Friday, June 22, 2007

Markets and Middlemen

You hear it all the time, even from many Catholic thinkers: Big Government is bad, markets are good. Now, I'm certainly not going to argue that governments should be running steel mills, but there are clearly areas where the profit motive can lead to highly inefficient (and even unethical) outcomes. I'm talking about social policy, where profit-making entities merely (in the manner of Tony Soprano) take their skim from an enticing pile of cash without providing any real benefits whatsoever. In other words, they engage in classic rent-seeking behavior, seeking to extract "uncompensated value from others without making any contribution to productivity". Let me provide two example, one in education, and the other in healthcare.

Education loans

As noted by TNR's Jon Chait, the old student loan program was inefficient. Third-level students borrowed from private lenders at interest rates set by the government, and the government agreed to cover any defaults. Bill Clinton decided to cut out the middleman, by having the government make the loans directly. Estimates suggested billions of dollars in savings. Clearly, the middleman loses. And clearly, the middleman was not happy. The lenders allied with a powerful chunk of so-called conservatives to fight what Grover Norquist referred to as the "government takeover of the student-loan program." And so a compromise was hammered out. Both schemes would stay, and the college would decide which to choose. The reformers were not unhappy, as they assumed the cheaper direct loans would win. But it was not so. Colleges started edging back toward the old model with private lenders. Conservatives gloated, complaining about the "shoddy management and financial losses" of the direct loan scheme. The truth turned out to be otherwise. Indeed, the earlier Sopranos analogy is quite apt, because the lenders simply bribed the colleges into choosing them. Classic rent-seeking activity!


Traditional Medicare, a single-payer system (the government pays doctors and hospitals) is actually a lot more efficient than private sector alternatives, though you would not always know it from listening to the rhetoric. Again, we are told that bringing a cold dose of market efficiency into the Medicare system would yield innumerable benefits. In the 1990s, as related by Paul Krugman, the government tried to entice people to leave traditional Medicare for private plans, with the government paying a fee instead to the HMO. But there were problems. No longer able to engage in adverse selection (weeding out the sickest), HMOs could simply not compete with Medicare, an efficiently-run program without a huge overhead. That wasn't the end. In 2003, unwilling to throw in the towel, the Bush administration began heavily subsidizing HMOs to induce them to keep taking Medicare patients. This program now costs 11 percent more per beneficiary than traditional Medicare. Clearly, a direct transfer from the taxpayer to the insurance industry!

But then the drug companies wanted a piece of the action. Possibly anticipating more unfavorable comparisons, Bush's Medicare drug coverage (Medicare Part D) takes traditional Medicare out of the picture entirely, as the government does not pay directly for the drug. Instead, the participant joins a private insurance plan, and the government then sends out the subsidy. There are two problems with this. First, the government is prohibited from negotiating prices with the drug companies. Of course, the "conservatives" will decry "socialist price controls". This is pure rhetorical nonsense, as the negotiation is market based. If the government has greater market power, so what? Consumers benefit (technically, the government takes advantage of is monopsony power). This, plus the skim that the insurance company takes for acting as middleman, pushes up costs dramatically. Doesn't this sound like Tony Soprano is in charge of health care too?

Krugman concludes with a moral point: "The costs imposed on Medicare by gratuitous privatization are almost certainly higher than the cost of providing health insurance to the eight million children in the United States who lack coverage". Indeed.

No comments: