The Health Econ Con

This post is especially relevant to college students enrolled in economics courses in which participation–either digitally or in person–constitutes a portion of the course grade. I’m taking my final undergraduate course Health Economics en route to earning a BA in Economics. Below, you’ll find my response to one part (on externalities) of the first lecture in the course. It may come as a surprise to college students that you can in fact disagree with your professor. And in courses in which participation is required, your statist professor is–quite literally–asking for it.

I think it’s important to present viable alternatives to what one learns in class. After all, what are these forums for if not to express new ideas?

It turns out that there are various schools of economic thought. Some of them include: the chicago school, the keynesian school, the neoclassical school, the “neoclassical-keynesian” school (a synthesis championed by Paul Samuelson, who Professor X mentioned in class), the post-keynesian school, the new-keynesian school, the market monetarist school, and the austrian school.

One could spend an entire Master’s or doctoral degree studying the differences between the schools. But the exact differences are beside the point. The point is that the issues we discussed in class today, and those that we will likely discuss throughout the quarter, are not settled issues. There are in fact, long-standing differences of opinion on all sorts of topics related to economics among the various schools of economic thought.

Throughout this course, you’ll find that I present the austrian interpretation of the topics we cover. I take this position not for the sake of being different, but because I think the austrian school of economics gets economics right. I look forward to disagreement and debate on this.

For this post, I’ll discuss the notion of “market failure,” specifically one type of alleged “market failure” (externalities), which you heard about in today’s class.

The required assumptions the model that mainstream economists use to diagnose reality was concisely presented in the Chapter 1 Notes in today’s class. Those assumptions are:

  1. Little or no barriers to entry
  2. Many producers in the market
  3. No one firm has market power [the ability to set the market price]
  4. All have information about the market conditions

Does this sound very realistic to you? Are there little to no barriers to entry in industries with high start-up costs? Are there many producers of electrical energy? Do you think Samsung really has no ability to set the price of high-tech smartphones? Does a new car-buyer have as much information about the car as the salesperson?

The answer in each of these cases is obviously “no.” What’s this mean? This means that the assumptions necessary for the models (and the conclusions that follow from those models) employed by mainstream economists are unrelated to reality.

What good is an economic model that has nothing to do with reality? Isn’t the job of an economist to explain reality, disabused of unrealistic assumptions?

Why is this important? Understanding that the assumptions of the “perfectly competitive market” (I mean, which human is perfect?) are unrealistic is essential in understanding the nature of so-called “market failure.”

Market failure is the basis upon which lobbyists, economists, and intellectuals call to government for intervention in the market. In other words, market failure is the reason many intellectuals–especially those concerned with health care–cite as the motivating reason for government intervention.

It’s important to note here that government intervention consists of the use or the threat of violent force. It’s another issue to address whether the use of coercive violence is good or bad, but it is important to call a spade what it is, a spade. Government intervention is distinctly different from peaceful, voluntary interaction.

But the question might be raised: If the notion that the “market fails” is a conclusion reached by analyzing reality with models based on unrealistic assumptions, should we trust the conclusion that markets do in fact fail? Perhaps not.

Externalities are a type of alleged “market failure” mentioned in class. A negative externality is some cost incurred to a third party as a result of a transaction between two other parties. A positive externality is the opposite: it’s a benefit received to a third party as a result of a transaction between two other parties.

Both negative and positive externalities, when identified, serve as reason for government to intervene. Regarding negative externalities, the argument is that the government should intervene in the market to force the party that has brought about the cost to a third party to pay for his/her behavior (often through taxes). On positive externalities, the argument is that the market, if left free from government coercion, would “underproduce” those goods and services that bring about positive benefits to third parties. Therefore, the government should intervene in the market (usually with subsidies) to encourage industries to produce those goods and services that lead to positive effects to third parties.

Negative and positive externalities are fiction. Negative externalities are the result of inadequate government protection of property rights. Government claims the authority to defend property rights in this country. When a factory dumps sewage into a river, which then poisons the drinking water for villagers downstream (this is the common example), what we have is the failure of the organization which claims to protect the property rights of its citizens: the government. We might employ complex language and call this phenomenon a “negative externality,” but that doesn’t change the fact that the agency that claims the authority to protect property rights has failed to do so!

I’ve always found it somewhat odd that economists endorse the idea of a positive externality. It must be pointed out that positive externalities are unpriced. What’s that mean? When two parties voluntarily trade, a price arises. When you agree to acquire a beer from a barman for $4.00, and the transaction occurs, a “market price” arises. I challenge all mainstream economists to price these mythical positive externalities. Remember, a positive externality is a benefit felt by a party not involved in the transaction in question. The person who received the positive benefit–unlike the student who bought a beer at a bar–never had to give anything up in order to receive the positive benefit! He never paid a price.

So how should resources be redistributed (through subsidies) in order to achieve the optimal allocation of resources to encourage the production of those goods and services that bring about positive externalities? There is no way. There is no way, because there is no price system for positive externalities. Therefore, the allocation of resources under the auspice of the positive externalities will always be irrational.

Without prices, markets cannot arise. How then do mainstream economists claim that positive externalities are a market failure?

In short, “negative externalities” are failures of the government to enforce property rights. “Positive externalities” cannot be priced, because those who enjoy them paid nothing to receive them. Therefore, any government activity to redistribute resources in order to increase the production of goods and services that bring about positive externalities must be irrational.

I hope it’s clear by now that externalities are not a type of market failure. They’re a product of government failure (failure to protect property rights and failure to rationally allocate resources).

As a side note, health care is not a need. If health care was a “need,” i.e., something that individuals absolutely must have, then there would be no reason to discuss elasticity of demand for health care. If health care were in fact a “need,” then all demand for all health care would be perfectly inelastic. That is, individuals would always purchase health care at whatever cost necessary, by foregoing consumption of other goods and services. A quick empirical study of the consequences of increasing prices for healthcare services will reveal that–just like with all goods and services–consumption of health care services decreases, other factors held constant. This means that demand for health care is elastic to some degree, and therefore should not be considered a “need” by the economist.


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