Butterfly Effects in the Market
In Ray Bradbury's classic sci-fi short story, A Sound of Thunder, an entrepreneur has created a business called Time Safari, Inc. Customers pay to travel back in time to hunt dinosaurs. Great care is taken not to cause a time paradox. The hunters must remain on hi-tech pathways that don't touch any of the flora or fauna. The hunters must remove the bullets from their trophies and never, never, never step off the paths. Well, of course, that's exactly what happens in the story. A man named Eckels steps off the path, kills a butterfly, and when his party returns to the present, everyone is speaking in Old English and, in place of the democratic leader who was in power before they left, a Hitleresque despot name Deutscher has won the election.
You don't have to be a sci-fi enthusiast to appreciate Bradbury's message. There is a delicate balance of interrelated cause and effect in natural history. Seemingly minor changes can have major effects. We easily grasp this delicate balance when we consider the ecology of the environment, but we often don't acknowledge it when we consider the intricate networks of exchange and the stages of production in the economy.
Government regulators—and those who advocate government interventions in the market—assume they can have adequate knowledge of the markets in order to make appropriate adjustments in the interest of the general welfare. Time and time again, the results of these interventions prove their knowledge inadequate. The intervention creates new inequities that call either for the original intervention to be rescinded or for further interventions.
A case in point: the Senate voted last week for an amendment to the Food and Drug Administration Revitalization Act. According to Roger Pilon of Cato's Center for Constitutional Studies
Given FDA safety and efficacy standards, it takes on average 12 to 15 years and over $800 million for a company (and most are American) to develop a new drug. But only the U.S. market is free. Abroad, pharmaceutical companies must negotiate prices with socialized medical systems. As a result, foreigners usually pay far less than Americans for their patented drugs. Americans bear the lion's share of R&D costs, subsidizing socialized medical systems in the process, while foreigners are classic "free riders."
The European socialization of healthcare is a market intervention which has created this inequity between American pharmaceutical companies and the European market. In order to check this inequity, the US government intervened in the market in 1987 to ban the importation of drugs from less expensive foreign markets. That created an inequity for seniors and other low- and fixed-income people who need medication. The Senate is now bowing to public pressure with this amendment, but it still insists on intervening in the market. Pilon reports
This bill would prohibit American companies from defending themselves against parallel markets. They would be prohibited from charging foreign exporters higher prices than they charge foreign firms that do not export. And they would be prohibited from limiting supplies to foreign firms that reshipped those lower-priced drugs back to the U.S. That's how Congress, unwilling itself to directly impose price controls on drugs, is trying to do so indirectly, by "importing" foreign price controls.
This will, of course, lead to a loss of the US profits that currently drive R&D for new medications, which will lead to a loss of innovation in this most important industry. So we will all lose due to incessant interventionism.
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The Mosquito Effect
I always thought it would be a more interesting story if the dead insect had been a mosquito, slapped in self-defense. This seems more the intervention model. Something that seems like a good idea, or even a necessity, at the time turns out to cause a terrible problem later on.
Mosquitoes and the Problem of Evil
Thanks Kate,
That's a very accurate elaboration of the analogy. It serves as an illustration that those who prefer a free market to a mixed economy do not view the market as Messiah. Rather, the free market is preferred due to a lack of faith in the State to make things better.
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I would suggest, though,
I would suggest, though, that Cato's take on the matter is not the full story. After all, pharmaceutical companies are not non-profits - lower revenue in their cases simply means taking out of their profit margins (a few seconds of looking turns up a Wahington Post article from 2005 that Merck had a profit margin greater than 25% and that the pharmaceutical industry was the second most profitable industry). There are also the insane amount of advertising spending they do - given the costs of advertising, that must surely rival their research costs. And then you have skeptical takes on the whole thing like an article by Marcia Angell based on her book about the pharmaceutical industry. She points out there that no one knows how much it really costs to bring drugs to market, but that, more importantly, much of the brunt of research costs are actually borne by universities and such and often funded with NIH money. (How's THAT for market intervention?)
Which raises the inevitable question - should we NOT fund drug research? I for one would be inclined not to say so. What I would like is if drugs funded with public money (at least largely public money - I don't mind if they paid for some of their research equipment with past research or something) weren't being sold at a profit to cover the "costs" of research.
The Scope of Interventionism
Ben, it's not surprising that the number of interventions extends beyond any single account and it is good to include various forms of corporate subsidies in the category of interventions. The problem with analyzing the effects of interventions is that they rarely involve proximate cause and effect and often involve opportunity costs, which go unseen. In fact, that is one of the reasons why I'm comparing them to the butterfly effect.
That said, there is no economic or ethical problem with large profit margins unless they are being maintained through interventionism. Entrepreneurial profits are by their very nature ephemeral because they are a signal and motivation for competitors to enter the market, which increases supply, reduces profit margins, and lowers the price of consumer goods.
Well.. I don't really
Well.. I don't really agree.
Your claim though was that "This will, of course, lead to a loss of the US profits that currently drive R&D for new medications, which will lead to a loss of innovation in this most important industry. So we will all lose due to incessant interventionism." I'm claiming though that (1) you have no evidence that that is the case (in fact, there is reason to believe it will have little or no impact) and (2) that R&D is in fact being funded in significant part BY government intervention. If both of those things are true, that significantly undermines your whole argument. In fact, even if only one is true, your argument is still significantly eroded. You've, in this specific case only, provided no evidence that intervention is having a negative effect. While it may be true that interventions can cause chaotic effects, this doesn't lool like a good example.
In fact, in so far as you've given things that high profit margins are supposed to cause (such as increased competition and lower prices), one might wonder why the market is in this case not responding any faster. It might be in part because of government intervention in the form of intellectual property law and import controls. Then again, it might just be a long lag, and maybe I'm not being patient enough. Or it might even suggest that once again the market model does not perfectly fit corporate economics in the modern era. I don't know which is responsible in this case.
(I would add, to address you side point, that while there is no economic or legal (at the moment) problem with making a profit, that there is a significant MORAL problem with maintaining such high profit margins in an industry that people's lives literally depend on. And public morality CAN be legislated. I understand you think that there are pragmatic reasons not to in this case, but there are certainly reasons one might be tempted to anyway.)
Does this illustration have no merit whatsoever?
Ben,
I think you realize this FDA example is just an illustration of my point. There are structural reasons why interventions have negative consequences. The above post actually began as an explanation of these structural problems, but I thought it got too confusing so I opted for an explanation by example instead.
Nevertheless, I don't think you've been fair even to my illustration. Perhaps my prediction that the loss of profits will hurt the industry is flawed on some accounts, but are you saying that everything in the FDA example (starting with European socialization) that has led to the situation we are in does not constitute some corroboration that interventions have negative consequences?
You said it, not me :)
You said it, not me :)
I mean, seriously though, in this case you've chosen an example of an industry that is one of the most profitable in the United States despite the supposed challenges they face (e.g. competing with subsidized medicine) - so there's no evidence anyone is suffering from regulation elsewhere, yet (though I don't know what profits are like for European drug companies, but frankly at 25% I don't expect to hear any whining from American companies, sorry). And, once again, there is evidence in this case of companies BENEFITING from intervention. Finally, the example is predicated on your and Cato's predictions of doom coming true. If American companies are subjected to this regulation and it has a substantial effect, then might be a time to bring the example back up. So right now, it's not a very useful example. And that's just not the economic side of it; again, in this case we've got a good argument - the welfare of patients - to suggest that intervention is a good thing. So I'm missing how all this is unfair to the argument.
Admittedly, you had the misfortune to pick an example I'm particularly sensitive about, and furthermore one with little evidence to back it up. I realize as you say though that is simply an example. So the question remains can you find one that works? I think the badness of this example might be evidence AGAINST your claim. After all, we have so far high profitability and the possibility of industry benefiting from government intervention. I'm open to (though skeptical of) the argument that intervention can have significant negative effects, though, so feel free to keep trying :) Though we do have a problem in that we know that careless intervention can always have bad effects, but that isn't an argument against all intervention - just like occasional bad laws aren't an argument that there should be no laws. So choose wisely.
Why can't the government act like a normal actor in the market?
Marc,
Let me get this straight. The government, spending my tax dollars, can't act like any other participant in the market and demand more goods for a lower price? How ridiculous is that? Why should I support anything that requires the government to spend more money than necessary to complete the task?
I like what Ezra Klein has to say on this,
The answer is very simple
Other actors in the market exchange voluntarily. Governmental involvement in the marketplace is coercive.
Not in this case...
In this case, it wouldn't be coercive. The US federal government wouldn't require drug companies to sell them anything. The government simply has a max price it will pay for certain drugs. The drug companies can sell them at that price or they won't. How is this coercive?
The question becomes, would
The question becomes, would the US government LET the drug companies just walk away from the table? If the drug companies decided NOT to sell drugs to the US government, and by extention the 23 million people who get their drugs through government programs, would the Gov't just say "ok". OR, would the government require (coerce) drug companies to sell them drugs at that point?
Drug companies will still sell their drugs
Curt-
The question is not whether drug companies will stop selling their drugs. Of course they will keep selling them. From the 2nd pill onwards, drugs cost just pennies to make. The only relevant question is will drug companies spend the millions of dollars in R&D that is required for that first pill.
I'd assert they will because the health care and pharmaceutical markets don't act like normal markets. They are inelastic.
Their is no suitable substitute for my life, arm or heart. I will pay whatever it takes to keep them. The value of my life, arm and heart is virtually priceless.
Therefore, and back to the original question, drug companies will still make their drugs. Why? Because if they create a drug that cures cancer, AIDS, diabetes or any other major diseases, people will want the drugs. They will either buy them individually OR apply massive political pressure to the politicians to require those drugs to be purchased.
Compare that to your HMO. If it refuses to buy drugs because they are too expensive, you have very few options. You can't vote the HMO president out of a job. You probably can't change HMOs because your employer only has one option. You can't buy the company and force a change because if you could do that, you'd buy the drugs in the first place.
So while many folks scream about government involvement in health care, remember our current system stinks. It is broken in many, many ways and government involvement can help fix some of those problems.
The Bigger Picture
The money the government will use to buy the drugs is acquired from taxation and deficit spending. Taxation is coercive and deficit spending demonstrates that the government does not even limit itself to tax revenues when it exchanges on the market. In short, it's entire existence on the market is supported through coercion.
This upsets price equilibrium. The intersection of supply and demand curves are predicated on voluntary exchange. Submarginal buyers don't buy when the price is at a certain level. The government is never a submarginal buyer because it will either increase taxes or deficits to get what it wants.
The appearance of voluntary exchange in this one tiny facet of the larger market is just that...an appearance. The underlying reality is much different.
Taxation, Coercion and the world I live in
Marc,
If this discussion is headed for taxation is coercion and therefore all government is inherently wrong/evil/unjust/improper, etc then we can stop there.
Death and Taxes. The two givens in life. It is unstated, but those taxes are spent in a marketplace somewhere. That's just the real world. In 2007, federal and state governments spends about 50% of all that is spent in the healthcare marketplace. You might hate it, but that's the way it is.
Now, back to the original. Assuming that people hold the federal government accountable on spending and taxation (and I agree that is a problem), the government should act like any other actor in the marketplace only on a much grander scale. They will want maximum good for minimum price. Therefore, allowing the US government to ask for the same price as other governments is perfectly reasonable and in line with what I'd expect of a financially prudent administration.
Coercion and the World WE Live In
Drawing attention to the coercive nature of taxation does not lead inevitably to any moral judgment about it as "wrong/evil/unjust/improper". Unless you are a consistent anarchist, you must allow for some kind of "legitimate coercion" even with the most minimal government. I'll try to prepare another post on what I think marks the line between legitimate and illegitimate coercion, but you might be interested in this current debate.
My concern here is mostly utilitarian. With all due respect to Professor Liam Murphy's critique of the concept of coercion, the government's role in the economy is sustained by coercion. This coercion upsets price equilibrium and creates inefficiencies. The effects of the interventions ripple throughout the networks of exchange and stages of production.
This may be the world we live in, but it doesn't have to be.
We love that broken system.
We love that broken system. It provides very good health care and Expat is right, people will pay for the drugs and medical services they need to stay alive. Patients from Canada and other national systems come here when they cannot get the medical treatment they need there. What good is treatment you can't get when you need it, even if it is free?
As to HMOs, if an HMO does not allow your expenses, there are market alternatives for your employer. One of the reasons the system seems rocky is that those insurance companies are always trying to find a balance between customer demand and what they, the insurer, can afford to supply.
Medicare and Medicaid consistently underpay for medical services. Because governments, state and federal, are such a major players in the market, doctors and hospitals have no choice but to pay those prices, and then pass the expenses on to the private insurers or private individuals, which drive up those prices. This is not exactly keeping the market in line by the beneficence of government involvement. Government involvement has caused many of the problems in our health care system and we can only wonder how much of that "cure" our health care system can take.
Who is "we"
Kate,
If by "we" you mean you and some of your friends, then maybe you do love the broken system. I, however, have no love for our current health care system. I find it difficult, expensive, and entrapping.
Difficult because I can't go to the doctor I want because I only get one physical a year and on my one physical trip this year, I didn't hit it off with my doctor, but I'm stuck with him for at least one year.
Expensive because my monthly contributions and my co-pay are extremely high. Why? Because I work for a private school. There is no money in schooling and so they need to cut costs where they can. Having minimal insurance coverage is one way to do that.
Entrapping because I really just want to leave the school and get a job on the Capitol Hill. However, everyone up there starts as an unpaid intern. An intern with health insurance. I cannot afford to go without health insurance. I'm not 21 anymore, so I'm stuck in my current job hoping I can make the jump from teacher to staffer without ever being an intern. Fat chance.
As far as the gov't underpaying for Medicare and Medicaid, that's ridiculous. No one requires doctors and hospitals to take Medicare and Medicaid. If they underpaid, that is, they paid less than the cost of the service, doctors would stop servicing them. My father's company in Las Vegas sold off their entire Medicare division recently because they didn't think they could make any money in it.
Now, it is true that private insurance will pay more, but I'm not sure that is a good thing. What is the intrinsic value in paying more more for a service?
Is the problem health care or paying for it?
Expat, I am sorry about your employment situation.
I did describe the system as broken. I would also say that it does wonderful, amazing things. I have a daughter-in-law who is alive either because of miracles or great health care or a combination of the two. She's been sick all of her life. Until she married my son, she was on Medicaid. Now they live with a mountain of unpayable debt. But she is alive. I doubt she would be alive in any other country on earth. Last fall when she was in the hospital, I was asked by her doctor why I looked so worried, and I mentioned my concern about how we were going to ever pay the bills that were accruing. The doctor looked down at me as if I had said something terribly rude. "We don't worry about that." He was perfectly sincere.
Which is to say, the health care system itself is not really broken, just our methods of paying for it are a problem. I do not see how your father's selling off the unprofitable Medicare division disproves my point, but rather the opposite. Of course, I don't know what your father's business is. But truly, the hospitals and doctors charge as much as they do because they have to cover the shortfall of treating Medicare and Medicaid patients and they CAN pass on the cost to the private sector. There will probably be some tipping point, where doctors and hospitals will not treat those patients, just as there is a shortage of doctors in states where liability insurance is so expensive that doctors are driven out. However, as long as we have even a fairly healthy private sector insurance market, those expenses CAN be passed along. It clobbers folks like you and my son and I try not to resent having to pay higher insurance premiums than we would, otherwise. I am not saying that there is any intrinsic value in paying more for a service. But we have a great hospitals and health care, because we are actually willing to pay for it.
Really, if you got sick without having health insurance, a hospital would have to take you in and treat you. They can't turn you away. You might have to pay for your treatment, eventually, but you do not get carried away to debtor's prison or anything like that if you can't pay right away. Some hospitals even have funds for treating the indigent. Where does the money for that come from? Don't ask. We don't worry about that.
False Premise Alert!
An efficient allocation of capital? Ya don't want the government involved. But basic safety is within the government's abilities. And that's because we know already that we're trading some economic efficiency for some safety (cars would be cheaper without seatbelts, for example). So the government doesn't at all need to know what the Pareto optimality would be, because it's not in search of that. It's hunting different game.
You lost me
Care to explain?
On Market Interventions
Isn't the American regime of strong intellectual property just as much a market intervention? No country, with the notable exception of France, has ever had a tradition of considering IP to be of the same type as property. In fact, the language of our Constitution expressly contemplates that IP is a market intervention created solely to advance other social goals (to promote the progress of science and the useful arts).
In internet parlance, I believe you've been p3wned.
Don't Be Too Quick
That would be true, I suppose, if I didn't have strong reservations about IP, but I do.
There is little love of freedom here
Marc:
People who value personal security and pleasure over principle, freedom and individual responsibility will never grasp your point(s). Your appeal to coercion will fall of deaf ears because it will be viewed as a minor point against the perceieved benefit and security promised by a wealthy, powerfull government. In short, they don't care about it. Who cares about those who disagree with the majority. Just take their money! What does principle have to do with this?
Where your treasure is, there your heart will be also. The idea that I should sacrafice any security or pleasure on pure principle is old fashioned. Live for yourself! Vote! Take! Me! That's what it's about.
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