The Waxman-Markey “cap and trade” global warming bill passed by the House of Representatives on June 26 introduces what are essentially government price controls on energy, which currently 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, MA still impose rent controls, to the great detriment of their housing markets.
Still, at the present time the price-controlled sectors of the US economy represent no more than around 5% of Gross Domestic Product 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 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 tons 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 healthcare 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 from Medicare. 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 healthcare 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 the costs of insurance, state regulation and legal claims bureaucracies to the overall expense of healthcare to the US economy, this will maximize the percentage of the 16% of GDP absorbed by healthcare 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. 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 would no longer 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.
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(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)