Market Failures and Public Goods

A fairly succinct definition of “public good.” Also, a cheap shot against an easy target.

Market failure is not unrelated to the concept of public goods; in fact I would submit that market failure is the more fundamental principle. All public goods are market failures; not all market failures are public goods.

An economist might be less interested in the notion of public goods, which is a political issue, and quite a bit more interested in market failures, depending on why they fail.

Sometimes, markets are engineered to fail. Housing might be a good example. Inflation drives up the cost of housing. If the price of a house is substantially higher than the return on rent, you’re dealing with a speculative bubble, regardless of whether you intend to rent it to yourself, or someone else. If at the same time there are constraints on production — for example, due to zoning laws — you may well fail the market, by making housing unaffordable. The answer is, to not do that.

Healthcare, on the other hand, is fundamentally different. All of economics boils down to people making their own individual choices about what to buy, and at what price. The problem with healthcare is, people are not fundamentally equipped to make their own choices.

Ideally, if you get sick, you should take the evidence at hand — what happened, and how your body has changed in response to illness — determine a range of possibilities, along with a frequency distribution of those possibilities. Determine a range of moves, and determine your expectations given the range of possible conditions for every move. The right move should be apparent. Only problem is, you don’t have access to that information. You need to consult with a doctor to determine the differential diagnosis, and to understand the range of moves available. And it helps to have an insurance company to verify the doctor’s credentials, her track record, the track record of the system overall (“evidence based medicine”) and an overview of market prices. In other words, you have to deal with information asymmetry. Somebody else, other than you, has the information you need to make a decision.

Information asymmetry is a part of every marketplace. If you want to buy a car, ideally you want to understand what sort of technology is available, and if you’re smart, you’ll consult Kelly Blue Book to see what the market looks like. You don’t have to — you can buy a car just because you think it’s pretty, if you like — but you have access to that information on the internet, in a form you can understand, if you are inclined to go looking for it. Unfortunately, it’s just not practical to think you can get enough information on the internet to make life-and-death healthcare decisions rationally, if you are so inclined. It took me 12 years of education to get to that point, and inasmuch as it takes everybody else the same amount of time, I doubt it’s because I wasn’t the sharpest knife in the drawer. In healthcare, information asymmetry is overwhelming. To the point where many of us doubt that healthcare will ever have a functioning marketplace, for anything more sophisticated than what you could get in the average veterinarian’s practice.

The other problem with healthcare is variance. A discussion of cumulative risk of ruin is beyond the scope of this post; suffice to say, it’s kind of unlikely a single visit to the grocery store will leave you flat broke, or unable to pay the bill at all. Not much chance of getting a surprise bill for $200,000 at the grocery store cash register, but that sort of thing happens in health care all the time. Which means we have to pool our resources; we can’t just let each individual bear risk on their own. That strategy will fail every time. That much is a mathematical certainty.

OK, so healthcare isn’t a public good, it’s a market failure. But it is, arguably, an insoluble market failure. What then? Let it go? It’s not just that some people lose, if you do that. Everybody loses, because there won’t be a healthcare system (or “marketplace,” if you prefer) at all. To be clear, I question whether government can effectively play the role of insurer. Among other things, government has absolutely no way of knowing market prices; dictating prices is a recipe for failure, as I have discussed. But that’s not the same thing as saying, “the market will work itself out.” No, it won’t.

Leave a Reply