Libertarians who support businesses’ right to discriminate have the advantage of a clear-cut and unambiguous line, whereas those who object have to explain why some is okay and some isn’t, and provide some consistent basis for doing so. Otherwise you’re left consistently rejecting price discrimination like California does, which is clearly an inefficient overreach, or wasting time and money on what most would regard as frivolous cases. On the other hand, those who object have the advantage of pointing to race based discrimination, which based on our ugly history of racism in this country we have a strong reaction against.
I suspect our solution will continue to be ad hoc and messy, which very well may be the best approach. My hope is that we can prevent drifting towards California.
A nail salon has made national headlines recently by charging an overweight customer an extra $5 because they were over the official weight limit of the pedicure chair, which can cost $2,400 to fix. This has been called price discrimination, and has been compared to the practice of dry cleaners to charge more to clean women’s clothes than men’s clothes even though the cost to the cleaner is the same. But in order for something to be price discrimination, the price differential has to be greater than is justified by different costs. In fact, if it costs more to serve an overweight person than a not overweight person, then charging them the same is price discrimination.
The FindLaw blog Free Enterprise does not appear convinced by the different underlying costs justification in this case, because:
…it is difficult to see how a $5 surcharge, unless charged hundreds of times each day, would help defer the over $2,000 dollar cost of fixing a broken chair. In the long run, the negative publicity the salon is receiving may end up costing much more.
But the negative publicity costs are probably why the charges aren’t higher for overweight customers. This constraint on the store’s price setting means underlying cost differences may be much larger than $5. The marginally higher prices for overweight customers will recover more of the underlying costs and are therefore less price discriminatory than when everyone is charged the same.
So is this type of differential pricing a “good” thing? I won’t weigh in on the morality of the issue, but at a first pass it does seem more efficient. However, if other customers value going to a salon that charges everyone the same regardless of weight, than they may find another salon to go to. This is the long-term PR cost to the firm. In this case, as in many other real life cases, otherwise efficient differential pricing based on personal characteristics may not be efficient when you consider that customers have preferences over these pricing issues aside from any direct monetary benefits or costs to them. This is why market outcomes can be “fair” without regulation despite the fact that narrowly defined self-interest may predict “unfair” outcomes. People value what they see as fair business practices, and they are willing to pay for it.