“The attempt to reform the world socialistically might destroy civilization,” Ludwig von Mises wrote. “It would never set up a successful socialist community.”1
Mises never encountered the insightful social critic (better known as a guitar-picker) Guy Clark, who posited that there are precisely two commodities for which marketplace price signals cannot be generated: true love and homegrown tomatoes. Mr. Clark was half right about that, which is not bad when it comes to market predictions. It is really hard to find good tomatoes, and, if you want to see market failure in action, you can speed down the produce aisle at your local grocer’s and have a gander at the mealy, tasteless wad of cellulosic pulp that Farmer Elmer is trying to pass off as a genuine tomato. While there has been some success in reviving such flavorful and fancifully named ancients of the tomato kingdom as the mortgage-lifter, the Cherokee purple, and the hillbilly, the overall failure of the marketplace to produce much fruit that could be dignified with the name “tomato” is one of the mysteries of capitalism.
Presumably, there is a way to blame Earl Butz or the factory-farm lobby (a.k.a. Big Elmer) for this, but we will leave that question, for the moment, to the historians and the Nixonologists.
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 info-mercials; prices are the Paraclete of the market economy, the mystical intercessor between producers and consumers, performing 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 without friction, 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-era history is worth discussing: 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 whose planning efforts find themselves nullified by the market, which is to say, by reality.) Coca-Cola USA 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.
Prices, however, said otherwise. While New Coke couldn’t be given 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. So poorly regarded was the new product that, in some southern cities, 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. Prices were saying: all your best minds got it wrong. Coke’s brain trust said “X,” but prices said “Not X.”
The price was right.
It took a little trauma to get there (Hail the Age of Reagan, when New Coke was our definition of an economic crisis!) but consumers prevailed, and New Coke followed socialism into the dustbin of history—for similar reasons, but with a lot less bloodshed. Coca-Cola USA had to bend to reality more quickly than the socialists 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, 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 socialism from 1985–91 is not to engage in frivolity.
As Hayek noted, the great problem facing central-planning regimes like that of the old Soviet Union is that there are no prices to facilitate communication between producers and consumers. The tales of Soviet-era production misalignments would be comical if they had not exacted such a high price in human blood. 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 the toilet paper 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.
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 epaulettes and braid, telling us to drink our New Coke and like it, because they had determined, rationally, that this is what we want. It’s scientific, damn it!
A good rule of thumb: fear the man who says he will make things rational by ignoring reality—and ignoring prices is ignoring reality.
Once the powers-that-be in the socialist world were wielding calculators instead of AK-47s, this began to become apparent. In 1968, economist Oldrich Kyn, who expressed considerable sympathy for the socialist system of the Soviet Union and for the socialist economies of Eastern Europe, nonetheless felt the need to broach the subject of pricing in a paper presented to a conference of the International Economic Association. In precise academic language, he reached the same conclusion that any number of anti-socialist economists had already come to—you aren’t going to magic prices away:
Until recently pricing was considered a secondary problem in a socialist economy. This was the result both of practices which had become established in the past, and of a set of generally-accepted theoretical postulates. Very little attention was paid to the theory of prices, the deficiency of which profoundly marked recent economic practice. This neglect of pricing was justified by the assumption that the central problem of the socialist economy was the assurance of planned proportions derived primarily from material balances and their disaggregation as directives for production enjoined upon individual plants. The role of prices was hence no more than as a subsidiary form of cost accounting; to make it independent and related to the market was in fact considered irreconcilable with the system of planning and central management.2
The major change in Marxist thinking came as the necessity of government forced socialists’ focus away from moral theorizing and toward the realities of governance—or, as Professor Kyn puts it, by the “rapid infiltration of mathematics into Marxist economics.” Like Mises before him, he came to the conclusion that prices hadn’t been planned at all; they had merely been set, by fiat, in the absence of the sort of information that would be necessary to conduct actual planning. According to Kyn,
It followed that price problems were basic to socialism and could not be brushed aside as secondary.
. . . The idea of planning was erroneously presented as inseparable from the administrative determination of targets and of prices. In fact, there was no planning of prices, for they remained constant until glaringly proved incompatible with evolving economic conditions; sets of such prices were more random in their relative values than those formed on the market, for they were a compound of errors in computations, false appraisals of the situation, and lack of information and subjective criteria on the part of decision-makers. It seems entirely justified therefore to use ‘central determination’ rather than ‘planning’ of prices. It may be noted that such determination was in line with the view, then common, that the utmost centralization was to be imposed on decision-making in subordinate units, as the only way to coordinate development towards ends most beneficial to society. It was also thought that an increase in any retail price would negate the aim of raising the level of living under socialism; retail prices were regarded solely in the framework of the cost of living.3
In the market, prices go up and they go down. Under socialism, Professor Kyn discovered, that was not the case. In reality, the only direction prices were going to be allowed to move was downward—for political reasons, supply and demand be damned.
Indeed, a systematic deflation was seen as essential, because the Marxist labour theory of value implied that, during economic growth, a rise in labour productivity reduced the value of commodities: obviously, the reduction of the labour value of a commodity is inconsistent neither with stable prices nor with inflation. The same sort of over-simplification—in this case on the role of ownership in economic relations—made the planners indifferent on whether surplus product be realized on intermediate or on final products. It accrued to the state at either level and ease of administration favored a levy on final goods. With all this went an unreasoning repudiation of anything evolved by bourgeois economic theories such as market equilibrium, the theory of consumer’s behaviour and the concepts of marginal utility and of the elasticity of demand. The incomprehensible rejection of mathematical methods, which, as can be seen today, are eminently applicable to pricing, had the same unfortunate results.
. . . An excessive centralization rendered a flexible price policy impracticable, for frequent adjustments of prices would have required a vast increase in the quantity of information processed at the center. Had the data been available, it would necessarily have enlarged inordinately the administrative apparatus. But information on changes of demand was not available and, given the priority allotted to industrialization, adjustments of the production pattern would not have been feasible. In this way a long-term disequilibrium on the market arose, a justification of which was sought in the theory that consumption demand had necessarily to exceed production under socialism.4
And thus did the socialists and the free-market men come to the same conclusion.
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 fifteen years ago, for example, Nasdaq traders indulged a curious habit of quoting stock prices only in quarter-dollar amounts, even though the actual prices were expressed 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 woeful lack of price transparency in medical procedures in our already half-socialized, soon to be much-more-socialized, healthcare sector.
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 undermine that agreement. 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 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.” The fact 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 men in his field, a man of great learning, and wit, and rarified 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 healthcare providers who were absolutely nonplussed by the fact that I wanted to pay them rapidly depreciating American dollars to provide me with healthcare services. 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.
So I talked to Alice in insurance. But even if you go through an insurer, 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.
Healthcare prices are a mishmash for lots of reasons, but one of the main ones is that the way we pay for healthcare—Provider A performs Service B for Consumer C and is paid by Insurer D—is an arrangement that gives A and D good incentives to obscure prices, so that C has no idea how good or how rotten a deal he is getting, while A and D attempt to game and swindle each other. Given the terrifying size of serious medical bills—my mother’s last stay in the hospital billed out at $360,000 (that’s a Ferrari Scaglietti for Doc X plus a BMW 5-Series for one of his kids)—Consumer C, quaking in his paper hospital slippers, no longer even asks, “What does Procedure X cost?” He only asks, “Does my insurance cover it?” No prices, no negotiation, no mystical coordination between producer and consumer—instead, maddening, expensive, and generally sneaky mediation by the insurer.
You can see the attraction of such an arrangement for the socialist central planner, who detects an open invitation to intervene.
Medicine is complicated. Then again, so are computers, but you can call Dell or Apple or Best Buy or whomever and ask, “What does Computer X 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 microchip fabricators in Taiwan, Dutch LED manufacturers, Irish customer-support agents, etc. Meanwhile, you can’t get a doctor or an insurer to name a price to fix 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 10 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.
Altogether, I counted nine major variables that could be combined in various iterations to determine the final cost of a yoga class. That means that there are 362,880 permutations of those nine factors. 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 healthcare 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 healthcare, we’re going full-tilt boogie in the opposite direction, specifically by insisting that insurance companies be barred from putting real prices on pre-existing 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 pre-existing condition is.
Insurance is, basically, a bet: Insurer A calculates that the possibility of Problem B befalling Consumer C is X, and so A charges C Premium Z. Actuarially speaking, the number of people who will suffer Problem B is fairly predictable within a large pool of people, so Insurer A can figure out roughly what it will have to pay out every year for every 100,000 policies, and Premium Z will reflect 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 Pre-Existing Condition X suffer from Pre-Existing Condition X. That’s an existential fact. It’s what pre-existing 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 Pre-Existing Condition X as it’s going to cost them to treat Pre-Existing Condition X. Ignoring the reality of prices—waving the magic wand and saying, “There shall be no price put on pre-existing conditions,” does not solve the problem. Healthcare costs money. The price is right, and you cannot politically engineer your way out of that reality, no matter how many diabetic toddlers you parade around on CNN.
Healthcare costs consume 17 percent of GDP and are 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 investments 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 fairy dust.
We could cloak the effects of rising house prices for a long time—about sixty 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, 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.
The cartel was a favorite tool of such noted national socialist planners as Benito Mussolini and Adolf Hitler, who understood that fewer players in the marketplace meant higher profits (encouraging a level of moral and political elasticity on the part of the cartel bosses) and fewer entities over which to exercise brute-force control when necessary. (It was Caligula who once wished, “Oh, if only all Rome had but one neck”—that he might break it.) We used these cartels to inflate the price of houses, to artificially depress the price of mortgages, and to cloak the price of the risks attached to doing so.
Our central planners believed this would help those of modest means to save and acquire capital. (Never mind that the capital one acquires in a house—the savings—is the equity, and all of these programs encouraged first low-equity mortgages, then no-equity mortgages, and, finally, negative-equity mortgages.) 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 accounting 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 immediately 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. First, 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. Second, you have contingent, contextual information of the “Got milk?” variety.
“Got milk?” is an interesting question, as we discussed earlier, 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 home-made ice cream for a summertime party, you will probably buy more milk than you usually do. If your daughter goes vegan, you’re buying less. Milk is complicated: survey the magnificence of the dairy aisle! You have nearly incalculable choice: 1 percent, 1.5 percent, 2 percent, skim, whole, organic, grass-fed, chocolate, strawberry, half-pints and pints and gallons. I have calculated that such is the complexity of the consumer milk market that the number of possible permutations of milk distributions among the 300 million consumers of the United States over the course of a year surpasses the number of seconds that have passed since the Big Bang. It’s one of those numbers they don’t even have a word for.
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 enormous number 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—all the world’s supergeniuses working together around the clock could not do that. 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 there is another unseen economic reality beyond market prices when it comes to healthcare, banking, housing, labor, cotton, sugar, fuel-efficient Japanese cars, solar panels, and every other product with prices distorted by politics—whose interests do you imagine are being served? Yours, chump?
In healthcare, 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 act efficiently and rationally: not perfectly efficiently, not perfectly rationally—that’s the stuff of theoretical models and utopian visions—but to make the best use of the best information we have.
Lowering healthcare 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 1930 and shows no sign of giving it up, the chances of their abandoning the Gospel of Scientific Socialist Central Planning, and taking up the Gospel of Price, are slim.