Phishing for Phools: The Economics of Manipulation & Deception

Economists and finance academics largely take as a matter of faith that market exchanges between consenting parties improve the well-being of both parties. Underlying this belief is the notion that market participants, including consumers, are capable of making rational decisions in their own interest: that is, when presented with a number of choices, they are capable of choosing the one that most closely matches their own preferences. In Phishing for Phools, George Akerlof and Robert Shiller—two winners of the Nobel Memorial Prize for Economics—challenge the notion that market transactions necessarily lead both parties to be better off than they would be otherwise. When one set of market participants are able to exploit predictable psychological biases on the part of another group of participants, or information asymmetries that exist within the market, the former can manipulate the latter into making choices that are not mutually beneficial to both parties.

Akerlof and Shiller refer to this type of manipulation as ‘phishing’. They claim that firms routinely attempt to manipulate us into making decisions that are not actually in our best interest, in much the same way that we often receive ‘phishing’ emails from unscrupulous parties masquerading as trustworthy entities that attempt to manipulate us into revealing sensitive information. In markets where there exists a group of participants that can be reliably ‘phished’ (what Akerlof and Shiller refer to as ‘phools’) in a way that leads to outsized profits for the phishers, the market will become characterized by a ‘phishing equilibrium’: competitive pressures will induce otherwise benign (albeit profit-seeking) firms to sell products and services that take advantage of their customers by tricking them into buying products that they do not really want. In Akerlof and Shiller’s view, the presence of manipulation and deception should not be seen as an anomalous outcome, but instead should be expected as a common feature of market exchange.

For readers with a background in information economics and behavioural economics, Phishing for Phools offers little in the way of new theoretical content per se. The ideas at its core—that information asymmetries can lead markets to equilibria that are sub-optimal, and that economic actors routinely behave in predictably irrational ways—are already central ideas within these well-established fields, within which Akerlof and Shiller have, respectively, made fundamental contributions. Instead, the majority of the book is made up of a collection of examples of phishing across a broad range of fields and industries, including financial markets, advertising, and even the political system. Reading through this bundle of examples can at times feel tedious, particularly given that each example is only given a cursory analysis.

Nevertheless, Phishing for Phools makes a compelling case that the phenomena examined within information economics and behavioural finance are not mere anomalies, but instead are much more pervasive throughout the economy than most economists are trained to believe. In the first year of an economics PhD programme, almost all graduate students are taught the abstract and austere mathematical theory of general equilibrium, a body of work that reached its apotheosis with the work of Ken Arrow, Gerard Debreu and Lionel McKenzie in the early 1950s. Central to this theory are the so-called ‘welfare theorems’ the first and most important of which states that market exchange will lead to a ‘Pareto efficient’ equilibrium allocation of resources when markets are competitive, complete and producers and consumers make consistent choices that maximize profit and utility, respectively. This latter assumption has been challenged in the last several decades by information economics and behavioural economics. Individuals’ preferences, for instance, tend to be time-inconsistent and context-dependent, and are subject to framing effects. Yet as Akerlof and Shiller note in the book’s Afterword, while the core tenets of these fields have been accepted into the mainstream of economic thinking, many economists are still inclined to assume a priori that in the absence of externalities, market exchange will generally lead to socially beneficial outcomes for all parties involved. The influence of general equilibrium theory is indeed powerful, despite its weak applicability to real-world markets. As Blaug (2007) notes, students are taught that the welfare theorems are simultaneously ideas of utmost importance—they are fundamental after all—but also depend upon assumptions that cannot be assumed to hold in the real world. As a consequence, many economists learn to form strong prior beliefs about the social benefits of market exchange that are only to be revised in particular circumstances when presented with substantial evidence that one of the assumptions of the welfare theorems has been violated.

Phishing for Phools shows how the existence of these psychological and informational imperfections shapes the behaviour of firms within competitive markets, and their impact on the social welfare of market exchanges. If firms know that they can profitably exploit consumers’ psychological biases, then doing so can become an equilibrium strategy within the market. The upshot of this insight is that Phishing for Phools, in contrast to traditional microeconomic theory, advocates a much more sceptical view of the social benefits of market exchange as a whole. In Akerlof and Shiller’s view, markets still tend towards equilibrium; but that equilibrium may not be one aligned with our ultimate preferences, i.e. what ‘we really want’ or ‘what is good for us’ (p. 5). In a phishing equilibrium, producers will instead attempt to manipulate us into buying products that we are led to believe will satisfy our preferences but do not; or worse, products that appeal to our desire for short-term gratification over long-term satisfaction (our ‘monkey-on-our-shoulder tastes’). Worse still, in an economy dominated by phishing equilibria, Akerlof and Shiller suggest that the direction of technological innovation will tend towards the development of increasingly effective techniques for phishing instead of products that satisfy consumers’ ultimate needs and desires.

These are important ideas with significant implications for how we think about markets. But in their desire to produce a book that is fun and accessible, Akerlof and Shiller fall short in following these ideas through to their logical conclusions. For instance, Akerlof and Shiller insist that we need not radically overhaul traditional microeconomic theory to accommodate the phenomenon of ‘phishing’; instead, we only need make a ‘small tweak’ to the theory by creating a distinction between consumers’ ultimate preferences and their ‘monkey-on-the-shoulder’ tastes (p. 6). Yet, within the confines of the atomistic form of economic interaction presumed by general equilibrium theory, it is difficult to explain how an equilibrium other than a phishing equilibrium could arise, given the myriad ways that consumers’ psychological biases could be exploited for profit. While they are common, manipulation and deception do not seem to be universal features of market exchanges: Indeed, there exist markets in which producers are able to be honest and trustworthy. Thus, to explain the absence of deception and manipulation within particular markets, one must invoke social structures—such as shared norms among producers or durable social relations that produce trust between producers and consumers—that are exogenous to microeconomic theory itself, a point that has long been made by economic sociologists (cf. Granovetter 1985). Akerlof and Shiller seem to implicitly adopt this view: In Chapter 11, they point to shared norms within business communities as an important set of factors that help stem the presence of phishing in markets. Thus, while Phishing for Phools claims to only advocate slight tweaks to microeconomic theory, if one follows its conclusions to their logical end, one must concede that microeconomic theory must be complemented by a broader sociological account of markets.

That ‘phishing’ is a normal phenomenon within markets also raises political questions which the book itself does not address. Consider, for instance, the concept of ‘libertarian paternalism’: the fashionable idea that public policy and regulation should seek to engineer slight modifications to the ‘choice architecture’ that consumers face in order to ‘nudge’ them away from making choices that are not in their best interest without explicitly restricting their freedom to choose. In Thaler and Sunstein’s (2003) original article on libertarian paternalism, they consider the example of a school cafeteria. Wouldn’t it be better, they suggest, for a regulator to require that apples be placed before Twinkies if doing so encourages patrons to eat more of the former and less of the latter? Akerlof and Shiller make clear that they believe that regulators play an important role in helping to keep phishing at bay within markets. Yet, an unstated implication of the concept of ‘phishing equilibrium’ is that we should be wary of what Rebonato calls libertarian paternalism’s assumption of an ‘always-benevolent nudger’ (Rebonato 2012, p. 221): When a phishing equilibrium emerges, we should expect that the entities that design our ‘choice architecture’ will face considerable pressure to manipulate individuals into acting contrary to their own self-interest, rather than benignly ‘nudging’ them in the right direction. Akerlof and Shiller seem to assume that regulators and policy-makers will be largely immune from the pressures to ‘phish’ that face private firms, a view that downplays the fact that regulators often depend upon input from lobbyists, industry groups and other private sector actors in designing and implementing regulation.

In short, Phishing for Phools provides an important corrective to the standard dogma that market exchanges between consenting parties will necessarily lead to an increase in welfare for all in the absence of externalities. But while the book sheds light on the importance of ‘phishing’ within markets, it is unlikely to have the final say on this topic.

Taylor Spears
University of Edinburgh
© 2016, Taylor Spears

Additional information

Notes on contributors

Taylor Spears

Taylor Spears is an economic sociologist whose research examines the cultures of mathematical modelling practiced in contemporary finance. He is an Honorary Fellow of the School of Social & Political Science at the University of Edinburgh.