THE BEAR'S LAIR US adds to its cost burden
By Martin Hutchinson
The Waxman-Markey "cap and trade" global warming bill passed by the US House of
Representatives on June 26 introduces what are essentially government price
controls on energy, which at present represents about 9% of the US economy. The
impending healthcare legislation, if passed in one of its more extreme forms,
will extend government price controls over healthcare, 16% of the US economy.
Given what we know about the supreme efficiency of the price mechanism in
allocating resources, one is forced to ask: are we in danger of reaching the
point at which the US economy stops working?
The current level of price controls in the US economy is quite small,
significantly smaller than in most European or Asian economies. Airfares,
railroad rates and interest rates were fully
deregulated in the 1970s, gas prices were deregulated in the 1980s and
electricity prices were largely deregulated in the 1990s. Insurance rates
remain regulated in some states, the Medicare system as a monopolistic buyer
imposes prices on a substantial percentage of medical expenditure, minimum wage
rates impose a significant level of price control at the bottom end of the
labor market, and New York and Cambridge, Massachusetts, still impose rent
controls, to the great detriment of their housing markets.
Still, at present, the price-controlled sectors of the US economy represent no
more than about 5% of gross domestic product (GDP) outside the direct
government sector. That adds about 15% to the price controlled share of output,
making the total around 20% (government transfer payments such as social
security and unemployment benefits should be excluded, since those resources
are subject to market forces once in the hands of the recipient.)
The Waxman-Markey energy bill imposes price controls through its manipulation
of the market for carbon emission permits. It would be possible for a
"cap-and-trade" carbon emission reduction system to operate economically in the
same way as a simple tax. To achieve that, all the carbon emissions permits
would have to be auctioned with no outside controls imposed nor "offsets"
allowed, so that the price for emissions would be set by a market process.
At that point, the only state intervention in the market would be the initial
decision on the volume of permits to issue, a decision that would no doubt be
the subject of intensive lobbying but once made, would allow the free market to
operate. This was the scheme presented by President Barack Obama as a
candidate, which suggested that his economic literacy was higher than that of
Republican candidate John McCain, who proposed handing out free permits.
Waxman-Markey bears little resemblance to Obama's original plan and is much
closer to McCain's concept, albeit with some additional anti-market features of
its own. Only 15% of the permits would be auctioned; the other 85% would be
given away for free, with the legislation specifying in exhaustive detail who
will get how many (electric utilities get 35%, for example, simply to reduce
the effect of the scheme on people's electricity bills.) Then another 2 billion
tonnes of carbon annually can be supplied by "offsets" either domestic
(reducing cow flatulence in the farm belt) or foreign (enabling the
cancellation of a purely notional polluting Chinese power station project.) In
addition, there is a "floor" on permit prices from 2012, and extra restrictions
on the energy efficiency of new housing from 2012.
In other words, the economic experts on the House Energy Committee get to
allocate well over 85% of the economic value in the permits scheme, with only a
relatively trivial amount left to be determined by the market. Energy spending
represented 8.8% of US GDP in 2006; that figure will have been significantly
higher in 2008, because of high prices, but 9% seems a reasonable figure going
forward. Depending on the percentage of energy costs represented by "cap and
trade" permits, some substantial fraction of that 9% would be withdrawn from
market price determination by the Waxman-Markey legislation.
As with carbon emissions reduction, the economic effects of health-care
legislation depend on the form it takes. At one extreme, legislation that took
the form of health savings accounts and a state catastrophic insurance plan
with very limited coverage and compulsory membership would reduce the
percentage of the economy subject to state pricing well below its current
level, because routine expenditure on drugs and low-level care would be removed
By eliminating health insurance except for catastrophic coverage, layers of
bureaucracy would also be substantially reduced. Impose sharp restrictions on
"pain and suffering" awards in medical malpractice cases, and you would have
designed a system in which medical catastrophes were universally covered, and
almost all expenditures were subjected to market discipline. Under such a
system, the percentage of GDP spent on health care would quickly decline from
its current 16% of GDP to roughly the rich world's average level of around 12%.
You might even get an improvement in US healthcare's mediocre output, in terms
of health and longevity indicators.
Needless to say, that's not the system we are going to get, and it would
probably not be the system we got whichever party was in power - the economic
illiteracy of politicians combines with the strength of lobbies to eliminate
such a common-sense approach. Instead we appear likely to get a system whereby
individuals are forced to buy health insurance, while a state insurance
provider is added to the private sector competition. The state provider will
then compete by forcing healthcare providers to reduce their costs to
state-approved levels, in much the same way as Medicare does.
Apart from adding insurance, state regulatory and legal-claims bureaucracy
costs to the overall expense of health care, this change would maximize the
percentage of the 16% of GDP absorbed by health care that is not subject to
price negotiation between the provider and the user of the service.
The addition to the non-market share of the US economy produced by
Waxman-Markey and the likely healthcare bill is thus less than 25%, but not all
that much less. Certainly it is difficult to see, if both bills pass, how the
non-market share of the US economy can be less than 25% plus the 15% of the
current government sector, which itself is likely to be considerably increased
by the current administration.
To see what economic effect that might have, we should look at the other
extreme, the former Soviet bloc of economies, in which all prices were set by
the state. It has since been remarked that the Soviet economic system only
lasted as long as it did because the Western economies existed alongside it, so
state price-setters had some idea of what prices should be in a market economy.
Without a free market system to copy, their task would have been much more
difficult, particularly for new goods such as computers.
Even if Soviet bloc technology had eventually been sufficiently innovative to
devise the personal computer, for example, it is most unlikely that the state
price-setting mechanism would have allowed PC prices to be set low enough to
build up volume production. With PCs being produced only in the hundreds or low
thousands, like small mainframes, their production costs would have remained
prohibitive for small business and personal applications.
It was notable under the Soviet system that partial price liberalization was
highly liberating for the economy. China's price liberalization in agriculture
after 1978 allowed a doubling of productivity in a decade, for example, while
Hungary and Yugoslavia, in which prices were partially liberalized even while
public sector control was maintained, proved notably more efficient generators
of growth than economies such as Czechoslovakia and Bulgaria where the price
system was not liberalized.
A US economy in which 40% of prices were set by the state (excluding transfer
payments) would thus not be wholly inefficient. It would operate much like the
economies of the more liberal countries of Eastern Europe under communism, or
like France in the 1980s, when much of its economy was under state control.
Economic growth would continue, but the sectors of energy and healthcare that
were under state control would become relatively more and more distorted and
inefficient, absorbing increasing amounts of resources and producing
diminishing output. For example, it is unlikely that either nuclear power or
Canadian oil shale would ever form substantial parts of the US energy mix in
such a system, since both sources of energy are politically unpopular.
In healthcare, a price-controlled sector would operate much like the British
national health system (NHS). Treatments would be determined by historical
accident, with new treatments being very difficult to introduce even when they
promised substantial clinical improvement. Shortages of resources and rationing
by waiting time would appear throughout the system. For example, it would
probably become very difficult to get care without entering a hospital, since
family medical practice would become unattractive as its economics were
squeezed by price controls.
Innovation in drugs and treatment would be greatly reduced, more so than in the
British NHS currently, since there no longer would be a substantial foreign
free-price system providing adequate returns for innovation (one of the reasons
for the high cost of US medicine is that as the largest free-price provider in
a controlled-price world, it subsidizes global research, allowing other
countries a partial free ride on US healthcare costs.)
President Obama's objectives of moving towards universal healthcare coverage
and reducing carbon emissions to avert global warming are both achievable at
the cost of only a modest expansion of the public sector (even if the
scientific basis for the latter objective is questionable). To achieve them,
however, programs must be designed so as to maximize rather than minimize the
role of the price mechanism. That both reduces the programs' costs and
increases their efficiency. In the current proposed incarnations of those
programs, this requirement is being neglected. That neglect, if not corrected,
will impose huge long-term costs on US living standards.
Martin Hutchinson is the author of Great Conservatives (Academica
Press, 2005) - details can be found at www.greatconservatives.com.
(Republished with permission from PrudentBear.com.
Copyright 2005-2009 David W Tice & Associates.)