Tuesday, December 29, 2009

It ain't competition when your "competitor" is funded by the government

People who advocate a so-called "public option" in the health care insurance market claim it will provide "competition" to the private firms in the market.

They miss one basic fact: This is not what we economists call competition. In a competitive market, firms must provide services at a price below what consumers are willing to pay for them.

So, to make a profit, firms must find ways to produce goods and services consumers value at a cost less than the value consumers put on them.

Firms that can do so with the least possible cost win by maximizing their profits.

Now, when a firm can resort to government aid either directly (Fannie Mae) or indirectly through price regulation (the Post Office), that firm no longer has to find the least costly way of providing what consumers want.

But for the government taking money out of our pockets and giving it to them, such firms would not survive. Not only that, they ought not survive because by using more in resources than their products are worth to consumers, they are shrinking the total happiness that can be produced by an economy.

The Post Office does not compete with Fedex and UPS and other express mail companies: It undermines them by cross-subsidizing its express mail service using its monopoly on First Class Mail.

A government coffee shop would not compete with Starbucks and Dunkin Donuts and local diners: It would undermine them by selling a cup of coffee for fifty cents when others have to sell it for two dollars to stay in business ('cause the government coffee shop can reach into my pockets to make up the difference).

I was reminded of all of this when I saw CenturyLink Won't Provide DSL, Wants To Block Competitor From Getting Fed Funds To Offer Wireless on the otherwise excellent Techdirt blog.

Once you realize that CenturyLink is opposing another ISP getting government funds to provide service where it is not profitable (and, possibly cross-subsidizing its operations elsewhere), CenturyLink's position makes sense.

And this all reminded me of one of Kathleen Blanco's grand achievements pre-Katrina: She spent $700,000 of taxpayer money (comes to about $47,000/phone) to provide phone service to 15 people who chose to live where phone lines did not reach.

The BellSouth Corporation spent $700,000, or about $47,000 per phone, to extend about 30 miles of cable through thick forests to Mink. The rest of the state's phone bills will cover the cost.

See, in terms of maximizing the wealth of the country, it does not matter that the expenditure will be financed by taking a small amount of money out of the pockets of the rest of the paying customers. What matters is whether the total cost of providing the service is outweighed by the total benefit generated by the service.

Now, show me someone for whom having a landline is worth $47,000. If phone service were actually that valuable to these people, they would have moved somewhere else where there was phone service. If they choose to live where phone service is not available, well, that is a valid choice, but the rest of us ought not to be obligated to pay to provide them with amenities.

So, the moral of the story: Governments do not compete. Governments do not minimize costs. Profit maximizing companies operating in markets with free entry and exit do. Any economist telling you otherwise has stopped being an economist and has become a politician.

4 comments:

  1. As one of your previous students, I understand your points and agree that the government has the track record of not maximizing overall utility, causing deadweight loss and many other economic "sins." But this post does not even scratch the surface of the arguments pro and con health reform. What about externalities? Maybe a healthy population (just like a well educated population in my opinion) can cause enough positive externalities to offset the cost of government subsidized health care. There are some services that sometimes are just necessary and health care may be one of them. I would love to read a blog post from you about your overall opinion on health care in the United States. I'm glad that you have this blog, now I can ask you questions I did not have the chance to in class. This is actually a great idea, more professors should keep blogs :D

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  2. I will comment on the so-called health care issue at some point. Unfortunately, the topic is tangled mess where care, financing and insurance related issues are unnecessarily mixed in with each other.

    I did participate in a panel at Cornell in November. See http://www.cornelldailysun.com/section/news/content/2009/11/18/national-health-care-debate-reaches-goldwin-smith and http://www.news.cornell.edu/stories/Nov09/HealthCarePanel.html

    As for positive externalities from education, it's a good story in theory. But, I have never been convinced that taking some schomo's money to give diplomas to people who are not willing to put in the effort is good policy.

    And, even if we assume for a moment that there exit definite positive externalities from sending more people to school, vouchers would help people rationally choose the best schools for their children or themselves, but I am always baffled by how many advocates of the "positive externalities from education" idea tend to abhor vouchers.

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  3. Right, I remember the class discussion about vouchers, I also don't understand why it doesn't garner more support. Maybe we should subsidize econ 101 classes for politicians, that'll probably cause positive externalities whether they want to take the class or not :)

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  4. It is rational for politicians to be ignorant of basic economics. They will pay attention to trade-offs only if the public does.

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