The disaster of price controls

Richard Fernandez writes in "True Lies"

And the latest person to be caught in that dilemma and become seduced by siren song of price controls is President Barack Obama who’s announced seeking “sweeping new authority to curb exorbitant rate hikes by the nation’s health insurance companies”.

Obama’s proposal would give the Health and Human Services secretary, Kathleen Sebelius, new powers to review premium hikes by private insurance companies – and in some cases, block those deemed excessive. Anthem’s rate hikes of up to 39 percent in recent weeks have focused attention on the skyrocketing health insurance costs, the very costs Obama vowed to fight when he undertook comprehensive health care reform last year. Obama’s plan would create a new board made up health insurance experts, which would determine annually what are reasonable premium hikes in various markets, and the HHS secretary also would work with state officials, the White House said.

At least part of those rate increases are due to Obama’s proposals themselves. His health care reforms were always going to drive costs up. According to Noam Levey of the LA Times, who examined the New York experience, average insurance rates were bound to go up simply because coverage was going to be extended to the uninsured — increasing the demand — and mandating that people with pre-existing medical conditions could not be refused. With more and higher-risk consumers entering the market and the supply of medical services inelastic in the short term, prices were bound to go up. If people can “buy insurance on the way to the hospital” as one economist put it, then the money had to come from somewhere else in the insurance pool. Levey said, “premiums in New York are now the highest in the nation by some measures, with individual health coverage costing about $9,000 a year on average.” But since higher premiums would mean political suicide for the Administration it is going to square the circle by imposing price controls. So what’s wrong with that? The problem with price controls is that it eventually creates underprovision and shortages in the long run. Everybody will remember his lesson from Economics 101. Here’s how Wikipedia retells it.

The primary criticism leveled against price controls is that by keeping prices artificially low, demand is increased to the point where supply can not keep up, leading to shortages in the price-controlled product. Shortages, in turn, lead to black markets where prices for the same good exceed those of an uncontrolled market. Furthermore, once controls are removed, prices will immediately be subject to rampant inflation, which can temporarily shock the economic system.

A classic example of how price controls cause shortages was during the Arab oil embargo between October 19, 1973 and March 17, 1974. Long lines of cars and trucks quickly appeared at retail gas stations in the U.S. and some stations closed because of a shortage of fuel at the low price set by the U.S. Cost of Living Council. The fixed price was below what the market would otherwise bear and, as a result, the inventory disappeared. It made no difference whether prices were voluntarily or involuntarily posted below the market clearing price. Scarcity resulted in either case. Price controls fail to achieve their proximate aim, which is to reduce prices paid by retail consumers, but such controls do manage to reduce supply.

At the margin the higher cost health care providers are driven out of business. Investment flows to non-price controlled industries unless capital controls are imposed and price controlled health care becomes an unattractive industry to do business in. Sooner or later good doctors become as hard to find as vacant rent controlled apartments in Manhattan, which is to say, hard to find unless you’re Charlie Rangel. But if price controls and artificially low rates cause so much damage why do politicians resort to it? Maybe because they live in a psychological world where everything could be ‘fixed’ by writing the right words or talking to the right people. Never mind the underlying economics. So why not make health care affordable by increasing demand on a fixed supply and then imposing price controls? Simple isn’t it? Except that it can’t be done, and when the scheme falls apart in the end many politicians will be genuinely surprised because it’s always worked before. Some people will never grasp the principle, strange as it may seem.

It's the politicos disease: the belief that words can change reality. That commands can stop the tides. It's an ancient problem that's made worse when people with no real-world accomplishments are in charge.