Milton Friedman’s Healthcare

In last week’s post, I discussed why healthcare should not be left to the free market. Since then I’ve done some more reading and have come across some pretty interesting stuff by Nobel Laureate Milton Friedman. Milton Friedman doesn’t like third-party payer systems, and he really doesn’t like government-sponsored healthcare. He believes the government has no role in regulating, purchasing, or administering healthcare services. If we had it his way, he would even do away with medical licensure. Fine. But what about people who cannot afford healthcare? He thinks that poverty-struck people should be given a negative income tax to the point that they are capable of subsisting at a socially-acceptable level. From there, people can then choose how to spend their money, whether it be on healthcare, mortgage payments, or highly marketed-high-fructose corn syrup products. While giving impoverished people extra money to survive is fine enough an idea, I must question how much people at the subsistence level would really demand health insurance when faced with many other options to spend their minimal income.

The problem with Friedman’s argument is people without health insurance likely will pose a higher cost to society through more extensive utilization of emergency care services instead of primary care physicians. By getting people invested in their own health and taking advantage of preventive measures, our healthcare costs will likely fall.

Moral Hazard and the Company Expense Account

You’re in a buffet line and although you’ve already stuffed yourself, you think about getting another plate. On one hand you probably don’t need another serving. But then you think “I already paid for it, so I might as well get some more.” Perhaps you, being the health-conscious person that you are, avoid going back for a second (or third) helping. But most people will inevitably return to the buffet. Is this because portion sizes in America are sky high? Perhaps. But it also can be explained by an economic theory known as moral hazard. Moral hazard is a phenomenon that explains that people make decisions differently when they are protected from some of the consequences of their actions. In the case of the buffet, people are protected from the cost of an additional plate because they prepaid for the meal, regardless of their portion. Moral hazard shows up everywhere. Do you treat rental cars as well as you treat your own? Are tenured professors as likely to care about course evaluation as those still hoping for tenure? And what about corporate expense accounts? Chances are you’re more likely to buy that filet mignon when the boss is paying for it. Of course most expense accounts have limits, but how efficient are those limits? Because a limit exists, there’s a high likelihood that people will utilize the expense account up to the limit, not actually based on the person’s need.

While this is more a theoretical exercise than a proposal to amend corporate reimbursement strategy, expense accounts should be managed more effectively. When people don’t bear the full responsibility of their actions, they are likely to behave differently, which results in outcomes that aren’t socially optimal. Thus by somehow forcing employees bear some cost (monetary or not) of expense accounts, corporations are likely to see a drop in expenditure without a loss in happiness for its employees.

Eliminating moral hazard can benefit not just expense account providers but a whole host of industries and sectors. When consumers of a good are different than the people who pay for the good, moral hazard is likely present. College students are more likely to order another round of drinks if they do so with mom and dad’s credit card. Although moral hazard will still appear unless the person paying is the person receiving the good, the goods recipient should feel some cost. In the case of the college student, a hearty guilt trip or reprimanding could suffice. For expense account holders, more knowledge (or reminders) about nutritional values might prevent him or her from ordering dessert with dinner.

Although economics is largely based on mathematics, it is still a social science. In trying to understand how the world works, economics must dissect individuals’ actions to try to make sense of trends and behaviors. Thus studying the theory behind individual decision-making can help to better understand how people act as it pertains to economics. And hopefully it can figure out a way to make people think twice about going back for seconds at the buffet.

A Socially Conscious Business is still a Business

I’ve been struggling to get my head around (and approve/dismiss) the concept of socially conscious businesses for a while. Socially conscious businesses are those who claim to conduct business and sell products in a way that does not negatively impact consumers, employees, and the environment. All right seems nice, but what does that entail? How are these businesses able to improve working conditions and manufacturing processes (adding to a firm’s costs) while still selling goods at prices consumers will pay? Business won’t exist for long if they aren’t making a profit. In Wealth of Nations, Adam Smith sums it up perfectly: “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 self interest.” Companies cannot act altruistically and sell products at market price (below their cost). Well turns out they don’t have to remain competitive in price compared to others, and economics can tell us why.

Consumers across the market for a product are believed to have unique (yet sensible) preferences. More is preferred than less, and cheaper is better than more expensive. However consumers will pick the cheapest good only when the goods are completely identical. This is hardly ever the case; laundry detergents have different brands, car models have varying features, and televisions come in different sizes. The above lists examples of differentiated products. Just as many consumers prefer Tide to generic detergent, shoppers can be led to purchase a more expensive item as long as they believe the pricier item contains more value. Value can come in a variety of forms: better quality, more appealing packaging, assumed reliability, and even satisfaction from purchase. Providing consumers with self-satisfaction is the key to socially conscious business. Socially conscious businesses won’t be able to sell their products if consumers are unaware of the philanthropy that the product brings to the world. Those businesses wishing to sell their goods (with purported added value) must therefore 1) make consumers aware of the difference between their product and that of their competition and 2) appeal to buyers such that they will select their product over others’.

The problem with socially conscious businesses is measuring consumers’ additional satisfaction from purchasing the differentiated, generally higher-priced product. How much will consumers pay to go to bed feeling like they changed the world? Will coffee drinkers spend $10 extra on free-trade products knowing that farmers are bargained with fairly? Economists can attempt to model consumer preferences to predict the ‘sweet spot’ to price a good, but not accurately. Therefore, socially conscious businesses should attempt to loudly make their intentions known and keep costs as low as possible.

 

The Ideal Market Includes an Ideal Government

Capitalism rests firmly on perfect competition theory; prices are solely determined by a buyer’s and seller’s interactions, each of whom cannot affect the price of goods being exchanged. If a seller attempts to charge a price above that of his competitors, no one will purchase. Similarly if a buyer is not initially willing to pay what everyone is charging, he or she will purchase less (or none at all) or belly up and pay market price.   But as is the case with any theory, the economists who developed it employed abstractions and made assumptions to first explain the free market. The core to the ideal market’s theoretical soundness is the conflict of self-interest and competition, a checks and balances of competing forces that should allow all players in an economy equal market power. However only in rare cases do both buyers and sellers possess the same dominance. Just as an older sibling can concoct a scheme to get more of the younger’s prime candy during post-Halloween divvying-up, interests who hold more power in a market will naturally take more. The government should therefore promote conditions under which worthy buyers and sellers interact as pound-for-pound rivals in order to preserve the foundation of perfect competition. Unchecked market power results in inefficiency and overall loss to an economy.

Before we begin, I want to first explain the scope of this paper. I am not proposing (nor wish to meddle in the details of) any new regulatory agency that might be necessary to administer intervention. My point is that government regulation at times is necessary to preserve perfect competition for the benefit of the overall economy. That said, the government is not always poised to intervene. In the case of changing technology, the market acts appropriately to determine winners and losers. However the government should intervene to promote stability for all agents across markets. In the case of monopolies, the government should force them to behave as though they have competition. But all cases for or against regulation rest on the regulatory agency’s ability to collect accurate and fair data, something very difficult to achieve.

But how do we know when it’s appropriate for the government to intervene? Indeed this question regularly arises amongst economists. Nobel Laureate Joseph Stiglitz in a 2006 interview asserted the following:

“the real debate today is about finding the right balance between the market and government. Both are needed. They can each complement each other. This balance will differ from time to time and place to place.”

Although this clear-as-mud explanation fails to identify when, where, or to what extent the government should be involved in market regulation, it highlights the complexity of intervention. In determining whether or not to intervene, there is no defined checklist that prescribes action. However one basic condition can disqualify a market or a firm from government help: changes in technology. Sometimes market participants earn new power due to innovation. As new technologies emerge, patent holders will benefit, and competitors will be left behind. Although this demonstrates market disequilibrium, we need not worry. So long as technology continually evolves, no one individual holds dominance within a market for very long.  Additionally, emerging technology aids in producing competition amongst suppliers, which then benefits consumers. As an example, it would have been foolhardy for Uncle Sam to intervene on Xerox’s behalf as email replaced the fax machine. Under the same logic, the Government should not have bailed out the US auto industry in October 2008. Faced with superior products from Asia, American autos were no longer competitive and showed no signs of being able to catch up to or exceed worldwide standards. In this case, government intervention resulted in a loss to society. Sure, autoworkers kept their jobs for the moment, but government aid subsidized poor management and decision-making at the top. By failing to punish bad behavior, inefficient structures (GM, Chrysler) still exist and will likely fail again. Simply put, any firm or industry that is resistant or unable to change to meet standards other producers can achieve should be left to die, not nursed back to ‘health.’

Although intransigence is a disqualification for government intervention, some necessary – but not sufficient – conditions exist to justify regulation. As stated above, there is no set of circumstances that necessitates regulation. But one element is common among most cases for intervention: unexplained variance. In economics, uncertainty can be lethal. All members of an economy are assumed to have adaptive expectations; tomorrow’s investment decisions are largely determined by recent economic data such as prices, inflation, and interest rates. If that data contains spikes or is inconsistent in any way, buyers and sellers, faced with uncertainty, will not know how to spend in the future. A company that cannot predict a raw material’s future price will have difficulty deciding on future output and what to charge. Alternatively if a consumer is faced with a sharp drop in the price of good, he or she will be unsure whether to buy today or wait and see if the price continues to decline. The cumulative result of uncertainty is that people just sit still, resulting in lower levels of economic activity. Supply shocks represent a situation in which the government should intervene. Supply shocks occur when the availability of a good decreases and the cost subsequently rises. This is most observable in the supply of oil and agricultural products. A drought can cause dramatic shortfalls in production. Rising oil prices due to a decrease in supply may result in widespread economic downturn. Because of the far-reaching nature of some supply shocks, the government should intervene on behalf of all market participants.

Although it is impossible to prevent all uncertainty in a free-market economy, the government should attempt to control for unforeseen change in key areas. As mentioned above, oil and agriculture are prime candidates for government regulation. Any change in the price or supply of agriculture and oil will have far reaching effects. Increased oil prices can lead to overall economic downturn. However not all markets within an economy are as significant as oil and agriculture. A spike in the price of lawnmowers is unlikely to cause a recession. However a sharp rise in the price of steel required to produce lawnmowers (the same steel also required for automobiles, buildings, and appliances) will more likely result in a negative outcome across the economy. Therefore in determining the necessity and scope of intervention, the government must consider not only intervention’s impact on correcting the specific market, but also the degree to which the entire economy is hindered by the specific market imbalance.

In the case of supply shocks that are purely the result of unforeseen circumstances, regulation still must attempt to give all market participants equal power. However in this case there is no clear culprit for the government to punish. It wouldn’t make much sense for the government to tax farmers for low crop yields due to a lack of rainfall. Instead, the government must recognize that some areas of the economy are vital, prone to disruption, and therefore must be stabilized. In the case of markets whose stability (or lack thereof) affects many other areas of the economy, trusting the free-market to regulate itself poses a threat to the larger economy.  The government should therefore stabilize the market through active participation. In the case of oil, the government should hold a reserve of oil such that any significant deviation in production can be matched by government compensation from reserves, in order to maintain prices within an acceptable threshold. In fact, the government does hold a reserve of oil, estimated around 730 million barrels. This seemingly large number quickly fades when paired against US daily consumption of 21 million barrels. The US oil reserve would be depleted in a little more than a month in the event production halted. Additionally this reserve did not help stabilize the price of oil in 2008, when the price of oil reached nearly $150 per barrel. Had the government injected substantial reserve oil into the economy, oil prices would not have increased so sharply, and the economy would have been more stable as a result.

We’ve just discussed a need for government intervention to alleviate uncertainty in an economy. Because uncertainty harms economic growth, it should be combated. But government intervention is also necessary to preserve perfect competition in markets. Buyers and sellers in a given market should hold equal power so both parties will be happy after they exchange goods. However in many cases it is not possible for all market participants to have equal power. The classic example of unequal market power is when a buyer has no choice but to purchase goods or services from one entity, a monopolist. Although the word monopolist is tainted with colors of distrust and greed, sometimes monopolies are inevitable outcomes in a market. Because of the high cost of infrastructure investment for utilities, consumers do not have options when purchasing them; only one entity provides the service. And because the initial investment for utility companies is high, offering consumers choices for utilities would likely increase the cost. Since a monopolistic market is distorted, monopolists will likely charge more money for fewer services, and consumers will be forced to oblige. Thus arises the need for government intervention. With intelligent regulation, the government can force monopolists to behave as though there exists competition to increase output and lower prices. The trick is finding intelligent regulation.

The government oftentimes is in a difficult place. If it attempts to correct a market and fails, it is defamed and marked inept. If it sits idly by as the economy suffers, it faces critique as well. Although the government doesn’t always act appropriately or at the correct time, that is not disqualification for future government intervention. The key to successful regulation is availability of information. In order for the government to enact good policies, it must be equipped with accurate information that allows it to produce regulation that produces optimal results. Acquiring good information is the key ingredient often missing from regulation. Regulation sometimes suffers from depending on biased sources to obtain necessary information to enact policy. One method of monopoly regulation involves setting a maximum price a company can charge its customers. This technique is based on analyzing a company’s accounting records and market demand for the good.  What incentive does a monopolist have (aside from following the law and respecting its community) to be earnest about their cost structures and profit? If a corporation is publicly traded, this information is more widely available, but it does not guarantee unbiased reporting.

Government’s role in the market is a complex one. Because there is inherent inequality in capitalism, some sort of agency should be there to bolster fair competition amongst conflicting self-interests. By carefully examining the need for regulation on a case-by-case basis, the government can best determine when and to what extent it should intervene. So long as the government abides by a few guidelines, regulation can benefit an economy. Disqualifying any organization that is unable to change helps to foster new, continually improving organizations. By promoting stable commodity prices and preventing supply shocks, the government can prevent uncertainty in an economy. Additionally, by making monopolists behave as though they were competitive companies, we can pass along more goods at cheaper prices to consumers. This all however rests on the ability of government regulators to accurately gather its facts. Without balanced accurate facts, regulation cannot yield beneficial results. Fortunately, much information is available to regulators today, allowing for more detailed and appropriate forms of intervention.