Magazine | December 21, 2009, Issue

Priceless Is Worthless

In health care, education, or bonds, the price is (metaphysically) right

MasterCard is right: Some things in life are priceless. Those are the things that don’t work. If you care about something — health care, education, a clean environment — put a price on it. 

Prices are, or should be, objects of awe and wonder, a mystery to be meditated upon. They are not mere intersections of supply and demand curves, the predictable $19.99 of late-night infomercials: Prices are the Paraclete of the market economy, the mystical intercessor between producers and consumers, making possible miracles of information management and economic coordination that could not otherwise be accomplished. Prices are the epistemological movers and shakers of community life, transporting knowledge instantly and frictionlessly, coordinating the actions of a shipyard in Virginia with those of a steel mill in China, directing global flows of capital, letting clueless executives in Atlanta know that New Coke is a fiasco. 

That last bit of Cold War history is worth thinking about: When it hit the market in 1985, New Coke was the most highly engineered, polished, researched, lovingly refined, focus-grouped, test-marketed product of its time. (Socialist governments aren’t the only organizations that find their central-planning efforts nullified by the market, which is to say, by reality.) The Coca-Cola Company had everybody from food scientists to psychiatrists working on what they codenamed, in the military-industrial style, Project Kansas. All the best minds told them New Coke was going to be a smashing success, but prices said otherwise: They found that they could not give New Coke away. The price of Old Coke, if you could find it, skyrocketed. Consumers began to spend extraordinary sums of money — to pay very high prices — to import “The Real Thing” from overseas, and an organization calling itself “Old Cola Drinkers of America” was able to raise $120,000 to lobby Coca-Cola for a return to the original formula. Price spoke loud and clear. So poorly regarded was the new product that, in some cities in the South, where Coke is considered an item of particular cultural importance, revanchist cola conservatives paid full price for bottles of New Coke for the sole purpose of emptying them out in the streets as an act of protest. Sales tanked, orders nosedived, regional bottlers revolted. Coke’s brain trust said “X,” but prices said “Not X.” The price was right. 

It took a little trauma to get there, but consumers prevailed, and New Coke followed Communism into the dustbin of history — for similar reasons, but with a lot less bloodshed. The Coca-Cola Company had to bend to reality more quickly than the Marxist-Leninists did. Prices are, among other things, a snapshot of the relationship between what producers are selling and what consumers want. That relationship, though intangible, is a reality, as real as gravity or a skyscraper or a case of pancreatic cancer.

To compare the contemporaneous declines of New Coke and Soviet Communism from 1985 to 1991 is not to engage in frivolity. As F. A. Hayek noted, the great problem facing central-planning regimes like that of the Soviet Union is that there are no prices to facilitate communication between producers and consumers. The tales of Communist-era production misalignments would be comical if they had not exacted such a high price in human suffering: There would be huge surpluses of, say, pesticides (not to mention tanks and rockets and ideology) but acute shortages of sugar, flour, shoes, and other common items. Toilet paper was used as filler in sausages until that homely commodity itself went into short supply. Burglars would break into houses and steal everything but the money — there was no point in taking it, as there was little or nothing to buy. (That might have changed during the toilet-paper shortage.) For the Soviets, there were no real prices, so there was no feedback loop between producers and consumers: If we’d had that model for soft drinks, we’d still be drinking New Coke, and the cola executives in Atlanta would be strutting around in their nifty military uniforms, with epaulets and braid, telling us to drink our New Coke and like it, because they had determined, rationally, that this is what we want. A good rule of thumb: Fear the man who says he will make things rational by ignoring reality — and ignoring prices is ignoring reality. 

Unhappily, there are sectors of the American economy that are almost as lacking in meaningful prices as those old Soviet shops were. And where the epistemological labor performed by prices goes undone, you may be sure that dysfunction and unhappiness will follow. Most of the occasions that find us lacking good prices are the result of political manipulation of the economy — the allegedly rational government planner overruling prices — but not all of them are. Up until about a decade ago, for example, NASDAQ traders indulged a curious habit of quoting stock prices only in quarter-dollar amounts even though they were actually calculated in amounts of one-eighth of a dollar. (This was back in the pre-decimal Dark Ages of the 1990s.) So a stock that might be offered at one and one-eighth dollars ($1.125) would end up being quoted on the market at one and a quarter ($1.25), increasing the traders’ profits. It was a terrible system for everybody but the top dealers and, when the practice was exposed and discontinued, spreads on some high-volume stocks, like Microsoft, dropped by half. 

But you don’t have to go to Wall Street to find prices being hidden and distorted, with ugly consequences for consumers. One of the most bothersome examples is the lack of price transparency in medical procedures. 

A few years ago, needing a medical procedure, I conducted an experiment, partly out of curiosity and partly out of dread of dealing with the insurance bureaucrats who are theoretically paid, by me, to provide me with an agreed-upon service, but who in fact earn their pay in no small part by scheming to renege upon and undermine that agreement in various sneaky ways. I asked my doctor: “If my insurance will not pay for Procedure X, how much would it cost me to pay for it out of pocket?” Doc X looked at me skeptically, as though I had asked to borrow one of his many Ferraris. “Just talk to Alice in our insurance office, and she’ll sort out the insurance for you. You may have to jump through some hoops, but they’ll cover it.” Undeterred (actually, a bit deterred by the many photographs of Ferraris on his office wall), I pressed on: “But, say I didn’t have insurance. What would it cost me?” Doc X: “You have insurance.” Me: “Yes, but if I want to pay for it myself, how much?” And so on. He had to consult with his business manager. “We bill the insurance companies $25,000 for Procedure X. If you pay for it out of pocket, we charge $18,000.” That different parties are charged wildly different prices is one sign of a defective market. Me: “So, is that $18,000 flat? Is there sales tax, or anything else?” Doc X: “The $18,000 is my fee. There’s the anesthesiologist, too, and the nurse, and the hospital will have charges, too. And . . .” And, as it turns out, there was a whole battery of tests, screenings, pre-procedure procedures, etc., necessary before Procedure X. “So, totaled up, the final bill looks like what?” Doc X is one of the leading practitioners in his field, a man of great learning, and wit, and rarefied taste in fine automobiles. “I have no freaking idea,” he said. “You should talk to Alice in insurance.” I spent a few days making phone calls, talking to perplexed and befuddled health-care providers who were absolutely nonplussed by the fact that I wanted to pay them to provide me with health care. The best I could figure was somewhere between $25,000 and $250,000 — which is to say, somewhere between a Honda Accord and a Ferrari F430. I talked to Alice in insurance.

Others have reported similar experiences. And even with insurance, it is well nigh impossible to find out in advance how much you will be charged for a particular procedure. Going into a doctor’s office for some common blood work, which was covered by my insurance, I tried, very diligently, to discover what I would be charged. “It depends,” the receptionist told me. I had the numbers in front of me: My deductible was X, my co-pay was Y, etc. So, “What’s the damage?” She: “I don’t know.” I called Alice in insurance. She didn’t know. 

Health-care prices are a mishmash for lots of reasons, but one of the main ones is the way we pay for health care — you don’t pay the doctor, your insurance company does, an arrangement that gives at least two of the three parties involved a good incentive to obscure prices, so that the consumer has no idea how good or how rotten a deal he is getting while the insurers and hospitals attempt to game and swindle each other. Given the shocking and terrifying size of serious medical bills — my mother’s last stay in the hospital billed out at $360,000 (that’s a Ferrari 612 Scaglietti for Doc X plus a BMW 5-Series for one of his brats) — the American health-care consumer, quaking in his paper hospital slippers, no longer even asks: “What does this procedure cost?” He only asks: “Does my insurance cover it?” No prices, no negotiation, no mystical coordination between producer and consumer — instead, maddening and expensive and often underhanded mediation by the insurer.

Medicine is complicated; computers are complicated, too, but you can call Dell or Apple or Best Buy or whomever and ask: “What does this sort of computer cost?” and you will receive an answer. And then, when you get to the store — miracle of miracles! — that will be the price. Computers are damned complicated to make, with programmers in the United States and India collaborating with Taiwanese microchip fabricators, Dutch LED manufacturers, Irish customer-support agents, etc. You can get a price on an iMac, but you can’t get a price quote on an ingrown toenail.

If I may make a populist-credibility-destroying admission, I live in New York City and I take yoga classes. Yoga is a super-competitive business in New York — there’s big money in sweaty enlightenment. Signing up for a series of classes, I was surprised at the specificity of the prices and the number of options available: There’s one rate for a one-off class, a discount for buying ten classes at once, another for a month’s or a year’s worth of classes. You can elect to bring your own yoga mat or to rent one, or to buy your own but have the studio store and clean it for you for a fee. There is a menu of options for towels, lockers, etc. I counted nine major variables that could be combined in various iterations to determine the final cost of a yoga class, with about 2,000 different possible combinations of those options. The yoga jock working the front desk at my studio does not, I would guess, enjoy quite as generous a neurological endowment as Doc X but, unlike Doc X, he could tell me what things would cost. He had the prices right there in front of him: Magic! I suspect that health care would cost less, and that Americans would be much less anxious about it, if rotator-cuff surgeries were priced as transparently as yoga classes or computers or Oreo cookies.

But rather than bring price transparency to health care, we’re going full-tilt boogie in the opposite direction, specifically by insisting that insurance companies be barred from putting real prices on preexisting conditions. Set aside, if you can, all those images of poor little children with terrible diseases being chucked out into the Dickensian streets by mean old insurance executives in top hats and monocles, and think, for a second, about what insurance means, and what a preexisting condition is. Insurance is, basically, a bet: The insurer calculates the probability that a certain unhappy condition will befall a consumer. Actuarially speaking, the number of people who will suffer heart disease or car accidents is fairly predictable within a very large pool, so the insurer can figure out roughly what it will have to pay out in a typical year for every 100,000 policies, and the premium will incorporate that number. But predictable applies to things that happen in the future. Maybe 3 percent of those 100,000 people will need to see a cardiologist in a given year, but 100 percent of the people with diabetes will suffer from diabetes. That’s a fact: It’s what preexisting means. 

Unless Governor Schwarzenegger manages to invent Terminator insurance, whereby Allstate agents travel back in time to insure you against problems you haven’t developed yet, you cannot insure against something that already has happened, and to pretend otherwise dumps a whole metaphysical can of worms all over the insurance space–time continuum, landing us in an alternative universe where Insurance = Not Insurance. You’d never take a bet that you knew you were going to lose, right? Insurance companies won’t do that, either, unless they get paid to do so — specifically, unless they are allowed to charge at least as much for covering Preexisting Condition X as it’s going to cost them to treat Preexisting Condition X. Ignoring the reality of prices — waving the magic wand and saying: “There shall be no price put on preexisting conditions” — does not solve the problem. Health care costs money. The price is right, and you cannot politically engineer your way out of that reality, no matter how many sickly toddlers you parade around on CNN.

Health care consumes 17 percent of GDP and the cost is growing at 10 percent a year; we spend about $7,000 per capita on it. Is there anything else you’re spending seven grand a year on but can’t get a price for? Yes, there is, now that you’re heavily invested, through your government, in the financial-services industry, with a diverse portfolio of craptastic positions in mortgage-backed securities, wobbly insurance companies, zombie banks, etc. You’d think that Wall Street suits, of all people, would have been paying attention to prices. But they weren’t. There were all sorts of pricing problems leading up to the financial crisis, the fundamental one being that the government wanted housing prices to keep going up but also wanted more and more people to buy houses, i.e. they wanted demand to rise with rising prices rather than to fall as prices went higher — which is to say, they wanted magical pixies to plant unicorn trees and fertilize them with faerie dust. We could cloak the effects of rising house prices for a long time — about 60 years, as it turned out — through all sorts of schemes, including the mortgage-interest tax deduction, artificially low mortgage-interest rates, and Fannie Mae and Freddie Mac shenanigans. 

Mortgages, like all loans, entail risk, and risk has a price, too, but we managed to find a way around that, creating a federally chartered cartel of credit-rating agencies — Moody’s, Standard & Poor’s, Fitch — that mindlessly applied the same formula over and over, slapping Triple-A ratings on securities. And it was the Triple-A rating, not the underlying security, that determined the price banks and other investors put on that risk. We inflated the price of houses, depressed the price of mortgages, and cloaked the price of the risks attached to doing so. But as even the Soviets found out, prices are not to be denied forever: The price of housing turned around, back down toward its normal, non–politically adjusted level, taking the price of mortgage-backed securities with it and sending the cost of borrowing, conversely, through the roof. Boom: financial meltdown. Turned out there was a lot of Triple-A toilet paper in our sausage. The lesson: Don’t mess with prices!

So we messed with prices some more. Mark-to-market accounting, the rule that says that banks and other financial institutions must value all the assets on their books at the most recent market price, decimated (and then some) the capital of our banks. Interesting thing about mark-to-market: It creates imaginary prices. If Security A sells at Price X, everybody who owns Security A has to write it down on his books to Price X — even if there is no way in tarnation he’d actually sell it at that price. Think of it this way: For almost any asset, there will be times when distressed parties sell at a fire-sale price. A degenerate gambler may hock his wife’s diamonds during a bad run in Vegas, but that does not mean that the folks at Tiffany’s will start selling the same jewelry at the price the pawnbroker paid. Mark-to-market essentially turned the structured-finance markets into a Quentin Tarantino Mexican standoff, with every bank holding a gun to every other bank’s head: In that situation, there were no real market prices for lots of those mortgage-backed securities, because everybody was too terrified to buy or sell and establish a theoretical price that, because of accounting rules that do not reflect economic reality, would require them to rebalance their books, to catastrophic results.

Prices do their thing because of the nature of economic information. Information basically comes in two flavors: You’ve got your for-the-ages, centralized, Library of Alexandria–type information, your Big Truths that are relevant at all times for all men. These are things like scientific knowledge and works of history, scholarship, philosophy, the grammars and lexicons of ancient languages — you know: stuff practically nobody ever uses. On the other hand, you have contingent, contextual information of the “Got milk?” variety. “Do I need to buy milk, and, if so, how much and what kind?” is an interesting question, because the answer is likely to be different every time you ask. How much milk you and your family need on any given day is likely to vary wildly: If you’re whipping up some homemade ice cream for a summertime party, you will probably buy more milk than you usually do. If your fruity daughter goes vegan, you’re buying less. Milk is complicated: Survey the magnificence of the dairy aisle! You have choices that are almost incalculable: 0.5 percent, 1 percent, 1.5 percent, 2 percent, skim, whole, organic, grass-fed, chocolate, strawberry, soy, lactose-free, half-pints and pints and gallons. Apply the whole range of choices to hundreds of millions of consumers making hundreds of purchases apiece over the course of a year and you have an information-management problem of a very hairy kind. No central planner, no matter how powerful or gifted, could predict Americans’ milk needs in advance or coordinate them with producers. Prices do that.

But milk prices in the United States are not set by the market — they are set by milk-pricing bureaucrats, partly in the employ of the U.S. government and partly in the employ of Big Bessy. Now, we know for a fact that, given the billions of possible distributions in the dairy market, the allegedly rational planners who set milk prices are not evaluating American milk consumption and production in their full glorious complexity. So, how are they making their decisions? Nobody really knows, but the Organization for Economic Cooperation and Development estimates that American families pay 26 percent more for milk than they would pay if they paid real prices, i.e. the prices set by a free market. Whoever’s interest is being looked after, it isn’t the interest of the guy on a tight budget staring down a dry bowl of Count Chocula. And as we continue to pretend that there is another unseen economic reality beyond market prices when it comes to health care, banking, housing, labor, cotton, sugar, fuel-efficient Japanese automobiles, solar panels, and every other product with prices distorted by politics — whose interests do you imagine are being served? Yours, chump?

In health care, banking, education, and other critical areas, Uncle Sam is putting his big ugly federal boot squarely on the neck of prices, choking off the lifeblood that allows economies to work efficiently and rationally: not perfectly efficiently, not perfectly rationally — that’s the stuff of theoretical models and utopian visions — but making the best use of the best information we have. Lowering health-care costs will require consumers to comparison-shop between providers (insurers, doctors, hospitals, specialists) just as reforming Wall Street will require giving investors real prices for the risks they are bearing — and charging “too big to fail” institutions a real price for the subsidy they now collect from taxpayers. We cannot make intelligent reforms without real prices, because we are blind without them. But given that Washington has been setting the price of milk since the 1930s and shows no sign of giving it up, the chances of their taking up the Gospel of Price are slim. Let him with ears, hear.

 

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