By Michael Hicks | Ball State University
For most of my adult life, I’ve described myself as a free market economist. But I should explain just what that means and how it influences what I research and write about. The best way to start this essay is to observe that nearly all economic research examines the points at which markets fail. It is rare to find a technical economic paper that reports markets working especially well.
In the past 25 years, across several hundred studies, I think I’ve concluded markets are working well in no more than one or two papers. This is largely how the rest of scientific publishing works. There would be no need for virologists if there were no viruses that made people unwell. But most of the time we are not unwell due to viruses, and very few papers in virology focus on well people.
Markets are much the same. Most of the time, in most places, markets work well. They allocate goods or services to those who value them most and they push factors of production, such as talent or equipment, to the places they’ll be most productive. Without any conscience design, markets tell us when there is too little or too much of a commodity in a certain place. This causes humans to “truck and barter” from places of plenty to places of scarcity.
Markets allocate financial assets, land and scarce commodities like copper and platinum in ways that humans could never effectively design. From the most basic level of human exchange to complex international trade, there are almost no examples where free markets don’t outperform any other human-contrived arrangements. They give us the most goods and services at the lowest price.
If all markets worked freely, there’d be no real need for economists and nothing for us to study. But alas, too many markets aren’t free. Economists define three broad conditions where markets do not operate freely. In each of these cases, some intervention in free markets may be needed to approximate market outcomes.
The first example of market failure is in a public good. A public good is one where no alternative market will form, because no one can be excluded from receiving the benefits of the good or service. For example, national defense benefits everyone, regardless of their tax rates. So, there’ll be no free market for the Air Force. If it is to exist, government must pay for it.
The second example is markets in which the production of a good or service affects more than just the buyers or sellers. The textbook example of this is pollution, which imposes some cost on people who neither buy nor sell the polluting good or service. In this case, the costs are higher than the seller perceived, so the price is too low and the quantity of the item produced is too high.
There are also instances where the production of a good benefits more than those who receive it. Education and vaccines are the textbook examples. Of course, schooling and disease prevention benefit us individually, but living in places with better-educated people boosts everyone’s incomes. Living in places that are heavily vaccinated reduces everyone’s risk of disease. This is why we publicly fund education and vaccines.
The third type of market failure are monopolies, of which there are two types. Natural monopolies occur when a single producer is the lowest-cost provider of a good or service. The classic example is a water, sewer, retail natural gas or electricity service. In these cases, the cost of building competing infrastructure would make the product more expensive for everyone.
Contrived monopolies occur most typically when there is room for competition, but firms are able to exclude competitors from the market. Often government creates these “barriers to entry” by rival firms. Patents are temporary barriers to entry. Other times, firms manage to create their own monopolies by buying up competitors or firms in their supply chain.
Free market economists understand that for markets to be truly free, market failures must be addressed. To do this, government has to provide public goods. Government also must have a hand in regulating polluters and funding education.
There is plenty of room for disagreeing about details, and government rarely gets it just right. In fact, most of those economic papers about market failures explain how government can do better. A large number of those economic studies argue that government should lighten regulatory restrictions, or perhaps use market mechanisms more effectively.
Still, to a free market economist, paying for a U.S. Navy, allocating tax dollars to create a first-rate education system or regulating mercury emissions are well within the scope of government. We free market economists also argue that government should own or regulate utilities in the case of a natural monopoly. We would also agree with the existence and enforcement of laws against contrived monopolies. In fact, the economic argument against monopoly power is that it interferes with the free functioning of markets.
American anti-trust laws outline a number of behaviors that are illegal if they lessen competition between firms. The first law, named for GOP Sen. John Sherman, outlawed cartels and price fixing. Interestingly, Sherman’s more famous brother is best remembered for “remodeling” Atlanta in 1864. Regardless, several court cases led Congress to expand anti-trust laws to prohibit a wide range of activities if they reduced competition. The 1890 Sherman Act outlawed monopolies after they occurred, but the 1914 Clayton Act outlawed behaviors that led to monopolies.
Today, Indiana’s legislature wrestles with powerful and well-entrenched monopolies in our not-for-profit hospitals. Let’s see if the things those hospitals have done to secure and maintain their monopolies sound like things that were outlawed more than a century ago to preserve free market competition.
The Clayton Act outlawed mergers and acquisitions that lessened competition. These mergers could be horizontal, such as a single network buying hospitals in several adjacent counties to remove competitors. They could also be vertical, through the acquisition of clinics or referring physicians’ offices, which would keep other hospitals from being built in a region.
The same law made it illegal to charge different customers different prices if doing so helped cause or preserve monopoly power. This is called price discrimination, and can only be successful if the actual prices charged to consumers are almost wholly invisible. The Clayton Act also barred “exclusive dealings,” such as requiring physicians with admitting privileges to send patients exclusively to your hospital. Another example might be forcing ambulance services to deliver patients only to your hospitals.
If these actions sound familiar to you, you’d be right. They are part and parcel of Indiana’s hospital monopolies. Aggressive legislation to dismantle these monopolies is an unequivocally free market economic approach for those whose time has come.
Michael J. Hicks, PhD, is the director of the Center for Business and Economic Research and the George and Frances Ball distinguished professor of economics in the Miller College of Business at Ball State University.