Taking a Look at Profits

Today let’s look at the profit argument that continues to be used as a reason to eliminate or marginalize insurance companies in the healthcare industry. Healthcare remains a service oriented business and as such, will perform better in a free-market environment

Profit is Bad for Your Health? : The Freeman Ideas On Liberty

Many self-styled healthcare “reformers” favor a “public” (read: government) insurance option. The advantage of the government plan, President Obama said, is that “there wouldn’t be a profit motive involved.” Some supporters hoped the public option would be a step toward a single-payer government-run system in which the profit motive would disappear entirely from healthcare decisions.

Suspicion of profit runs deep. In an Atlanta Journal-Constitution op-ed, Cynthia Tucker spoke for many last summer when she wrote, “The for-profit health insurance industry is in the business of maximizing profits for their shareholders, and the only way they can do that is to hold down the payments they make for medical care” (emphasis added).

It just ain’t so. Holding down payments unreasonably or in violation of contract would give a company a bad reputation. Firms with bad reputations would have a difficult time attracting future customers in a competitive market, George Mason University economist Bryan Caplan argues. What would happen to profits then? Reputation provides a powerful incentive against the conduct Tucker fears. However, reputation would be a more potent force if people bought their insurance directly rather than through their employers. Nevertheless, the potential for profit does not lie simply in minimizing the payment of benefits.

But, Tucker argues, “There is no real competition among insurance companies, as recent research has shown.” She’s right. Competition is sparse, however, not because of any inherent market failure but because, among other things, the federal government forbids interstate competition. The purpose of the prohibition is to prevent consumers from finding better deals than those permitted by their state insurance regulators. The protectionist limit on competition is fine with the insurance companies, confirming Freeman contributing editor Steven Horwitz’s First Law of Political Economy: “No one hates capitalism more than capitalists.”

Admirably, Tucker takes Republicans to task for not doing something about competition when they could have. But the failure to repeal a bad policy hardly justifies piling a new bad policy on top of the old.

Profit: the Cure, not the Disease

Some people are repulsed that doctors and insurance companies profit from illness; indeed, Michel de Montaigne wrote a famousessay in which he argued that “the profit of one man is the damage of another.”

Illness, however, isn’t the source of profit. Rather, as FEE web columnist William Anderson points out, it’s the ability and opportunity to make someone well.

In a Freeman article last year, Horwitz went further: “Profit is not just a motive; it is also integral to the irreplaceable social learning process of the market. Critics may consider eliminating the profit motive the equivalent of giving the Tin Man from Oz a heart; in fact it’s much more like Oedipus’ gouging out his own eyes.”

Advocates of government-run health care argue that the profit-driven U.S. system is inferior to its Canadian and European counterparts. There is plenty of reason to doubt that claim, but more fundamentally, a system with government-subsidized consumption (Medicare, Medicaid, and tax-advantaged employer-based insurance) and government-constricted markets is not the system free-market advocates have in mind.

Some also argue that private for-profit insurance has higher administrative costs than the government’s nonprofit Medicare program. But lowering such costs is no free lunch. Economist Greg Mankiw points out that “Low administrative costs are not to be confused with high administrative efficiency” and cites his colleague Malcolm Sparrow, who argues that “health care fraud and abuse [cost] hundreds of billions of dollars per year. . . . The rule for criminals is simple: if you want to steal from Medicare, or Medicaid, or any other health care insurance program, learn to bill your lies correctly. Then, for the most part, your claims will be paid in full and on time, without a hiccup, by a computer, and with no human involvement at all.” If anything, this suggests that administrative costs for Medicare and Medicaid might be too low.

A Learning Process

It’s a misconception that profit is something tacked onto the price of goods and services. If that were so, why would profits change from year to year and why would companies go out of business? Profit and loss are indispensable to consumer well-being because resources are scarce and have alternative uses. How do we decide how much to devote to making people well and how much to devote to feeding, clothing, entertaining, and educating them? It isn’t merely that this is a difficult question to answer. It is literally impossible to answer in any meaningful way without market prices, profits, and losses.

Profit rewards the entrepreneur who takes a risk in transforming resources into products she correctly thinks consumers will value more than those currently being made with those resources. Entrepreneurs get needed feedback from profits and losses. If they create value, profits are the reward. If they destroy value, losses are the punishment. In a free market no entrepreneur may rest on her laurels. Profits attract competition and are competed away before long. So the incentive to innovate and economize is strong.

Contrast this with government. On several online networks I asked for examples of successful and sustainable government programs giving away 12- and 13-figure pots of money. The best examples were infrastructure and basic research, but even these aren’t disciplined by the market. Without market prices— and the possibility of profit and loss—we can’t calculate the opportunity cost of any given project. Our experiences with the Cash for Clunkers and ethanol debacles do little to inspire confidence.

Profits and losses provide crucial information that enables producers to engage in rational economic calculation in the service of consumers. Grasping this is one of the most important contributions economics has made to our understanding of the world. Thus the profit-and-loss system is as badly needed for medical services as it is for any other product or service. It is true that health care is unique in some ways, but this strengthens rather than weakens the case for subjecting it to entrepreneurial profit and loss. Health care is not “too important to be left to the market.” It is too important not to be.