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.

Downplaying Terrorism

According to Reuters:

"We believe this was an attempted act of terrorism," a White House official told Reuters on condition of anonymity.

This is silly. Trying to blow up a plane in flight is an act of terrorism. The fact that the act did not succeed in killing hundreds of people does not mean it did not strike terror in the hearts and minds of civilians.

So, to explain it to all the feeble minded anonymous White House sources, let's try it one more time: An attempt to blow up a plane whether it succeeds or not is an act of terrorism.

One has to ask: Why is the White House trying to down-play terrorist attacks? Is it because they truly are naive enough not to understand the nature of the threat?

Beware! Politicians Live in a Different Universe

Politicians live in a different universe, apart from the rest of us regular people.

There are no trade-offs in their universe. Politician look at a program giving people money to destroy working cars so they have to buy new cars and see a win-win situation: The person with the older car now has a new car and the person who sold the car now has money instead of the car (which, presumably, is better than having the car for otherwise he would not have sold the car).

An economist who has not yet sold his soul to get chummy with politicians looks at this and screams: You idiot!

Where did this "cash" for a "clunker" come from? It came out of the pocket of someone who has no right to use the car or share in the dealer's profit..

And, what about that previously working "clunker" that now had to be destroyed so its owner could get a new car and the dealer could get some cash? Could the resources devoted to that purpose have been put a different, better use?

What about the people who were or would have been in the market for used cars? Are there now not fewer used cars to go by (because they have been destroyed) and therefore, don't those people have to pay higher price?

A politician not only does not want to hear any of this, he tries to drown rational economic analysis out. A bunch of talking heads on cable TV think the answer to whether Cash for Clunkers is good for the people (rather than the politicians and their friends in industry) depends on one's political orientation.

The simple fact is, such answers are independent of whether you voted for the current administration or not. Regardless of your political affiliation and the party in power, you would almost always be correct if you always said that the government intervention du jour being pushed by politicians and representatives of any particular industry will do more damage to the economy than good.

Economics identifies only a handful of very specific situations in which intervention by an ideal government could improve the market outcome.

It turns out, most government interventions occur in contexts where such interventions result in unambiguously worse outcomes for most people because politicians live in a separate universe from the rest of us.

Politicians are best off creating incentives for the rest of us to fight over our shares of an ever-shrinking pie as opposed to fostering an environment where we can focus on making the best and the largest pie possible.

Every day is a scene out of Idiocracy

Just listening to a commentator gushingly proclaim his approval of the provision in the new Senate health care bill requiring insurance companies to spend at least 80% of the premiums they collect on providing care rather than administrivia such as fraud control, wages, salaries and incentives for workers and advertising etc etc.

Apparently, all of this stuff is deemed unnecessary and wasteful by people who have never run any business themselves let alone an insurance company.

Please avoid voting in elections until and unless you can rationally discuss the following question and see its relevance to what will happen to the cost and availability of your health care and insurance.

What would happen to

1. the price of doughnuts,
2. profits of doughnut makers, and
3. the number of people who can have a doughnut

if the government required all doughnut makers to spend at least 80% of the money they make from selling doughnuts on dough?

Food for Thought: Mises on Socialist Economies

Every one of my exams contains a Food for Thought section with quotations from frequently ignored authors. These quotations are selected because they distill the central point of the material covered by the exam into its essentials.

The following quotation from Ludwig von Mises points out the essential flaw in the thought process of all those who want to get rid of free markets. In a democratic planned economy where decisions are made according to what the public "wants", only those products which are found necessary and desirable by at least 51% of the population will be produced meaning the happiness generated in all the niche markets will be foregone.

In a planned economy, the only alternative to the dictatorship of the majority is the dictatorship of one person. In this case, it is even less likely that economic decisions will be made in accordance with everyone's wishes.

Both reason and the experience of the last few centuries show conclusively that the only way to provide the greatest amount of happiness to the largest number of people at the least possible cost is to set up a system where free people with defined property rights can interact through free markets.

Guided by central authority according to central plan, a socialistic economy can be democratic or dictatorial. A democracy in which the central authority depends on public support through ballots and elections cannot proceed differently from the capitalistic economy. It will produce and distribute what the public likes, that is, alcohol, tobacco, trash in literature, on the stage, and in the cinema, and fashionable frills.

The capitalistic economy, however, caters as well to the taste of a few consumers. Goods are produced that are demanded by some consumers, and not by all. The democratic command economy with its dependence on popular majority need not consider the special wishes of the minority. It will cater exclusively to the masses.

But even if it is managed by a dictator who, without consideration for the wishes of the public, enforces what he deems best, who clothes, feeds, and houses the people as he sees fit, there is no assurance that he will do what appears proper to "us."

The critics of the capitalistic order always seem to believe that the socialistic system of their dreams will do precisely what they think correct. While they may not always count on becoming dictators themselves, they are hoping that the dictator will not act without first seeking their advice. Thus, they arrive at the popular contrast of productivity and profitability.

They call "productive" those economic actions they deem correct. And because things may be different at times they reject the capitalistic order which is guided by profitability and the wishes of consumers, the true masters of markets and production.

They forget that a dictator, too, may act differently from their wishes, and that there is no assurance that he will really try for the "best," and, even if he should seek it, that he should find the way to the "best."

. . .

Surely, in a capitalistic order a fraction of national income is spent by the rich on luxuries. But regardless of the fact that this fraction is very small and does not substantially affect production, the luxury of the well-to-do has dynamic effects that seem to make it one of the most important forces of economic progress.

Every innovation makes its appearance as a "luxury" of the few well-to-do. After industry has become aware of it, the luxury then becomes a "necessity" for all. Take, for example, our clothing, the lighting and bathroom facilities, the automobile, and travel facilities. Economic history demonstrates how the luxury of yesterday has become today's necessity. A great deal of what people in the less capitalistic countries consider luxury is a common good in the more capitalistically developed countries. In Vienna, ownership of a car is a luxury (not just in the eyes of the tax collector); in the United States, one out of four or five individuals owns one.

Ludwig von Mises, Critique of Interventionism, 1929. See http://mises.org/etexts/mises/critique/section6.asp

What is competition?

In economics, the standard assumptions we use to define a competitive market are straightforward. We say that a market is competitive if the following conditions are satisfied:

• There are enough buyers and sellers so that no individual participant can exert significant influence on price. 
• Products are not differentiated: This does not mean there are no physical differences among products but that consumers consider the products of all firms to be very close substitutes. 
• There is perfect information about prices. In a competitive industry, buyers and sellers are always looking for the best deal. If they do not have good information about prices, some mutually beneficial transactions may fail to occur.
  
•  Free entry and exit: Firms are free to enter and exit the industry as they see fit.

In my experience, students tend to get hung up on phrases like "perfect information": They, correctly, realize that, in the real world, no one has perfect information about anything. They also realize, in the real world, products are differentiated: A generic MP3 player is no iPod.

Those conditions, however, matter very little for the actual most desirable aspects of free competitive markets: To provide the greatest amount of satisfaction to the largest number of people at the least possible cost.

After all, if information has value, someone will be able to smooth out the kinks and provide it to people who desire it. Have you ever wondered where Mayor Bloomberg made his fortune?

If someone is making a boat load of money selling a special product, others will be motivated to provide other products that provide similar functionality or solve similar problems for their users. The fact that they are not identical usually does not matter. Have you ever wondered why all sorts of products from cars to candy bars of similar specs and quality tend to sell for a narrow price band?

Yes, unfortunately, most people miss the fact that free entry and exit is the condicio sine qua non of competition.

Industries can be close to perfect competition even if the first three conditions are not satisfied. But, without free entry and exit, there can be no real competition.

Free entry means any firm which perceives a profit opportunity can set up shop and start selling the product. Free entry is what drives prices down in markets (making consumers better off because now they can afford more of what they want).

Free exit means any firm that is no longer profitable can leave the industry. This is the mechanism that frees up resources in industries whose products are no longer in demand and allows them to shift into industries whose products are in greater demand.

Past posts

You can find past posts on Qτ.