Diatribes of Jay

This is a blog of essays on public policy. It shuns ideology and applies facts, logic and math to economic, social and political problems. It has a subject-matter index, a list of recent posts, and permalinks at the ends of posts. Comments are moderated and may take time to appear. Note: Profile updated 4/7/12

15 February 2008

Hillary-ous Economics


“Fool me once, shame on you. Fool me twice, shame on me.”

Hillary’s economic policy proposals are testing this old saw on the American public. She now proposes to flout the laws of economics a second time. Maybe she hopes the people on whom her candidacy most depends—poorly educated and ill-informed working people—won’t notice.

Hillary’s economic mistakes are classic. She proposes to order the economy about like one of her campaign managers. No doubt if things go completely sour, she’ll upbraid the economy and fire it.

Hillary’s most recent mistake is a proposal to freeze interest rates for struggling homeowners. Interest is nothing more or less than the price of a loan. So her interest-rate freeze is a price control. Well-established economic theory and a century of experience show that price controls don’t work.

Any introductory course in economics explains why. Price controls distort the natural balance between supply and demand that is the essence of a free-market economy. They are the proverbial monkey wrench thrust into a delicate machine in order to slow a single cog.

For readers with the background and patience to read them, I’ve summarized the reasons why price controls don’t work in more detail below. Every basic college economics course teaches them.

But you needn’t have a firm grasp of economic theory to understand why price controls don’t work. All you need to know is a little economic history. Lenin tried price controls. Stalin and his successors did, too. Mao tried them. Our very own Harry Truman, Richard Nixon and Jimmy Carter tried them. None worked, and all had unintended consequences.

For us Americans, the most fascinating failure was Nixon’s. A conservative Republican, he had opposed price controls all his life. But he imposed them nevertheless, out of political expediency. They failed. As one report notes, “Ranchers stopped shipping their cattle to the market, farmers drowned their chickens, and consumers emptied the shelves of supermarkets.” The conclusion of Nixon’s own economic advisor is worth repeating: “we have now convinced everyone else of the rightness of our original position that wage-price controls are not the answer.”

Hugo Chavez is trying price controls right now. That’s why the shelves of markets and groceries in Caracas are empty despite Venezuela’s oil wealth. He’s doing us all a service in proving once again, to this generation, that the laws of economics still hold true.

“What’s the big deal?” you might ask. Aren’t even the Republicans freezing interest rates right now? Yes, they are. But there’s a big difference in duration. The Republicans propose freezing interest rates for thirty days, to allow private markets to adjust. That’s a temporary emergency measure, not a price control. Our huge economy is resilient enough to withstand an interference that short. But Hillary proposes to freeze interest rates for five years.

Just think how much and how quickly interest rates have changed over the last five years. Then you’ll understand why a freeze that long is bad economics. Our credit economy can stand a brief “time out;” it can’t survive being handcuffed for half a decade in a time of rapid global economic change.

Hillary’s other hilarious economic proposal would “solve” our health-care crisis with “mandates.” It would force people who don’t want health insurance to buy it.

The notion behind this plan is that rising health-care costs aren’t responsible for our health-care crisis. “Free riders” are. Supposedly there are many, many people who can afford health insurance but won’t buy it because they don’t think they’ll get sick. If they get sick, they go to emergency rooms, driving up health-care costs for the rest of us. There are so many of them, the story goes, that if we just force all of them to buy insurance, cost increases will disappear and we will all enter health-care Nirvana.

If you want a “fairy tale,” this is it. The health-care “free rider” is Hillary’s version of the Republicans’ “welfare queen”—the mythical woman who used fraudulently procured welfare payments to get rich. Like health-care free riders, welfare queens were a neat bit of demagoguery, a powerful metaphor with no empirical support.

The notion of so many people free riding is inherently implausible for a whole host of common-sense reasons, including the aversion to risk that pervades our culture. But Hillary gets away with her implausible claim because no one has any idea how many—or how few—health-care free riders there are in fact.

How would you measure the number of supposed “free riders” accurately? Would survey takers go into hospital emergency rooms and ask patients, “Are you here because you gambled with your health and refused to buy health insurance even though you could afford it?” Wouldn’t that be like asking voters whether they refused to vote for Senator Clinton because she’s a woman or for Senator Obama because he has African genes?

Can you think of any reliable way to measure this so-called “free rider” phenomenon accuately? I can’t. Nor, apparently, can economists. There is a lot of speculation and guesstimation, but no hard evidence either way.

Without hard data, no one can definitively challenge Hillary’s claim that free riders—not free-market cost increases and the high price of innovation—are responsible for our health-care crisis. She thinks she can fool the public and win the election with an inherently implausible claim which there is no practical way to prove or disprove conclusively.

There’s a word for that: demagoguery. She wants us to believe that there is such a thing as a free lunch, and that only she can provide it.

Our purblind media have fostered the myth that there is no significant difference between Senators Obama and Clinton. Nothing could be further from the truth. Obama understands economics. Clinton does not. Her economic proposals demonstrate that point beyond dispute. In a time of rapid economic decline, that difference ought to be decisive, if only voters could see it.

We jeer at Hugo Chavez and his economic demagoguery. But we have a serious candidate for president engaged in the same enterprise. It’s so easy for a candidate to say, “Just give me all that power and I’ll command your problems away.”

Yet life is not so easy, even for a president. A president must be smart, not just commanding. You have to understand the economy before you can fix it.

King Canute once tried to command the tides. He failed. Every leader from Lenin to Nixon to Carter to Chavez who tried to command the economy failed.

Command economics in the Soviet Union and Communist China reduced great powers to third-world status. If we voters are gullible enough to elect a leader with third-world economic ideas, a third-world economy is what we’ll get. No one will think that’s hilarious, least of all working people, who are always the first to get hurt.

Why Price Controls Don’t Work

Three things happen under price controls. First, private firms go out of business as the costs they pay for things like labor and raw materials go up and they can no longer make a profit by selling products at controlled prices. To avoid this outcome, the government has to subsidize the losses incurred by the controlled businesses. Or the government can take over the affected businesses entirely and run them itself, paying for the continuing losses out of its general revenue. That, in essence, is the story of the Soviet Union and Communist China.

If the price controls are not too severe, the private market can still function. But the private market will produce less of the controlled commodity at the controlled price. Producers, who still have to make money to survive, have to follow the inexorable law of supply and demand, on the cost side. They produce less output, causing shortages compared to what a free market would provide. In Hillary’s case the effect will be a shortage of credit, driving up interest rates in the non-subprime-mortgage part of our economy.

The government can try to get around the laws of economics by controlling more and more. Nixon did that by trying to control wages (producers’ cost of labor), in addition to prices. He failed. That’s also what our Fed does in lowering general interest rates. But more control always has unintended consequences. For the Fed, inflation is one.

As the government begins to control more and more of the private economy, it enters a vicious circle. More control means more unintended consequences, which require more control. After a while the nation begins to look like the Soviet Union or Mao’s China. We all know how those experiments turned out.

There’s also a simpler way to understand why price controls fail. If a productive firm is inefficient, in a free market more efficient firms eventually will replace it, perhaps producing lower prices. But if a productive firm is efficient, forcing it to lower prices will force both it and its efficient rivals to lose money.

If the losses continue, even the most efficient firms will die. In order to keep them in business, someone has to pay for the losses that price controls force them to incur. Investors can pay by throwing their money down a rathole (unlikely!). Government subsidies can pay—which means you and me, through taxes. Or the buying public can pay, through shortages, rationing, poor quality, and delay. That’s what happened in the Soviet Union, with empty grocery stores and long waits for basic commodities like toilet paper.

There are no other alternatives. Someone or something must pay the difference between the controlled price and the (higher) costs of production. This result follows from economics’ most basic law: there is no such thing as a free lunch.

Hugo Chavez is dumb enough not to understand economics and not to learn from history. He is running the same failed experiment again. Do we want our next president to follow his lead?


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7 Comments:

  • At Fri Feb 15, 04:08:00 PM EST, Anonymous Ron Chusid said…

    The free rider argument against Obama's plan is just absurd. There are numerous ways in which incentives can be built into the system to provide incentives to join and consequences for trying to wait until one needs the coverage.

    Medicare has just such a situation with the Medicare D program which covers prescription drugs. People who do not currently have expensive drug costs might be tempted not to participate and wait until they do.

    This problem was solved by having charging a higher premium should you join later. Those purchasing the insurance later would be charged both the higher rate than in effect as well as an additional charge. Should people try to game the system it doesn't matter because down the road the system picks up increased premiums when people do join, eliminating the fears that the free riders are making the coverage more expensive for all.

    Another way in which the Medicare D Program discourages free riders is to have open enrollment only during a brief period every year. This makes people consider the fact that should they develop a medical condition which requires expensive medications to treat after the open enrollment period, they will have to pick up the cost for several months.

    There are a couple other areas of concern with mandates. With mandates it will be necessary to waste resources on enforcement. It would be better to keep overhead to a minimum and put as much money into actual health care as possible.

    Another problem with mandates is that there is less need for the program to actually keep the cost of coverage down. If everyone is forced to pay, the price can continue to rise to the point where those who don't receive coverage are having difficulty affording the cost. Without mandates we have a feedback mechanism. If the cost is too high, people will drop out of the system and the problem will be more apparent. Under Obama's plan the government is forced to actually develop a system which provides affordable coverage.

    While Clinton claims only her plan provides universal coverage, there will never be one hundred percent compliance with mandates. Nobody really knows for sure how many people will be uninsured under both the Obama and Clinton plans. (This lack of understanding of the unpredictability of the actions of individuals is a common failing in Clinton's view of the economy).

    Perhaps mandates will wind up meaning more are covered, but this is not terribly important if the only ones left uninsured are uninsured because they choose not to take the coverage. As there will not be universal compliance with mandates, other aspects of the plan might determine how many are left uninsured. Some people like Robert Reich actually believe that Obama's plan will cover more people, as I noted in this post:

    http://liberalvaluesblog.com//?p=2465

     
  • At Fri Feb 15, 05:29:00 PM EST, Blogger jay said…

    Thanks, Ron, for the additional reasoning.

    The point of my post was not to argue the details of the Clinton-Krugman health plan. I’ve already done that in three posts, the latest of which links to the others.

    I wanted to make a broader and (in my view) more important point. Hillary Clinton simply doesn’t understand economics. Electing her president at a time when the economy is the most important issue on most voters minds makes no sense at all.

    In addition, she has poor political judgment on economic issues. Not only do her health-care mandates make no economic sense. By energizing the right wing, they would also make it much harder to pass any kind of health-care reform at all. Hillary’s failed 1993 proposal proved that; her mandates for small businesses helped kill it.

    Hillary doesn’t have the basic understanding of economics that you would expect of any good college student in economics. And her poor political judgment makes it harder to pass her proposals at all. Thus her proposals won’t pass and, if passed, won’t work.

    If you can think of a better recipe for economic suicide in these trying times, please let me know.

    Jay

     
  • At Mon Feb 18, 04:02:00 AM EST, Blogger LovedbyL said…

    I love reading this blog so far. I've just started searching for blogs that show comparisons of Obama and Clinton on issues past and future without all the bickering comments left by posters who just want to start trouble. I just want the facts side by side and nothing else.

     
  • At Mon Feb 18, 12:42:00 PM EST, Blogger jay said…

    Some comments on this blog accuse me of bias. I confess that I support Obama strongly, and I don’t try to hide it.

    But that wasn’t always true. At first I, too, thought Obama might be a “rock star,” all fluff and no substance. My first post on him (fourteen months ago) was tentative and questioning; it expressed my doubt.

    But then I read his books, his speeches, and his position papers. I soon discovered a brilliant intellect, extraordinary judgment, wisdom, imagination, and uncanny empathy for follow human beings. His approaches to issues struck me as comprehensive, practical, common-sense, transparent, and devoid of ideology and “spin.”

    Although the brilliance of his intellect comes across in his speeches, not all his speeches show how solid, thoughtful and practical a leader he is. The debates definitely do not. No one could explain his careful, nuanced, comprehensive plans for health care and fighting terrorism in 90 seconds. For that, you have to read his writings and/or something like my comments on his plans.

    We all know this is the most important election in 48 years. Our choice may determine whether we continue to enjoy an open and responsive democracy or become something more like Pakistan and Russia today. Our choice will almost certainly determine whether we and our ideas continue to lead the world.

    With those stakes in mind, don’t you owe it to yourself and your country to get beyond the media blather and opponents’ spin and study the facts for yourself?

    I’m preparing a short “Obama reading list,” which I’ll post on this blog later this week. It’s designed for people who are undecided or skeptical of Obama and want to learn more. I’m trying to make the reading as painless and quick (but as accurate) as possible.

    I hope that folks who haven’t yet made up their minds will at least glance at it.

    Jay

     
  • At Mon Feb 18, 07:18:00 PM EST, Anonymous Ron Chusid said…

    Jay,

    Interesting to read your comments on at first being unsure about Obama. My first posts were also on Obamamania and questioning if their was substance. Then I paid more attention to what he is really saying.

    Obama was not my first choice (but in retrospect maybe he should have been). Prior to Iowa, Obama was just one of a handful of candidates who I thought were acceptable. Since then, with the field narrow down, I've become increasingly impressed with Obama while Clinton has repeatedly demonstrated that she is unfit to be president.

     
  • At Wed Feb 20, 09:33:00 AM EST, Blogger Henry Cobb said…

    not free-market cost increases and the high price of innovation

    How exactly can either of these exclude customers from a market?

    If innovation is causing value for money to decline then won't the providers who don't innovate grab more marketshare?

    Since the customers aren't getting poorer at the same rate that they are dropping out of this market there must be a market-wide supply side distortion keeping low cost providers out of the market.

    So it must be regulation and taxes.

     
  • At Wed Feb 20, 02:26:00 PM EST, Blogger jay said…

    Dear Henry,

    Free-market cost increases and the high price of innovation don't exclude anyone directly.

    What they do is raise prices for everyone. The price increases "exclude" those who can't afford the resulting higher prices, whether for care or for insurance to cover it.

    Most people have no idea how expensive innovation in health care is. For example, full-scale clinical trials for a single drug cost $1 billion, even if the drug fails. And four out of five trials do fail. Someone has to pay that price, including the price of all the failures.

    So basic economics—the law of supply and demand—excludes people. The higher the price, the fewer people can afford something.

    Innovation doesn't cause value for money to decline. On the contrary. It causes both value and price to increase.

    From an economic standpoint, that is our national health-care dilemma in a nutshell. We Americans provide the lion's share of innovation in health care worldwide. We've done so for decades.

    But because of a number of global market imperfections, we also pay almost all the bill for innovation. Those who can afford the price get the best health care in the world. Those who can't need some sort of help or safety net.

    Eventually, foreigners get the benefit of our innovation, but only after a significant delay, and often in diluted form. So they don't pay much of the price for innovation.

    The notion that you can solve this fundamental economic problem with mandates, cost controls, deregulation or any other "command" panacea is nonsense.

    I've been working on an essay explaining these points in more detail. I hope to post it in the next few days.

    Jay

     

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