Government Failure

I can’t even count the number of articles and blog posts I’ve seen asserting that markets can’t work in health care.  Or that they work very imperfectly.  Or that they suffer from serious “market failure.”  In every case, the writer just assumes that government can remedy these problems.

Yet when Gerry Musgrave and I wrote Patient Power, we concluded that our most serious health care problems stem from bad government policies, rather than from markets failing to work.  In other words, “government failure” not “market failure” is the source of most of what is going wrong.

Why is our perspective so different from so many other health policy analysts?  I think the answer is:  the vast majority of people in health policy do not understand the concept of “government failure.” For example, health economist Austen Frakt, following Nobel Laureate Joe Stiglitz produced a list of “market failures” in health care and in health insurance at his blog recently. These include imperfect competition, unequal access to information, external costs and benefits for others generated by private activities, etc. He then offered this observation:

In principle, government intervention can increase that benefit (economic welfare) in such cases.  In practice and in some cases, it’s debatable.

How does Austin know that government “in principle” can solve these problems without a model of government decision making?  He can’t.  Moreover, it turns out that many of the factors alleged to cause “market failure” also contribute to “government failure.” In fact, in the political sphere their impact is much worse. Here is the bottom line: There is no model of government decision making in health care (and in most other areas as well) that shows that government will reliably improve upon the market. (At least a real market.)

A model of government decision making is a theoretical structure that links public policy to the competing interests that create them. There is no such thing as a pure dictator who can make decisions while disregarding the wants and wishes of everyone who is governed. Like the marketplace, political systems are complex systems in which the final outcome is dependent on complicated interactions of millions of people. A realistic model of government is one that recognizes that people can do things to influence what the government does:  vote, contribute to election campaigns, offer bribes, offer military support, form coalitions with others, etc.

When economists talk about “market failure” they begin with a model in which consumer welfare is maximized. “Market failure” arises when imperfections cause outcomes that fall short of the ideal.  If we were to do the same thing in politics, we would begin with a model in which the political system produced ideal outcomes and then consider factors that take us away from the ideal.

But here is the problem:  whereas in economics, “market failure” is considered an exception to the norm, in politics, “government failure” is the norm.  In general, there is no model of political decision making that can reliably produce ideal outcomes.

Let’s take an example.  Economists believe that an in an ideal market, price will equal marginal production costs.  On the buyer side of the market, people will continue to purchase a good until the value of the last unit acquired equals the price they have to pay. On the seller side, producers will continue to produce goods until the cost of the last unit produced equals the price they can sell it for.  The end result is optimal output.  The value of the last unit produced to consumers is exactly equal to the cost of producing it.

Now suppose we let government dictate the output level and allow consumers and producers to influence the decision through votes, campaign contributions, bribes, etc. Assume consumers always want higher levels of production (making the market clearing price lower) and producers generally want less output (making the market clearing price as well as profits higher). Is there any political system (majority voting, other types of voting, politicians selling their votes at auction, etc.) under which government will make the ideal decision? Answer: No.  Ideal outcomes are virtually impossible.

How do I know that?  Because I can state a general principle that has to hold to get ideal outcomes: The political “prices” that consumers and producers are willing to pay to get a dollar of benefit must be exactly the same.  And this is true regardless of the “political currency.” The currency could be guns, (military effort), money (campaign contributions), votes on election day, or something else.

Imagine that the parity did not exist. Suppose that producers (as a group) were willing to pay 20 cents to get $1 of extra profit and that consumers (as a group) were willing to pay only 5 cents for each dollar of consumer satisfaction they derive. Then political decision makers will be tempted to impose $4 of cost on consumers in order to create $1 of extra profit for the producers.  (The reason this is socially bad is that, summing over both groups, society as a whole is $3 worse off.) With parity, however, competing interest groups communicate through their bids that $1 of benefit is equally valuable, regardless of who gets it. Then and only then will we get optimal public policy.

Why, you might ask, would producers only spend 20 cents of effort to get a dollar of reward?  Why would consumers only spend 5 cents? The answer is: policy changes don’t benefit or penalize people as individuals; they affect whole groups of people. Each consumer, for example, benefits from more output and lower prices whether or not he contributes to the effort to change the policy.  So as individuals, we will be tempted to free ride on the efforts of other and not contribute anything unless we think our personal contribution will decide the election or put a legislative proposal over the top.

Despite complaints about the enormous amounts of money spent on elections, most people contribute far less than elections are personally worth to them.  In other words, we all understate our interest in policy questions in the way we reward politicians we like and punish those we dislike.  This understatement for most people is quite large.  In general, the signals we give to politicians are very imperfect representations of our true interests and these imperfections vary radically from group to group and market to market.

Phil Porter and I have shown that these principles are generalizable. In order to get an ideal government budget, for example, the political price offered by the beneficiaries of any one spending program must equal the price offered by the beneficiaries of every other spending program and these, in turn, must equal the political price taxpayers are willing to pay to keep an extra dollar of their earnings. Yet equality of political prices is an impossible condition.  There is no way we can reasonably expect producers and consumers in every market to make equal (marginal) political efforts.  Nor is there any reason to expect that beneficiaries of every spending program will make the same (marginal) political effort or that their effort will equal the effort of taxpayers who resist more spending.

Even more discouraging, Phil and I have shown that small differences in political prices will produce political waste and inefficiency far greater than the inefficiency that private markets are thought to contain.

Interestingly, Austin Frakt has written eloquently about what can go wrong in politics. But like so many others, he does not seem to see that what goes wrong is “government failure” and that failure is conceptually no different from “market failure.”

Nothing follows from the fact that there is “market failure.” To make the case for transferring decision making power to government one would have to show that the likely “government failure” would be less harmful.  In health care, that’s hard to do — particularly given the track record of government in health in the twentieth century.

Overall, the market and the government have comparative advantages in certain areas and the sphere where government has a comparative advantage would appear to be very small.

John C. Goodman, PhD, is president and CEO of the National Center for Policy Analysis. He is also the Kellye Wright Fellow in health care. His Health Policy Blog is considered among the top conservative health care blogs where health care problems are discussed by top health policy experts from all sides of the political spectrum.

13 replies »

  1. Goodman acolyte Devon Herrick writes:

    Healthy people wanting easy access to primary care are a more influential voting block than the relatively small number of very sick people needing very costly care. A Savvy politician knows where to invest public funds — and spending large sums on the few doesn’t maximize votes.

    Well said Devon – of course, the public OR private spending of large sums on the few doesn’t maximize individual or public health, either.

    So what exactly is your point?

  2. I’ll third Paul’s good post as well. But not just healthcare, the government pumps Q-billion$ into the balance sheets of hundreds of companies who lobby and bid on gov’mt work every day – is that considered government failure?

    Devon, NHS is not free for healthy people, they have to judge what they pay in taxes against what they receive or have the potential of receiving. Healthcare is not IF you get sick like other types of insurance, it’s for WHEN you get sick.

  3. Government failure pertains to health care in the sense that under Public Choice Theory the incentives for politicians are very different than the incentives under markets. In Medicare and Medicaid, providers are paid rates that are well below private sector payments. Rationing by waiting is more common (due to low reimbursements). The British NHS is a good example of the politics of medicine. Healthy people wanting easy access to primary care are a more influential voting block than the relatively small number of very sick people needing very costly care. A Savvy politician knows where to invest public funds — and spending large sums on the few doesn’t maximize votes.

  4. NCPA has been around a long time promoting a free market approach to health care. The problem with tossing around the terms “market failure” and “government failure” when it comes to health care is that more than 50% of all dollars spent on healthcare in the U.S. come directly or indirectly from the federal government — directlly through programs like Medicare and Medicaid, or indirectly through tax breaks to companies or individuals for the purchase of health insurance, or through the approval or disapproval of drugs and medical devices by the FDA.

    To pull the federal government completely out of health care would mean a massive change in the health care market — not just in how people pay for health insurance or get their care, but in how hospitals get paid, how medical schools are financed, how medical research for the next generation of breakthrough therapies is financed.

    Plus, remember how the market for health insurance has treated the sick — the sicker you are, the less likely it is you can get insurance. And if you have an employer who doesn’t provide insurance, and you either have or come down with a chronic illness, the market will label you with a big “l” for “loser.”

  5. “whereas in economics, “market failure” is considered an exception to the norm, in politics, “government failure” is the norm.”

    No bias there.

  6. There is no model of a market based health care system that provides good care and holds down costs. There are multiple models where there is significant government involvement. A few studies rife with selection bias, of short duration, are not convincing. Perhaps most worrisome is that no state which is dominated by those who claim to believe in market solutions has instituted market based health care.


  7. “There is no model of government decision making in health care (and in most other areas as well) that shows that government will reliably improve upon the market.”

    Tell it, e.g., to the the Scandinavians, the Swiss, and the Israelis. Moreover, “markets” properly exist to serve and advance humanity, not the other way around, as people like you would have it. Absent rational and effective regulation (“government”) markets inexorably devolve into Gresham’s Law death spirals.

  8. I read this post and concluded, “what!?”

    What does this have to do with health care concerns? Full of sound and fury, signifying nothing.