Reform and Economics

Two things come to mind when I watch the ‘debate’ over health care and banking reform, the Senate needs to be fixed, and we need to provide lessons in economics.

The Senate has never been a democratic institution. It was designed with stasis in mind. The over representation of small states is astounding in a country that likes to flaunt its democratic heritage in the world’s face: a voter in California or any of the larger states is vastly under-represented compared with the lucky folks of the Great Plains or New England states. That we tolerate this is a testimony to our zealous embrace of tradition rather than an attachment to democratic government. With over half the population now living in cities where the day to day problems are radically different from those of the rural areas, the quaint notion that the big states should be prevented from dominating legislation is simply silly. All it does is to create an alienation from government and a growing cynicism. It also creates absurdities such as the Agriculture Committee of both houses being able to oversee the financial derivatives market. I realize that farmers use options, but this old fashioned representation merely highlights how much we need to reform our government.

Nowhere is this undemocratic tradition more apparent than in the tortuous discussions going on now concerning both health care and banking reform. The Senate process prevents coherent and transparent legislation. It encourages back room deal making and corruption. It also allows single senators to hold up the national agenda and divert the entire process into an orgy of personal glorification or aggrandizement. Hence we have been treated to endless sightings of Joe Lieberman or Olympia Snowe as they position to derail whatever they dislike. Apparently the other 98 don’t count for much.

This is exactly the disfunctionality that has plunged California over into near banana republic status. By allowing one or two officials to bargain for personal gain because they represent the critical vote, the legislative process is perverted. It becomes hostage to a single person and their peccadilloes. Lieberman’s mood swings matter more than logic, fairness, ideology, national interest, the common weal, or any other larger more noble cause.

Such a process diminishes America.

If we add in the evidently secondary importance of community welfare we seem destined to slip further into the dangerous zone of ungovernability that sank California. Judging by the hole that California has fallen into, such a fate is something we all earnestly should avoid.

Then there’s the lack of basic understanding about economics. This is so deep a problem that it is hard to know where to begin.

Both health care and banking reform have a central economic thrust to them. In neither case is it clear that those involved have a good grasp of the theory essential to each.

Let’s take a whack at it:

I have said here repeatedly that the main point of health care reform is cost control. Somehow we ned to stop allocating as much of our wealth as we do to health care. We are running the risk of suffocating other, more important, sectors of the economy. Bluntly put: we cannot afford the current set up. So reform is vital. In the extreme there are two choices: a market driven system; or a government driven system. The essential point to grasp is that it is devilishly difficult, if not impossible, to establish a market driven system in health care. Why? Because the basic ingredients of a market, things like incentive structures, competitive pricing, information symmetries etc, are just not there. More to the point: they cannot be there. The current reform process illustrates that.

A pure market system would not produce health care for everyone. This is because markets treat health care as a ‘good’ or ‘service’ akin to any other. Individuals then are left to allocate their wealth to those goods or services they most want. In other words health care is qualitatively no different from a washing machine or an iPhone. It is a ‘nice to have’ not an essential. Nor does it have any community properties. By this I mean that a market does not recognize or value ‘common goods’ like disease prevention. Each individual is left to choose whether to be vaccinated or treated for a disease. Some may choose to buy that iPhone instead. The public health consequences of those individual decisions are left unresolved or even unrecognized by a market system. Which is why there has always been an element of government intervention in the market. What we might choose as a group – mass vaccinations – is not what we might choose as a collection of free individuals. Free market economics has no place for group decision making.

Nor does it have any room for profit.

I have mentioned this before. A free market eliminates profit. It is not possible – in theory – to make a long term or sustainable profit in a pure capitalist system. Why? Because the attraction of profit elicits competition. The more competition the less profit. Eventually the market ‘should’ arrive at a point where no business is making a profit, but all are covering costs. Capitalism is about the profit motive, not actual profits. So wherever we see a business making a regular profit [which in the real world is everywhere] we are looking at a market that is not free. There must be some factor undermining competition. This could be insider information; it could be anti-competitive legislation; it could be collusion; it could be any one of a number of well known sources of ‘inefficiency’. The broad point is that policies built upon a free market model, things such as deregulation, inevitably fail since they do not fix these inefficiencies. The result is not pure capitalism, but a system rigged to benefit certain groups – usually business, but sometimes a privileged group of individuals like bankers.

Which brings me to my main point: since those who advocate deregulation or market based systems for either health care or banking never face up to the reality of the theory underlying that philosophy. A true pro market advocate is anti-big business. By definition. In banking a free marketeer would want to break up the big banks and introduce more competition. This would reduce profits and increase innovation. They would look at big bonuses and recognize that they are symptomatic of a ‘market failure’. For instance: Goldman’s failure to pay out its profits to its shareholders rather than to its employees, suggests that its managers have too much independence and its shareholders not enough. A true market system would eliminate any room for those managers to ignore their shareholders.

Similarly in health care a free marketeer would force doctors to compete or would make sure that insurance companies faced many competitors.

I should add that there are no CEO’s that I am aware of who are true capitalists. They are all too wedded to protectionism, central control of their businesses, and other decidedly anti-market activities. In other words they are not motivated by profit, they are ‘rent seeking’, which is the economics jargon for trying to pervert the system for personal or institutional gain.

Usually, however, we find market advocates doing the bidding of business. They encourage rent seeking. The natural end result of this is a flow of cash into politics designed to protect special interests. Rent seeking thus induces corruption.

The beauty of the free market model advocated by the likes of Milton Friedman is that it eliminates anti-social behavior like rent seeking. Or at least it does in the text books. That is why Alan Greenspan could be so spectacularly naive as to believe that market pressures would discipline bank managers and prevent them from playing fast and loose with their shareholders capital. He was blissfully unaware of human nature and its endless capacity to ‘game’ the system to their own advantage.

Ultimately the persistent existence of rent seeking stands as an indictment of the free market theory upon which the deregulatory thrust of the past thirty years was built.

It would help is more people were aware of this. We would be having a much more sensible and constructive debate about reform. At least the notion of relying on mythical market forces to solve all our problems wouldn’t be on the table. That would be a step in the right direction.