Why We Don’t Need Prices Within A Family

In reading The Price of Everything, by Russell Roberts, I came across a passage explaining why prices aren’t needed within a family. He describes a situation in which a mother has two cookies to share among three children, and asks if the mother should auction off the cookies to the highest bidder. The notion is ridiculous to even the most ardent free-market economist, and the reason is because the mother has the knowledge to determine which of her children should receive the cookie. For example, maybe she knows that one kid had a candy bar for a snack that afternoon, so that kid can do without the cookie. Or one kid can offer to be nice and let his brother have one, or perhaps they give each kid 2/3 of a cookie.

In a small town the case is often the same, and prices aren’t needed to allocate scarce resources in times of emergency. I quote,

“In a small town, most citizens do the right thing either because they care about each other or because being selfish when there is a crisis has costs – people might shun you in the future. So when there’s an earthquake in a small town, the hardware store owner doesn’t raise the prices of the portable generators. And even if they sell out, someone who desperately needs one can probably find one to borrow. But in a big city, there isn’t as much love or knowledge to go around. Higher prices substitute for the lack of love [emphasis mine]. They encourage people to step aside and let strangers who are willing to pay the higher price, get the goods. And higher prices give business people an incentive to stock up on crucial items and bear the costs of inventory.”

This distinction is really important. Many people have heard the childhood song, “Sharing Is Caring” and assume that sharing is best. As children, we are admonished by our parents to share our toys with others, because at an individual level, this makes us a pleasure to interact with. But you can’t just blindly apply the maxim “sharing is good” across all levels of society. We can share within a family because we have the knowledge and emotional bonds to make optimal decisions (although this doesn’t mean we always do). We also bear the costs of bad decisions. At a societal level, where we live and interact with hundreds, thousands and millions of people we don’t know, we can’t expect people to have the same love for strangers that they do for their closest of kin. And it is impossible for us to gain and use the knowledge of each individual’s situation when figuring how who gets the cookie.

To remedy this lack of “love and knowledge” prices emerged, and do the work for us.

How Shortages Occur (Or the Inevitability of Scarcity)

I am reading The Price of Everything: A Parable of Possibility and Prosperity, by Russell Roberts, and it got me thinking about shortages and what causes them. The book is a fictional novel that introduces basic concepts of economics to the layperson in an easy to understand manner.

In the book, Ruth Leiber, an economics professor at Stanford, is describing the gas shortages that took place in the 1970′s. She describes a situation where OPEC cut back on production and the price of oil went up. To protect citizens from “price gouging”, the American government put a cap on how much gas stations could charge for gasoline. However this didn’t resolve the underlying scarcity of supply – all it did was increase demand due to the artificially lower price, and decrease supply because the price ceiling cut into the profit incentive of gas companies to find ways to supply more gas. This created shortages of gas, and consumers in the 70′s would often arrive at a gas station and see a sign that said, “Out of Gas. Come Back Tomorrow.” The professor said that the 70′s was the only period in her lifetime when you had to worry about whether the gas station actually had gas.

Contrast this situation to today. Gas prices fluctuate, and we may get upset if prices are higher than what we deem to be “fair” (even though in most cases they are simply reflecting the relative scarcity of gas), but we never worry about whether the gas station actually has gas or not. We would think it ludicrous to arrive at a gas station and have the attendant tell us, “Sorry, we’re out of gas, but if you come by sometime within the next week, we should have some.” It would probably make the news and that company would get a ton of bad press.

However shortages due to government manipulation of prices is still with us. Recently, it has come in the form of the attempt to limit “price gouging” after natural disasters. After Hurricane Katrina hit the U.S. and destroyed a bunch of gasoline refineries, a group of attorney generals imposed fines on gas stations that charged prices they deemed “excessive.” As a result, gas stations in New Orleans ran out of gas in the middle of the day and President Bush had to beg people to not buy gasoline unless they needed it. Higher prices would have achieved BUsh’s desired result of lower gasoline consumption in a more effective manner – people listen to their wallet much more than they do a man on TV (even if he happens to be the President…especially if he happens to be the President).

The same thing happened when the flu vaccine was in short supply. The same group of attorney generals threatened fines for “gouging”, so prices stayed artificially low, and lines began to form. Supply could not meet demand, and people stood in lines for six, seven even eight hours. One elderly woman even fainted, banged her head on the pavement, and died. If flu vaccine producers were allowed to respond to the increased demand for the flu vaccine, there would be temporarily higher prices, but prices would eventually fall as competitors rushed into the vaccine market to make a profit. All with no shortages.

The bottom line is that scarcity is real, and cannot be done away with just because the government wants it to disappear. So the only question should be: should we deal with scarcity by allowing the market to work, or should we let bureaucrats ration scarce resources outside of the market? Both history and common sense show that the market works far better.

What implications does this have for other parts of our economy? Health care comes to mind. In countries with single-payer health care systems (i.e. the government is the sole provider of health care), the supply of medical services (e.g. doctors, medical equipment, hospitals, etc) are rationed out by government employees. Because this process is not as efficient and responsive as a market where prices can change instantaneously, many people seeking health care end up waiting in long lines to get services. In a free market, the relative scarcity of medical services would be reflected by higher prices, not waiting lines.

Why are higher prices better than lines? Prices allow each individual to weigh the value of that good relative to other goods as well as his local circumstances, and make a decision as to whether it is worth it to buy that good at that price. Let’s take the market for prescription drugs. If there was a decreased supply or increased demand for drugs, the potential for a shortage would appear. But as long as the market had free and functioning prices, no shortage would occur because the change in prices would cause behavior changes. Some people buy the same amount of prescription drugs even if the price increased, others would cut back on their use of prescription drugs, and still others would stop buying drugs and seek out natural alternatives.

The important point is that given the inherent scarcity of the good (prescription drugs), the market provides the maximum opportunity for each individual’s preference to be met. With waiting lines, some people will benefit from the artificially reduced price, but only at the expense of others who will not be able to buy prescription drugs at all. And there is a good chance that some of those people who really need prescription drugs (heart attack victims, for example) would not be able to get drugs under a rationing process (perhaps they arrived late and waited at the back of the line) . And because it is impossible for the people doing the rationing (the government) to read people’s minds and make the best decision for everyone, lots of people will be royally screwed in the process.

Do You Support Dictator Mubarak?

Hosni Mubarak

The guys trying to bring him down

Sorry, but you don’t have a choice.

Egypt has been all over the news for the past few days, as anti-Mubarak protesters take to the streets and duke it out with the dictator’s supporters. Most recent articles have focused on the government’s decision to kill the Internet or the attacks on journalists.

While are both are tragic, few have addressed the fact that “President” Moubarak is a close ally of the American government, and is the 4th largest recipient of American foreign aid. Last year, Egypt received over $1.5 billion of taxpayer dollars. The only countries receiving more foreign aid are Afghanistan, Israel, and Pakistan. $1.3 billion of this aid is allocated for “peace and security”, or in other words, armaments.

Mubarak’s brutal military regime has been characterized by political corruption, sham elections, censorship, imprisonment of political opponents without trials, oppression, torture, murder, kidnapping, socialism, state control of the media, an enriched oligarchy at the expense of the majority of poor Egyptians, the crushing of dissent, and a litany of human rights abuses. Is this the kind of entity you want to support?

Every American citizen has a right to use their justly earned property as they see fit. The fact that the government confiscates the wealth of Americans and sends part of it overseas to protect a military dictatorship is unconscionable. If I had a choice, I would not send any money to Mubarak, and I’m guessing that a majority of Americans would share similar sentiments. I would rather support charitable organizations I trust, and in light of the recent events in Egypt, I would probably donate to disaster relief agencies that provide humanitarian aid to the people of Egypt.

What right does the government have to deprive me of this choice, and force me to support a government I disagree with?

Some may argue that the government needs to support foreign countries when it is in our national interest, and use this as a justification for our current foreign policy. I say let the American people decide. Don’t use our tax money for anything but strict self-defense against invasion. If foreign governments want support, let them send their ambassadors to convince American citizens who may give it voluntarily, rather than government officials who dole out other peoples’ (the taxpayers’) money.

This philosophy of military isolationism and political non-interventionism is one first enshrined by our Founding Fathers. It was Thomas Jefferson who said, “I am for free commerce with all nations, political connection with none, and little or no diplomatic establishment” and, “We ask for peace and justice from all nations; and we will remain uprightly neutral in fact.”

It would behoove us to heed his wisdom. It might serve us well.

Obamacare: Making Enemies of All

*This is a guest post by Thomas Hochmann, of Objectivist Voice.

Setting aside the very important issues of rights, free markets, and the like, there is an interesting consequence of government interference that often gets overlooked: government control inevitably seems to lead to people being just barely held in check by an ever-growing myriad of laws. This is increasingly true with health care, and specifically with Obamacare. Rather than have contract-based interactions between consumers and providers that can be handled in rational ways, and (when necessary) enforced by objective court systems, we have an environment where everyone is increasingly at everyone else’s throat.

In “Obamacare Criminalizes Medicine,” Shikha Dalmia offers two examples. First, there’s the government versus its own citizens, especially those in low-income households:

“When the government hands out subsidies, it will use a household’s income in the previous year as the basis for guessing what the household is qualified to get in the current year. But if the household’s income grows midyear, the subsidy recapture provision will require it to repay anywhere from $600 to $3,500…

This will make it very hazardous for poor working families to get ahead. In the original law, the loss of subsidy with rising income already meant absurdly high effective marginal tax rates—the implicit tax on every additional dollar of income earned. How high? The Cato Institute’s Michael Cannon puts them at 229 percent for families of four who increase their earnings by an amount equal to 5 percent of the federal poverty level or $1,100. In other words, a family that added this amount to an income of $44,700 would actually see its total income fall by $1,419 due to the loss of subsidies.”

This subsidy “recapture” mechanism will have government agents chasing after low-income workers, forcing them to give back government money because these people had the gall to advance themselves and improve their income. Shikha predicts that with this threat looming overhead, recipients of these subsidies will feel pressured to fudge the numbers on tax returns or to work for cash under the table — thus creating whole new problems, and (I would expect) leading to further enforcement measures to reign in this government-encouraged “fraud.” Never mind that none of this would be necessary if we had a government that did not provide these wealth-redistributing, gunboat altruism programs in the first place.

Second, Shikha points out extensions to the government’s already-existent “rat out your colleague” system for whistleblowers in the medical industry who report fraudulent Medicare claims. Doctors will be increasingly subject to searches by private “Recovery Audit” contractors who will be “authorized to go to doctors’ offices and rummage through patients’ records, matching them with billing claims to uncover illicit charges.” Actual intent to defraud the government will not have to be proven, and billing errors can be fined $50,000 each.

Government versus low-wage citizens? Check. Doctors, nurses, and private mercenary contractors versus each other? Check. Giving doctors yet another massive financial risk to worry about? Check.

This is not new to Obamacare, however. In a 1985 lecture titled, “Medicine: The Death of a Profession,” Leonard Peikoff highlighted the government intervention in place at that time. As he called it, the official “dropping of the noose” around doctors’ necks came with the introduction of DRGs, or “diagnosis-related groups.” With DRGs, the government would pay a fixed, arbitrary fee to a hospital based on whatever was diagnosed:

“For example, for a Medicare patient in the Western mountain region who is admitted to a hospital with a heart attack and finally recovers enough to go home, the government now pays the hospital exactly $5,094 — no more and no less. And it pays this no matter what the hospital does for the patient… If the patient costs the hospital more than the government payment, the hospital loses money on him. If he costs less, the hospital makes a profit.”

An obvious, immediate conflict of interest is introduced here. If a hospital receives the same payment regardless of how long a patient stays, how much or how little care he is actually provided, etc. then the hospital has an incentive: save as much money as possible, and get the patient out as quickly as possible. Peikoff outlines how this can easily pit doctors and administrators against each other: doctors (hopefully) trying to do right by their patients and provide the best care possible, and administrators (likely) trying to minimize costs and losses. It’s not hard to see how this also raises suspicion of doctors in the eyes of patients: is my doctor doing the best he can to treat me, or is he going to cave to the government-imposed bottom line?

The government versus its own citizens; doctors and nurses versus each other; hospital administrators versus doctors (and by proxy, their patients); patients versus their doctors and their good intentions. Socialized medicine makes enemies out of everyone, and the webs of suspicion, distrust, fudged numbers, fraud, and “recapture” simply multiply with each new law that gets passed.

It’s not bad enough that some people actually demand that doctors be servants to the creed of need (“I think it’s disgusting for doctors to make a profit,” one protester shouted on a TV broadcast I saw last year). With the creed of need enforced by government mandates, we end up with a system littered with servants and criminals on both sides of the equation.

“There is nothing left but the coercive apparatus of the state to keep patients and doctors in line. This would be unimaginable where the customers receiving or contracting for services are actually the ones paying for it. If Whole Foods “overbilled” its shoppers, they would just go to Trader Joe’s. No one would think of summoning the police. If a mechanic submitted unjustified bills to All State Insurance for car repairs, All State would contract with someone else. There would be no need for an FBI stakeout.“
~ Shikha Dalmia, “Obamacare Criminalizes Medicine“

Obama’s State of the Union, Part 1

Last night I watched President Obama’s State of the Union Address. I agree with some things he said and disagree with others, and I want to comment on certain parts of his speech.

*Obama’s words are in quotes and italics.

“America still has the largest, most prosperous economy in the world. No workers are more productive than ours. No country has more successful companies, or grants more patents to inventors and entrepreneurs. We are home to the world’s best colleges and universities, where more students come to study than any other place on Earth.”

I’m glad he pointed out some of the positive aspects of America’s economy. The steady growth in American productivity from 1947 has led to higher living standards, and is something to be celebrated.

Rate of Worker Productivity Growth (BLS)

America also still has the world’s largest economy, measured in nominal GDP.

Ten Largest Economies In The World (IMF)

America has also seen steady growth in the number of patents given. See this table by the U.S. Patent & Trademark Office.

“What’s more, we are the first nation to be founded for the sake of an idea – the idea that each of us deserves the chance to shape our own destiny. That is why centuries of pioneers and immigrants have risked everything to come here.”

I also applaud Obama’s confidence in celebrating the moral ideals of our Founding Fathers. America is a country based on freedom and natural rights. Immigrants continue to flock to our shores in the hopes that they will be able to escape oppression and make a better life for themselves. Many people shy away from discussing morality, but we must never forget the morals that created the United States.

“Our free enterprise system is what drives innovation. But because it’s not always profitable for companies to invest in basic research, throughout history our government has provided cutting-edge scientists and inventors with the support that they need. That’s what planted the seeds for the Internet. That’s what helped make possible things like computer chips and GPS. Just think of all the good jobs – from manufacturing to retail – that have come from those breakthroughs.”

Here Obama argues that it is necessary for government to intervene in the free markets because companies can’t afford to invest in their own R&D. He uses government involvement in the Internet as a case study.

Obama confuses correlation with causation. The government did in fact control Internet technology in the 1980′s, and only allowed universities and the military to use it. However it wasn’t until the 1990′s, when key resources were privatized and everyone was allowed access, that the Internet revolutionized industry and created all those jobs cited by Obama.

If the Internet had never been privatized, the public would not have benefited from this technology. Tyler Cowen, a professor of economics at George Mason University, wrote a blog post refuting the notion that the government was responsible for inventing the Internet we have today.

In Part 2 I will examine more of Obama’s claims made in the State of the Union Address.

Do you agree or disagree? I welcome rational arguments in the comments.

Health Insurance Makes Health Care More Expensive

Have you ever wondered why health care costs are rising faster than inflation? It’s not because doctors or insurance companies are “greedy”. It’s because the government is not allowing the free market to function.

Health insurance, like any other insurance, is designed for major emergencies. You buy car insurance in case your’e in an accident, and you buy flood insurance in case your home is damaged in a flood. Similarly, you buy health insurance for major medical emergencies, like cancer, heart attacks, or serious injuries.

Insurance of any kind is not designed to cover day to day, routine expenses. The model just doesn’t work. You don’t use car insurance to cover oil changes and trips to the gas station. If you did you would have to pay sky-high monthly premiums that wouldn’t make any financial sense.

The reason health care is so expensive is because government requires routine medical procedures to be covered by health insurance. Insurance companies realize that they will lose money by paying for routine care, so they pass the cost on doctors. Doctors are forced to provide health care services for free and then chase down the insurance company for payment. This can take several months, and sometimes the insurance company decides not to pay at all. This system makes providing health care to patients with insurance a money-losing deal, so doctors will often over-charge patients without insurance to make up the difference. The result: exploding health care costs.

A common argument made by supporters of universal health insurance coverage is that health care is essential to human life, and thus too important to be left to the free market. However, the fact that health care is so important is also the reason why it should be left to the market, free of government intervention.

For example, food is even more essential to human life than health care, and the free market does a fine job of making food affordable and accessible for everyone. The market does such a good job that in first-world countries the biggest health problem we have is obesity, not famine. Consumers can buy everything from cheap fast food to expensive gourmet food. There are even soup kitchens and food drives for the homeless who can’t afford any food. Imagine if we had government mandated food insurance? Everyone would buy steaks, and the cost of food would skyrocket.

To really lower costs and expand accessibility, the government should deregulate the health care industry and allow the free market to do its job. If the competitive forces of the market are allowed to work, health care costs will go down. We’ve already seen it happen in areas not covered by health insurance, such as LASIK. Every year costs come down and LASIK becomes more affordable for everyone.

We don’t have to confine ourselves to the health care industry to see the cost-lowering effects of free markets. Take a look at cell phones and TV’s. When these products were first introduced, they were expensive and not everyone could afford them. Now, through the competitive forces of the free market, the average “poor” person in America has both. Why would it be any different for health care?

If you agree with my arguments and would like to sign a petition to repeal ObamaCare, click here.

I welcome rational arguments in the comments.

The Idea That Will Change The Way We Do Business

The Science of Success, by Charles G. Koch

The idea is this: the same principles that make societies prosperous can also make companies prosperous.

In the Science of Success, Koch Industries CEO Charles G. Koch calls this idea Market Based Management (MBM), and he shows how he used it to grow his company into the largest privately owned company in the world, with over $100 billion in revenues in 2009.

Part-philosophy, part-economics, and part-management science, The Science of Success should be read by every executive of every company in the world. In it Koch discredits command-and-control corporate hierarchies, functional departments, and old-school compensation plans based on education and/or experience. Koch argues that in order to be successful, companies should be planned like free societies, where each individual is free to pursue his or her rational self-interest within certain mutually accepted rules of conduct.

This revolutionary idea is applied through 5 Dimensions, which Koch describes in the book:

1. Vision: Determining where and how the organization can create the greatest long-term value.
2. Virtue and Talents: Helping ensure that people with the right values, skills and capabilities are hired, retained and developed.
3. Knowledge Processes: Creating, acquiring, sharing and applying relevant knowledge, and measuring and tracking profitability.
4. Decision Rights: Ensuring the right people are in the right roles with the right authorities to make decisions and holding them accountable.
5. Incentives: Rewarding people according to the value they create for the organization.

For this blog post I will describe how MBM handles the concepts of Decision Rights and Incentives differently from traditional companies.

DECISION RIGHTS

Koch correctly points out that the biggest problems in society have occurred in those areas thought to be best controlled in common: the atmosphere, bodies of water, air, streets, the body politic and human virtue. This is known as “tragedy of the commons”, because when there are no clearly defined property rights in a society, no one has an incentive to take care of the thing they use.

In an attempt to replicate the positive effect of property rights in a company setting, MBM uses the idea of decision rights. Decision rights should reflect an employee’s demonstrated competitive advantage, meaning he or she can perform an activity more effectively at a lower opportunity cost than others. The key point is that this authority is based on the degree to which an employee has demonstrated a competitive advantage in that area, NOT arbitrary factors like experience, education, seniority or being chummy with the boss. For example, an employee who has demonstrated a superior ability in accounting would have significant authority to approve financial statements. However this would not automatically grant him a similar authority to hire and fire junior accountants. Contrast this with the situation in many corporations, where technical excellence can get you promoted to a management position in which you are responsible for leading a team of people, despite demonstrating absolutely no management ability.

INCENTIVES

Abraham Maslow stated that the central problem of management is, “how to set up social conditions in any organization so that the goals of the individual merge with the goals of the organization.” That means that every employee in MBM is considered an entrepreneur, and is paid a portion of the value they create for the company. That means no cost-of-living adjustments, no automatic promotions or bonuses due to seniority, and no golden parachute severance packages if you run the company into the ground (I’m looking at you Wall Street).

Compensation in an MBM company is based on the long-term, real value you add to the company. If you take unnecessary risks that lose money for the company, your compensation will be decreased accordingly. On the other hand, if you are the leader of a project that is financially successful in the long-term, your compensation will be increased accordingly. Compensation isn’t set in stone, so employees cannot rest on their laurels but must continually strive to add value.

Also, MBM strives to tailor incentives for each employee. What any individual employee values is highly subjective and includes both financial and non-financial components. Just as in a free society, some citizens may value a high salary, some may value time freedom, and some may value a remote working agreement. The variations are endless. In MBM, compensation packages, where feasible, are tailored to the individual and may be different for different employees. Some employees may be awarded with company stock, increased vacation time, or the ability to bring their kids to work. It all depends on the unique situation surrounding the employee.

Those are only two of the vast number of differences between a traditional company and an MBM company. To get the rest, you’ll have to read the book.