Markets Do Not Work?

There is nothing that I find more annoying that the refrain that ‘markets do not work’ that arises whenever we have a crisis or even when someone dislikes an economic outcome. Markets as an abstraction can be always shown to be functioning quite nicely. The difficulty arises when the market is deliberately or accidently distorted to misplaced advantage. We have in fact a barbarian horde attacking our economy at all times with battalions of lawyers and paid flacks.

And here is where I must wade into the debate. Any given market is like a game of poker or like any game whatsoever. It requires a commonly agreed upon set of rules to work by. These rule books if created properly will optimize the given market. If they are distorted to one group’s particular advantage, then the market will be optimized for that group and offsetting distortions will arise. Thus when we investigate a market it is necessary to discover who if anyone is gaming the market to his particular advantage. And after saying that, is this gaming in the common good?

I hope you got all that, but it eliminates a lot of confusion and double talk.

A good example is the Canadian milk marketing boards. Its outcome was to stabilize selling prices and over forty years to produce equity for supply participants in terms of quotas. It also produced a large number of prosperous producers large enough to attract capital to support fairly large scale operations that are probably too big. This was not a bad out come.

In the USA, the industry found that unlimited access to capital for the few created far larger operations even more disconnected from good farm practice, while also driving out the small individual producer by income suppression. Those folks are no longer dairy farming.

One point here is that agricultural industrialization was going to sharply reduce the number of participants regardless of the system over the past forty years. In Canada, a managed decline optimized the process itself and likely optimized government revenues while certainly producing all the milk needed.

Now in the above case, we are dealing with a truly finite market that is not overly flexible regarding price unless you think any agribusiness is willing to sell seriously below cost. We presently buy milk at a premium over US prices but not significantly so and our industry is finally waking up to the potentialities of making artisan cheeses.

The real lesson here is that so called free markets are often gamed by capital sources themselves. This is particularly true when there is no proprietary title to the knowledge involved. It is no trick at all for a source of capital to bank roll a large buggy whip concern and then to sell in a given market below cost until the competitors exit the market. At that point you can gain the advantage of monopoly pricing. Usually this strategy will work out just fine because reentry into the market is again prohibitive in term of capital.

So let us return to the healthcare industry which is the subject of this particular article.

First off, we are dealing with a universal human need whose delivery cost per individual life varies across a wide spectrum and is individually unpredictable. Secondly, healthy individuals produce income and taxes. Thus we have a universal societal need to optimize our human capital by keeping them somewhat healthy.

The only effective way to deliver at least a basic service is to provide it for all. That will at least lower the delivery cost to the lowest per capita base. That is what universal health coverage means. Then let providers capitalize the extras that can improve upon the base itself. They will buy MRI machines and the like to provide a superior service.

In the USA the insurance industry has grabbed this market and will stoop to any lie to preserve this capital based monopoly. It is managed only to the extent of shortchanging the customers.

Let us recall what they deliver. They provide full service to a third of the population at top cost to the customer. He is kept happy. They provide a base service to a third and over manage that and none at all to the remaining third. All of this costs about twice what universal service costs in Canada and elsewhere. Could we do better in Canada? Surely, but to do worse in terms of patient outcomes is hard to imagine when a third get none.

Of course, the insurance industry wants to keep their fat one third of the pie when the USA finally institutes a valid universal coverage. I wonder how many of the prosperous will stomach paying three times what their next door neighbor pays for exactly the same service.

Let me assure you, if I walk into my doctor’s office and offer to pay cash for a procedure in Canada, it will happen in twenty four hours. However, the real wait times in Canada are in fact quite minimal, unless you are unlucky enough to have a specialist with little seniority.

My wife needed a serious hernia operation. She first went to a specialist by the simple process of picking up the phone. The wait time was an impossible six months or so. So instead she got a referral from her GP who knew better and was in and out in a week. A young surgeon may be excellent but so far down the ladder that you get to wait for him.

Of course the industry flacks work the worst case scenario with enthusiasm.

The whole point of this article is that a viable market must be designed well and gamed properly to maximize benefits and to minimize the cost structure. We have shown a bit of how a better system can work for all participants. Do we have to remain vigilant to keep folks from unfairly gaming such a system? The answer is a loud yes.

Except that the cry of free market has been used in the US to blind everyone to the fact that they have been grossly swindled by the insurance industry who have dodged half to two thirds of the real costs while charging double for the part they do service. In what way has the American consumer been vigilant?

July 26, 2009

Markets Don't Work in Health Care?
Don Boudreaux

At Marginal Revolution, Tyler today quotes (and intelligently challenges) Paul Krugman; says Krugman:
There are, however, no examples of successful health care based on the principles of the free market, for one simple reason: in health care, the free market just doesn’t work.

First of all, I can list lots of examples of successful health care based on the principles of the free market: the regular, smooth, widespread, and affordable supply of aspirin, bandages, decongestants, toothpaste, dental floss, toothbrushes, contact lenses, running shoes, and gyms. I could go on.

But, of course, Krugman (rather circularly) is referring to those health-care services and products that are typically believed today to be poorly supplied. So let's play along.

A good rule of thumb is to always be very skeptical when someone -- even if he or she boasts a Nobel Prize -- proclaims that "markets don't work" for this particular good or that particular service. That person is either a special pleader (such as the college professor who insists that markets don't work to supply education) or he or she is someone with an excessively narrow (and, hence, mistaken) understanding of markets. Alas, far too many economists have an excessively narrow (and, hence, mistaken) understanding of markets.

I recommend to Krugman (and to Kenneth
Arrow, Paul Samuelson, Joseph Stiglitz, the ghost of George Stigler) and to too many other economists, great and not-so-great, to name, that they read Jim Buchanan's 1963 Presidential address to the Southern Economic Association; it's published as an article entitled "What Should Economists Do?" Here's a key passage (which appears on pages 31-32 of a collection of Buchanan's essays by the same title):

The motivation for individuals to engage in trade, the source of the propensity [to "truck, barter and exchange" - Adam Smith (1776)], is surely that of "efficiency," defined in the personal sense of moving from less preferred to more preferred positions, and doing so under mutually acceptable terms. An "inefficient" institution, one that produces largely "inefficient" results, cannot, by the nature of man, survive until and unless coercion is introduced to prevent the emergence of alternative arrangements.Let me illustrate this point and, at the same time, indicate the extension of the approach I am suggesting by referring to a familiar and simple example. Suppose that the local swamp requires draining to eliminate or reduce mosquito breeding. Let us postulate that no single citizen in the community has sufficient incentive to finance the full costs of this essentially indivisible operation. Defined in the orthodox, narrow way, the "market" fails; bilateral behavior of buyers and sellers does not remove the nuisance. "Inefficiency" presumably results. This is, however, surely an overly restricted conception of market behavior. If the market institutions, defined so narrowly, will not work, they will not meet individual objectives. Individual citizens will be led, because of the same propensity, to search voluntarily for more inclusive trading or exchange arrangements. A more complex institution may emerge to drain the swamp. The task of the economist includes the study of all such cooperative trading arrangements which become merely extensions of markets more restrictively defined.

Textbook economic theory blinds too many who master it to the myriad cooperative ways -- ways broader than simple arms-length exchanges -- that persons seeking each their own best advantage creatively figure out mutually advantageous means of cooperating. The
research of the great Elinor Ostrom supplies just some real-world examples.

Quoting Buchanan and linking to one of Ostrom's books hardly proves that cooperative, mutually advantageous arrangements to better supply health care would happen if government removed its bulky, blind, and burdensome self from this arena. But it does expose the limited intellectual purview of Krugman (which, again, he shares with most modern economists). And so pronouncements made from the vantage point of persons such as Krugman ought to be treated skeptically. Reality is more creative than the typical economist realizes.

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