The Ex Post Distributive Case for "Insurance-Like" Compulsory Terms in Consumer Contracts

This unpublished draft paper posted here as written in 1998, suggests that in deciding whether to impose compulsory terms in consumer contracts the most important criterion should be whether their ex post distributive consequences are desirable from an ethical/political point of view. It then identifies a subclass of terms that operate analogously to compulsory insurance, including among many others product liability and mortgagor and consumer borrower protections. It models the results of the term for three income classes that differ both in their preferences for protection and in the cost of protecting them. The term generates cross subsidies among them and also withdrawals from the market. These are the ex post distributive stakes in the choice to make the term compulsory. The paper then demonstrates that in some circumstances imposed insurance-like terms plausibly generate significant cross subsidies from the upper and middle to the lower income group. These are stable when transaction costs prevent sellers from pricing to keep the poor separate from the rich and the middle. The focus on ex ante efficiency and on distribution between buyers and sellers has obscured cross subsidies between rich and poor buyers. One result has been the common but incorrect argument that because poor buyers likely value compulsory terms less than the rich, compulsion “hurts the people it is trying to help.” The paper shows that it is precisely because of this difference in valuation that existing compulsory terms can function to redistribute and that new ones may be justified on the same basis