– Coauthored with Mercatus MA Fellow Walter Stover
The advent of artificial intelligence technology use in dynamic pricing has given rise to fears of ‘digital market manipulation.’ Proponents of this claim argue that companies leverage artificial intelligence (AI) technology to obtain greater information about people’s biases and then exploit them for profit through personalized pricing. Those that advance these arguments often support regulation to protect consumers against information asymmetries and subsequent coercive market practices; however, such fears ignore the importance of the institutional context. These market manipulation tactics will not have a great effect precisely because they lack coercive power to force people to open their wallets. Such coercive power is a function of social and political institutions, not of the knowledge of people’s biases and preferences that could be gathered from algorithms.
As long as companies such as Amazon operate in a competitive market setting, they are constrained in their ability to coerce customers who can vote with their feet, regardless of how much knowledge they actually gather about those customers’ preferences through AI technology.
On the surface, it seems reasonable to suppose that knowledge about consumer preferences leads directly to coercive power. The more I know about a consumer’s weaknesses, the more I can predict their behavior and exploit such knowledge. However, let’s assume that companies possess perfect knowledge of consumer preferences through advanced AI technology. Even with this knowledge, Amazon needs to worry about setting prices too high, because customers can always vote with their feet and leave for another competitor. The threat of consumer choice appears to affect Amazon’s behavior; anecdotal evidence from former Amazon employees suggests that the company’s pricing algorithm finds and applies the lowest prices it can find from its competitors. If Amazon possessed true coercive power through AI, why would it use these algorithms for the benefit of the consumer unless it was worried about losing them.
In the previous scenario, knowledge of consumer preferences does not translate into monopoly prices. To see where it does potentiallytranslate, assume a different institutional context where Amazon is granted a government monopoly over all sales in the United States, preventing any competitors from entering the market. In this scenario, Amazon is free to use their greater knowledge gained from AI to set monopoly prices above what consumers might ordinarily be willing to pay.
These hypotheticals illustrate that the value of knowledge differs depending on the institutional context. In a competitive market, consumers can walk away at any time from proposed terms, no matter how much information the other party might have about their preferences. Note, however, that knowledge by itself does not grant the ability to set monopoly prices in our model; coercive power does not manifest as a result of knowledge, but because power is bestowed by the government.
Surprisingly, this suggests that knowledge and coercive capability do not necessarily correlate with each other as strongly as some might think. Indeed, the best examples we see of coercive market behavior have little to do with sophisticated AI technology, and more to do with asymmetries between the company and its consumers that grant it actual coercive power such as price hikes in pharmaceuticals for consumers that have no alternatives. Note that at least part of the reason for this coercive power is because of government regulation and licensing practices.
In fact, knowledge of others’ preferences is more valuable in non-coercive settings. It is precisely because I cannot force others to do my will that I must worry about what they want, and what they desire. As Adam Smith wrote, “It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest.” If instead I was the absolute dictator of everything, what need would I have to understand the self-interest of the butcher? Much literature has been devoted to the impossibility of economic calculation in centrally planned economies, precisely because a coercive form of decision-making has supplanted a non-coercive, distributed form, eradicating the economic value of local knowledge. Hayek and Don Lavoie, among others, have made it clear that centralized planning is infeasible because the economy itself is an emergent property of dispersed knowledge that cannot be collected by a central planner, much less a company with large market-share.
If coercive power is absent, a company must appeal to consumers’ self-interest, no matter how much knowledge it may have. As long as Amazon operates in an environment where consumers can select other options, it must appeal to those consumers and provide value to maintain its market share. In fact, this greater understanding of consumer preferences is valuable to Amazon precisely because it is unable to exert coercive power. Instead of rushing to regulate the use of AI in business as a threat to consumer welfare, then, we may want to first examine the institutional environment in which a company is operating to understand if there’s any real coercive power present. It might be the case that the company is gathering that knowledge precisely because of the laws of the market, not in spite of them.
Note: This piece is part two of a series on the epistemic limitations of Artificial Intelligence. Part one of that series can be found here.
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