The Market Can't Cure Medicare

Why competition won't lower prices

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Our faith in the power of the free market to solve our problems got a big endorsement from Congressman Paul Ryan. The Republican from Wisconsin believes there's nothing so wrong with Medicare's soaring spending that robust competition can't fix. He's proposed to shift Medicare clients to private insurance coverage by 2022, with the government chipping in the first $11,000 for most people.

The government's cost would be capped. That's where you derive the savings. Under the Ryan Plan--a pessimist might call it Ryan's Hope--so many companies will be rushing in to provide health insurance to aging boomers that the competition should keep the price of premiums from rising much. "There's no evidence of that," says Yale School of Management professor Fiona Scott Morton. "There really isn't. We have many uninsured people who are paying out of pocket for things, and it's not driving down prices."

A robust market is a wonderful thing. The prices of televisions, cell phones, clothes, fast food, computers and major appliances have declined over time, in part because consumers are rational creatures who are pretty good at figuring the value proposition being offered by the sellers. We can drive a hard bargain.

But the game doesn't work in our favor all the time. The airline industry is crazy competitive, right? Except that fares have increased nine times since mid-December. Gasoline is approaching $4 per gal. in many places. You may notice that having four service stations within two blocks of one another hasn't noticeably lowered the price at the pump. Cable- and satellite-television providers are constantly attacking each other in their advertising. Has your cable bill retreated over the past five years?

Nowhere in the Adam Smith rule book does it say that prices have to come down every time new competitors show up. We tend to forget what a price does: it's a mechanism for balancing supply and demand. It's not necessarily price's job to make steel less expensive. Price is about making steel available.

Likewise, there's more to competition than price alone. We have had two brand-name colas in the U.S. since 1902. Coke and Pepsi have been happy to share the market and earn profit margins that most companies in the consumer-electronics industry would be mad for. So why aren't there five or six more big competitors in the sugar-water business, which has no great technical barriers to entry? Because nobody wants to get into an expensive marketing war with Coke and Pepsi, two great marketers. That's not the case in consumer electronics. Flat-panel factories are hideously expensive to build, yet the cost of a high-definition television has fallen quickly because of the number of suppliers whose low-wage factories are churning out product. The profit margins are stinko. But if we look at computer operating systems, where the profit margins are lush, there's Microsoft and--who? Linux can't make a dent even though it gives away the source code. An entrenched competitor with a technical advantage is hard to displace.

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