Category Archives: Profit Motive

Health Insurance Profits Are Not the Problem

08 Thursday Jul 2021

Posted by in Health Insurance, Profit Motive

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My dentist said, “Oh well, these days it’s really only about whether the insurance company makes a profit….” A giant appliance was in my mouth at the time, propping it open, so I couldn’t respond. But I made a mental note because it reminded me of the hypocrisy so common in how people regard the concept of profit. That’s especially true of the Left, and I happen to know that my dentist, whom I personally like very much, stands well to my left. 

Profit Is Income

It’s worth pointing out that profit is merely compensation. My dentist collects revenue, often paid to him by insurers. If he runs an efficient practice, then he earns an income after paying staff, office rent, various suppliers, and for equipment, including interest on any debt outstanding. You wouldn’t be wrong to call that profit, and he does pretty well for himself, but somehow he thinks it’s different.

My dentist probably feels locked into an adversarial position with my insurer, and of course he is in the short run. He says his price is $750; the insurer says, “Sorry Charlie, you get $250”. So as far as he’s concerned, it’s a zero-sum game. Not so in the long run, however. He needs to partner with insurers to get and keep patients, so the exchange is mutually beneficial. And while he might do some picking and choosing among insurers, he’s essentially a price taker. His “price” of $750 is something of a fiction, as he’s clearly willing to do the work for the insurer’s reimbursement. 

I think the key qualitative difference between my dentist’s income and that of any wage earner is that his income is always at risk. After all, profit is often regarded as a return to entrepreneurial risk-taking. As it happens, he’s taking a loss on my new crown because it cracked as soon as he put it in. Then, he had to start from scratch with new impressions, after painstakingly removing the cemented, cracked pieces with what felt like a tiny circular saw.

Middling Profitability

But what about those profit-hungry health insurers? In fact, they are not known for outrageously high profits, and their earnings are typically not valued as highly by the market as those of other industries, dollar for dollar. Competition helps restrain pricing and enhance performance, of course. And since the advent of Obamacare, profits have been subject to a loose “cap” (more on that below).

The profitability of health insurers improved in 2020, however, because so many tests and elective procedures were postponed or foregone due to the coronavirus pandemic. That also prompted the government to make more generous subsidies available to consumers to pay COBRA insurance premiums.

Profits Drive Efficiency

I’ll put aside concerns about the crony capitalism inherent in the health system-insurer-regulator nexus, at least for a moment. The profit motive is the fundamental driver of efficiency in the production of insurance contracts and pooling of risks, as well as efficient servicing and administration of those contracts. Absent the possibility of profit, these tasks would become mere bureaucratic functions with little regard for cost and resource allocation. Furthermore, managing risk requires a deep pool of capital to ensure the ability of the insurer to meet future claims. Reinvestment and growth of the enterprise also requires capital. That capital is always at risk and it is costly because its owners demand a return as fair compensation. 

Poor Alternatives

Eliminating profit from the insurance function implies that resources must be put at risk without compensation. That’s one of the reasons why non-profit insurers, over the years, have tended to be thinly capitalized and unstable, or limited in their offerings to “health maintenance” benefits, like primary or preventative care, as opposed to insuring against catastrophic events. Capital grants to non-profits (private or governmental) usually come with strings attached, which can severely limit the effectiveness of the capital for meeting existing or future needs of the operation. Growth requires reinvestment, so a profit margin must be earned in order to grow with internal funds. Where non-profits are concerned, you can call the “margin” whatever you want, but it is functionally equivalent to a profit margin. 

On the other hand, insurance provided by the public sector puts the taxpayer at risk, and the potential liability to taxpayer “capital” is never rewarded nor indemnified. But it is not free. Now, you might insist that we’d all benefit from government-sponsored health insurance because of the broader risk pool. The problem with that perspective is that it turns the pricing of risk into a political exercise. We’ve already seen the destructive effects of community rating. Younger, healthier, but budget-constrained individuals tend to opt out due to excessive premiums, leading to a systemic “death spiral” of the pool.

Administrative Costs

A puzzling contention is that private insurers drive up administrative costs, presumably when compared to a single-payer system. Obamacare regulations limit the so-called Medical Loss Ratio of a health plan. To simplify a bit, this requires rebates to customers if premiums exceed claims by a certain threshold, which varies across individual, small, and large group markets. This regulation obviously places a loose cap on profits. It is also arbitrary and probably has hampered competition in the individual market. And of course there have always been suspicions that the ratio can be “gamed”. 

Nevertheless, under a single-payer system, it would be shocking if economies of scale were sufficient to reduce administrative costs to levels below those incurred by private insurers (especially if we exclude profit!). After all, scale is seldom a prescription for government efficiency, and that’s largely due to the absence of a profit motive and any semblance of competition! What administrative savings might be achieved by a monopsony public payer are likely to derive mainly from “one-size-fits-all” decision-making and product design, with little heed to consumer preferences and choice.

I’ll Take the Profit-Maker’s Coverage

There is plenty to criticize about the health insurance industry. In important ways, it has already succeeded in shifting risks to taxpayers with the help of its policy-making cronies. The insurers are further protected by a flow of government premium subsidies to the individual market; and the largest insurers have benefitted from Obamacare regulations, which encourages increased market power by large hospital networks, which are happy to negotiate charges that benefit themselves and insurers. All else equal, however, I’d rather have a few choices from profit-making health insurers than a single, community-rated choice from the government. I’d rather see risk priced correctly, with direct subsidies made available to individuals in high-risk segments unable to afford their premiums. And I’d rather see less government involvement in health care delivery and insurance. We’d all be better off, including my dentist! 

Note: This post also appears at The American Reveille.

Ex Ante Agreements, Ex Post Gripes

23 Tuesday May 2017

Posted by in Health Insurance, Profit Motive

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Anyone signing a contract better know the terms to which it binds them. They sign voluntarily and do so because they believe it has value. They are presumed to understand what they are obligated to pay and when; what they are entitled to receive, when, and under what circumstances; what actions (and non-actions) are required of them to “perform” under the contract; and what recourse they have should the counter-party fail to perform. The value they perceive upon signing is always based on an expectation. Sometimes, that expectation summarizes risks they are paying to avoid, even as a counter-party is more than willing to carry the risk. The contract is signed and everyone is happy… enough.

Health insurance is an example to which I’ve dedicated ample space over the past couple of weeks (see the links in the left margin). Obviously, one buys health insurance before knowing an entire series of outcomes. The contract specifies what kinds of expenses the insurer is obligated to pay. Insurance is a highly complex product, and so an insurance policy or contract must be relatively complex, as the cartoon above suggests. In a well-functioning market, however, the insured pays a premium no higher than they consider worthwhile. Everyone would like to pay less, but absent a government mandate (heh!), no one is obligated to buy.

The ink is dry and life goes on. The premium is paid, health needs arise, costs are incurred, and sometimes those costs exceed a limit (the deductible) above which the insurer is obligated to pay at least a portion.

A calamitous health event typically brings heavy costs, and this possibility is exactly why people buy coverage, and it is exactly why insurers demand sufficiently stiff premia. These things happen to a fairly predictable percentage of an insurer’s  customers, but with enough variance to make the cash flows risky. As a backstop, insurance contracts sometimes include limitations on total lifetime benefits or on payments for certain kinds of treatments. Pre-existing conditions are a prominent example of limiting the risks that enter the risk pool, but there are other possible limitations on treatments and other aspects of care. While these are known upfront, disastrous health outcomes and their financial consequences are not.

An increasingly common refrain is that no one should profit from an individual’s acute health care needs, and that health insurers do just that. For logical consistency, this same complaint should be leveled against doctors, nurses, paramedics, hospitals, medical equipment manufacturers, and pharmaceutical companies. They all earn income by providing for health care needs, whether medical or financial, and income is income, after all. Whether that income is a wage or a profit is irrelevant. They are both forms of compensation for the use of resources. The major difference between insurers and the other income-earners is that insurers handle the financial risk of potential health care needs and pay when those needs arise, within and up to policy limits.

The crux of the complaint, however, is that insurers can deny claims, thus protecting their profits. Certainly there are claims denied for which the rationale can be disputed. Just as certainly, a financially prudent insurance company must impose some limits on the benefits offered by their policies. These limitations might preserve profitability, but they also protect the contingent benefits of other insureds as well as the solvency of the carrier. Those objectives are not independent.

The insurance buyer reveals the value of the contract ex ante, but sour grapes are easily conjured ex post if a claim is denied, no matter the agreed-to provisions of the insurance contract. The insurer is under no greater obligation to pay costs in excess of policy limits than the doctor, the nurse, or the man in the street. Yet insurers take special blame when inadequate coverage is an issue, whatever the reason.

Hospitals and physician practices sometimes provide uncompensated care. There are also a number of support organizations for severely-ill but inadequately insured patients. So, private charity is one answer to the dilemma of extreme health-cost outcomes. Public aid is another, and the appropriate breadth of the state’s role in cases of pre-existing conditions and extreme individual health care costs is a legitimate question.

In the end, private health insurers provide a valuable service by pooling and carrying the financial risk of health care events faced by individuals. Health insurance profits as a share of owner’s equity have fallen well short of market-wide averages in recent years (see my last post), though I regularly hear outrageous claims about excessive profits in the industry.

It’s not unusual for a buyer to feel remorse after signing a deal, but in cases of health coverage shortfalls, one could say that the insured bet too little or qualified for too little, or one could say that society doesn’t set aside enough resources to adequately care for the sick. However, one cannot say that the resources dedicated to arranging private coverage deserve no reward, or that the business should be pillaged on account of certain policy limitations, or that the future claims of other policyholders should be hijacked. Those who proclaim such nonsense are guilty of severe ethical misjudgment.

Good Profits and Bad Profits

18 Thursday May 2017

Posted by in Health Care, Profit Motive

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Toles-on-Regulatory-Capture

There are two faces of profit. It’s always the fashion on the left to denigrate profits and the profit motive generally, as if it serves no positive social function. This stems partly from a failure to examine the circumstances under which profits are earned: is it through competitive performance, innovation, hard-won customer loyalty, and the skill or even luck to spot an underpriced asset? Such a “good” profit might even exceed what economists call a “normal profit”, or one that just covers the opportunity cost of the owners’ capital. On the other hand, profit can be derived from what economists call “rent seeking”. That’s the dark side, but the unrecognized spirit of rent seeking seems to lurk within many discussions, as if the word profit was exclusively descriptive of evil. The “rent” in rent seeking derives from “economic rent”, which traditionally meant profit in excess of opportunity cost, or a “supra-normal” profit. But it’s impossible to know exactly how much of any given profit is extracted by rent seeking; a high profit in and of itself is not prima facie evidence of rent seeking, even though we might argue the social merits of a firm’s dominant market position.

Rent seeking takes many forms. Collusion between ostensible competitors is one, as is any predatory attempt to monopolize a market, but the term is most often associated with cronyism in government. For example, lobbying efforts might involve favors to individuals in hopes of swaying votes on regulatory matters or lucrative government contracts. Sometimes, a rent seeker wants lighter regulation. At others, a rent seeker might work the political system for more regulation in the knowledge that smaller competitors will be incapable of surviving the heavy compliance costs. Government administrators also have the authority to change fortunes with their rulings, and they are subject to the same temptations as elected officials. In fact, in the aggregate, administrative rule-making and even enforcement might outweigh prospective legislation as attractors of intense rent-seeking.

Rent seeking is big-time and it is small-time. It takes place at all levels of government, from attempts to influence zoning decisions, traffic patterns, contract awards, and even protection from law enforcement. When it’s big time, rent seeking is the very essence of what some call corporatism and more generally fascism: the enlistment of coercive government power for private gain. A pretty reliable rule is that where there’s government, there is rent-seeking behavior.

Otherwise, the profit motive serves a valuable and massive social function: resources are attracted to profitable uses because they signal the desires of potential buyers. In this way, profits assure that resources are drawn into the most-valued uses. The market interactions between new competitors, drawn by the prospect of profits, and willing buyers leads to a self-correction: supra-normal profits get competed away over time. In this way, the spontaneous actions of voluntary market participants lead to a great achievement: all mutually beneficial trades are exhausted. Profit makes this possible in the short-run and it assures that trades evolve optimally with changes in tastes, technology and resource availability. By comparison, government fares poorly when it attempts to plan outcomes in the short- or the long-run. Rent seeking is an attempt to influence and even encourage such planning, and the profits it enables impose costs on society.

Good and Bad Profits In Health Insurance

I’ve written a few posts about health insurance reform recently (see the left margin). Health care is scarce. If relying on government is the preferred alternative to private insurance, don’t count on better access to care: you won’t get it unless you’re connected. Profits earned by health insurance carriers are roundly condemned by the left. It is as if private capital utilized in arranging coverage and carrying the risk on pools of customers deserves zero compensation, that only public capital raised by coercive taxation is morally acceptable for this purpose. But aside from this obvious hogwash, is there a reason to question the insurers’ route to profitability based upon rent seeking?

The health insurers played a role in shaping the Affordable Care Act (ACA, i.e., Obamacare) and certainly had hoped to benefit from several of its provisions, even while sacrificing autonomy over product, price, coverage decisions, and payout ratios. The individual and employer mandates would force low-risk individuals to purchase extensive coverage, and essential benefits requirements would earn incremental margins. Sounds like a nice deal, but those policies were regarded by the ACA’s proponents as necessary for universal coverage, stabilizing risk, and promoting adequate coverage levels. There were other provisions, however, designed to safeguard the profitability of insurers. These included an industry risk adjustment mechanism, temporary reinsurance to help defray the cost of  covering high-risk patients, and so-called risk corridors (also temporary).

As it turned out, the ACA was not a great bet for insurers, as their risk pools deteriorated more than many expected. With the expiration of the temporary protections in Obamacare, it became evident that offering policies on the exchanges would not be profitable without large premium hikes. A number of carriers have stopped offering policies on the exchanges.

It should be no surprise that health insurance profitability has been anything but impressive over the past three years. The average industry return on equity was just 5.6% during that time frame, and it was a slightly better 6.2% in 2016, about 60% of the market-wide average. It’s difficult to conclude that insurers benefitted greatly from rent seeking activity with regard to the ACA’s passage, but perhaps that activity had a sufficient influence on policy to stabilize what otherwise might have been disastrous performance.

The critics of insurance profits are primarily interested in scapegoating as a means to promote a single-payer health care system. While some are aware of the favors granted to the industry in the design of the ACA, most are oblivious to the actual results. Even worse, they wish to throw-out the good with the bad.

The left is almost universally ignorant of the social function served by the profit motive. Profits stimulate supply, competition and innovation in virtually every area of economic life. To complain about profits in general is to wish for a primitive existence. Unfortunately, the potential for government to change the rules of the market makes it a ripe target for rent-seeking, and it creates a fog through which few discern the good from the bad.

Gains From Medicare Trade

08 Thursday Dec 2016

Posted by in Medicare, Privatization, Profit Motive

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Boomers and Medicare

Here’s a bit of zero-sum ignorance: private profits are robbed from consumers; only non-profits or government can deliver full value, or so this logic goes. Those who subscribe to this notion dismiss the function of private incentives in creating value, yet those incentives are responsible for nearly all of the material blessings of modern life. What the government seems to do best, on the other hand, is writing checks. It’s not really clear it does that very well, of course, but it does have the coercive power of taxation required to do so. Capital employed by government is not a “free” input. It bears opportunity costs and incentive costs that are seldom considered by critics of the private sector.

The role of private profit and the zero-sum fallacy come up in the context of proposals to privatize government services. In what follows, I discuss a case in point: privatization of Medicare. Rep. Tom Price, the Chairman of the House Budget Committee, is Donald Trump’s nominee to head HHS. In November, Price said Congress would attempt to pass legislation overhauling Medicare in the first year of the Trump Administration. James Capretta of the American Enterprise Institute (AEI) explains some of the features of the possible reforms. Price has supported the concept of a premium support plan whereby seniors would purchase their own coverage from private insurers, paid at least in part by the government (also see here).

Medicare and Its Ills

The Medicare program is beset with problems: it has huge unfunded liabilities; it’s cash flows are being undermined by demographic trends; fraud and bureaucratic waste run rampant; it’s unpopular with doctors; and the regulations imposed on healthcare providers are often misguided.

Writing checks to health care providers is really the primary “good” created by the federal government in the administration of Medicare. The Centers for Medicare & Medicaid Services (CMS), a branch of the Department of Health and Human Services (HHS), also performs regulatory functions mandated by legislation, such as the Affordable Care Act (ACA).

More recently, CMS has been implementing the Medicare Access and Chip Reauthorization Act of 2015 (MACRA), which will introduce changes to the payment formulas for physician compensation under the plan. Economist John C. Goodman offers a cogent explanation of the ill-conceived economic planning at the heart of Medicare regulation and its implementation of MACRA in particular:

“…the government’s current payment formulas create perverse economic incentives — to maximize income against the formulas instead of putting patient welfare first. The goal is to change those incentives, so that providers will get paid more if they lower costs and raise quality.

But after the new formulas replace the old ones, provider incentives in a very real sense will be unchanged. They will still have an economic incentive to maximize income by exploiting the formulas, even if that is at the expense of their patients.“

After describing several ways in which Medicare regulation, now and prospectively, leads to perverse results, Goodman advances the powerful argument that the market can regulate health care delivery to seniors more effectively than CMS.

“If the government’s metrics are sound, why not allow health plans to advertise their metrics to potential enrollees and compete on these quality measures. Right now, they cannot. Every communication from health plans to Medicare enrollees must be approved by CMS. … Under MACRA, health plans profit by satisfying the government, not their customers. … Better yet, why not let the market (rather than government) decide on the quality metrics?“

Private Medicare Exists

Wait a minute: profit? But isn’t Medicare a government program, free from the presumed evils of profit-seekers? Well, here’s the thing: almost all of the tasks of managing the provision of Medicare coverage are handled by the private sector under contract with CMS, subject to CMS regulation, of course. That is true even for Part A and Part B benefits, or “original Medicare”, as it’s sometimes called.

Under “original” Medicare, private insurers process “fee-for-service” claims and payments, provide call center services, manage clinician enrollment, and perform fraud investigations. Yes, these companies can earn a profit on these services. Unfortunately, CMS regulation probably serves to insulate them from real competition, subverting efficiency goals. Goodman’s suggestion would refocus incentives on providing value to the consumers these insurers must ultimately serve.

Then there are “Medigap” or Medicare Supplement policies that cover out-of-pocket costs not covered under Parts A and B. These policies are designed by CMS, but they are sold and managed by private insurers.

And I haven’t even mentioned Medicare Parts C and D, which are much more significantly privatized than original Medicare or Medigap. The Part C program, also known as Medicare Advantage, allows retirees to choose from a variety of privately-offered plans as an alternative to traditional Medicare. At a minimum, these plans must cover benefits that are the equivalent to Parts A and B, as judged by CMS, though apparently “equivalency” still allows some of those benefits to be declined in exchange for a rebate on the premium. More optional benefits are available for an additional premium under these plans, including a reduced out-of-pocket maximum, a lower deductible, and reduced copays. Part C has grown dramatically since its introduction in 1996 and now covers 32% of Medicare enrollees. Apparently these choices are quite popular with seniors. So why, then, is privatization such a bogeyman with the left, and with seniors who are cowed by the anti-choice narrative?

What’s To Privatize?

Not privatized are the following Medicare functions: the collection of payroll-tax contributions of current workers; accounting and reporting functions pertaining to the Trust Fund; decisions surrounding eligibility criteria; the benefit designs and pricing of Part A (hospitalization) and Part B (optional out-patient medical coverage, including drugs administered by a physician); approval of provider plan designs and pricing under Parts C; regulation and oversight of all other aspects of Medicare, including processes managed by private administrative contractors and providers of optional coverage; and regulation of health care providers. 

The Independent Payment Advisory Board (IPAB) was created under the Affordable Care Act (ACA), aka Obamacare, to achieve Medicare costs savings under certain conditions, beginning in 2015. Its mandate is rather confusing, however, as IPAB is ostensibly restricted by the ACA from meddling with health care coverage and quality. Proposals from IPAB are expected to cover such areas as government negotiation of drug prices under Part D, a Part B formulary, restrictions on the “protected status” of certain drugs, and increasing incentives for diagnostic coding for Part C plans. Note that these steps are confined to optional or already-private parts of Medicare. They are extensions of the administrative and regulatory functions described above. Despite the restrictions on IPAB’s activities under the ACA, these steps would have an impact on coverage and quality, and they mostly involve functions for which market solutions are better-suited than one-size-fits-all regulatory actions.

The opportunities for privatization are in 1) creating more choice and flexibility in Parts A and B, or simply migrating them to Parts C and D, along with premium support; 2) eliminating regulatory burdens, including the elimination of IPAB.

Impacts On Seniors Now and Later

Privatization is unlikely to have any mandatory impact on current or near-future Medicare beneficiaries. That it might is a scare story circulating on social media (i.e., fake news), but I’m not aware of any privatization proposal that would make mandatory changes affecting anyone older than their mid-50s. Voluntary benefit choices, such as Part C and D plans, would be given more emphasis.

There should be an intensive review of the regulatory costs imposed on providers and, in turn, patients. Many providers simply refuse to accept patients with Medicare coverage, and regulation encourages health care delivery to become increasingly concentrated into large organizations, reducing choices and often increasing costs. Lightening the regulatory burden is likely to bring immediate benefits to seniors by improving access to care and allowing providers to be more patient-focused, rather than compliance-focused.

Again, the most heavily privatized parts of Medicare are obviously quite popular with seniors. The benefits are also provided at lower cost, although the government pays the providers of those plans extra subsidies, which may increase their cost to taxpayers. Enrollees should be granted more flexibility through the private market, including choices to limit coverage, even down to catastrophic health events. Consumers should be given at least limited control over the funds used to pay their premia. That would include choice over whether to choose lower premia and put the excess premium support into consumer-controlled Health Saving Account (HSA) contributions.

Other Reforms

Pricing is a controversial area, but that’s where the terms of mutually beneficial trades are made, and it’s what markets do best. Pricing flexibility for private plans would be beneficial from the standpoint of matching consumer needs with the appropriate level of coverage, especially with fewer regulatory restrictions. Such flexibility need not address risk rating in order to have beneficial effects.

Regulations imposed on physicians and other providers should be limited to those demanded by private plans and the networks to which they belong, as well as clear-cut legislative rules and standards of practice imposed by professional licensing boards. The better part of future contributions to the Trust Fund by younger workers (i.e., those not grandfathered into the existing program) should be redirected toward the purchase today of future benefits in retirement, based on actuarial principles.

Perhaps the best cost-control reform would be repeal of the tax deductibility of insurance premia on employer-paid insurance plans. This provision of the tax code has already inflated health care costs for all consumers, including seniors, via demand-side pressure, and it has inflated their insurance premia as well. If extended to all consumers, tax deductibility would be less discriminatory toward consumers in the individual market and most seniors, but it would inflate costs all the more, with unevenly distributed effects. Unfortunately, rather than eliminating it entirely, qualification for the tax deduction is very likely to be broadened.

Conclusions

The Medicare program is truly in need of an overhaul, but reform proposals, and especially proposals that would put decision-making power into the hands of consumers, are always greeted with reflexive shrieks from sanctimonious worshippers of the state. The most prominent reform under consideration now would offer more of what’s working best in the Medicare program: private choices in coverage and costs. Solving the long-term funding issues will be much easier without a centralized regime that encourages escalating costs.

Earning a profit is usually the mark of a job well done. It is compensation for the use of capital and the assumption of risk (i.e., no bailouts). Physicians, nurses, chiropractors, insurance agents and customer service reps all earn compensation for their contributions. Providers of capital should too, including the owners of health insurance companies who do well by their customers. And if you think the absence of profit in the public sector creates value, remember the damage inflicted by taxes. Capital isn’t “free” to society just because it can be confiscated by the government.

Parks, Prisons and Profits

30 Friday Sep 2016

Posted by in Government, Profit Motive

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img_3117

One of my favorite pastimes is tallying the economic and social death wishes espoused by leftists, populists and other statists. A frequent theme of their entreaties is the presumed ugliness of profits sought by private businesses. Their expressed distaste is usually couched in terms suggesting that profits are a certainty, which of course they are not. Profits are always at risk unless protected by government. The critics are sometimes focused on lines of business that involve public assets or a supposed public purpose, such as education. Two other examples of that nature recently came up in my news feed: privately-operated prisons and private management of public parks.

The complaints heard about these kinds of business operations are based on ill-founded notions about the function of profit: that it is appropriate for resources to earn rewards only in some endeavors and not others, regardless of the property invested and the risks assumed by the enterprise. Another fallacy is that somehow, as if by magic, the motives and competence of public employees are beyond question. In fact, the ineffective and sometimes perverse incentives faced by public institutions and employees tend to undermine effective performance. That’s the underlying reason why privatization of services is often in the public interest. The detractors of profit usually rely on anecdotal evidence of poor performance by private managers without any objective basis of comparison.

Warren Meyer at Coyote Blog discusses the common misconception held by many regarding the relative morality of profits and wages. His comments are in the context of the company he owns and manages, which operates public parks under contract with the US Forest Service (USFS) and other public agencies, collecting revenue via entry and camping fees. Meyer (and I) find it astonishing that the aversion to private park operations is so common:

“The most typical statement I hear from USFS employees that summarizes this opposition — and it is quite common to hear it — is that ‘It is wrong to make a profit on public lands.’ …. This general distaste for profit, which is seen as “dirty” in contrast to wages which are relatively ‘clean’ (at least up to some number beyond which they are dirty again), is not limited to the USFS or even to government agencies in general, but permeates much of the public.“

Meyer goes on to describe a conversation he had with a USFS District Ranger. I provide a few excerpts below:

“Me: If you think it’s wrong to make money on public lands, I assume you must volunteer, else you too would be making money on public lands.
Ranger: No, of course I get paid.
Me: Well, I know what I make for profit in your District, and I have a good guess what your salary probably is, and I can assure you that you make at least twice as much as me on these public lands.
Ranger: But that is totally different.
Me: How? … My profit is similar to your wage in that it is the way I get paid for my effort on this land — efforts that are generally entirely in harmony with yours as we are both trying to serve visitors and protect the natural resources here. But unlike your wage, my profit is also a return on the investment I have made. Every truck, uniform, and tool we use comes out of my profit, whereas you get all the tools you need paid for by your employer above and beyond your salary. Further, your salary is virtually guaranteed to you, short of some staggering malfeasance. Even if you do a bad job you likely would just get shunted to a less interesting staff position at the same salary, rather than fired. On the other hand if I do a bad job, or if one of my employees slips up, or even if some absolutely random occurrence entirely outside my control occurs (like, say, a flood that closes our operations) my profit can completely evaporate, or even turn into a loss. So like you, I get paid for my efforts here on public lands, but I have to take risk and make investments that aren’t required of you. So what about that makes my profit less honorable than your wage?
Ranger: Working on public lands should be a public service, not for profit
Me: Well, I think you are starting to make the argument again that you should be volunteering and not taking a salary. But leaving that aside, why is profit inconsistent with service to the public?”

Privatization is not inconsistent with service to the public except under one circumstance highlighted by Meyer in a postscript. The ranger might have asked:

“How do we know your profits are not just the rents from a corrupt, cronyist government contracting process?“

Of course, if that were true, it would not necessarily be worse than a park operated exclusively by a public agency with no incentive to operate efficiently. The key here is to have effective review of the contracting process and good performance incentives in place. Meyer notes that his company serves millions of visitors each year at high service levels for a cost that is low relative to government-operated parks, and the company receives excellent reviews. More power to him! Profits are not synonymous with graft. Unfortunately, the purely emotional “feeling” that profits are immoral or dishonorable is amplified by the public nature of park assets, and that idea won’t ever be purged from the populist mind.

Ann Althouse brought similar thoughts to mind in describing Hillary Clinton’s weakly-reasoned condemnation of privately-operated prisons. Here’s Hillary at the first presidential debate early this week, after expressing approval of the Obama Administration’s decision to phase out most privately-operated federal prisons:

“You shouldn’t have a profit motivation to fill prison cells with young Americans.“

You can almost hear Althouse, a law professor at the University of Wisconsin, laughing at the idea that operators of private correctional facilities have any ability “to fill prison cells”. That’s not how our justice system works, Hillary! Some argue that “occupancy guarantees” in private prison contracts give prosecutors an incentive to seek harsh sentences, but that is a tenuous argument, especially with prisons generally over-crowded as they are. And it isn’t as if private prisons are free of oversight. Althouse contends that Hillary Clinton’s position is a concession to the left made necessary by earlier outrage that the Clinton campaign had accepted contributions from the private prison industry, itself prompted by a Bernie Sanders’ attack on that point.

Reason Magazine commented on Sanders’ condemnation of private prisons last year, which then housed only about 12 percent of the federal prison population. Reason noted that closing private federal prisons would contribute to over-crowding at publicly-operated facilities. Sanders also proposed forcing state and local governments to close private prisons under their jurisdictions within two years. Not only would that action ignore objective measures of performance and cost, it would violate established contracts and constitute an outrageous overreach of federal authority.

The Administration’s decision to phase out private prisons was subjected to an even-handed critique by Sasha Volokh (younger brother of Eugene) in August. Volokh covers the evidence on costs and quality of private versus publicly-operated prisons. He finds that the DOJ memo announcing the decision to phase out private operators exaggerates cost and quality differences that favor government operations, and discounts evidence that favors private prisons. Reminiscent of Warren Meyer’s notes on privately-operated parks, Volokh stresses the importance of creating appropriate incentives for operators. Current quality incentives are weak, and he believes there is vast room for improvement:

“It might seem surprising, but private prisons have almost never been evaluated on their performance and compensated on that basis. …. In light of that, maybe it’s even surprising that private prisons have done as well as they have in the comparative studies. Be that as it may, the advent of performance-based contracting could open up possibilities for substantial quality improvements. This could work in the public sector too (bonus payments for public prison wardens?), but the private sector is probably better situated to take advantage of monetary incentives.“

The Reason Foundation published a report earlier this year entitled “Private Prisons: Quality Corrections at a Lower Cost“. The study reveals the leftist critique of private prisons to be a sham. Here are the two major takeaways:

“Private prisons save money-10 to 15 percent average savings on operations costs, based on fourteen independent cost comparison studies.

Private prisons provide at least the same quality services that government prisons do-based on six independent quality comparison studies, rates of American Correctional Association accreditation, recidivism comparison studies, contract terminations, and prisoner and correctional officer lawsuits.“

People often get their “facts” from questionable sources. As to privately-operated correctional facilities, I’ve heard critics state that people should watch the fictional Netflix serial “Orange Is the New Black” to gain a proper understanding of the horrors of private prisons. And many seem eager to accept that narrative without any knowledge of the facts. That’s probably because they have been taught that profits are “dirty”, that public purposes like the operations of parks and prisons are so pure of public purpose that private operators can have no legitimate role, and that government operation can be counted upon for quality and efficiency. Now doesn’t that sound oxymoronic?