Posts tagged ‘price signals’

Why Do We Manage Water Via Command and Control? And Is It Any Surprise We Are Constantly Having Shortages?

In most commodities that we consume,  market price signals serve to match supply and demand. When supplies are short, rising prices send producers looking for new supplies and consumers to considering conservation measures.  All without any top-down intervention by the state.  All without any coercion or tax money.

But for some reason water is managed differently.  Water prices never rise and fall with shortages -- we have been told in Phoenix for years that Lake Powell levels are dropping due to our water use but our water prices never change.  Further, water has become a political football, such that favored uses (farmers historically, but more recently environmental uses such as fish spawning) get deep subsidies.  You should see the water-intensive crops that are grown in the desert around Phoenix, all thanks to subsidized water to a favored constituency.   As a result, consumers use far more water than they might in any given year, and have no natural incentive to conserve when water becomes particularly dear, as it is in California.

So, when water is short, rather than relying on the market, politicians step in with command and control steps.  This is from an email I just received from state senator Fran Pavley in CA:

Senator Pavley said the state should consider measures that automatically take effect when a drought is declared to facilitate a more coordinated statewide response.

“We need a cohesive plan around the state that recognizes the problem,” Pavley said at a committee hearing. “It’s a shared responsibility no matter where you live, whether you are an urban user or an agricultural user.”

Measures could include mandatory conservation, compensation for farmers to fallow land, restrictions on the use of potable water for hydraulic fracturing (“fracking”), coordinated publicity campaigns for conservation, increased groundwater management, and incentives for residents to conserve water. Senator Pavley noted that her hometown Las Virgenes Municipal Water District is offering rebates for customers who remove lawns, install rain barrels or take other actions to conserve water.

Pavley also called for the state to create more reliable, sustainable supplies through strategies such as capturing and re-using stormwater and dry weather runoff, increasing the use of recycled water and cleaning up polluted groundwater basins.

Note the command and control on both sides of the equation, using taxpayer resources for new supply projects and using government coercion to manage demand.  Also, for bonus points, notice the Senator's use of the water shortage as an excuse to single out and punish private activity (fracking) she does not like.

All of this goes to show exactly why the government does not want a free market in water and would like to kill the free market in everything else:  because it gives them so much power.  Look at Ms. Pavley, and how much power she is grabbing for herself with the water shortage as an excuse.  Yesterday she was likely a legislative nobody.  Today she is proposing massive infrastrure spending and taking onto herself the power to pick winners and losers (farmers, I will pay you not to use water; frackers, you just have to shut down).  All the winners will show their gratitude next election cycle.  And all the losers will be encouraged to pay protection money so that next time around, they won't be the chosen victims.

Health Care Prices Are Not Actually Real Prices

Good stuff from Peter Suderman at Reason

 In March, journalist Steven Brill published a lengthy piece in Time magazine on high medical bills, comparing hospital “chargemaster” rates—the listed prices—to the rates paid by Medicare. And over the weekend, Elisabeth Rosenthal compared U.S. prices for a variety of health services to the lower prices paid by other countries.

Both pieces offer essentially the same thesis: The U.S. spends too much on health care because the prices Americans pay for health care services are too high. And both implicitly nod toward more aggressive regulation of medical prices as a solution.

Part of the reason these pieces get so much attention is that most Americans don’t actually know much of anything at all about the prices they pay for health services. That’s because Americans don’t pay those prices themselves. Instead, they pay subsidized premiums for insurance provided through their employers, or they pay taxes and get Medicare or Medicaid. Even people who purchase unsubsidized insurance on the individual market don’t know much about the particular prices for specific health services. They may open their wallets for copays to health providers, or cover some expenses up to a certain annual amount, but in many if not most cases they are not paying a full, listed price out of pocket.

What that means is that, in an important sense, the “prices” for health care services in America are not really prices at all. A better way to label them might be reimbursements—planned by Medicare bureaucrats and powerful physician advisory groups, negotiated by insurers who keep a watchful eye on the prices that Medicare charges, and only very occasionally paid by individuals, few of whom are shopping based on price and service quality, and a handful of whom are ultra-wealthy foreigners charged fantastic rates because they can afford it.

This is the real problem with health care pricing in the U.S.: not the lack of sufficiently aggressive price controls, but the lack of meaningful price signals.

Much more at the link.  If they really want an interesting comparison, compare the prices of medical care not covered by insurance (actually pre-paid medical plans) in the US, and those that are -- e.g. for plastic surgery vs. other out-patient surgeries.

Medicare Taxes are Too Low

If Medicare is really an insurance program, than as I wrote last week, the premiums are absurdly low.  And this isn't even a rich-poor transfer issue - the premiums are too low for everyone.  See the bar chart about halfway down on this page at the NY Times.  Here is a screenshot:

Take Social Security first.  Taxes come fairly close to covering benefits, with some rich-poor redistribution.  These numbers look sensible (leaving aside implied annual returns on investment and whether the government should be running a forced retirement program at all) -- the main reason social security is bankrupts is that in the years when premiums exceeded benefits, Congress raided and spent the funds on unrelated things.

Medicare, though, is a huge problem.  Even for high income folks, premiums cover only 43% of the expected benefits (I am not sure how they treat present values and such, but again lets leave that aside, I don't think it affects the underlying point).  Assuming we end up with some rich-poor transfer, it looks to me that premiums are low by a factor of three.

Everyone seems to think Medicare is a great deal.  Of course it feels that way -- premiums are only covering a third of the costs.  There is no way we can have intelligent debate on these programs when the price signals are corrupted.  Its time to triple Medicare premiums.

 

Weird -- Someone Should Develop A Theory on This

Strangely enough, it turns out that increased prices seem to induce market participants to seek out and invest in new sources of supply.   Someone should develop a theory around this.

From a good article in today's New York Times: 2009 is turning out to be a bumper year for new oil discoveries; new oil discoveries always occur, but this year has been unusually fruitful. This quote from the article illustrates the important dynamic intertemporal incentives that price signals provide:

These discoveries, spanning five continents, are the result of hefty investments that began earlier in the decade when oil prices rose, and of new technologies that allow explorers to drill at greater depths and break tougher rocks.

"That's the wonderful thing about price signals in a free market "” it puts people in a better position to take more exploration risk," said James T. Hackett, chairman and chief executive of Anadarko Petroleum.

More than 200 discoveries have been reported so far this year in dozens of countries, including northern Iraq's Kurdish region, Australia, Israel, Iran, Brazil, Norway, Ghana and Russia. They have been made by international giants, like Exxon Mobil, but also by industry minnows, like Tullow Oil.

Universities are Farther Left Than I Remembered

It is not at all surprising that an Ivy League University professor does not recognize a difference between rationing by individual choice based on price signals and rationing based on government mandate.  What is surprising to me is that I remember this particular professor, Uwe Reinhardt, as the only person who would ever take the free market side of campus debates.  Kind of depressing.  I guess he must have seemed free market just by contrast, or else he has evolved a bit.  Is it ironic to anyone else that radicalism of the 1960s, which purported to be based on individualism and freedom, has led to campuses where it is normal not to even consider individual liberty as part of a public policy equation?  It just reinforced my sense that no one really wants to get rid of "the man," they just want to be "the man" themselves.

In particular he writes:

As I read it, the main thrust of the health care reforms espoused by President Obama and his allies in Congress is first of all to reduce rationing on the basis of price and ability to pay in our health system

We actually have plenty of examples of the government ending rationing by price and ability to pay.  Gas price controls in the 1970s are one very good example.  Anyone remember the result?

donovan02

Or more recently in China, where gas prices were controlled well below world market levels:

gaslines

We substituted gas rationing by willingness to pay the posted price with gas price rationing by ability to waste four hours of one's day sitting in lines. (I had never thought of this before, but there must be some interesting economic implications of preferentially routing fuel to those least likely to have a full-time job).

Perhaps worse, Reinhardt equates criticism of the current health care system ( and particularly its productivity) with support for socialization of the system.  Really?  There are perfectly valid free market reasons to criticize health care, where any number of government policy decisions over the years have disrupted the efficacy of price signals and created terrible incentives.

More here from Doug Bandow of Cato

Postscript: Farther left?  Further left?  Sorry, I try, but your scribe is an engineer at heart and sometimes struggles with the native tongue.  When I was in fourth grade, I remember doing a battery of achievement tests, and getting 99+ percentile scores on every test but spelling, where I got something like a 25th percentile.   I think this score put me down mostly with kids for whom English is a second language  (or maybe even worse, with Russian kids for whom ours is a second alphabet).  Only technology in the form of spell-checkers has bailed me out of my personal handicap.

Prices Matter

The other day I was having a discussion with a smart, well-informed woman who tends to be a bell-weather for Democratic talking points.  When asked about the recession, I said something like this:

The story for banks, corporations, and people are all the same -- everyone has too much debt, everyone took on too much in expectation of things going up and up.  With flat or even down expectations, everyone is now trying to clean up their balance sheet.  They are spending less, building equity and reducing debt.  And the economy is going to slow as a result, no way around it.   I went on to say that I was not only opposed to the stimulus bill in particular, but I was offended that the government would try to interrupt this deleveraging process.  The government had essentially made the decision that if individuals won't spend, then the government will take their money in the form of taxes and spend for them.  And if no one wanted to have debt, the government would go about and take debt on in the name of everyone.

She responded that she thought it was ironic that after the government had worked so hard for so many years to tell people to save more, and that they are only doing it now when it was counter-productive.

Forget for now the whole Keynsian "saving is counter-productive" argument, and focus for a minute on the government communication effort around individual debt.  There is no doubt that to the extent that the government has verbally communicated on individual debt, is has generally been to encourage savings and not take on expensive consumer debt.

But verbal communications are generally the least effective form of communication in the economy (Ralph Nader and his theory that we are all zombies to corporate marketing notwithstanding).  In fact, markets don't communicate via words.  They commucate with price.  Prices are the giant semaphores of the free market, and they are extraordinarily powerful communication tools.  Do people drive less or turn down their thermostats after Jimmy Carter gives a fireside chat about energy conservation in his little cardigan sweater?  No.  People conserve more when prices go up.   When gas prices go up, prices are telling consumers that gas is now scarcer vis a vis demand, and it may be time to conserve.  The same goes for every other thing we buy.  In fact, the only things we actually run out of  (water in a drought, electricity during summer brownouts, gasoline in the early 1970s) are all commodities where the government interfered with and/or severely restricted the ability of retail prices to move with demand.  In these cases, the government tends to substitute public exhortations for pricing signals  (for example, you can't escape water use guilt ads in California).  But these never work as well.

It is the same with personal savings.  The government in its verbal communications may have been saying to save, but what were its actions saying?  The Federal Reserve followed a long-term policy over the last decade of keeping interst rates artificially low.  Low interest rates send a clear and powerful dual message -- save less (because the returns are low) and borrow more (because borrowing is relatively cheap).  Federal tax breaks from mortgage debt and  Federal programs to provide looser credit with lower down payments to less qualified buyers made debt even more attractive vs. savings.  And numerous federal programs helped encourage home buying, while local government zoning and anti-growth ordinances helped keep home prices going up and up.  Every action the government took said "save less, take on more debt."  Is it any wonder their actual verbal communication was ignored?

Government as Price-Maker vs. Taker

Megan McArdle makes a great point that should be absolutely uncontroversial:

government is much better as a price taker than a price maker.
Government procurement is all kinds of tedious and cluttered with red
tape, but in the end there's no gigantic problem with the government
pencil supply. Defense procurement, on the other hand, is pretty well
agreed to be godawful-expensive for what we get, the only excuse being
that we can't think of another way to buy fighter planes.

That means that government procurement alongside a free market looks a lot
different from government procurement when the government is the only
buyer. Yes, the health care market is extremely screwed up, but the
prices in it do tell you something about demand for various services,
and provide some signals about cost/benefit. You may think that viagra
is a prime example of wasted pharmaceutical R&D spending (though if
you do, I am willing to bet that you are either under forty, or
female), but the fact that a lot of people are willing to pay a fair
amount of coin for it tells you that they probably feel it is improving
their lives in some significant way. Governments can estimate
cost-benefit when the benefit is limited to crude mortality
improvements, but they are pretty much at sea when it comes to
quality-of-life. America's price signals are wildly distorted by its
insurance markets--but they're almost certainly better than no signal
at all.

Europe's governments operate their health care systems in the
context of an existing US market that provides information about demand
for new treatments (and of course I would argue, also the new
treatments). They don't use that price information to set what they pay
for drugs, but it does filter through to their markets--for example,
more widespread use of Herceptin for breast cancer in the US is putting
pressure on the British government to provide it. I think an American
shift to single-payer would be more problematic than the European
example for a variety of reasons related to our government structure.
But one important reason is that if we did, we'd have no where left to
get prices from.

Virtues of a Carbon Tax

Michael O'Hare and Matt Yglesias (via Megan McArdle subbing at Instapundit) makes this very good point about carbon taxes:

Tragically, if you tell people you're going to tax their ft ossile
fuels, they freak out and your political career dies a swift and
merciless death. But if you tell people you're going to subsidize alternative energy sources
the people will like that. Functionally, however, these are basically
the same thing, except for the fact that the tax method works much,
much better.

This is unfortunately true.  As I have posted a number of times, I am skeptical that man-made global warming and the net of the problems (and opportunities) it brings will be bad enough to justify the economic cost of slowing or reversing CO2 emissions.  However, I can imagine being convinced that efforts to limit CO2 emissions are necessary.

Regulations on emissions, whether to the air or into shared waterways, is one of the few areas of government action that actually facilitate the smooth operation of strong property rights.  As I explained before, one could easily imagine a world of strong property rights bogged down in constant suits and counter-suits, as any property owner could rightfully sue over molecules of emissions that crossed their property line from another.  Certainly I can imagine private solutions and agreements that could have developed in the absence of government to sort this out, but government emissions restrictions, when done well, are not an unreasonable approach.

Of course, there are a lot of bad ways to manage emissions, and the government has tried about all of them.  New source controls, which are still debated and, incredibly, supported, represent all the worst of government hubris in trying to micro-manage solutions and technologies rather than just defining the desired outcome.  If anything, new technology subsidies (think ethanol) have been even worse, acting more like political pork and rent-seeking than intelligent pollution policy.

However, the government, especially the environmental lobby which tends to be full of technocrats and statists, greatly prefer the government micromanagement approach.  The impossibility of the task should be clear.  Take CO2 reduction -- to micromanage the reduction, the government would have to sort through every source of CO2, every available technology, and come up with a prioritized plan for investment to get the most reduction for the least $.  And even if the tried, they would be wrong, because this is a problem with a billion variables.  And even if they happen to get it right, they would not implement it, changing their plans the minute the Archer Daniels Midland lobbyist walked in the door. 

To understand the complexity, take one example: electric cars.  Hey, everyone loves the idea of electric cars -- they are zero emissions, right?  Well, sort of.  Actually they are emissions outsourcing devices, shifting emissions from the individual car's tailpipe to the power plant where the electrical charge is coming from.  Now, that power plant is a lot more efficient at burning fossil fuels, so often the net is better, but what if the marginal electricity production is coming from coal?  Does that net reduce CO2?  And, if electric cars reduce carbon emissions, does $10,000 investing in electric cars reduce more or less carbon emissions than $10,000 in solar?

These decisions are impossible to make, but we don't have to.  Every day, markets and price signals help individuals make such tradeoffs rationally.   That's why a carbon tax, that raises the price of CO2 emissions fairly directly, would be a much more efficient approach to managing emissions.

Update: People have asked about emissions trading.  Emissions trading schemes are OK, in that they help push emissions reductions towards the people who can do it most efficiently.  What I don't like about them is they are a government form of incumbent subsidy - basically industry incumbents get a tradeable asset of value, while new and future entrants do not.