Post-Keynesian Observations

Understanding the Macroeconomy

Health-Care Economics: Part Two

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Market Structures and Competition

I’m going to try to make this one fast today as I have a paper I’d like to finish by Friday (but probably won’t). To reiterate yesterday’s points, the market is a tool. Under some circumstances, it is the ideal means of solving social problems. Under others, it’s not. If we actually want to devise effective solutions, it is necessary to focus on the merits of the specific situation. This is particularly the case because the popular notion that markets equal freedom of choice is false. This is true only under specific circumstances (i.e., lots of competition–even then, there are other caveats, but I’ll get to some of those later), and firms will obviously try very hard to change those circumstances since it means more profit for them. The goal of policy is to make that impossible, something that can become very difficult when those firms enter the political debate and try to equate their freedom to act as they wish with the beauties of free-market capitalism. Tricky (though, to be honest, I’m not sure that some of them don’t truly believe it because it’s handy to think that what makes you rich is also fair)! The bottom line is that both governments and business can exploit us. The key to preventing this is creating a means by which they are held accountable. Making business accountable by using the market system is no more fool proof than making government accountable via the voting booth–probably much less so.

What I thought I might do this morning is have a quick look at a couple of specific industries (including health care) in the context of the four conditions for competition (again, there are more than four, but I decided to focus on these) I mentioned these yesterday: many sellers, easy entry, homogeneous products, and plentiful and accurate information for the buyer and seller. Note that no industry is going to fit all these perfectly, and even if we find a major exception that does not imply, “Oh, then the government should do it.” It’s more complicated than that. It may just mean that we need to tweak the market, have a mostly government solution with some market-type features, or go all government. It requires hard thinking and analysis and there are no easy solutions, but it starts with a study of how the industry works with respect to certain guidelines.

Restaurants

Many Sellers: According to http://www.restaurant.org/research/facts/, there are 945,000 restaurants in the US. That means that for every 320 people in the US, there is one restaurant. That certainly seems like “many,” but that’s not enough information. Market share is a better guide, because what if 90% of the sales are all concentrated in one location (not likely!) or chain? Then “many” really isn’t satisfied. A common means of checking this is the 4-firm concentration ratio, or the percentage of sales dominated by the top four firms. The rule of thumb is that if this is below 40%, it’s competitive. Above that, you start to take a second look (though you don’t necessarily do anything). In 2002 (census data: http://www.census.gov/epcd/www/concentration.html), the top four full-service restaurants were responsible for 8.6% of all sales. Pretty small. The worst I could find was for cafeterias, buffets, and grill buffets, which was 39.2%, and they wouldn’t release the data for coffee shops on the principle that it would give away the stats for one particular company (I’m guessing I know which one!). But otherwise, I think it’s very safe to say that there are many, many restaurants (and hotels, too, incidentally–those data are grouped together). And don’t forget another major source of competition for restaurants: eating at home. PASSED.

Easy Entry: It’s a little tougher to just cite a stat for this. The data above certainly suggest it’s easy, and I suspect that it’s an obvious and common choice for the budding entrepreneur. In the interest of getting back to that paper I need to finish, I hope you don’t mind if I just assume it’s relatively easy as businesses go. PASSED.

Homogeneous Products: Always with this one the problem is going to be how specifically you define the product. If you say, “food,” then all restaurants sell exactly the same thing. If you say, “hamburgers,” then McDonald’s, Wendy’s, and Burger King are all the same, but different from Taco Bell. An additional problem with the restaurant industry is that variety is exactly what consumers want. I don’t have any evidence of this, but I would strongly suspect that consumers would much prefer to pay higher prices in exchange for the ability to make a choice among various methods of food preparation and presentation. And the many-sellers is really more important to making sure there is competition. QUESTIONABLE, BUT REASONABLE.

Plentiful and Accurate Information for the Buyer and Seller: Food is relatively cheap, so restaurants do not have to do a background check on customers before they seat them. Everything the seller needs to know can probably be established by seeing how the client is dressed and groomed. If a homeless person wanders into a fancy restaurant, it will be fairly obvious and they’ll be escorted out. With respect to consumers, they will want to know the price and exactly what they are getting. The former will be clearly indicated on the menu (usually!) and while the latter may not be exactly clear, the transaction is relatively inexpensive and therefore not only is the cost of an error small, but it will likely be repeated many times so that the consumer gains experience with the product. In addition, there is not a significant time lag between ordering and seeing what you get (it isn’t a year later and you say, “but I thought I got fries with this?”). One thing consumers don’t know is how the food was prepared and various perishables were stored. Since doing so poorly can cause illness and even death, the government regulates what goes on in the kitchen. If every consumer were an expert in hygiene and insisted on a kitchen tour before ordering, this would not be necessary. But, they aren’t and they don’t, so we have inspectors. PASSED.

Conclusion: Thus, the restaurant industry seems to be pretty dang competitive. Let’s let the market handle that. There is no need for the government to start its own chain of hamburger stands: “We hold these truths to be self-evident: that all meals are tasty at Honest Abe’s Burger Cabin!”

Retail Trade

This is a huge industry, including both store and non-store businesses. Here are the Census definitions:

Store retailers operate fixed point-of-sale locations, located and designed to attract a high volume of walk-in customers. In general, retail stores have extensive displays of merchandise and use mass-media advertising to attract customers. They typically sell merchandise to the general public for personal or household consumption, but some also serve business and institutional clients. These include establishments, such as office supply stores, computer and software stores, building materials dealers, plumbing supply stores, and electrical supply stores. Catalog showrooms, gasoline service stations, automotive dealers, and mobile home dealers are treated as store retailers.

Nonstore retailers, like store retailers, are organized to serve the general public, but their retailing methods differ. The establishments of this subsector reach customers and market merchandise with methods, such as the broadcasting of “infomercials,” the broadcasting and publishing of direct-response advertising, the publishing of paper and electronic catalogs, door-to-door solicitation, in-home demonstration, selling from portable stalls (street vendors, except food), and distribution through vending machines. Establishments engaged in the direct sale (nonstore) of products, such as home heating oil dealers and home delivery newspaper routes are included here.

TONS of stuff! How competitive? Let’s see…

Many Sellers: In 2002, there were 1.1 million establishments and the 4-firm concentration ratio was 11%. There are certainly sectors that are highly concentrated: “Appliance, television, and other electronics stores” (BestBuy?) came in at 53.6% and “Home centers” (like Home Depot and Lowe’s, I guess) are 91.1%. But, a) some of the stuff you can buy there you can get at one of the other, more competitive, retailers, and b) in general, retail trade has very low concentration ratios. PASSED.

Easy Entry: Again, I’m going to go the easy route and assume that this is relatively easy or we wouldn’t have so many of them. PASSED.

Homogeneous Products: Product definition is again the key. Obviously, there is a huge difference between a toaster and a distributor cap. It’s worth considering here, however, that the same toaster may be available from more than one retailer, and that’s important to making it competitive. Also, as with restaurants, consumers want some variety here. So I’ll give it the same grade as I did above and with the same caveats. QUESTIONABLE, BUT REASONABLE.

Plentiful and Accurate Information for the Buyer and Seller: This is going to vary a lot by product. For the seller, they need to know if you can afford it, which will be determined at the cash register for some transactions, when you apply for credit with big-ticket items, and over the course of your payments if you pass that last test (of course, at that stage you may be the bank’s problem and not the store’s). Consumers may try to hide details from the buyer, though that is becoming increasingly difficult. Hiding things from the consumer is much easier, and can be done at various stages of the process (product features, extended warranties, service plans, financing arrangements, etc.). The situation is not ideal and the question becomes now much regulation is necessary to bring about something closer to the competitive outcome (note here the implication that government involvement in the free market may be necessary to create the competition and therefore accountability that doesn’t otherwise exist). We have various truth in advertising laws and it is now much more difficult than it once was to confuse the consumer with various financing plans. But, for the most part here we follow caveat emptor: either do some research on the internet before you go to the store, or suffer the consequences! It is not entirely evident that there is anything more that the government could do, anyway, and, again, “many sellers” really helps keep firms more honest here. PASSED FOR MOST GOODS AND SERVICES, NOT FOR OTHERS..

Conclusion: Again, a pretty competitive industry. No need to open a branch of Ronald Reagan’s “Tear This Wall Down–And Then Build It Back Up!” Home Supply Store.

Health Insurance

Finally, the payoff for all your had work reading through the other junk! You should be getting a working idea now of how looking at markets for competitive forces works. We want accountability, not markets, and in markets accountability generally results from competition. How’s it look in health insurance (spoiler: not good!)?

Many Sellers: In 2002, there were 4, 415 “Direct health and medical insurance carriers” and the 4-firm concentration ratio was 23.5%. So far, so good! Unfortunately, that tends to overstate the number of firms that actually offer the services we have in mind, plus there have been numerous mergers since then (see http://www.fas.org/sgp/crs/misc/R40834.pdf). The American Medical Association, whose data come out more frequently than the census and hence have something for us since 2002, say that health insurance is highly concentrated. The ad for their 2009 document (I can’t get it because I either have to be a member of the AMA or spend $150!) reads in part:

Market shares and concentration (HHI) measures are presented for 313 metropolitan areas (MSAs) and 43 states. This study finds that virtually all health insurance markets are highly concentrated. In 92 percent of the MSAs examined, one or more insurers had a share of 30 percent or greater, while 54 percent of the MSAs had an insurer with a share of at least 50 percent. These findings indicate proposed mergers and acquisitions ought to be seriously questioned by the public. And they should prompt federal and state policymakers and the antitrust agencies to seriously scrutinize such consolidation as it can adversely affect consumers and providers of care. Source: https://catalog.ama-assn.org/Catalog/product/product_detail.jsp?productId=prod1590006

These are just for one or two firms, not the four we were using above. It’s a highly concentrated industry, so much so that the relatively conservative AMA has been waiving a red flag about it for years. FAILED.

Easy Entry: Again taking the easy way out (particularly since this has taken me 2.5 hours so far and I”m not done!), if there aren’t many folks in it, entry must not be terribly easy. FAILED.

Homogeneous Products: Well, I don’t know. I guess not since plans vary so much, but then does that mean you have the greater choice that consumers might prefer? It would if you really had a choice, but according to the AMA you don’t, and you’re mostly stuck with that which your employer offers, anyway. I think I can make a case for this being bad, but I’ll leave it undecided so as not to bias the argument. UNDECIDED.

Plentiful and Accurate Information for the Buyer and Seller: This one is a big mess. First off, it really matters to the seller what sort of bundle of pre-existing conditions you represent. Because they are private sector, they need to make a profit. That means 1) selling primarily to healthy people (i.e., folks that will pay in but not make claims) and 2) denying claims whenever possible. I know this makes them sound like bad people, but they have a business to run and families to feed (and CEOs to shower with diamonds–sorry, got carried away). Of course, that’s what they are going to try to do, and that means they need lots of info on you. On the other side of the bargain, customers will want to know the price and exactly what they are getting for that price. For routine procedures and office visits, that’s fairly, if not completely, clear. For anything more complicated (i.e., more expensive), however, it’s not. Typically, insurance companies will delay giving any specific information (and what they do and don’t cover may change after you have purchased the insurance and after you’ve had the procedure), may return claims numerous times for sometimes trivial technicalities, and then make various adjustments after the fact. Consumers (those that can afford it), lacking much choice (as indicated under “many sellers”), turn in the claim and hope for the best. It’s a bit like now knowing how much you dinner will really cost until after you have ordered and eaten it. Information is a terrible problem in health insurance, for both sides, but particularly for the consumer. The insurer knows you don’t have a choice because there is very little competition. FAILED.

Conclusions

(I may still get this sucker written in under three hours, but it’s getting close! UPDATE: with revisions, closer to four hours, dammit.) Restaurants and retail trade are very competitive industries in which the characteristics match closely what we would want if the free market is to guarantee what we’re really after: accountability. Where they vary, it is not evident that either consumers would want it any differently or that there would be anything useful additional regulation could accomplish. With health care, however, there are very few firms, difficult entry, some variety of products but a lack of realistic ability to choose among them, and information problems aplenty, particularly for the consumer. What does this mean for policy? A couple of regulations here and there, a breakup of the big firms, or government run health care? To answer those questions, more analysis is necessary and will be forthcoming in later installments. But, for now, those who believe that any form of government intervention represents an infringement on their freedom need to understand, you ain’t free now. We’ve got markets, but we don’t competition and accountability. Even those of us who can afford it are getting screwed.

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Written by rommeldak

March 25, 2010 at 10:33 am

Posted in Uncategorized

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2 Responses

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  1. Hi John:

    I’m going to assign your posts on the market vs gov’t control to my macro class. Well done!

    Mike Radz

    Mike Radzicki

    March 25, 2010 at 2:21 pm

    • Haha! Thanks, Mike. I’m sitting here, revising an SD model of Keynes chapter 22 (much more sophisticated than the one I did for the JEI years ago). I sent it to SD Review as my goal is to REALLY learn this stuff properly. But it was sent back right away for me to correct some errors. This is painful, but I think I’m working it out! Just got done correcting all my dimensional errors!

      rommeldak

      March 25, 2010 at 2:27 pm


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