Tag Archives: Profit Motive

Good Profits and Bad Profits

18 Thursday May 2017

Posted by in Health Care, Profit Motive

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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.

Parks, Prisons and Profits

30 Friday Sep 2016

Posted by in Government, Profit Motive

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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?

 

Those Halcyon Days of Desperation

18 Monday Jan 2016

Posted by in Capitalism, Markets, Poverty

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Nostalgia is hard to resist. Youth is fleeting, and for most of us, it seems more magical in hindsight than it might have been at the time. It’s also easy to imagine that certain historical eras were more interesting or romantic than the present. For example, my spouse tells me she’d love to have lived in the frontier days, yet she can’t tolerate the reality of a camping trip. We also tend to lionize certain leaders of the distant past, ascribing greatness based on history written by victors. Our objectivity may be obscured by narratives shaped over many years.

Today, some imagine and aggrandize the past in a different way: as a time when motives were “selfless”; when the world was inhabited by less acquisitive and more “minimalist” folk; when practices were more “sustainable”, or even “legitimate”. Despite the primitive conditions of that world, it was a better place for “free” human beings. So it is said, seriously!

Sarah Sqwire takes a look at these flights of fancy in “The Good Old Days of Poverty and Filth“. She dissects the views of one Luc Sante, a cultural historian, as an archetypical patron of primitivism. She invokes the French phrase “nostalgie de la boue, ‘longing for the mud,’ which means a romantic yearning for a primitive or degraded behavior or condition.” Here are some of Skwire’s colorful comments about the past:

“We don’t need every medieval romance novel to remind us that the heroine’s breath didn’t smell like cool mint Listerine. It’s probably for the best that the historical re-enactors at Colonial Williamsburg don’t actually use authentic colonial medical remedies for their health problems…. Any lover of history will occasionally find him or herself dreaming about attending a performance in the pit at Shakespeare’s Globe, or roughing it in the saloons and shacks of a gold rush town. … But a good student of history will acknowledge that the Globe was undoubtedly loud, smelly, crowded, and occasionally even dangerous for playgoers. And the rugged romance of the gold rush town is offset by the knowledge that you were probably far more likely to die of gangrene or cholera than you were to strike it even moderately rich. And those glorious 18th-century wigs? Heavy, hot, smelly, and prone to harboring bugs.“

She then quotes Sante:

“In the Paris I write about, people ran businesses to make a living, not to make a profit. Cafes, bars: they’re no longer public institutions or part of a community. There’s no possibility for eccentric self-determination amongst the shopkeepers.”

Skwire notes the odd distinction that Sante makes in the first sentence above, as if profit is not how proprietors ever made “a living”, or that they observed certain limits on their finances not imposed by market forces (i.e., their customers). She adds that businesses often seek to “create communities” as part of their business models, now in the era of social media more than ever, contrary to Sante’s presumption. Here’s Skwire’s verdict:

“Sante, though, has so much mud in his eyes that he is blind to the tangible and important progress that has been made in human wealth and welfare. His mucky nostalgia leads him to claim that our increasing wealth — which has given us more health, more discretionary income, more food, and more free time — is a danger more pernicious than terrorism.“

I am surprised that Skwire fails to mentions the environmental left in this context. It is, after all, the source of hysteria related to population and scarcity, and the source of so much criticism of modernity. As an antidote to such nonsense, I recommend the Human Progress web site. This recent entry on Julian Simon is instructive. I also recommend Matt Ridley’s Rational Optimist blog. Try this entry on “The Long Shadow of Malthus” for a start.

Skwire views Luc Sante’s infatuation with pre-modern life and lifestyles as an elitist’s prescription for “other” people. That may well be. It also fits the profile of many environmental elites. Whether or not Skwire’s characterization of Sante is accurate, he is at least ignorant of the great diffusion of prosperity taking place around the globe, fueled by markets and economic development. It seems awkward that anyone would bemoan economic progress when, in fact, world poverty is declining, yet that very misgiving is implied by many critiques of markets and modernity.