Worse than the Bourbons

If the catalog of market failure has failed and the dogmatic myth of market success has prevailed, it might be because the myth serves the powerful. But, it might also because myths do not serve knowledge and understanding.

The market analysis is stubbornly ignorant of how the system of production and distribution is actually organized. This is as true of Bator’s almost painfully abstract analysis as it is of Friedmanite cheerleading. The actual economy of feedback and rules and hierarchy can barely be glimpsed in the list of exceptions to the idealism of markets.

It isn’t only that people “forgot” Bator. The problem is that Bator had so little to say that would fit into the familiar context of control of production processes. None of his market failures is cast as bureaucratic failure.

The naive argument for privatizing education or health care is often tied to vague ideas about how to better organize the production process. Testing of students and firing teachers for poor performance features in these arguments because bureaucracies seeking feedback and control are success stories of actual experience while markets are mythical creatures.

I do not disagree with the main thesis: that for-profit schools and for-profit health insurers are singularly bad ideas is proven by experience as well as theory. The theory of a market economy is not sufficient critic, however, because it is not a sufficient theory.

The sector experiencing some of the most dramatic failures, failures prescribed by Bourbon economists, was banking and finance. These were in the main failures of hierarchy, yet economists insist on market failures categorization that struggle to account for the behavior of executives and managers.

I think there are lots of universal health coverage systems with fairly large amounts of privatization baked in, though not always for-profit. Most of Australia’s primary health care system, almost all of Japan’s provider network, and I think some elements of the German and Korean systems are private or semi-private, though the exact details of ownership and profit-making are in most cases heavily regulated. I don’t know if any of these systems were privatized from a previously public system, though, or organized and regulated under a single government payment system based on a pre-existing private market. I don’t know what difference that makes, but most of those health systems are functioning relatively well despite their different levels of private involvement.

I know, it is scary, isn’t it? Sounding the same theme as Howard Frant! And, maybe not even doing it as well. But, when he is right . . .what can I do?

From the article “The issue is not, in the end, one of public versus private. Rather it is the fact that market competition and the profit motive inevitably associated with it is antithetical to the professional and service orientation that is central to human services of all kinds.”

Why this analysis would not apply to e.g. law firms, or restaurants?

(Cross-commented from JQ’s blog)
The fifty-year old economic analysis by economists of market failure has been enormously buttressed recently by psychologists. Before, the corrective to the simplistic but enticing homo economicus model of human nature relied on commonsense observations: people have imperfect information and they often make mistakes in processing it. But this wasn’t enough to overcome a “beautiful theory”. Now, thanks to Daniel Kahneman and others, we do have an elegant Theory of the inevitability of systematic cognitive failure. The neoliberals sound now as if they are reading from a dog-eared Victorian textbook.

You have multiple factors. First, since markets favor the holders of capital, those
holders prefer market based theorizing that supports their priorities. And they support those who support them.
And you have people of Faith, many of whom have the same dogmatic Faith in the markets that religionists have in their religion.
It seems a little like Fred Hoyle clinging to the “Steady State Universe” long after the evidence pointed heavily in favor of “The Big Bang”.

To restate Manta more forcibly, the profit motive is a “moral hazard” in cases of public service. Though, I consider it a “moral hazard”
in general, it is less obviously detrimental in consumer goods.

“Remember: the profit a business generates ultimately derives from the gross benefit the business’s services provide to consumers, and the greater the profit the smaller the net benefit. At the point of profit-maximisation the net benefit is, definitionally, zero… and there’s no net reason to keep using the business, and no net cost-to-consumers in winding the whole thing up.”

No.

Profit maximisation is the maximum profit you are able to make. There’s nothing at all to insist that you reach that point and then there’s still a consumer surplus.

What you’ve really said is that you’re defining profit maximisation as capturing all of the value add. This is not the same thing.

Noting the disturbing trend by the Right and Christian groups describing public schools as “government schools”

I cannot endorse James Wimberley’s peculiar use of “neoliberal”, that is true. I do not think 21st century neoliberals are anachronisms, fundamentalist throwbacks to classical liberalism — if that is what JW intended to invoke. But, let’s not . . .

Howard @15 yes, I slightly garbled it.

Another way to put it is that only if all producers can perfectly price discriminate/product segment will there be no consumer surplus. And since they can’t…..although all try to some extent….

Howard Frant:
Your are no doubt right that the bits of cognitive psychology that economists have taken up tend to be those that hew fairly closely to the homo economicus model. But Kahneman’s book is largely about miscalculation. It’s Murphy’s Law all the way down, and this has not yet been fully taken in.

Kahneman does not SFIK propose a theory about how we can learn to be wise. The answer has to involve other people, and a structured conversation. As in a good blog post and a good comments thread.

James Wimberley: Kahneman’s book is largely about miscalculation. It’s Murphy’s Law all the way down, and this has not yet been fully taken in.

In Kahneman, it is not always obvious who is doing the miscalculation: the economist or the subject employing a rule-of-thumb.

This has not been “fully taken in” because it has not been fully sorted out.

Economists have notoriously undue confidence in highly stylized rules of rationally calculated behavior. It is easy enough for Kahneman to show that untutored subjects either do not understand the conventions of these stylizations or simply do not follow the rules. Their thinking is fuzzy compared to the sleekly abstract rationalizations of the economists. It is not so easy to show that the subjects are irrationally wrong to apply fuzzy thinking in situations that fully manifest the complexity and uncertainty of real life.

This makes Kahneman and Tversky a two-edged sword, as likely to cut into the hubris of economists as the alleged residual irrationality of humanity.

I’m not convinced that “private” vs “public” or “market” vs “government” are useful analytically. That we talk in these terms is the inertia of a centuries-long political struggle. No economy I have ever seen described is purely private, nor wholly government-directed or provided, and all have large components that fit neither of these descriptions. So I think it frames the analysis wrongly to start in terms of “market failure”.

Howard Frant’s “contract” vs direct provision” is a little sharper, but even here the issue is not whether but how much. C18/early C19 European states were very much into contracting, but learned by experience that it paid to keep some part of capacity in public hands. They also learned that, where continuity of service is critical, direct provision worked better – more costly day to day, less so over the long run.

One model with a lot of history is for private investors to build some major infrastructure, which then does not pay the anticipated returns, is written down and taken into state ownership (Panama, Suez, many railways, Channel Tunnel…) . Is this market failure or success?

One could also note that the reasons for choosing one mode of operation rather than another are much broader than cost. That the plebs will riot and burn the palace if the price of bread is too high a perfectly good reason for guaranteeing supply. That government provision has a more equitable salary structure is an equally good reason.

“We seem to be in furious agreement.”

We are. My doubts are around starting the analysis at market failure, which puts markets at the centre. Markets seem to be a very small part of the economy – in their purest form confined to a few commodities (oil, sugar, wheat, pork bellies, plywood…). I’ve never seen much economics writing on the changing forms within the household economy, and analysis of the composition of the corporate sector (in terms of scale, composition) seems to be very thin. And “not for profit” also seems to cover a wide range, while contracting with IBM or Serco is a very different proposition to contracting with Steptoe and Son. Going back and forth on government vs market does not seem to really get at the issues. At that, I’ll wait for cassander to turn up, and leave it.

OK, in the spirit of comparing and contrasting the U.S. with the RoW:

Here’s an egg scheme.

Or, you might consider the case of milk.

Milk can get really complicated.

And, it is not as if it is without consequences consumers may notice. But, the ultimate causes of consumer complaints may be difficult to identify and remedy in what is, after all, quite a complex system.

The market failures canon is a product of a priori theory. As Francis Bator observed in that paper you referenced, almost sixty years ago:

I am not here concerned . . . with the efficiency of “real life” market institutions
operated by “real life” people in a nonstationary world of uncertainty,
miscalculation, etc.

What follows is an attempt, rather, to explore and order those phenomena which cause even errorless profit- and preference-maximizing calculation in a stationary context of perfect (though limited) information and foresight to fail to sustain Pareto-efficient allocation. I am concerned, in other words, with the decentralizing efficiency of that regime of signals, rules and built-in sanctions which defines a price-market system.

“the decentralizing efficiency of that regime of signals, rules and built-in sanctions which defines a price-market system.” — In the history of political ideas in economics, I do think it is worthy of note in passing that Bator was self-consciously connecting the market failures canon with the Hayekian idea of price as a sufficient statistic coordinating a decentralized laissez-faire system of markets and with the project for delineating a theoretical neoclassical “socialist” economy. As Phillip Mirowski has documented, the import of Hayek’s idea into the Friedmanite version of Chicago School market economy as a system was and is an important underpinning of neoliberal ideology. (Sorry Howard, I know, there’s that word; I will try to make my point from here on without that label.)

The uses of information or knowledge in society and in the “self-organization” of society’s political economy feeds into common intuitions and expectations about when the performance of a sector poses a problem that might be solved by reform and reorganization. The a priori purity of “markets” vs public provision and “justified” state interventions to remedy “market failures” carries important insights, but it is too spare, too little informed by actual and practical experience.

As Howard and I pointed out at the beginning of the thread, the “markets” framework conspicuously left aside the processing of information through hierarchy. I objected to casually waving a hand at for-profit provision in the food supply and the use of regulation to remedy its manifest problems, not because I necessarily think “competition for profits will always find a way to subvert” regulatory frameworks, but because I think the reality of the “mixed economy” is not a sharp line separating a public sector from a private sector from a non-profit sector, but rather a heterogeneous jumble of real people in real institutions “in a nonstationary world of uncertainty, miscalculation, etc.”

The most common use of knowledge in society is not the mediation of value and scarcity by price, but feedback for the control of error and learning. Contra Hayek, critical information is often not recognizable on the front-line atomistic periphery of workers and consumers. Instead, it emerges from centralized processing of statistical information and expert investigation; the periphery is constrained to follow rules by bureaucratic supervision, in mixed chains of public, private and professional devising.

The example of milk is instructive. It is certainly not an example of problem-solved for all time by the magic of markets, nothing to see here, consumer sovereignty prevails. Uncertainty matters and, therefore, history and precedent matter. And, my cites above didn’t even get into the complex schemes that manage the quantity supply and price of milk, dairy cooperatives and so on. On some high level of abstraction, it is not wildly different from education, where complex systems manage the training and certification of teachers, the certification of schools, professional standards, research on curriculum effectiveness, testing students, et cetera.

In my area (Los Angeles), there’s a local dairy that has built its business around a reputation for delivering high-quality milk and dairy products at a premium price. It has a long history (more than 50 years) of pushing back against the requirement that milk be pasteurized. The Alta Dena folks are convinced that there is a market niche for unpasteurized milk and that, with their superior processing and distribution systems and controls, they could safely supply that market, if they were allowed to do so. Periodically, pushing against the regulatory apparatus, they have managed to try (we call that innovation!) and, of course, they kill or injure a few people (deniably) and the public health authorities quash their efforts until next time. Clearly, I am skeptical, but it is not obviously crazy to suppose that some people might value unpasteurized milk if “the market” could safely deliver it. Nor do I think the for-profit motivation to subvert the system is pure greedy evil.

In one of the articles cited above, an Australian firm is mentioned, which is trying to market so-called “A2” milk in the U.S. and other places where “A1” milk is standard, and may, arguably, cause some people digestive difficulties. They have some intellectual property associated with sorting out A2 milk cows from A1 milk cows.

Other cites mention the differences between U.S. standards for pasteurization and European standards for ultra-high temperature pasteurization. UHT milk is distributed in the U.S., but receives limited consumer interest. (I am rather fond of Nestlé chocolate milk, which I believe is UHT pasteurized though it is distributed in the U.S. refrigerated and has a weirdly pleasant texture that I like.)

You don’t have to search very hard to find controversies concerning organizational performance and sectoral structure in the food supply. The nutritional value of McDonald’s fast food. (In India, whether the grease used to fry the potatoes contained beef — doing my bit for RoW.) Monsanto and Round-Up and gene patents. GMOs and hormones and mad cow in the U.S., Europe and RoW. Michael Pollan wherever he goes.

In education and health care, the struggles over “for-profit” are side-by-side with the emergent attempts to reform the technology of “production” with more effective hierarchical control of the “production process”. Craft methods have been giving way to new systems of student testing or electronic medical record-keeping. The country doctor administering his own practice and taking his own counsel is long out-of-date. That kind of professional craft production has long since given way to systems that generate rules of best practice for medical doctors and other care-givers to follow. I’m not advocating; I’m just observing that that is part of the context for controversy and emergent organization and reform.

In relation to your thesis — that for-profit provision of services is often a bad idea for fundamental reasons — I am in agreement. I don’t know it is furious agreement, but what I offer above could be considered a quibble, though it is founded in fundamental objections to some of the presumptions and self-limitations of neoclassical economics.

I do object to the market failures framework as rhetoric, for hiding hierarchy, for demanding exceptional “justification” for state interventions, for a language of exceptionalism that falsely implies that perfectly competitive markets could exist (free of market failure), and for excusing economists from the obligation to actually know things a posteriori about how the economy works: the whole real people in real institutions facing uncertainty, miscalculation, learning and the challenges of controlling production processes.

I hope that’s less opaque, informative and not offensive to you.

John Quiggin

The thing that sometimes bothers me reading your stuff is the feeling that you’ve formed model in your head about how things work in the Westminster or “-our” countries (my third and fourth attempts at coming up with a term to designate the English-speaking world excluding the US) and then tried to stretch the US to fit that model. That’s certainly true for my unease about the word “neoliberal,” and it resurfaces on rereading the linked “Face the facts” article, and the statement “What works is traditional public provision.” That’s not so obvious in the US.
It may be that a lot of these experiments in the “-our” countries were attempts to fix something that wasn’t broken, but in the US there was good reason to think that things were in fact broken.

In education, the US has an extremely decentralized system that produces very good results in more privileged neighborhoods ad very bad results in poor neighborhoods. In the sixties, in fact, the call to bypass public schools came from the left (e.g., Jonathan Kozol), accusing the political system of racism. That led to the fights in NYC between the newly created community school boards and the teachers’ unions. No one ever took for-profits seriously as an alternative; for-profits were always a low-status fringe in American (higher) education. But it was not crazy to think that schools in poor neighborhoods might improve if there were more political accountability, which required more measurement. Nor was it crazy to think that competition from non-profits might help. Unfortunately, measuring without creating perverse incentives turned out to be a lot harder than people realized.

Though the basic framework was created under Bush, this was never something that the right ideologues strongly supported. Their goal is vouchers to individual parents.

Hillary Clinton, btw, was/is strongly supported by teachers’ unions, despite her alleged neoliberalism.

Things are even worse with prisons, which again are highly decentralized. In addition to the violence between inmates, and by inmates against guards, there is some really horrific violence against inmates by guards. And the guards’ unions use their considerable political clout to protect their members. Not totally crazy, even if it seems so ex-post,to think that private prisons might be worth a try. People who complain that privatization created a powerful constituency for more draconian sentencing should be aware that there has long been such a powerful constituency, using votes instead of money.

Frankly, I often envy the “-our” countries ability to turn things over to a nationwide apolitical bureaucracy. This is even more true for elections. Where did the US ever get the the idea that football should be refereed by whichever team was ahead at the start of the period?

Howard Frant @ 33

You make some good points. At the risk of being parochial, I would just like to add a couple of points.

Re: education. Primary and secondary education in the U.S. is highly decentralized, but it has also been remarkably homogenous. For all the decentralization, we didn’t get much diversity or experimentation.

Re: prisons. I worked with a pioneer in private prisons briefly way back when and I don’t feel guilty. The for-profit orientation came with obvious hazards, which, at least initially, were offset with adequate safeguards. But, back in the day, introducing private provision was often the occasion for breaking political stalemates that had created horrendous conditions. I particularly remember what a revelation it was for a board of county commissioners that had a poisonous relationship with a sheriff, when a private company with professionals in nice suits presented a short business plan that specified a reasonable budget per head for inmate meals that met nutritional standards. Ditto for laundry and janitorial and health services and educational services.

Whatever the merits of for-profit v public provision in the long-run, the change constituted a garbage can solution to an acute problem of administration. I didn’t follow up to see the long-term history; I think they went to a mix of public and private provision later.

I suspect that testing and charter schools are often seen as a similar garbage can solution: a way to break a political stalemate and relieve a straitjacket of bureaucratic monitoring and reporting. (Of course, there’s the grift and the looting, but that might also be related to the runaway financial sector in the U.S.)