Trump’s Price Transparency Is Not Magic

During the recent state of the union, Trump mentioned that he was planning on introducing price transparency in healthcare prices. Now there are a bunch of conservative and libertarian reforms for healthcare that are supposed easy fixes. One such idea is that healthcare prices are a scam created by lack of transparency. This seems logical and intuitive. Basic economic reasoning would suggest that if you don’t know the prices, then you can’t do the necessary economic calculations to make a competitive choice. This allows for the companies to charge you higher prices and create an uncompetitive market. 

This seems all fine and good. I would like to argue that there are economic considerations that this reasoning does not take into account. There is some evidence that price transparency will lead to higher prices. At one time, I might have supported price transparency for the healthcare industry. I have changed my mind after a consideration of the facts. Some libertarian organizations such as FEE have made articles endorsing such a proposal. I might surprise libertarians by referring to the great libertarian economist, Murray Rothbard. His economic history has been of great use in my article to demonstrate the problem at hand.

So let us consider the famous game, the prisoner’s dilemma. Two people have committed a crime and they are interrogated. They are offered the same deal for prison time. Above is the time in jail for each outcome. The principle to learn here is something called the dominance principle. If you betray your partner, then you are guaranteed to get 1 year less in prison. However if you both betray each other to the police, then you will both get 2 years. In this situation you will get a combined maximum time in prison for a total of 4 years. If you both would have just cooperated you would have got the least amount of combined prison time for a total of 2 years. 

This simple story about prisoners is a fun experiment in how cooperation is very lucrative, but hard to maintain. People are incentivized to cheat against cooperation. Once cooperation breaks down, everyone is worse off. This simple story can have multiple parallels in economic situations. Corporations can make a lot of money if they cooperate to raise prices. However there is an incentive to lower your price and gain larger market share. Corporations have to deal with these conflicting incentives. 

This little game is not the end all be all, because it is a simple model. Corporations ultimately would prefer that they didn’t have to compete. Assuming that there are steep barriers to entry they could if theory execute a conspiracy; This of course assumes that the corporations can trust each other and they face little chance of new competition arising. Given enough time, they might try to conspire. This conspiracy will last as long as their competitors don’t lower their prices. This is not so hard to imagine that this could go on for a while. There are a few friends of yours who you might confidently be willing to play the prisoner’s dilemma with. There is one thing we haven’t considered; You could of course try to be sneaky. Remember, you are only in trouble if you get caught. If you lower your prices without your competitors knowing, then you can cheat the system. 

This sounds completely bonkers. When people go to buy something they will notice the lower prices and then the secret will slowly get out. Stay with me here, what if you just pretend to have the higher price, but conspire with some of your customers to offer a lower price. This is called price discrimination and it is when you try to discriminate against people by offering them different prices. In this case, you can have a price which everyone knows about and offer certain customers a discount. As long as those customers don’t reveal they are getting the discount, you can fool your competitors. This is assuming your other competitors aren’t trying to pull the wool over your eyes and do the same thing. Eventually all the corporations offering secret discounts will drag the price down to the competitive price. Either way conspiracies are hard to maintain.

In Murray Rothbard’s The Progressive Era, he details the attempts of Railroad companies to cartelize and raise prices. He explains how they attempt to get their cartels supported by law through a few different regulations. While many wanted to have prices outright fixed by law, this was something harder to get people behind. One of the main issues the cartels faced was members secretly offering discounts on freight rates. This led to the idea of passing regulation which prohibited such discounts. Rothbard lays out how this issue was a major driver behind Railroads lobbying the government for regulation in the Progressive Era. 

If such discounts were prohibited, then the corporation would have to charge the price they publicly declare. In other words, government enforced price transparency is a tactic corporations can use to help price fix. This way you can make sure your competitors aren’t trying to cheat the agreement and thus it creates more barriers to prevent the cartel from dissolving.

Healthcare has a lot of similarities to the railroads Rothbard talked about in the following ways. Hospitals have a lot of fixed costs, it is very hard to just open a new hospital to compete with existing hospitals. Patients pay different prices for the same services at the same hospital. This is in part because of healthcare insurance negotiations. Remember this is the problem the regulation is trying to solve. Prices are not uniform and are hidden from the public. The one difference here is that price fixing is illegal now and there is no evidence hospitals are secretly trying to conspire. 

Does this mean that we are safe and this objection is nothing to worry about? No! There is a more recent example of danish concrete mixing companies where they tried price transparency. There was the issue of only a few concrete mixers, because it is hard to transport long distances and the demand is not sufficient to have too many suppliers within reach. People were negotiating all sorts of prices for the service and thus the government stepped in with price transparency. Once everyone was transparent about the prices they charged, the prices rose by more than 15 percent. Shockly, no evidence of a grand conspiracy to raise prices exists. So what happened? 

In the situation where prices are transparent, it is harder to compete with other businesses because you have to be transparent in the prices you are charging. If you try to get someone to switch over to you and you offer them a lower price, your other customers will legally have to know about it and you will have to offer them the same deal. If you raise prices, it is harder for your competitors who are further away to try and compete for your customers. Price transparency still makes it harder to compete for customers between two businesses. This can lead to an incentive to raise prices as you have in effect a cartel preventing competition. In these uncompetitive markets, it is a serious danger that price transparency will reduce competition. This is because the competition is occurring so far as the price is not transparent. They are competing for only a segment of the market by offering only that segment discounts. 

Only time will tell whether this leads to prices being reduced or increased. The actual effect of this policy is an empirical issue. We can only look at prior cases and draw conclusions from the evidence. That being said there is a lot to be skeptical here as we have some state implementations of the law. Various states, including New Hampshire have introduced various reforms that are similar in effect. There is no evidence that these reforms have worked. This might simply be a matter of implementation, lack of knowledge, patient habits, etc. People need to actually make use of the information for it to work. There is no guarantee that will even happen. We are just going to have to wait and see what happens. That is the issue with policy debates.

The main issue here I take with price transparency is that people present it as some smoking gun that will solve the healthcare crisis. Being optimistic and naive about the effects of the market can lead to people ignoring economic information in the future. It may help reinforce the notion that economics is just a bunch of theory that has nothing to do with the real world. Economics is a very important subject for informing people of public policy. So it is important to get it right.

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