Regulation and Cheap Stuff

A quick followup to my last post. One question that libertarians sometimes ask is why the government should be involved in product safety regulation. Let's say you've got n manufacturers of cheese, with the safety of their products evenly spaced along a spectrum. And let's say it's readily apparent to the public how safe each cheese is. Isn't it reasonable that someone with limited resources might choose one of the cheaper, less safe cheeses? Maybe that's better than no cheese at all. If the government steps in and imposes minimum safety regulations, then all that has happened is certain manufacturers have been put out of business and certain poor people have been denied cheese.

This is of course very stupid, but it's worth thinking about why it's stupid. To me the answer is that in reality people are very bad at figuring out how safe cheese is. (By contrast people are pretty good at figuring out how tasty cheese is, and there's no need for tastiness regulations.) If you end up with a world in which safety is strongly correlated with price, but people have limited information, then bargain-hunting becomes a very difficult thing to do. You never know if this half-price-off cheese is cheap because the retailer accidentally ordered too much, or because listeria was found in the warehouse where the cheese was stored. You can't shop around for cheap cheese without putting your family's health at risk.

By contrast, if all cheese is required to be reasonably safe, then bargain-hunting becomes a totally reasonable thing to do. This means that manufacturers and retailers can compete on price without signaling that their product is unsafe. This, in turn, drives down prices (at least at the low end) and facilitates a market in economical cheese, which might not exist in an unregulated system.

Now you can imagine all of this happening without government involvement. You can imagine a certifying organization that runs safety checks on a voluntary basis and controls a label that only reasonably safe cheese is allowed to use. Then people would shop for bargains within the universe of safety-labeled cheese, and truly desperate people would buy the unlabeled stuff. This is the kind of model libertarians hang their hat on, and it's not totally crazy. (In fact, when it comes to product quality, we use this kind of system all the time. I believe it is also how compliance with religious dietary restrictions are monitored/communicated. By contrast allergen labels are mandatory.)

Anyway it's a thought experiment. But much the same logic applies to Amazon's counterfeit goods problem. In a world where Amazon reliably delivers the product that you order, you are free to look for the lowest price possible. Unfortunately that's not the world we're living in. You can never tell whether you've found an amazing price on an LCD monitor because of a temporary oversupply or because someone has just manufactured a run of counterfeit Samsung monitors.

Of course with Amazon the rot goes deeper—even if you go out of your way to buy from a reputable retailer on the platform, foregoing suspiciously low prices from scammy sellers, your order may be fulfilled from a scammy seller anyway. So in a way my point doesn't apply to the Amazon situation. But in general maintaining standards helps people by making it safe to buy an economical option.

The Corruption of the Platform

Yesterday I read two stories about different businesses tied together by a common theme. The first was a stunning piece in the New York Times about how easily Jeffrey Epstein was able to use mainstream media outlets to restore his reputation after his negotiated guilty plea for soliciting a minor. The implicated outlets are Forbes.com, the National Review, and Huffington Post. These sites basically published a press release as a straight opinion item, with no disclosure of its source. (Read the Times piece for the details.)

The second story was a Financial Times piece from a few months ago (which only came to my attention yesterday), which described how the "commingling" of goods sold by Amazon mixes counterfeit goods with genuine ones. I'm going to spend a little bit of space describing the article's revelations because I think they are shocking, and after discussions with friends I have come to believe they are not obvious to the casual reader.

Commingling is actually only half the problem, and in a sense it's the less important half. The initial problem is that when a seller submits a product to Amazon for sale on its website, Amazon puts very little effort into ensuring that the product is what it purports to be. So when you buy, say, Apple EarPods, you may end up receiving counterfeit goods of much lower quality. I want to pause here for a moment and highlight how profitable this scam can be. In general, you can make money by manufacturing a high-quality product (product A) and selling it for a premium price, or you can make money by manufacturing a lower-quality product (product B) and selling it for a modest price. But both of these activities are highly competitive, and you have to be really good at what you do (good at making a quality product, or good at keeping costs to a minimum, or both) to remain profitable. But this assumes that the rules of the game require you to label your product accurately. If you can just make product B and sell it as product A, then fat profit margins are yours for the taking. And that's what Amazon is permitting people to do.

In my view this is shocking—why would you ever trust a retailer that charges you for product A and ships you inferior product B? The answer is that Amazon is both a retailer and a platform for other retailers, and it is a very low-margin business. Amazon and its sellers would not be able to sell products so cheaply if the goods were genuine. First, genuine products are expensive (at least relative to counterfeit ones). But second, verifying that sellers aren't fraudulent requires spending serious resources on an ongoing basis. This is trivial for the retail business itself (just communicate with the manufacturer, who has no reason to tolerate counterfeits), but it's more difficult when it comes to products supplied by the manufacturer.

So anyway the result is that a lot of counterfeit goods get sold on Amazon. But you can imagine a business model where some sellers (maybe including Amazon itself, when it's acting as a retailer) are scrupulously honest, develop a good reputation, and sell their products for a premium. Buyers willing to pay that premium will get the genuine product, while buyers looking for a bargain will get counterfeit goods. It's not ideal but it makes a certain amount of sense. (More on this in a separate post.)

But that's where commingling comes in. Commingling is driven by the fact that Amazon maintains multiple warehouses around the world (I guess they call them "fulfillment centers"), and it is helpful to ship products from the warehouse closest to the customer. To facilitate this, under certain circumstances Amazon treats all products bearing the same manufacturer bar code as a fungible bulk. In other words, if Seller A and Seller B have each delivered a product with the same bar code to Amazon, and those products are held in different locations, then Amazon fulfills each seller's orders from the warehouse that is closest to the customer, regardless of whether the goods in that warehouse actually came from Seller A or Seller B. If Amazon also sells the same product on a proprietary basis, then it may also fulfill its own orders with products provided by Seller A and Seller B, again based on the location of the warehouse and the location of the customer.

Now I hope the problem is apparent. Amazon's platform lacks integrity, because policing its sellers would be expensive. And you can't avoid the problem by buying from honest sellers, because Amazon doesn't silo its sales by seller, it freely substitutes counterfeit goods for genuine ones. The platform's integrity is defined by its least honest seller. It's like a fast food chain that buys good quality produce and then mixes it with produce contaminated with salmonella or listeria or whatever.

There is probably also a Gresham's Law effect where the counterfeit products chase out the good, because they are cheaper to produce. On the other hand, Amazon will go out of business very quickly if the public concludes that its products can't be trusted, so Amazon is probably at least somewhat motivated to cut off ties to fraudulent sellers. In equilibrium there will be lots of genuine goods and lots of counterfeit goods, and customers roll the dice every time they place an order. Speaking for myself, that's not a gamble I care to make.

But putting all that aside, I hope it's obvious why I opened this post with the corruption of Forbes.com, National Review, and the Huffington Post. It is a remarkably similar story. If you want to persuade people of something, you can always place an ad, but ads are relatively unpersuasive because everyone understands that their claims are self-interested. If I read an ad that says that a movie is great, I discount it to zero. If I read a review that says a movie is great, I give it more weight.  But the problem is that no one is going to write an honest opinion piece saying that Jeffrey Epstein is a great guy. (Actually I'm probably wrong, you could probably arrange that without paying the writer, but it would not be easy.)

So the trick is to pay for an ad but present it as a review. And that's basically what was going on with the corrupt publications, except that (as with Amazon) I don't think the illicit profits were paid directly to the publications. Instead they benefited from the extremely cheap content that their shoddy business practices made possible. But as with Amazon, I don't see why anyone would trust a publication with such low standards.