Competition it ain't

In the last two months, the White House seized on a brilliant PR plan to sell the "public option": emphasize that it promotes competition. After all, that should appeal to those free-market types, right? Imagine the brain freeze: "I don't trust government intervention, but I do like competitive markets. What do I do?!"

In communication, this would be called co-opting a term: taking a term used favorably by the other side and using it to promote your side, perhaps with some implicit redefining. (The term is rather ironic, since the public option seems destined to be replaced by "co-ops" :-). But in a debate, one should always view co-opting with suspicion. Do they really mean competition as the word is commonly used, or are they slapping a palatable name on an inedible dish?

The dog-eat-dog world of competitive markets

Competition is the bedrock of what makes markets function well. With it, we can be certain (indeed, it can be mathematically shown) that the best products will be produced, by the most efficient methods, for the lowest possible prices. But without strong competition, we have no such assurance.

When economists make these claims, we have a very specific definition of competition. In particular, there must be:

1. Many small buyers and sellers of the product (no 800-pound gorillas in the market).
2. Similar product are offered by various sellers (there's no reason to favor one brand name over another).
3. New businesses can enter the industry without much difficulty.
4. It is easy to gather the needed information to compare products and prices.

If all of these conditions hold, we have a ultra-competitive (or, as we would say, perfectly competitive market). If one firm charges more than the others, consumers will find out and everyone will abandon that firm. If one product is of lower quality than another, either its price has to be appropriately lower, or people will stop buying it. If one firm has higher costs than the others, it will be driven out of the market after sustained losses.

It's not much fun to be a seller in a perfectly competitive industry — you won't make much profit. But there is a strong incentive to innovate. If you come up with a new product variation or a cost-saving technique, you will be rewarded with higher profits. But only temporarily; eventually everyone else will duplicate you and erode that advantage.

Even so, many people are willing to start businesses in highly competitive industries. Food production (with the exception of those that are subsidized) are good examples. Indeed, the miracle of competition explains how we have gone from having most of the population in agriculture two centuries ago, to merely 2% growing all the food we need (and then some) today.

Does the Shoe Fit?

Now that we're clear what economists consider to be a competitive market, does health insurance qualify? Unfortunately, no.

1. Although there are a large number of health insurance companies, a given individual usually interacts with just one — whichever one his or her employer has selected.
2. Most insurance companies offer a similar collection of plans, with various levels of coverage and copays. Unfortunately, there are some less visible differences, such as which doctors or treatments are covered.
3. Entry into the industry is difficult, particularly because each state has a different set of insurance regulations (several books worth!). Just because you operate in Utah doesn't mean it is easy to expand into Arizona.
4. Information gathering is not so easy, particularly on exclusions.

So clearly it would be a stretch to consider health insurance to be a competitive market. And it shows. Insurers have not been pushed to create the right incentives for their customers (see previous posts on insurance), nor have they had much motivation to innovate. As a consequence, it is no surprise that health costs are high and satisfaction with insurance is mediocre. Most people feel the same about their cable company, an industry that shares some of these limits on competition.

That said, it would be wrong to say that insurers face no competition. Even if there is a single firm in a market, sometimes the would-be monopolist can be held in check just by the threat of challenger (some nice examples are found in this article by Steve Chapman). As evidence, profit margins in health care are roughly the same as in other industries. It is safe to say, though, that the market would benefit from greater competition.

So why not let loose the 800 pound gorilla?

I accept the premise that competition is good, and that health insurance is not sufficiently competitive. So why not let the government provide that competition?

Quite simply, the "public option" does not provide the competition described above. In fact, for most people (whose employers offer health insurance), it won't even be an alternative (at least, not at first).

Check the list. Does it solve the difficulty of comparing plans? Does one more alternative make for "many small sellers"? Does it make it easier for new competitors to enter? The answer on each is no. Instead, it lets one 800 pound gorilla loose into the market, with the power to smash competitors and no fiscal responsibility.

What is this really about?

The whole "competition argument" for the public option is really a red herring. That's not what the Democrats are after, and there's an easy way to see it. If Nancy Pelosi just wanted to provide more competition, she could easily start her own insurance company. She could even make it a non-profit, with any mission of her choosing: generous coverage, no limitations on pre-existing conditions, low premiums, cross-subsidization among policy holders.

But as a private venture, it would have to be self-sustaining. She would have to charge enough in premiums to at least break even with what she pays out in claims. If not, even George Soros wouldn't give her financial backing.

They want a government-sponsored insurance plan in order to have access to the tax coffers. They know full well that their ideal plan will not be self-sustaining, requiring heavy subsidies. It would never fly as a private enterprise — not even as a non-profit.

And that is the problem. The 800 pound gorilla has no chains; it can keep burning through cash indefinitely, making it capable of undermining any and every private insurer. For those who think "No, they would never let the public option bankrupt us," just look at Medicare. It is a fiscal disaster just around the corner, and yet no one has the political will to avert the train wreck. Once the public option is available, no matter how bad it is hemorrhaging, no politician will touch it.

To make matters worse, the proposed reform will assign the government to define what qualifies as mandatory coverage. Even though Obama says you can keep your insurance if you like it, that may not actually be true. If the bureaucrats decide that your plan has too high a deductible, or excludes the wrong conditions, they will threaten to take it off the list. Then, either your insurer will have to change your plan (making it more expensive), or your boss will switch insurers (or drop coverage), or you will have to pay the tax penalty to keep your plan. What Obama really means is that you can keep your insurance plan if we like it.

Combining the twin powers of endless subsidies and regulatory control, it doesn't take much imagination to see this undermining all private insurance. Indeed, Barney Frank and others have admitted that the public option is the path to a single payer system.

Real competition, please!

The aggravating thing is that there are policy changes that will promote real competition. The biggest single problem in the health insurance market is its special tax treatment. Anything you or your employer spend on an employer-sponsored insurance plan is not taxed. If, instead, you try to buy insurance outside of employment, you will be paying for it with after-tax income, making it 20 to 35% more expensive. As a result, almost no one shops for insurance beyond their employer. At best, any competition among insurers will cater to the employer, not the customer actually being insured, because the employer is the one choosing.

A simple change in tax code would eliminate this bias. This could be done in one of two ways: (1) make all insurance premiums (including self-paid) tax deductible. Currently, only the amount over 7% of your income can be deducted. (2) make all insurance premiums (including employer-paid) taxable. To keep tax burden roughly the same, one can simultaneously increase the standard deduction by the average insurance premium. (This was the McCain plan, by the way, and was supported by many Obama advisors until their campaign decided to attack McCain for "taxing health care.") Either way, an individual would be on equal footing to shop among any insurance company — and thus bring many insurers competing in your market.

A larger change would be to introduce an option to organize a private insurance firm under a federal charter. That is, create a set of federal regulations that would allow an insurer to operate in all 50 states, independent of state regulations. This will introduce more firms into any state, and will reduce the barriers to entry.

As part of that regulation, I advocate clear disclosure laws. An insurance contract is only meaningful if it can be readily understood. This includes keeping copays and coinsurance consistent across most procedures and clearly listing exclusions. Better information is necessary to unleash the power of competition.

Motivated by Profits ... AND Losses

Countless editorials and pundits in this debate have moaned that a profit-motivated health care system will obviously never act in the patients' best interests (even though these people seem to trust profit-motivated restaurants to deliver a reasonable meal, as I have previously written). Their complaint seems even more out-of-place when we consider that the majority of large health insurers are non-profit organizations (including my own insurer)!

But it is worth clarifying that concern for the bottom line is exactly what makes competition matter. If an insurer didn't care about making profits, why would he worry about losing customers to a competitor? It is only the threat of losing his income that keeps him trying to please his customers.

And this brings me to my final and very crucial point: capitalism is not just a profit-motivated system. It is a profit- and loss-motivated system. That is to say, losing money is just as important a motivator as earning profits — and maybe even more so! It's nice to get a little extra income, and that might keep someone working a little later into the evening or thinking harder of ways to innovate. But how much harder will they work when the life of their business hangs in the balance, when slacking off could result in losing all your invested effort!

In the big picture, profits and losses serve as a signal. If a firm is making unusually large profits, it will garner attention: others will start replicating their success. As they do, it tends to split up the market and drive down prices, until profits eventually return to normal.

By the same token, if a company is losing money, this also is a signal. The market is trying to say (as politely as possible) that they are doing a bad job. They are not delivering enough value to enough people to make it worth the cost of operating. Either they need to improve their product (make it more valuable), or produce it more efficiently (reduce its cost), or get out of the business.

(For a wonderful explanation and copious examples on this topic, see Chapter 6 of Thomas Sowell's Basic Economics.)

And this is precisely why we cannot allow congress to create a government-subsidized insurance plan. Whether we call it a public option or a co-op, if it is allowed access to general tax revenue, it will have no incentive to listen to the profit and loss signals. They won't have to please their customers, or deliver great value for the insurance premiums paid. Most of their enrollees will be there because they have no where else to turn (after their employer dropped insurance coverage).

But my real concern isn't lousy coverage from a public option. The real problem is that they will provide fabulous coverage, unreal coverage, the type of coverage you could only offer if money didn't matter. Insuring people for anything and everything, charging them next to nothing. Of course, they can only do that because of their backdoor access to tax revenue. No private insurer — not even non-profit insurers — can keep up with that. And that's exactly why the House of Representative's Progressive Caucus insists on a government-sponsored plan. The public option is not really meant to provide "healthy competition," and "may the best plan win." It's purpose to stack the deck against private choice, so that the public option will be the "last plan standing."