Cochrane on Aca’s Unravelling: Parallels to Electricity

John Cochrane’s commentary in last Thursday’s Wall Street Journal, What To Do When Obamacare Unravels, provides a strong and thoughtful analysis of what a free health care market could look like. In his argument he accomplishes two important tasks: he lays out the extent to which the U.S. health care market is not a free market, and he offers some design principles for a set of market rules and regulatory institutions that would enable competition to flourish and improve consumer welfare:

There is an alternative. A much freer market in health care and health insurance can work, can deliver high quality, technically innovative care at much lower cost, and solve the pathologies of the pre-existing system.

The U.S. health-care market is dysfunctional. Obscure prices and $500 Band-Aids are legendary. The reason is simple: Health care and health insurance are strongly protected from competition. There are explicit barriers to entry, for example the laws in many states that require a “certificate of need” before one can build a new hospital. Regulatory compliance costs, approvals, nonprofit status, restrictions on foreign doctors and nurses, limits on medical residencies, and many more barriers keep prices up and competitors out. Hospitals whose main clients are uncompetitive insurers and the government cannot innovate and provide efficient cash service. …

That the rest of the world spends less just shows how dysfunctional our current system is, not how a free market would work.

I encourage you to read his whole argument and think about it in the context of health care, if you haven’t already. But what really struck me while reading it was the relevance of his logic and his general market design principles to electricity. If you, as I did, reread his argument replacing “health care” with “electricity”, you will see parallels.

Long-standing legal entry barriers, erected decades ago as a regulatory corrective against putative market failure, reinforced and perpetuated by the material interests and political power of the groups that have benefited from the regulation (hospitals and insurance companies in health care, regulated utilities in electricity). Beliefs that the market in question is somehow unique, or at least different from other markets because the services in question are considered to be so essential to human well-being and to our living standards. Conviction, especially among policy makers, that the main way to meet the “public interest” is through control rather than choice, and that as political elites they are the right people to make decisions on behalf of those individual consumers whom they have deprived of making their own choices. These parallels mean that much of Cochrane’s critique is as relevant to electricity as it is to health care.

A final parallel makes this point obvious: the challenge of innovation and technological change to those established interests and their ideas about the public interest and business models in these markets. In both health care and electricity, innovation holds great promise for improving consumer well-being at lower costs, but attempts to create or implement innovation within each industry have been … fraught. In health care new technologies have enabled new treatments, but at a paradoxically high cost due to the lack of competition that Cochrane observes. In electricity new technologies have been concentrated in transmission and distribution operations. In both cases technology’s role and use have resulted from top-down regulatory determinations, not from bottom-up choices based on individual value. Economies of scale and information asymmetries may still make such organic, decentralized choices difficult, but information technology has lessened these asymmetries while other technological changes have reduced economies of scale. In fact, in both industries regulations have reinforced economies of scale that would otherwise have eroded.

Both markets also suffer from the Bastiat problem: the seen benefits of the control approach are much more salient than the unseen benefits of the choice approach in each case. In each case the threat of costly disorder (illness and death, electricity outages) is more salient than the benefits of more individual choice.

Cochrane observes that

Only deregulation can unleash competition. And only disruptive competition, where new businesses drive out old ones, will bring efficiency, lower costs and innovation.

His observation is just as true in electricity as in health care, and in electricity new businesses cannot drive out old ones in most retail markets and many wholesale markets. The sad and pathetic irony is that using the tools of regulatory control to attempt to achieve the desired outcomes of efficiency, lower cost, and innovation in each case will in fact achieve the opposite, by slowing down or stifling innovation and learning-by-doing on the part of consumers as well as producers.

Market processes and liberalization face significant political headwinds in both cases:

While economically straightforward, liberalization is always politically hard. Innovation and cost reduction require new businesses to displace familiar, well-connected incumbents. Protected businesses spawn “good jobs” for protected workers, dues for their unions, easy lives for their managers, political support for their regulators and politicians, and cushy jobs for health-policy wonks. Protection from competition allows private insurance to cross-subsidize Medicare, Medicaid, and emergency rooms.

But it can happen. The first step is, the American public must understand that there is an alternative. Stand up and demand it.

As we look forward into 2014 while reflecting on the experience of 2013, the failure of control, regulation, and political processes to achieve their stated objectives is increasingly palpable for more and more people. Control and politics cannot achieve these objectives, in either health care or electricity.