Tragedy of the Commons and Game Theory

Conversation with one of my Environmental Economics students at the final exam regarding the two large plates of cookies I made for the students.

Student: Are these cookies a common pool resource?
Me: I suppose.
Student: In that case there is about to be a tragedy of the commons.
Me: This class has certain social norms.
Student: I will not see them again so I don't care about social norms.
Me: You forget that I have not graded your exam yet and I assure you that sequential game theory will apply.

A Book Review of 'Priceless' by John Goodman

          John Goodman played a leading role in the historical movement to increase patient control over their health-care dollars. Due largely to his efforts, the U.S. Congress passed the Medicare Prescription Drug, Improvement, and Modernization Act in December 2003, which included the provision for Health Savings Accounts (HSAs) (NCPA 2004). Most of his ideas on how to increase patient independence were outlined in his co-authored 1992 book Patient Power (Musgrave and Goodman 1992). Almost ten years later, Mr. Goodman has released a follow-on book attempting to address what he suggests could have been titled “Doctor Power.” The book is, in fact, mostly an effort to respond to the passing of the Affordable Care Act (ACA) and as the author states in his conclusion, “The focus of this book has been . . . identifying the perverse incentives created by government policies and considering ways to remove them with a minimum of social disruption.” (Goodman 2012).

          The book Priceless by John C. Goodman is built on his foundational argument that the lack of clear pricing signals in the healthcare system is at the heart of almost every one of the myriad problems. The new book takes a very different position from his previous book, which focused on patient or demand side issues. Mr. Goodman states, “What I didn’t anticipate was that the changes on the supply side of the market would be far more profound than the changes on the demand side” (Goodman 2012).

          Early in the book, Mr. Goodman proposes that the heated debate over health care is primarily the result of differences in the terminology used to describe the issues and the perception of political motivations. He claims that while economists refer to patients as consumers and health care as a medical marketplace, others take offense at the notion of health care as an economic system—that “econospeak” somehow dehumanizes a system focused on service. He then goes on to suggest eight additional conflicting perspectives of health care including; the importance of individual preferences, the public vs. private approach, economic vs. engineering social views, and the nature of entrepreneurial activities.

          The book presents the incentives of doctors, employers, government, and insurance companies, describing how they are at odds with patient objectives. Goodman then presents an historical analysis of the dramatic ramp-up in health-care expenditures and why the ACA and other efforts to reduce costs will not deliver the hoped for results. He follows by describing past efforts including; price fixing, output controls, Medicare Part B price controls, and the difficulty in expanding generic drugs. Particularly insightful, is Goodman’s explanation of why we cannot compare the spending levels of other countries with those of the United States. He explains how the pricing of health care consists of artificial prices and costs resulting from the suppression of market forces. In one example, he describes how in Greece, the bribes, and other informal payments are almost equal to the formal or measured costs.

          The book lists the three dimensions of care as quality, quantity, and amenities, explaining that the time cost of care is the single largest factor determining true cost. This discussion is similar to that of the printing industry, which offers three dimensions of service and asks that you select any two—quality, price, or timeliness. Like any industry, health-care must force patrons to make the same choice. Mr. Goodman argues that the quality dimension is effectively hidden because the third-party payer system negotiates the direct price and amenities and the patient experiences effectively only the time price. The result is a lowering of quality to accommodate the other two.

          In the middle of the book, Goodman presents his arguments for why increases in the time cost of care will be more keenly felt by the poor. He points out that the wealthy will be able to negotiate around the time cost thus pushing the poor even further back down the waitlist. After recounting the results of numerous studies that see to determine the effect of being insured on mortality rates, Goodman concludes that the evidence most strongly suggests that insurance does not affect the life expectancy of Americans. He proposes that it would be much more efficient to incent providers to improve quality as a way of increasing life expectancy. In one example, the book describes the Parkland Hospital in Texas. With 16,000 births a year (leading the nation) and the majority of the new mothers being illegal immigrants, the hospital is able to innovate in the delivery of care rather than suffer from typical bureaucratic rules. Midwives instead of physicians perform the majority of births and nurses provide the prenatal care. Goodman concludes this section laying out the reasons the ACA will only exacerbate the access problems in the health-care system.

          The book provides an insightful account of the evolution of the health-care system and explains the difference in true insurance and the third-party payer system. Goodman highlights the difference between payment from insurance and from subsidies and the economic impact of the two very different reimbursement approaches on the level of health-care consumption. The book then provides an exhaustive list of options for increasing the patient role in setting levels of health-care spending.

          The second half of the book is devoted to offering solutions to the health care cost crisis. Goodman begins by focusing on ways to make the patient responsible for more of the health care decisions and follows with suggestions for improving incentives for doctors and insurance companies. The list of suggestions is comprehensive and as a result confusing and overwhelming. Another section is devoted to a discussion of malpractice insurance and liability. Not to be let off the hook, the author provides two chapters dedicated to offering suggestions for Medicare and Medicaid and then reviews the new ACA law and its ramifications. Lastly, before drawing his conclusions, Goodman addresses what laws need to be repealed and what can be replace in the new law.

          Goodman’s conclusions are simple and straightforward. First, patients should pay a price for care equal to the marginal social cost. Second, providers should receive a price equal to the marginal value of their care. Lastly, these prices should ideally be determined in competitive markets.

          The book is chock full of ideas, many of which are probably useful. The style is readable, with enough antidotes to keep the reader’s interest. Unfortunately, the book is almost as confusing as the health-care system. There are too many moving parts, too many clever ideas, and not enough high level insights into how to cut the Gordian health-care knot. As hard as it is to make changes in the U.S. health-care system, it is unlikely the author’s suggestions will find a listening ear.

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Works Cited

Goodman, John C. Priceless: Curing the Health-care Crisis. Oakland: 
          The Independent Institute, 2012.

Musgrave, Gerald L, and John C Goodman. Patient Power: Solving 
          America's Healthcare Crisis. Washington, DC: Cato Institute, 1992.

NCPA. "A Brief History of Health Savings Accounts." National Center 
          For Policy Analysis. April 13, 2004. http://www.ncpa.org/pub/ba481
          (accessed November 7, 2013).

The Quest for Order: A Clash of Assumptions and Strategies

          It is often difficult to understand the motivations of political agents based only on their choice of political party or their vote on a specific issue. However, if we can determine their political core—their prime directive, key assumptions, and choice of strategies—then analyzing and predicting actions by the polity is greatly simplified. The purpose of this paper is to isolate the prime directive of the polity and the various ways it is put into action based on key assumptions and strategies. For simplicity, only the political core of progressives and classical liberals will be considered.

          For any politician, the chance to address a crisis, real or imagined, is seen as an excellent career move. Former U.S. Representative and White House Chief of Staff, Rahm Emmanuel expressed this concisely in 2008, “You never want a serious crisis to go to waste. Things that we had postponed for too long, that were long-term, are now immediate and must be dealt with. This crisis provides the opportunity for us to do things that you could not do before" (Seib 2008). Politicians see a crisis as a situation resulting from chaos that creates uncertainty in the electorate. It is this chaos, real or threatened, and the resulting uncertainty that is used to make the case for political action. Thus, the prime directive of the polity is to reduce chaos and uncertainty. In simpler terms, this directive can be restated as an effort to increase order.

          If the prime directive of the polity is to increase order, what are the underlying assumptions of progressives and classical liberals that determine the strategies they choose to achieve that order? There are two opposing views about the emergence of economic order. Similar to the ongoing debate between cosmologists over evolution and intelligent design, is the rift between economists over spontaneous order and induced order. Fredrick Hayek wrote of spontaneous order as “functioning without a designing and directing mind . . . the spontaneous collaboration of free men often creates things which are greater than their individual minds can ever fully comprehend” (Hayek 1948). In contrast, induced order refers to the effort of a hierarchical polity seeking to foist order by executing centrally conceived master planning.

          Progressives and classical liberals stand together in their desire for economic order and the avoidance of uncertainty. Both groups also point to the importance of well-defined and enforced property rights as essential to an efficient economy. The bifurcation begins with their key assumptions about the nature of economic markets. Classical liberals assume that free markets will, under the guidance of the Smithian invisible hand, result in spontaneous order while approaching Marshallian optimality. Progressives, on the other hand, assume that markets require the oversight and management of a central planner, implementing induced order as the only way to avoid or remedy the inevitable market failures and achieve Kaldor-Hicks optimality. Thus in the quest for order, the opposing parties clash in the marketplace of political ideas. Based on these two underlying assumptions, progressives seek a commanding heights form of governance, while classical liberals attempt to encourage self-governance. The commanding heights approach allows induced order to be imposed by the progressive central planner, while the classical liberal sees self-governance as essential for the emergence of spontaneous order in free markets.

          The dichotomy between these two philosophical approaches to bringing about economic order can be illustrated by comparing the business cycle theories of Keynes and Hayek. Keynes sees the underlying cause of cyclicality as the result of market failure in the form of animal spirits that requires a commanding-heights fiscal policy to restore the market to equilibrium. In contrast, the Hayekian or Austrian view is that business cycles result from monetary disturbances, usually instigated by the central bank, that create market distortions. The remedy, then, is to restore interest rates to their natural rate and let the market forces work to bring about a recovery from the boom/bust cycle.

The final impact of induced order is the attempt to use the same commanding heights approach to remedy so-called “social injustice.” Thomas Sowell, in his book The Quest for Cosmic Justice, explains how progressives seek to expand the use of commanding heights to induce order and bring about market equality of results. In other words, the polity moves beyond fiscal policy and attempts to remedy such things as disparity in income and education (Sowell 1999). Once Pandora’s box of induced order has been opened, opportunities for its use will be difficult to restrain.

          In conclusion, while both progressives and classical liberals seek well-ordered markets, they diverge over the explanation of how to create such order. Progressives seek to address the problem by using commanding heights to induce order, while classical liberals look to well ordered free markets and self-governance to generate order spontaneously. This great philosophical divide continues to fuel the political and economic debates over efficient public policy and is likely to continue for some time.

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Works Cited

Hayek, Friedrich. Individualism and Economic Order. Chicago: University of Chicago 
           Press, 1948.

Seib, Gerald F. "In Crisis, Opportunity for Obama." The Wall Street Journal. November 
           21, 2008. http://online.wsj.com/article/SB122721278056345271.html (accessed
           October 13, 2013).

Sowell, Thomas. The Quest for Cosmic Justice. New York: Touchstone, 1999.

The Bazaar Catallaxy as an Entanglement of Public and Private Enterprise

          The word bazaar is Persian for “place of prices” and historically described an enclosed and covered area housing numerous privately operated booths trafficking in commodity goods. These markets have existed in both western and eastern cultures for thousands of years. In the book, Bazaar and State in Iran, Arang Keshavarzian defines a bazaar as “a series of socially embedded networks within a bounded space that is the mechanism for the exchange of specific commodities.” (Keshavarzian 2007). These ancient marketplaces served as the central economic institution for trade and became the hub of not only market activity, but also political, religious, and social interchange. Many large shopping malls, international airports, and even state universities of today share much with the economic model of the bazaar.

          Foundationally, the bazaar catallaxy begins with the designation of a bounded space to be used for a single primary purpose. In the case of the ancient market bazaars, this purpose was trade. This same requirement for common purpose is at the center of modern examples—transportation for airports, shopping for malls, and education for universities—each requiring the allocation of a large bounded space. The first element of entanglement of polity and economy usually begins with the acquisition of these spaces, which is easily accomplished when wielding the coercive power of government eminent domain.

          One of the largest and most successful bazaars was the Nizhnii Novgorod Fair, founded in 1817 and situated on the Balakhonskaia Peninsula at the confluence of the Oka and Volga rivers (Fitpatrick 1990). Marshaling the skills of architects under government contract, the location and construction of the fair’s infrastructure arose in much the same way airports or malls emerge today (Coburn 2011). In the Nizhnii Novgorod Fair, the regional government provided the policing and sewage control as well. Patrons tend to think of the plurality of vendors in a bazaar catallaxy as a single entity—“Do you want to go shopping at the mall?” rather than to a specific store. This perception allows the creator/owner of a bazaar to provide services as a market maker.

Figure 1

          Structurally, the bazaar consists of a set of horizontally competitive enterprises residing within the bounds of the catallaxy as shown in Figure 1(H₁, H₂, H₃, H₄, …). The horizontal business units, while competitive with each other, form a critical mass that draws not only large numbers of customers, but also vertical or supporting services (V₁, V₂, V₃, V₄, V₅, …) such as money changing, food courts, transportation, and possibly even housing. The bazaar entanglement of polity and economy increases further when the polity provides some of these ancillary services—most often policing and utilities, as represented by element V₀ in Figure 1. The vertical services in a bazaar, when not provided by the polity, tend to consist of competitive offerings. For example, in an airport there will be multiple transportation services including private automobiles, taxicabs, metro lines, rental cars, and buses. Food and shopping services will be varied, as will on-property hotels if any.

          An important phenomenon of the bazaar is the partnerships that often form between competing horizontal firms. In Afghan bazaars, these loosely bound guilds are known as quams (Coburn 2011). In airports, the airlines organize into quams as a way of dealing with difficulties such as mechanical failures, bumped passengers, and as a way of extending their market reach. If American Airlines suffers from a mechanical failure, they have the ability to electronically transfer bumped passengers and luggage directly to a competitor’s flight. These quams also extend their membership to include vertical services such as hotels for weather-stranded passengers and meal coupons accepted by airport restaurants. The close proximity and shared infrastructure of the bazaar makes this kind of collaboration simple and worthwhile to implement.

          International airports present another set of administrative challenges, because their primary purpose is cross-border travel, which requires them to deal with such things as immigration rules, import and export duties, and potentially incompatible security standards. These regulatory aspects of travel present additional opportunities, and perhaps excuses, for the polity to further imbed itself into the catallaxy.

          Whatever the primary service offering of the bazaar, the homogeneity of the horizontal competition and the well-defined nature of the vertical and ancillary services make the bazaar catallaxy highly susceptible to active participation on the part of the polity. 

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Works Cited

Coburn, Noah. Bazaar Politics: Power and Pottery in an Afghan Market Town. Stanford, 
          CA: Stanford University Press, 2011.

Fitpatrick, Anne Lincoln. The Great Russian Fair: Nizhnii Novgorod, 1840-1890. New 
          York: St. Martin's Press, 1990.

Keshavarzian, Arang. Bazaar and State in Iran. Cambridge: Cambridge University Press, 
          2007.

The Political Business of addressing Information Asymmetries

          A political business model commonly financed by the parliament is a political firm, tasked with addressing supposed market information asymmetries. These agencies often serve as gatekeepers, suffering from distorted incentives that arise from inappropriate sources of funding. Competitive markets have faced information asymmetries since the dawn of human trade because it is inevitable that one of the parties to a transaction will have an information advantage over the other. Sometimes the problem is addressed through pricing mechanisms and perhaps more often with reliance on reputation effects. A seller on eBay, with no ratings history, will have to post a significantly lower price to overcome the risk a buyer sees in dealing with a first-time seller. In comparison, a long-time seller with hundreds of positive ratings can expect to receive a premium price. Market-based business models that successfully address the risk of information asymmetries include objective third-party ratings firms earning fees by providing buyers with independently generated ratings (i.e. Consumer Reports), and market makers that collect and present crowd-sourced ratings (i.e. eBay). In both of these cases, the information generated is objectively produced and helps to reduce transaction costs.

          If a market-based ratings firm chooses to generate revenue from producers instead of consumers, the information provided to the consumer becomes tainted, as shown by the once highly respected financial instrument ratings agencies. For many years, the earnings of these firms came from investors seeking to overcome the information asymmetries inherent in complex financial transactions. When new government ratings requirements were imposed for investments made by certain money market funds, pensions, and government agencies, the ratings firms made the tragic decision to move to the more lucrative model of charging the issuers and providing their services free to investors (McLean and Nocera 2010). This shift in the business model forced the issuers, desperate to satisfy the new rating requirements, to negotiate with the four government-anointed rating firms as “paying customers.” With revenue and profit on the line, investment ratings suffered severe inflation. The inflation began when the ratings agencies chose to generate revenues from the source of the information asymmetries.

          Political firms created to address information asymmetries receive funding from the parliament and often additionally from user fees paid by the producers being rated. For example, it is the mission of the Food and Drug Administration (FDA), as an “objective” third party, to act as a gatekeeper and as the primary source of essential healthcare information for the public. While two-thirds of the funding for the FDA comes from Congress, the third part is collected from pharmaceutical and medical device companies in the form of user fees (Fontanarosa, Drummond and DeAngelis 2004). There is ongoing pressure from Congress to increase the revenues from these fees, thus reducing the dependency on taxpayer funding (Food and Drug Administration 2012). Since there are numerous FDA employees tasked with assessing new medical breakthroughs, it is likely that producers will expend significant resources to determine the smoothest path through the approval process. Mid-level bureaucrats are afraid of garnering negative attention from supervisors and are therefore motivated to be reasonable in their treatment of what are essentially “paying” customers. An obstructive bureaucrat, with a reputation for being heavy-handed, will be avoided or will receive numerous complaints.

          In opposition to the revenue incentive is the fear of making a rating error that results in deaths or other catastrophes and once again drawing unwanted negative attention. Since the primary funding source of most political firms is the parliament, the bureaucratic prime directive of self-preservation is the highest priority. This risk can be mitigated by creating a mountain of well-documented procedures that, if followed, protect the individual worker from the wrath of a supervisor and provide documentation if it becomes necessary to defend the actions of the agency. The "red tape" mechanism addresses the fear that failure will lead to inevitable funding and job cuts. In the case of the Food and Drug Administration, we see a political firm that responds to these incentives by making the navigation of the bureaucratic process very costly—smaller firms and orphan drugs need not apply—while providing an expensive but almost inevitable approval for the innovations of larger health-care providers.

          In conclusion, in a competitive market, without the entanglement of the polity, the asymmetric information problem is usually addressed with an objective business model, ensuring consumers receive the information required to reduce transaction costs. In contrast, the political firm operates on funds from the parliament and the producers to provide consumers with what is perceived as free information, but is in fact costly, incomplete, and suspect.

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Works Cited

Fontanarosa, Phil B, Rennie Drummond, and Catherine D DeAngelis. "Postmarketing  
          Surveillance—Lack of Vigilance, Lack of Trust." The Journal of the American Medical 
          Association 292, no. 21 (December 2004): 2647-2650.

Food and Drug Administration. "FY 2013 Budget Overview." www.fda.gov. May 21, 2012. 

          http://www.fda.gov/downloads/AboutFDA/ReportsManualsForms/Reports/
          BudgetReports/UCM301719.pdf (accessed October 5, 2013).

McLean, Bethany, and Joseph Nocera. All The Devils Are Here. New York, NY: 
          Penguin Books, 2010.