Monday, April 12, 2010

Ending the Myth of 'Market Fundamentalism'

Ending the Myth of 'Market Fundamentalism'

By Dean Baker, CEPR

--This article was originally published in the Spring

2010 issue of Dissent Magazine


Progressives have wailed against "market fundamentalism"

for the last quarter-century. They complain that

conservatives want to eliminate the government and leave

everything to the market. This is nonsense.


The Right has every bit as much interest in government

involvement in the economy as progressives. The

difference is that conservatives want the government to

intervene in ways that redistribute income upward. The

other difference is that the Right is smart enough to

hide its interventions, implying that the structures

that redistribute income upward are just the natural

working of the market. Progressives help the Right's

cause when we accuse them of being "market

fundamentalists," effectively implying that the

conservatives' structuring of the economy is its natural



This is not just a question of framing; although the

framing is important. Economic outcomes that appear to

be the result of the natural workings of the market will

always sound more appealing than the machinations of

government bureaucrats, especially in the political

culture of the United States. If we label the Right's

interventions as nothing more than the free market left

to itself, then we place progressive policies at an

enormous political disadvantage.


But the confusion that this misguided war against market

fundamentalism creates in designing policy is even more

serious than the political damage. Progressives have no

reason to look to government to reverse market outcomes.

Rather, like our conservative opponents, we should look

for ways in which we can structure market rules so that

markets have better outcomes from a progressive



The most obvious recent government intervention to

redistribute income upward has been the bailout of the

financial industry. Faced with complete collapse in the

fall of 2008, Goldman Sachs, Citigroup, Morgan Stanley

and the rest did not yell that they wanted the

government to leave them alone. No, these financial

behemoths insisted that the government lend them money

at below-market interest rates and guarantee their

assets. Firms like Goldman Sachs even insisted that the

government make good on the debts of bankrupt business

partners, such as AIG.


Deregulation also increases profitability and has

nothing to do with the free market. In other words, the

financial industry wants the government to provide

"insurance" through the Federal Reserve Board, the

Federal Deposit Insurance Corporation and various ad hoc

channels, but it doesn't want to pay for it. It also

doesn't want the insurance to come with any

restrictions. In effect, the financial industry wants to

run an explosives factory out of its home and pay only

the standard residential insurance premium. That's not

the free market.


The demands of the financial industry on government are

not qualitatively different from what other sectors get

as a result of government interventions in structuring

the market. To take another example, the government

grants pharmaceutical companies patent monopolies that

allow them to mark up the price of prescription drugs by

several hundred percent or even several thousand percent

above what the same drugs would sell for in a

competitive market. As a result of patent protection,

many drugs sell for hundreds or even thousands of

dollars per prescription. By contrast, if all drugs were

sold as generics in a competitive market, the

overwhelming majority could be bought for $4 or $5 per



Patent monopolies do serve an important economic

function-they provide an incentive for researching new

drugs-but they clearly are not the only way to finance

research. The government spends more than $30 billion a

year financing biomedical research through the National

Institutes of Health, an amount comparable to what the

industry spends on research. In principle, we could

replace the industry-funded research through direct,

publicly funded research. Or, as Nobel Prize-winning

economist Joe Stiglitz has suggested, research could be

carried on in its current manner, but new patents could

be bought out through a prize system. Under this system,

a committee would assess the value of new patents and

pay this amount to patent holders. This would allow the

drugs based on new patents to be sold as generics in a

competitive market.


We can debate whether these alternative mechanisms are

better for supporting prescription-drug research than

the patent system, but the patent system is clearly not

the free market, and it is not essential for financing

prescription drug research. The proponents of drug

patents cannot claim to support a free market.


There is real money at stake. The country spent $250

billion last year on prescription drugs. In a

competitive market, the cost likely would have been

closer to $25 billion. The difference of more than $200

billion swamps the size of the payments to such programs

as Food Stamps, the State Children's Health Insurance

Program (SCHIP) or Head Start.


Furthermore, the drain from this patent monopoly is

projected to grow rapidly through time. Prescription

drug spending is the most rapidly rising component of

health care costs. In 2019 the country is projected to

spend almost $500 billion on prescription drugs. Over

the course of the next decade, expenditures are

projected to exceed $3.5 trillion, implying excess

payments to the drug industry of more than $3 trillion,

more than three times as much as will be spent on the

health care reform proposed in Congress at this writing

in early winter.


A similar story can be told about copyrights. Bill Gates

is an incredibly rich man because the U.S. government

gives him a monopoly on Windows, threatening to arrest

anyone who sells it or even gives it away without

Gates's permission. Without the monopoly created by

copyright protection anyone would be able to instantly

download Microsoft software anywhere in the world at no

cost. As with drug patents, copyrights serve an

important economic function. They provide an incentive

for creative and innovative work, like developing new

and better software or producing good movies and music,

but we already have alternative mechanisms for

supporting this work and can develop new ones.


Copyright monopolies lead to an enormous transfer of

income to software and entertainment companies.

Microsoft alone pockets more than $60 billion a year in

revenue, almost all of which would not be possible

without copyright protection. The industry association

claims that, taken together, copyright industries

accounted for 6.6 percent of GDP. This is more than one-

third of the tax revenue collected by the federal



I could list more mechanisms and beneficiaries, but the

point should be clear. The idea that a "free market" is

allowing some people to get incredibly rich and causing

other people to be poor or financially insecure is

nonsense. The distribution of income is determined by

government policies that favor some groups and work

against others. If progressives accept the structures

put in place by conservatives as the free market and

then look to use tax and transfer policy to redress the

inequities, we have given ourselves a hopeless task.


We must instead focus on altering the rules that

redistribute income upward. There are many different

ways to structure markets. We must be as opportunistic

and creative as the Right in finding rules that both

produce efficient outcomes and lead to better

distributions of income.


The health care bill illustrates the need for a

fundamentally different approach. It does a good job of

meeting the important goal of extending coverage to most

of the uninsured. However, it does very little to

address the problem of exploding cost growth. As a

result, we will have created a system that we know will

be unaffordable over the long run. The idea that we can

somehow pay for this system in future decades with

progressive taxes is absurd on its face. It will almost

certainly not be possible politically to raise taxes

high enough to cover public-sector health care costs. We

will eventually either have to ratchet back the extent

of coverage and/or the quality of care or impose

substantial taxes on the middle class.


The alternative route is to directly attack the

structure of the health care system that leads to such

bloated costs. In this context, it is important to

remember that we pay more than twice as much per person

for care as people in other wealthy countries. As any

number of studies have shown, the reason for higher

costs in the United States is not the better quality or

greater volume of services but rather the higher cost of

the services that we get. This can be addressed by

changing the markets for these services.


Let's return to prescription drugs. The current system

leads to enormous inefficiencies from any perspective

and leaves us with absurd choices that would disappear

with a more rational system of financing prescription

drug research.


Consider the situation of an 80-year-old woman, in

generally good health, who develops a form of cancer.

Suppose that the only treatment likely to be

successfully is a new, bioengineered drug that would

cost $250,000 a year. Should the government be willing

to pay this expense?


As our moral philosophers labor over this problem,

consider that the drug would probably cost $200 a year

in the absence of patent protection. That would be the

marginal cost of manufacturing and distributing the

drug. Although the drug company may have spent a huge

amount of money developing the drug, this is money out

the door. We have already paid the research cost

(ideally through one of the mechanisms discussed above.)

The relevant question is, what does it cost to produce

the next dose. In the world where the year's dosage

costs $200 we won't have to spend too much time debating

the treatment.


This is not the only problem with the patent system.

When the government intervenes to artificially inflate

prices, it creates unexpected perverse incentives. As a

result of the enormous profits on its drugs, the

pharmaceutical industry spends a fortune marketing them.

This causes them to court and even bribe doctors to get

them to prescribe drugs. It leads to expensive direct-

to-consumer marketing campaigns. It leads the industry

to buy politicians to ensure that Medicare, Medicaid and

other government programs pay for the drugs. And, it

gives the industry an enormous incentive to conceal

research results that call into question the

effectiveness and safety of its drugs.


Progressives should have been pushing these "free

market" arguments in discussing prescription drugs. The

amount of money at stake dwarfs the sums at issue with

either the "Cadillac" plan tax or the millionaires'

surtax in the health care plans approved by the Senate

and the House.


Similarly, we could use a little free trade in health

care. Trade policy has been quite explicitly designed to

place our manufacturing workers in direct competition

with low-paid workers in the developing world.

Progressives often point to the loss of manufacturing

jobs in the United States and the depression of wages

for non-college educated workers as evidence that free

trade doesn't work. This is completely wrong. These

outcomes are exactly what the trade models predicted

would be the result of the trade policies that the

United States has pursued. I would be surprised if there

were any other outcome.


However, we can design "free trade" policies that

produce different outcomes. In the case of health care,

we can start by allowing Medicare beneficiaries to buy

into the health care systems of other wealthy countries.

Because health care costs are so much lower in Germany,

Canada and everywhere else, if beneficiaries opted to

move to another country to receive their care, there

would be enormous savings that could be split between

the U.S. government and the beneficiaries. We recently

did calculations showing that a few decades out the

projected savings would be tens of thousands per

beneficiary each year. This was even after allowing for

a substantial premium above costs to the receiving

country of treating elderly patients, to ensure that

they also benefited from the deal.


In fact, since these countries would be getting a

premium above their cost of care, this could be a major

source of growth for these countries. The fact is that

everyone has a huge comparative advantage in health care

relative to the United States. Our health care industry

only survives because of the extraordinary protectionist

measures that restrict foreign competition. It is easy

to devise mechanisms through which foreign countries

could provide care for U.S. citizens and use the profits

to provide better care for their own populations. An

international Medicare voucher system could allow

retirees to enjoy a much higher standard of living than

would otherwise be the case, while at the same time

saving the U.S. government tens of trillions of dollars

in Medicare costs over the long term. By reducing demand

for health care in the United States, it would also lead

to downward pressure on domestic medical costs more



There are other ways in which the government can promote

trade in medical services. For example, it can license

facilities in other countries to ensure high standards

and also standardize rules on legal liability to ensure

that people who go overseas for treatment can be assured

of reasonable legal redress in the case of malpractice.


Given the enormous gap in costs for health care services

between the United States and Europe, not to mention

high-quality facilities in places like India and

Thailand, there would likely be a huge flow of patients

for treatment outside the country, if we created the

proper institutional structure.


Of course, it would be much better to reform the system

in the United States so that people did not have to

leave the country to get decent affordable care. But, if

we lack the political power to reform the domestic

system, as is obviously the case now, it is absurd to

hold patients here as hostages of a broken system. After

the forces of market competition have worked their

magic, we will be much better able to discuss reform

with the domestic health care industry.


It is far more productive to talk about ways to use

market mechanisms to fundamentally restructure the

health care system than to try to scrape together

nickels and dimes in tax revenue to pay to maintain a

broken health care system for a few more years. The same

approach can be applied to almost any social problems.

We can and should push for progressive taxation, but it

is even better to change the institutional structures

that lead to gross inequality.


CEOs in the United States get paid tens of millions of

dollars a year because we have created a corporate

governance structure that allows top managers to plunder

the corporation for their own ends. This corporate

governance structure was created by the government, it

did not develop through the free market. No other

country allows for the same sort of plundering. Changing

the rules in ways that return control to shareholders is

not government interfering with the market; it is simply

repairing a dysfunctional system. Europe and Japan both

have dynamic capitalist economies, but they do not have

the huge executive compensation packages of the United

States. This is not due to legal restrictions on pay, it

is due to the fact that they have governance structures

that don't allow the top executives to pilfer the

corporations that they ostensibly work for.


In the same vein, although minimum wages and other

direct income supports for less-educated workers are

desirable, it is better to restructure markets in ways

that increase the relative demand for their services.

For example, we should insist that the Fed allow the

unemployment rate to fall to low levels, rather than

raise interest rates to choke off any possibility of

inflation. Former Federal Reserve chief Alan Greenspan

made this choice in the 90s (over the protest of Bill

Clinton's appointees to the Fed), allowing the first

sustained period of real wage growth for workers at the

middle and bottom of the wage distribution since the

60s. More union-friendly laws, such as serious civil or

even criminal penalties for employers who violate

workers' right to organize, would also help equalize the

distribution of income.


We can also apply some good free market principles to

highly paid professionals, such as doctors, lawyers and

economists. Easing professional and immigration

restrictions that largely protect the most highly

educated workers from international competition will

reduce pay for those in the top 1 percent to 2 percent

of the wage distribution and help to lower the cost of

everything from health care to a college education.


There is an endless list of policies that alter economic

rules to lead to more egalitarian outcomes.. The current

rules were not given to us by a deity or by nature, they

were written by the wealthy and powerful interest groups

who benefit from them.


These people are absolutely not free market

fundamentalists, nor are they opposed to a well-working

government. No one can mass market unauthorized versions

of Pfizer's latest drugs or Microsoft's new software.

Even under Republican administrations the government

would quickly arrest a large-scale violator of patent or

copyright law. The wealthy want and expect a government

that enforces the rules that protect their wealth and

power. They don't care about government social programs,

but that is because they don't depend on these programs.

No rich person died in Hurricane Katrina.


A serious long-term progressive agenda must move away

from a focus on tax-and-transfer policy and instead

concentrate on changing the rules that lead to

undesirable market outcomes. We must be as aggressive

and creative as the Right in designing new rules that

redistribute income downward rather than upward. And, we

must bury the concept of "free market fundamentalism."

There are no free market fundamentalists in this debate,

just conservatives who want to pretend that their rules

are the natural working of the market. Progressives

should not help them in this effort.



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