Sunday, January 9, 2011

Evil Profits?

I have a friend, who, while claims to support free-markets, doesn’t like firms profiting from cancer and other medical treatments.  He claims firms (primarily big pharma) should not reap billions while ordinary folks suffer from such a horrid disease.  He conjures up images of the CEO of Ely-Lily making millions in salary and bonus and self-righteously decries this to be morally reprehensible.  I must say the media has also done a good job of promoting this same mindset, that the profiteering of medicine can somehow be wrong.  I disagree.

Profits are signals.  [i]Profits tell us where our resources are used most effectively.  If Merck is reaping economic profits in the pharmaceutical industry, it’s a signal that society values this activity, and other firms will seek to enter this market.  (Note that government regulations and other barriers to entry can restrict access, but imagine for a moment these restrictions are minimal.)  As more firms enter (competition) and additional products are brought to market (additional supply), economic profit will decline.  In truth, government intervention can cloud profit signals, thus allowing firms to earn economic profit beyond what they would normally earn.  The pharmaceutical industry may reside in such a marketplace.

What my dear friend falsely believes is that if government reduces big pharma’s profits through taxes or regulations, that human suffering would decline.  This just isn’t so.  Profits allow for the development of new drugs.  Profits allow big pharma to hire researchers, scientist, and chemists to develop medications to extend our lives and to ease our suffering.  Reducing Merck’s profits would have the opposite effect, and society would be worse off, not better.

Profits are not evil.  They are incentives to firms and individuals to keep doing what they do best.  As Adam Smith said in Wealth of Nations, “It is not out of the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own self interest.”

[i] Baye, Michael R., Managerial Economics and Business Strategy


  1. Cranky Prof J,

    So, are you back in the classroom today? I remember your very first statement to the DCP class for micro economics. You said, “My name is Jeff and I’m your worst nightmare.” This is not the kind of opening statement most folks want to hear from the teacher. Ultimately, there was a lot of truth in your opening salvo, but nevertheless, a more congenial greeting might have been warranted. BTW: We were pretty impressed with your ability to hear and then recall all our names the first day. Not bad.

    So, do you greet your current students with the same friendly gesture?

  2. BD,

    No sir. Up here in the frozen north, ain't no school in January. Least ways not at my college.

    I try to be less scary because I'm teaching finance and that is somehow easier than micro.

    If I got back to teaching micro I would rock it Austrian style. I think that would have been a way better class than the charts and equations and other crap.

    I do memorize the grad students names.

  3. So you get the whole of January off? That's not a bad deal. Of course, you live practically on the North Pole, so I'm not willing to trade with you just yet.

    I agree an Austrian micro class would have been great. You could have assigned Human Action or something similar. So are you teaching any econ or strictly finance? I must say, I was very disappointed in our finance course at SU. They yanked our prof 1/3 of the way through, and replaced him with some dude who frustrated us even more. Bad experience.

  4. Isn't the U.S. pretty much the only developed democracy that does not provide universal health care? Doesn't the U.S. pay approximately 5% more in GDP (about 16% total) than any other country on the entire planet? Didn't the World Health Organization list the U.S. at 37th on its ranking of healthcare systems worldwide?

    The current American healthcare insurance industry may indeed be profitable but it is anything but efficient. Seriously how much waste would you say is involved in the insurance claim submition process? And paying 5% more than anyone else in GDP and still not being able to cover everyone doesn't sound very "efficient" to me.

    Thank God for the medical tourism industry giving patients quality and affordable options. The industry is proving attractive even for countries with universal healthcare who desire faster, more flexible service. Take a look at the prices below and tell me you think the U.S. healthcare system is still the most "efficient."

  5. Eddie,

    I am the last one who will defend the status quo in America. But I don't understand the point about medical expenses as a percent of GDP. Why should it not be high, if the results are better? What if there is more r&d happening in the U.S., more cutting edge (and thus expensive) drugs and medical device usage, and so on?

    Also, I think you should look into that 37th ranking a bit more closely. The U.S. is ranked low because of capacity usage (we have way more than we use) not because of outcomes. This, btw, does prove your point that our system is woefully inefficient. This I would never deny. But it remains better than others I've experienced personally.

    The one thing that I do reject, and fully reject, is the statement that the U.S. has a market-based medical industry. I know you didn't make that claim, but I did want to make that clear to any other readers out there.

  6. Just wanted to post this graph illustrating how much more we pay in GDP.

    What makes this graph even more sad to me is even after we spend this much more something like 16.7% of our citizens (approx 50M) still do not have healthcare. We can do better.

  7. Eddie,

    Like I said, I won't defend the status quo.

    What about the idea of having a free market for health care, and then the gov't could send health care vouchers to people below a certain income? I'll keep aside my economic issues with this one, but what are your thoughts?

  8. Eddie,

    Your claim that 50M don't have health care is probably overblown. Can you break that number down for me?

    How many young adults in that 50M choose not to purchase health insurance?
    How many illegal aliens are part of that number?
    How many transient folks (recently laid off or otherwise in between coverage) are in that number?

    I think when you boil it down to folks who want health care and cannot afford it, the number is much smaller than 50M.

  9. Prof J,

    I lack understanding of the voucher proposal. One version I had heard was extending vouchers to all Americans. It was stated to be benefits similar to what federal employees have. It claimed to be universal while providing the freedom to choose your provider and supposedly encouraged competition. I didn't dig into it deeper because it sounded like a fantasy.

    The other version I have heard of would require employers to provide vouchers for low income employees. My personal preference is employers would not have to pay for health insurance at all. I would prefer it if we were all in one big pool and not base our healthcare on whether or not you are fortunate to get a job at UPS.

  10. Brad,

    I completely agree that there are several factors that make up the 50M uninsured. However, no matter how you slice it this is how many are unisured in the only modern society that doesn't have universal coverage. The fact that we spend so much more than any other country just makes this statistic more unforgiveable.

    We are arguably the greatest nation in the world. We spend far more than anyone on healthcare but yet can't accomplish what every other modern society has done. I say we can do better. Maybe it's studying the voucher system Prof J mentioned or maybe it is learning more about the French healthcare system which is said to have some similarities to ours. The point is other countries pull it off and do it for less.

    Medical tourism is the closest thing I have seen to a free market system.

  11. Eddie,

    I was thinking something along the lines of your second para. Essentially, a totally open market for health care, but where a declining dollar amount of vouchers are provided depending on a person's income.

    I hear the Swiss have a good model. But the problem with the European and Canadian style public health delivery is that they have non-voluntary enrollment.

    The U.S. has to go one way or the other. This severely hampered health care market is awful. Obviously, I think a more open market is the solution, but that is based on my experience in public health care markets (Canada) and observations about state intervention generally.