THE BUMBLING COLOSSUS  By Henry F. Field                                              
The Regulatory State vs. the Citizen; How Good Intentions Fail and the Example of Health Care;
                                  A New Progressive's Guide    
  (available at amazon.com)

How Profit-Making Aids Cost Reduction and Not-For-Profit Doesn't


   In January, 2013 the N.Y. Times ran a headline story captioned, "Profits and Health Care: A Bad Mix". The piece noted the huge jump in insurance premiums especially in the individual market in anticipation of ObamaCare's new mandates that all policies be based on "community rating" and "guaranteed issue". The insurers are trying to anticipate the huge increase in costs which these mandates usher in. Basically, these mandates force all persons, no matter their health needs and problems, into one vast pool, so people who previously could exclude say, unwanted or marginal treatment regimes, or the grossly overweight, now have to pick up these costly risks. 

Many people react to these cost increases by thinking, "Well, let's cut out insurance company profits. Let's have not-for-profits or government take over health insurance. That way we can keep costs down."

But these reactions, while understandable, are nonsense. They are based on "The Nirvana Approach", a fallacy in which the failures or shortfalls of a real situation are contrasted not with another real situation, but with a hypothesized imaginary alternative. This wishful thinking underlies utopian schemes -- the outcomes of which have been uniform disasters. Nonetheless, even the brightest people, including a few Nobel-prize economists -- fall into this trap. (See, e.g. TBC at Ch VIII, pages 227-238 for examples of nirvana thinking in recent economic history).

How short our memories are. In TBC at 260-261, the recent experience in Massachusetts is recounted, where similar huge cost increases caused public outcry and political reaction (the insurers were forced to rescind increases and went to court). But these were not profit-hungry, price gouging capitalist insurers. They were all not-for-profits!! So apparently something other than profit-seeking is at the root of our cost explosion.

A Brief Exercise in Economic Thinking

Maximum Prices.   It doesn't take much noodling to understand why non-profits fail to solve cost issues and why for-profits are far more likely to be our cost "friend". Imagine you are a business or profession trying to secure customers or clients in a competitive arena -- law, or medicine, or widgets for example. What price do you set for your product or service? After some fits and starts, you arrive at the price which makes you comfortable. What is that price? It is the price which is not too high to drive people to the competition or to alternative resources, and not too low to scare your banker, turn away customers, or starve your family. This price is the "profit-maximizing price" and is where the price and profit curves cross. If you are a monopolist, things are the same, except it is called the "monopoly price". In any case, it is the price of maximum profit where a higher price reduces profit. Since you are not a charity, presumably you set your price not too low so you "give it away". If you do, and your wife or husband hears of it, you would catch hell.

Minimum Costs.   Now let's say you want to increase your profits. How do you do this? Since you can't increase your profits by raising prices (they are already at the maximizing point), you try to cut costs. How? through all the tricks and techniques which profit-seeking business and professions have developed over the millennia. You figure out how to get more from your labor force by redoing processes or practices. You seek new machines (labor-saving devices). You engineer new products or services. You do time-studies, or introduce technology. 

This is called productivity, and it is the heart and soul of economic progress. It is also the bane of labor unions and their allies in political life which seek to avoid or prevent such changes if they in the least threaten union members' jobs, pay, or conditions. The process (and threat) of obtaining gains in productivity led early "reformers" to seek laws preventing employers from making cuts. The Luddites in England went so far as to destroy and seek to ban new machinery and virtually all aspects of economic progress.  TBC at 147-157 describes this process and the virtues of "efficiency" -- economists' fancy word for the process of cutting costs to effect profit and net social gain.

Once the essential role of profit in cutting costs is understood, it is easier to fathom why it is that non-profits or government fail to trim costs where for-profits succeed. James Bucannan (who just died) and Gordon Tulloch got Nobel prizes for their work applying the self-interest principles of economics to public agents and agencies. What they demonstrated (named the "public choice theory") is that so-called "public servants" seek to expand their budgets and domains in their own self-interest, regardless of any real net social value. (TBC at 174-178, 213). Thus costs (taxes) rise, unchecked by the drive profit-making instills to achieve ever lower costs.

Non-profits have the same infirmity. They lack the drive which for-profits have to ever seek greater profit margins by reducing costs. Instead, non-profits often become aging bureaucracies seeking to expand their donations and donor base while preserving their own jobs and increasing their pay -- just like any public employee. And cost/benefit is rarely of primary concern.

Only for-profit enterprises have a clear standard for success or failure -- the famous bottom line. Whereas a profit-seeking enterprise which loses its market goes out of business, non-profits can continue on, mining the donor machine. A business which mistreats its customers or tries to gouge them may enjoy brief success -- until the customers go elsewhere. With government, too often there is no "elsewhere". While not all public employees are rude and abusive, the incentive system in which they live does not promote the "customer-friendly" attitude which most businesses insist on at pain of removal because they need it to survive. Job security and tenure are more important. So profit making combines cost reduction with customer satisfaction in a way non-profit and government do not. 

The great irony, then, is that those urging the elimination of for-profit insurers (or other profit entities in health care) are working to bring about the very harms they "high-mindedly" seek to promote.  It is an economic truism, but a popular bedevilment, that profit-making aids health, and not just in reducing costs but also in spurring innovation, just as it does in every other area of economic activity.

This is not to say there is no role for non-profits or government. Non-profits are best at efforts to deliver welfare to people in need on the street (e.g., the myriad charities set up through the centuries to help the poor). Government is best at raising broad-scale revenues by taxation, and dispensing it -- although all too often the ends for which this forced revenue is expended are frivolous or politically-designed and help no one. 

In health care finance, the best role of the federal government is to fund individuals who cannot otherwise afford the treatments they need. As TBC explains at Chs IV and V, this needs to be channeled through accounts which allow individual/family control without allowing profligate spending on other pursuits. Hence a voucher regime in Health Savings Accounts is recommended.

The most important thing is to get government out of the business of running health care. Rid providers and the rest of us of the intrusive regulatory stranglehold. Encourage profit-making. Lift the dull hand of bureaucracy off the throttle of progress.

Our costly and unfair mandates fall by the wayside. They become counterproductive and unnecessary in a regime of HSAs where government provides money directly to individuals in need under a voucher program. Government is allowed to do what it does best -- fund the needy via the tax system. People are allowed to do what they do best -- make sure they get the most or the best, for the least cost to them. Giving people the financial means to choose spurs others to try to fulfill needs in unanticipateable ways.

Don't believe it? Just look around you at your sons and daughters who are starting up internet software companies right and left to fulfill needs and wishes suddenly everyone has and didn't know they had. This is the result of freedom in an unregulated environment. The freedom in which the world of the web thrives can become the freedom the world of health care is saved by. 

"The Bumbling Colossus" is available at amazon.com
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