March 15
Done
Conspicuous Investment

Conspicuous Investment

March 3, 2023
 
With apologies to Thorsten Veblen, I’ve long thought of Williamsonian hostages as a case of conspicuous investment.
Investment because hostages are given with the intention of securing a future stream of income. Conspicuous because certain types of hostages only work when they’re highly observable. The sorts of hostages I have in mind are brand-name investments like the ones Klein and Leffler examine. I elaborate on that logic in this video:
The reason I bring all this up now is because a recent Peter Leeson paper relies on the idea of what I’m calling “conspicuous investment” in his characteristically creative way. In a new paper, “A Normal Market,” he uses the presence of conspicuous investment to suggest that sellers in a particular historical episode were not behaving fraudulently.
One hypothesis about the 19th century market for patent medicines is that it was rife with charlatans, frauds, and snake oil. That’s the prevailing interpretation of the non-economist man on the street. His abstract:
Historical markets were often ones of symmetric but inaccurate information: buyers and sellers had similar information, but because knowledge was scant and unscientific, the information they had was false. These markets were “normal” in the same sense as classical markets of symmetric and accurate information. With hindsight, however, they are easily mistaken for markets of asymmetric information. I use novel data to study one such market: the market for patent medicine in Industrial Revolution England. I find that: (1) Patent medicine consumers and medical professionals had similar but false medicinal information. (2) Patent medicine ingredients and claims were consistent with professional medicine. (3) Patent medicine producers believed in their medicines’ efficacy and credibly informed consumers of their belief. Conventional wisdom that this market was deceptive perceives it with medical hindsight and thus misapprehends the market as one of asymmetric information. Viewed in the context of Industrial Revolution-era medical knowledge, the market for patent medicine was normal.”
Another hypothesis is that these sellers were operating in markets of poor, but symmetric information. That’s Leeson’s view, as evidence by the title of section four: “patent medicine producers believed their medicines were efficacious.”
As Leeson puts it:
A producer who invests in brand-specific capital such as advertising creates a “hostage” whose value he loses if consumers cease purchasing his product. Consumers will cease purchasing a product that disappoints them; hence, a producer will invest heavily in brand-specific capital only if he believes his product will satisfy consumers’ expectations. Fly-by-night operators are unlikely to generate sufficient sales to recoup large brand-specific expenditures (Klein and Leffler 1981)…
By the same logic, if consumers observed that a patent medicine producer invested heavily in brand-specific capital, they would be credibly informed that he believed his medicine was efficacious: only a producer who expected sufficient sales of his medicine would f ind the investment profitable, and only a producer who believed his medicine was efficacious would expect sufficient sales. For that reason, consumers would also be willing to pay a premium for such a medicine. A heavily branded medicine would mean a large capital hostage for the producer and thus an assurance of quality for consumers.”
It turns out that patent medicine suppliers invested extensively in advertising. But that wasn’t the only brand-specific investment that these sellers made. Leeson again:
Some patent medicine producers, such as Francis Spilsbury and Elizabeth Shackleton, made donations of their products to the poor (Mackintosh 2018: 84, 93). Other producers, such as John Ching and Isaac Swainson, gave away metallic promotional tokens—imitation halfpennies stamped with information about their medicines, which circulated as currency amid the small-coin shortage in late eighteenth-century England. Still other patent medicine producers, such as John Burrows and Robert Turlington, gave away free reading material containing, of course, advertisements for their medicines (Basford 2012: 115). Choosing to incur these nonsalvagable costs would not make sense unless producers believed their medicines were effective, for if producers did not believe their medicines were effective, they could not expect to recoup the costs. Further, because the nonsalvagable costs were publicly observed, they credibly informed consumers of producers’ belief.”
What’s most unique about this paper is the use of hostages as evidence for something else that’s not immediately observable (were the sellers fraudulent or not?) Well worth a read. And see more on this logic, here.