Notes on Healthcare, Part I: Fundamentals and the ERC-GAC

Opinions and arguments in the recently renewed debate over healthcare have been quite strong, and thus the debate has been a heated one. One need merely look, for example, at Rep. Joe Wilson’s outburst of “you lie!” during Obama’s speech on healthcare, or at the thousands of people who have spoken out at “town hall meetings” to debate such issues. Republicans and Democrats, it seems, are entering into a confrontation greater than any in the last few years, even though everyone speaks of the need for “healthcare reform.”

So it may be surprising to think about how much alike our members of Congress really think on healthcare. Politicization has created a huge debate out of, relatively speaking, small differences. Just about everyone agrees on certain major points. Such issues on which there is general agreement include the desire for universal healthcare insurance, a demand for a general government program on healthcare, a want to continue the Medicare and Medicaid programs, a need to reform both of these programs to cut their costs while not benefits, a stipulation that insurance companies not discriminate on the basis of existing medical conditions, an agreement that health insurance “costs too much” and that the insurance companies make “too much profit,” an agreement that large amounts of regulation, bureaucratization, subsidization, and government involvement in healthcare are all needed in the industry. But most fundamentally, there is roughly a consensus that having a free market in the healthcare industry would fundamentally be wrong. Even most of the congressmen who often talk about free markets are not proposing a free market for the healthcare industry.

Why is this so? What is their reasoning for these different claims and this virtual consensus? This is what I want to start analyzing in this blog post, but this is a huge issue: several large books could be written on the subject with still plenty left over to consider. And so we must begin with a fundamental insight into the general nature of the anti-free market thought process. This insight is that the arguments against the free market in the healthcare industry focus on supposed “exceptions” that the healthcare industry has with regards to the proper working of a free market, thus requiring government intervention because of these exceptions. There are, of course, those socialists who reject markets all together, but those arguments get less support than those that speak of “exceptions” to the general rules of markets in the healthcare industry, and so I focus more on the “exception” supporters.

One of the biggest so-called “exceptions” that healthcare poses deals with emergency medical care. The chain of reasoning goes something like this: Joe can’t afford health insurance because he’s too poor and it’s too expensive, or because he has some preexisting condition that causes the insurance companies to refuse to insure him. Joe then has to rely on emergency medical care for his healthcare. Emergency medical care is expensive, and Joe has no way to pay. Then because the emergency medical provider is taking on a large cost without remuneration from Joe, they have to raise their prices on all of their other, paying customers. Because the prices for healthcare go up, fewer people can afford them, and then there are more Joe’s out there who have to rely on emergency medical care and continue to drive up the costs, resulting in a vicious cycle. Let us call this vicious cycle the emergency room common-good abuse cycle, or the ERC-GAC.

The fallacy involved here is that this problem of free emergency medical service for those who cannot pay is a result of some market process. It is considered a “market failure” in a basic neo-classical analysis. This is particularly ironic given that many liberals/socialists constantly lambast businesses for callousness against the poor when it comes to making profits, because these liberals/socialist then turn around and blame the “free market” for providing free healthcare to those who can’t pay for it and then blaming the “free market” for the problems which result because of this. This is, of course, a problem resulting from government intervention in the healthcare industry, supported by the liberal/socialist sentiment that no one should be denied healthcare on the basis of ability to pay for it, as they see healthcare as a “right.” The government has passed laws that prevent hospitals and emergency rooms from turning away anyone in need, partially socializing emergency medical care, and now that this partial socialization is causing major problems in the industry, the liberals are proposing... why, more socialization of course!

In a free market, any hospital or emergency room that took in people who had no ability to pay and who are now expecting free medical care that then tried to turn around and pass those costs to its paying customers would be driven out of business by the competition of those hospitals who would not pass on other people’s costs to those with the ability to pay, and healthcare costs would stay low. The immediate objection that most people pose to this is that healthcare is a “right” and that no single person should ever be denied healthcare if they do not posses the ability to pay the full price for their healthcare. However, if there existed a free market in the healthcare industry, it would not mean that a large number of people, particularly the poor, would be unable to purchase healthcare. But due to reasons discussed further on, this would not be the case.

The second part of the ERCGAC has to do with insurance and people with preexisting conditions. This brings up the very important definition of the function of insurance, which is blatantly ignored in virtually any discussion on healthcare insurance. Insurance is something bought and sold in a market which guarantees the purchaser of the insurance policy to certain remuneration if a certain event happens to occur. The purpose, of course, is for people to reduce the amount of risk they take on in their life.

Market Power

When one thinks of a monopoly today, one thinks of large business or corporation that exercises total control of an industry while often exercising any means necessary to maintain that control. The common thoughts are that no one can stand up to a monopoly, take down a monopoly, and that the effects of a monopoly are destructive to the general welfare. The common conclusion is, therefore, that government should regulate or break up monopolies or companies with “too much” market power wherever they happen to arise. This is, however, a frightfully misguided chain of reasoning that ignores the mechanics of a free market, when such a market exists, that is.

In a free market, the ability of an individual, business, or corporation to compete on the market is not restricted by any government rules, regulations, obstructions, or inhibitions, and nor is any individual, business, or corporation allowed to use force to prevent or discourage others from competing (which is the government’s responsibility to prevent). And so if one thinks of a monopoly that uses practices such as intimidation, threats of physical violence, special government privileges, or bribery of public officials to maintain its monopolistic position, then one is either not thinking about a free market or is thinking about situations which should not exist in a free market and which the institutions present in a free market tend towards eliminating, though there is only so much that can effectively be done at any time to prevent criminal activity in any system.

However, many people will take their objections to monopolies farther and say that monopolies that fit the common conception of a coercive business or corporation that is unchallengeable and destructive to the general welfare will arise even in a free market where no direct force is used against competitors or potential competitors. Many of them therefore think that the government should intervene in these markets in order for the market to even be considered free in the first place. It is not true, however, that market power accumulated in a free market is either unchallengeable or destructive to the general welfare. To see why, one must have a proper understanding of the mechanics of a free market.

And so in order to understand these mechanics, let us first examine a situation in which there are no governmental barriers to competition and also in which there are proper governmental restrictions of the use of force and coercion. For example, no potential entrant in the market can be legally prevented from competing and no business can threaten the entrant with physical force, whether initiated from the business or from the government on the business’s behalf. This is the free market. Now let us suppose that we have a certain industry, and in this industry, let us say that there is a particular firm with a large amount of market power: for example, suppose it has a market share of 80%, meaning that this particular firm sells 80% of the good or service that the industry it is a part of produces. In essence, this firm is a monopoly. Let it also be stated, however, that a company with a high market share does not necessarily decide to raise prices to a monopolistic level, for reasons which should become clear after reading this.

Now, this monopoly can change the price at which it sells its good or service, just like all businesses can. However, because this business has market power, when it changes its prices, the effect is not the same as when a business without market power changes its prices. In a very highly competitive market, when one business raises its prices, consumers can immediately just buy that same good or service from another business for a lower price, and thus by raising its price, that one business has lost money because it has lost all of or nearly all of its sales. When a certain business has a large amount of market power, then the effect is not nearly so powerful, and sometimes a business can profit by raising its prices because the increased amount of profit from its sales outweigh the total loss in the quantity sold. It is for this reason that most people learn in introductory economics that monopolies are “inefficient” compared to a perfectly competitive market, and it is for this reason that market power often makes companies who have it very profitable.

But it is this very profit that works to check the power of a monopoly. Let us say that our supposed business with an 80% market share is raising its prices and also making a lot more profit than it was before it decided to raise its prices. A standard, classical, Econ 101 analysis of monopoly would call this inefficient, because the higher price would discourage potential buyers that the monopoly could have produced for. However, in a free market, competition is free to all comers, and thus, if the monopoly has impacted the market price for a good or service, the monopoly has suddenly created a huge profit potential for potential entrants in their particular market. This potential profit then enables people to get the funds to start their own businesses in the monopoly’s industry and then the new competition drives the price back down to its efficient level. If the price for the good or service in this particular industry is too low, then the lack of profits will drive certain businesses out of the industry letting the remaining ones which were more efficient raise their prices back to where they can continue to make enough money to maintain their businesses.

There is however, still yet another objection to the postulate that a free market can properly deal with monopolies simply through the market process. This particular fallacy is what I call the shortsighted market fallacy with respect to market power (I have never heard anyone else give a name for this fallacy, so I took the liberty for efficiency’s sake), which goes something like this: if competitors try to enter a market in which a monopoly has raised prices higher than they should be, then the monopoly will be able to lower its prices below what prices should be so that none of the competitors can then profit, and will therefore go out of business. Then, because the monopoly has more resources and is more established than the newcomers, it will outlast them, and then the monopoly can raise its prices once again to a higher price than they should be at (the price that “should” exist in the market is determined by an inordinate number of factors, but it is always the price that a free market price tends towards. Simply consider it the “market price”).

This fallacy rests on several false assumptions. The first is that speculators in the market will not react to a large temporal inequality of prices. In other words, when the monopoly lowers its prices below a sustainable level, people who fall for the shortsighted market fallacy do not take into account the huge amount of profit to be made from buying large quantities of what the monopoly produces and then selling these quantities after the monopoly raises the prices back to the very high levels. There are huge gains to be made from taking advantage of this inequality of prices. “Buy in the cheapest market, sell in the dearest” has always been one of the easiest ways to make a profit. This weakens the power of the monopoly by first dramatically increasing its sales when its selling at a price that it cannot sustain and then again by creating a competitive market after the price goes back up, because the price cannot go back to where the monopoly wants it because the speculators begin selling the good the monopoly produces. The other false assumption that this fallacy lies on is that, after the price goes back up to an artificially high monopoly level, the same process of threatened competition resumes because the same profit motive is created. And so for these two reasons, I call this fallacy the shortsighted market fallacy, as it does not take into account the other actions that the supposed actions of the monopoly create and it does not take into account the continuation of time.

Therefore, it cannot accurately be contested that government methods of “anti-trust” are necessary, beneficial, or necessary to call a market “free.” Nor can a free market be opposed on the grounds that monopolies would take it over and destroy the general welfare of the economy. The free market is the best way to handle the issue of prices and market power, because competition will always monitor it and cause it to constantly tend towards the efficient level. And it should also be seen that a company, even with a large market share, will not usually try to raise prices to monopoly levels, even though still pursuing the benefits of selling a large quantity of a good to the market and the efficiency benefits that come from economies of scale.