A few recent federal regulations have been accompanied by Regulatory Impact Analyses in which benefit estimates assume that consumers are, well, stupid. Exhibit A in this genre is the RIA prepared by the National Highway Transportation Safety Administration in support of the last increase in corporate average fuel economy (CAFE) standards for passenger cars and light trucks. NHTSA counted as benefits from regulation savings from reduced fuel costs associated with more fuel efficient vehicles. But for this to be cognizable as a benefit, there must be an externality preventing consumers from rationally accounting for fuel costs. Consumers must be incapable of recognizing reduced fuel costs as private financial benefit; regulation must be needed to internalize this externality and capture the benefits.
In a different context, a recent federal district court opinion explains the limits of the “consumers are stupid” meme. The case pits WesternGeco (the holder of five relevant patents) against ION Geophysical Corp. (an alleged infringer).
IPNAV, a company that specializes in monetizng the value of patents, reports that a federal judge has denied the use of a method for estimating damages which requires the assumption that the alleged infringer is stupid. As a measure if its stupidity, the method assumes that the alleged infringer would have been willing to agree to obviously unreasonable royalties. While the stated purpose of the method is to estimate “the amount of profit an infringer earned from selling the infringing product and multiply that by 25% to get the baseline royalty rate, then adjust as needed,” the expert hired by WesternGeco appears to have derived an exorbitant profit estimate:
On July 16, Judge Keith Ellison of the Southern District of Texas partially granted a pretrial motion by Ion to exclude testimony of WG’s damages expert on the “reasonable” royalty that Ion should pay if the court determined that WG’s patents are valid and infringed.
The expert had proposed a “reasonable” royalty that would have exceeded Ion’s revenue from the allegedly infringing product; i.e., they would have lost money on every sale.
Ion argued that it wouldn’t be “reasonable” to agree to such a stupid deal, and the judge agreed.
The judge held that he could not assume, as WG’s counsel suggested,
that ION, in a hypothetical negotiation with WG, would have … agreed to a huge, profit-eliminating (and even revenue eliminating) royalty obligation for itself. As a matter of law, no such risk can be taken in a hypothetical negotiation in which infringement is deemed known. With knowledge of validity and infringement, such a financially catastrophic agreement would have been totally unreasonable. The court in Georgia-Pacific acknowledged the proposition that negotiators in hypothetical negotiations must be deemed to act reasonably…. Even putting case law aside, any unreasonable negotiating approach must be rejected, since the ultimate goal is to arrive at what the statute terms a “reasonable royalty.” Mr. Sims’s methodology inherently arrives at an unreasonable result, and one to which no reasonable negotiator for ION could possibly have agreed.
An RIA that requires consumers to be stupid in order to realize regulatory benefits does the same thing. In the case of the CAFE standard for model year 2017-2025 passenger cars and light trucks, NHTSA estimated private consumer benefits from fuel savings that exceeded by a wide margin all the social benefits of the fuel economy mandate. In other words, the RIA implied that the regulation would have been cost-effective even if there were no social benefits. But for that to be true, consumers must be too stupid to recognize that vehicles with greater fuel economy save money on fuel costs.
U.S. Department Of Transportation National Highway Traffic Safety Administration, “Preliminary Regulatory Impact Analysis Corporate Average Fuel Economy for MY 2017-MY 2025 Passenger Cars and Light Trucks,” November 2011 (PDF).