Economic principles and healthcare reform

On Thursday, May 4, 2017, the US House of Representatives passed a bill repealing major aspects of President Obama’s healthcare law (Obamacare), as reported (here) in the Wall Street Journal and other news outlets. The bill goes to the Senate for a vote. The bill ends mandates for people to carry health insurance and for companies to offer specific types of health coverage, among other things. Another Wall Street Journal article (here) states that backers of the bill “are betting that these changes will engender competition, draw healthier people into the insurance pool and cut premium prices overall.” Interesting, this is the same justification that backers of Obamacare gave when it was passed in 2010.

I know a thing or two about economics. There is nothing in economic theory or experience to suggest that anything in the old or new laws will necessarily increase competition or lower costs. Competition exists when there are many buyers and sellers in the market, where it is relatively easy for buyers and sellers to enter or exit the market, and where “all” sellers sell products or services that are similar enough so that it is relatively easy for buyers to comparison-shop for the best product at the best price. In this system, sellers have incentives to lower costs and prices and to increase quality in order to attract customers to their products. Companies that do this well are rewarded with profits; companies that don’t do this well go bankrupt. The incentive to lower costs and prices and to increase quality diminishes when it is difficult for buyers to compare products and services — that is, when it is costly for consumers to shop around, and when companies know it is costly for consumers to shop around — and when it is difficult for potential sellers to enter markets — that is, when there are barriers to market entry. The health care system is rife with problems of comparison shopping and market barriers. That is, the health care system is not a great model of markets and competition, and it won’t be anytime soon.

The root cause of the problem with contemporary health care is the thing Americans like most about it. We pay a monthly fee for health insurance. Then when we get sick or need health care services, we might pay a nominal fee (e.g., $20) in return for health services, while most of the cost of care is paid by insurance companies whose revenue comes from the thousands of patrons paying the monthly fee. Once we have health insurance, we have no incentive to shop for the best healthcare product at the best price, but rather the best healthcare product at any price, because the primary cost of service is paid by the insurance company. The insurance company does not have a strong incentive to induce health care providers to lower costs because the company can pass costs on to patrons.

Even when individuals want to know the cost of a particular medical procedure or service, it is nearly impossible for them to get a straight answer. “How much will the physical therapy cost?” I once asked a clerk at the reception desk? “I don’t know. It depends on the contract your insurance company has with us,” was the reply. “What is your normal rate, and what discount does my insurance company offer on that rate?” I asked. “I don’t know what our main charge is. Your discount will depend on your co-pay and co-insurance.” The conversation never got any better. Only after I got the bill did I learn what the cost of the service was.

Transparency in pricing for medical care will help here. Giving individuals an incentive to price-comparison shop will help, too. Health savings accounts can do this. Recently I have been scrutinizing our health insurance bills because we have a health savings account. It’s time consuming because there are so many individual charges, most of which I do no understand. In one instance we received a bill for a doctor’s visit on a day we could prove no one in our family was at the clinic. If I was not paying out of a health savings account I would not have thought twice about questioning the bill. The insurance company would have paid it. But I did question the charge and was able to get it removed.

I understand the health care system is very complex. But economic principles are not.

Corruption, 2016

Transparency International is a non-governmental organization, headquartered in Berlin, with a mission to document and root out public corruption worldwide. The organization defines corruption as “the abuse of entrusted power for private gain. It can be classified as grand, petty and political, depending on the amounts of money lost and the sector where it occurs.”

For more than two decades Transparency International has produced an annual Corruption Perceptions Index. The most recent edition of the index (here) ranks 176 countries from the least corrupt to the most corrupt. The index ranges from a scale of 0 to 100, “where a 0 equals the highest level of perceived corruption and 100 equals the lowest level of perceived corruption.” The Index  “aggregates data from a number of different sources that provide perceptions of business people and country experts of the level of corruption in the public sector.”

CPI2016_Map_web

The least corrupt countries are Denmark, New Zealand, Finland and Sweden. They always stay at the top of the list. The most corrupt countries are Syria, North Korea, South Sudan and Somalia. Denmark’s score is 90 while Somalia’s is 10. The United States is number 18 on the list, with a score of 74, below Canada, Germany and the UK. That’s alarming. Not that the US is below other countries but that the US is more than halfway to the midpoint of the CPI scale (Slovakia and Croatia have scores of 51 and 49 respectively).

Corruption matters because it erodes public trust in government and business, and trust is very important for promoting economic growth and well-being. For example, note the following figure I produced showing the correlation between corruption and per capita gross domestic product. Of course, correlation does not mean causation. And we can debate whether corruption produces low growth or whether low growth invites corruption, but the correlation is stark. Highly corrupt countries are very poor. Moreover, for every 10 point improvement in a country’s perceived corruption, GDP per capita increases by more than $7,000 (that’s what the equation in the figure shows).

CPI-GDP2016

Transparency International also draws a connection between corruption and social inequality. As noted on their website (here): “it’s timely to look at the links between populism, socio-economic malaise and the anti-corruption agenda. Indeed, [US President] Trump and many other populist leaders regularly make a connection between a ‘corrupt elite’  interested only in enriching themselves and their (rich) supporters and the marginalisation of ‘working people’. Is there evidence to back this up? Yes. Corruption and social inequality are indeed closely related and provide a source for popular discontent. Yet, the track record of populist leaders in tackling this problem is dismal; they use the corruption-inequality message to drum up support but have no intention of tackling the problem seriously.”

In other words, we preach virtues but don’t practice them ourselves.

Which reminds me. After discussing these ideas in my applied ethics class I suggested that students can obtain an automatic A in the class if they leave me a $100 bill with their name written on it in pencil. Some students laughed while others wanted to negotiate the price. Apparently they didn’t learn anything.

It’s best to be far on the right side of the line, not close to it

I am reading Maureen O’Hara‘s book, Something for Nothing: Arbitrage and ethics on Wall Street. Professor O’Hara is a financial economist at Cornell University. In her book she explains how modern finance works and what led to many of the contemporary ethical scandals of Wall Street. I’ll probably have more to say about the book after I finish it, but I enjoyed this tidbit:

Some people want to stay as close to the legal line as possible, while remaining on the “right” side of that line. However, Professor O’Hara says, “laws reflect moral standards, and over time the laws change to reflect what is acceptable to society. … But that also highlights why a strategy of being exactly on the line of legality is a poor business practice; when the lines shift, you go from being a weasel to being a felon, even when you have done nothing differently.”

Adopting an ethical standard is a higher one than merely following the letter of the law. So being on the right side of the ethical line, even close to it, can keep you from falling into the “weasel” category. But adopting a strategy of staying close to the ethical line can cause problems. There are differing ethical perspectives, and these don’t always agree or even provide clear-cut answers. Therefore, if you really want to follow a strategy of ethical conduct, it is best to stay as far away from the ethical line as possible–if there really is such a thing as an ethical line anyway.

When is an increase in price fair?

In my previous post I wrote about the fairness of drug companies that dramatically increase the price of their products. I suggested, and public reaction confirmed, that these price increases are considered unfair.

When is a price increase fair? When is it unfair?

The economic principle of profit maximization tells us that firms ought to increase prices when there is an increase in demand or a decrease in supply, regardless of whether the change is short-term or permanent. So if a hurricane is closing in on the East coast of the U.S., then suppliers of lumber, bottled water, gasoline and other supplies that people will need should and will increase the prices of these things … a lot. But is that fair?

Daniel Kahneman, Jack L. Knetsch and Richard Thaler published a paper on this topic 30 years ago in the American Economic Review. They argued that people’s perceptions of fairness will (or ought to) constrain impulses to take advantage of short-run increases in demand or other reasons to increase prices, under certain conditions.

Their discussion entails two elements. One has to do with reference points and the other has to do with reasons for gaining at the expense of others.

First, a reference point is the basis upon which people create expectations about the fairness of a transaction or a change in prices. If transactions or price changes are consistent with the reference point, then people will judge the transactions or price changes as fair. In other words, reference transactions and reference profits are considered fair. If there is a deviation from the reference point, then assessments of fairness will be made based on whether good reasons exist for the deviations.

The authors define the reference points as follows:

Market prices, posted prices, and the history of previous transactions between a firm and a transactor can serve as reference transactions. When there is a history of similar transaction between firm and transactor, the most recent price, wage, or rent will be adopted for reference unless the terms of the previous transaction were explicitly temporary. For new transactions, prevailing competitive prices or wages provide the natural reference.

For example, if a gas station has been selling gas for $1.99 a gallon for several weeks, then the reference price is $1.99 a gallon, and people will expect that to be the price the next time they get gas. If the price of gasoline increases, say to $2.09 a gallon, then people will likely consider the price increase unfair unless they understand there to be a good reason for the change. Good reasons have reference points, too. For example, raising prices at the expected rate of inflation is not considered unfair, since inflation-based price increases can be a reference point. We have historical experience with that, so there is no basis for claiming unfairness. The same about price changes in gasoline. If the reference point for price changes is 5 cents a gallon, then people won’t be bothered by finding the price of gasoline is higher by 5 cents the next time they buy gas. But if prices increase by more than 5 cents, then they might believe or expect something unfair is happening at their expense.

Understanding reference points for transactions, pricing and profits can help us understand why unfairness might be claimed when businesses increase prices. For example, if employees had previous experiences of getting pay increases when competitors raised their employees’ wages, then a reference point is created for employees. But if the employer has not historically increased wages when their competitors have, then the reference point for the employer will differ from that of the employees, resulting in disagreements about fairness.

Second, an important principle of fairness is that one should not gain by imposing a cost or harm on others.

Raising the price of lumber, bottled water, gasoline and other supplies that people will need when a hurricane is imminent can be considered imposing a harm on others to acquire a short-term gain. It doesn’t matter that economics dictates that price increases are needed to resolve shortages that will arise when there is a sudden increase in demand. There is usually no viable reference point for such behavior.

Raising prices because a business experiences an increase in costs is different. Such behavior is not considered as imposing a harm on others merely to benefit at their expense. Businesses are not gaining substantially, if at all, when they increase prices to cover their rising costs.

The implication is that people are willing to accept as fair an increase in price to cover rising costs. They also consider it fair for businesses to maintain prices when costs decline. But people consider raising prices when demand increases or without explanation or justification to be unfair.

Most people have no reference point for drug prices rising 5000 percent or even 500 percent. Such behavior is very unfair.

Business leadership and the making and punishing of unethical employees

A study published in the current issue of Business Ethics Quarterly links ethical leadership with improved engagement of employees at work, greater employee voice and lower intentions for employees to exit. In other works, when employees perceive or know their leaders to be ethical, they are more likely to feel good about being at work, more willing to communicate their opinions, recommendation, concerns or ideas to their supervisors, and less likely to leave or intend to the leave the business.

In this context, an ethical leader is someone who is a moral person and who models high moral standards at work. The specific indicators of ethical leadership used in the BEQ paper draw from research by scholars at Pennsylvania State University. If valid, the indicators are informative. There are 10 of them. Ethical leaders

  • conduct their personal lives in an ethical manner
  • make fair and balanced decisions
  • can be trusted
  • ask what the right is when making decisions
  • listen to their employees
  • discuss business ethics and values with their employees
  • have the best interest of their employees in mind
  • set an example of behaving ethically at work
  • discipline employees who violate ethical standards
  • define success by the way results are obtained in addition to results.

I would add one more item to the list. When designing and implementing performance measures and incentives, ethical leaders are careful to ensure that they are promoting incentives rather than pressures to perform. The line between incentive and pressure can be thin. Leaders who are not careful may find that their efforts to motivate workers create pressures for them to lie, cheat or steal.

The CEO of Wells Fargo is learning this lesson the hard way. According to the Wall Street Journal’s report of John Stumpf’s testimony during a Senate Banking Committee hearing yesterday (September 21), the Bank is accused “of fostering a culture where low-paid branch employees were pressured to meet impossible sales quotas to keep their jobs, and so signed up customers for products without their knowledge.” Pressure does not create an environment where employees behave ethically. Even well-meaning employees may find the temptation to fudge numbers or behave inappropriately too strong in such an environment. The Bank reported that it fired more than 5,000 employees for wrongdoing.

So, Wells Fargo created unethical employees and then punished them.

Reminds me of the statement by Thomas More in his book, Utopia, made famous by Drew Barrymore’s character Danielle (aka Cinderella) in the movie Ever After. Danielle is arguing with Henry, the Prince of France, for the release of her servant, who is bound with other poor and destitute prisoners for the America’s. Here is the exchange:

Danielle: A servant is not a thief, your Highness, and those who are cannot help themselves.

Henry: Really! Well then by all means, enlighten us.

Danielle (quoting More): If you suffer your people to be ill-educated, and their manners corrupted from infancy, and then punish them for those crimes to which their first education disposed them, what else is to be concluded, sire, but that you first make thieves and then punish them?

Henry: Well, there you have it. Release him.

That’s quite a commentary about one of the nation’s most prominent banks.

Potash peril

Potash refers to a variety of compounds that contain potassium. Plants require potassium (chemical label is K) for their development, along with Nitrogen (N) and Phosphorus (P). These three chemicals are the key ingredients of fertilizers and are thus widely used in plant agriculture.

The largest potash producer in the world in terms of production capacity and market value is Potash Corporation of Canada. It has a market value of roughly $14 billion and controls 15 percent of global production and 19 percent of production capacity, according to the company’s website. There are larger companies in minerals and mining (e.g., the UK’s Rio Tinto Group), but none dominates potash production like Potash Corp.

The Wall Street Journal reports today that Potash Corp is merging with Agrium, also a Canadian fertilizer company, the combination of which will be a company with $21 billion in annual revenue and controlling 23 percent of global potash production capacity but 60 percent of capacity in North America. The two companies justify the merger as we might expect–stabilizing prices, lowering production costs, accessing other markets, etc.

Now, if US farmers want to buy fertilizer, they will likely have to get if from the combined company. Farmers are concerned, as they should be. According to the WSJ, “The deal likely would sow further unease among North American farmers wary of reduced competition and higher prices as top seed and pesticide developers pursue their own tie-ups. Already grappling with a three-year slide in major crop prices, some farmers are concerned that mergers between some of the world’s largest farm-supply companies will consolidate pricing power among fewer players and lead to higher costs at a time when farmers are scrimping to eke out profits.”

Efficiency is good, as are lower costs. But as I noted in a previous post, so is choice. Where do we draw the line when struggling with efficiency versus choice? Will the combined company pass on the cost savings to farmers by lowering prices of fertilizer? I hope so. But then I hope for $100 bills to rain on my home, too.