Tuesday, November 22, 2011

Ask RC: Why are college and medical care so expensive?

Every year we can count on two costs outpacing the rate of inflation- medical insurance and college education. Some might think this is because of how important these two commodities are, but the cost of food does not rise as quickly year after year, and it stands even higher in anyone’s hierarchy of needs. Some might think it’s because both are labor intensive, and the labor must be highly trained. But the cost of a cab ride in New York doesn’t rise as quickly year after year, and there is precious little more labor intensive than having one person driving another around. And if you’ve been in New York traffic, you want a well-trained driver.

The real answer is much more fundamental. In both cases we are seeing government pouring more and more money into each. To understand why this drives costs up we need to first disabuse ourselves of a common bit of economic “wisdom.” We are told, by left and right both, that taxes on businesses are always passed along to the consumer. The government can’t, these folks argue, actually extract money from businesses. Utterly false. The truth is that the price a consumer is willing to pay for a good or service has nothing to do with where the money goes. The price is set by supply and demand. Raising prices, for whatever reason, reduces demand. Imagine, for instance, that Washington determines to impose a $15,000 luxury tax on all new cars. Can Detroit, or even Tokyo, just “pass that on” to the consumer. Would you spend $30,000 on a car you value at $15,000? The artificially high price reduces sales, hurting the business’s bottom line. This is not just an abstract suggestion. Check out what happened to the luxury boat business after the first President Bush broke his no new taxes pledge.

Now back to government subsidizing education and medicine. How much would you be willing to pay for a college education? If that number for most people is $15,000, a year and the state stayed out of the equation, then the cost of an education would stay around $15,000. But suppose the state comes in offering scholarships, grants, and guaranteed loans. Now how much are you willing to pay? Still $15,000. That’s how much you value the education, and so that is what the college can get you to pay. Nothing at all wrong with that- it’s a free trade. How much though, would you be willing to pay of other people’s money? The trouble is that they can charge others, taxpayers, another $15,000, and still get your $15,000.

Don’t believe me? Well, consider the difference in the rates the uninsured pay at the local walk-in clinic compared to the insured. Why are the uninsured given this break? Is it because of the altruism of the medical profession? No. If I am willing to pay $150 to have my son’s arm x-rayed, that is what they will charge. If they can get the state, however, to pay $150, they will seek to charge $300, the $150 I am willing to pay, and the $150 the state is willing to pay.

All of this, in both instances, involves people receiving goods and services that they aren’t paying for, which increases demand. Increasing demand increases prices. Increased prices increases demands for government to “do something.” More government money is poured in, increasing demand, which increases prices. This friends, is how bubbles are blown up. We’ve lived through a tech bubble. We have lived through a stock bubble. In both these instances it’s a more nuanced argument to lay the blame at the feet of the state. We are still recovering from a real estate bubble. The education and medical care bubbles, however, are here. What’s next is when those bubbles pop.

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