Hayek versus the 2010 Healthcare and Financial Industry Reforms

Friedrich Hayek, the Nobel-prize-winning Austrian economist (and now YouTube sensation), upheld economic competition and opposed government policies that reduced it. In his surprise bestseller, The Road to Serfdom, he argued that central planning would undermine competition, hamper the economy, and lead to pressures for more and more measures that would enhance the power of the government at the expense of individual liberty. Competition, he wrote, “is the only method by which our activities can be adjusted to each other without coercive or arbitrary intervention of authority.”

What would Hayek, who died in 1992, have said about last year’s legislative overhaul of the healthcare and financial sectors? In a nicely done recent paper, Peter J. Wallison, a scholar at the American Enterprise Institute, makes a good case that the great economist would have opposed both measures as anti-competitive.

The regulatory overhaul of the financial sector—the Dodd-Frank Wall Street Reform and Consumer Protection Act—would enable the government to directly control financial companies it deems “systematically important” because their failure could destabilize the US financial system. Wallison describes several ways in which this provision of the Dodd-Frank Act would undermine competition in the financial sector, but I found this passage of his especially helpful:

In return for the Fed’s protection against failure and competition, the largest financial firms in the US economy will be inclined to follow the government’s directions on how to conduct their business. For example, if a smaller financial firm is failing, the Fed will be able to induce one of the larger firms to acquire it; if a country is having difficulty selling its bonds, the Fed will be able to get some of the firms it is regulating to invest in those securities. These are not fantasies. In the past, when the Fed was regulating only bank holding companies, it induced them—in the interest of stability in financial markets—to lend to countries that were having difficulty meeting their international payment obligations.

By contrast, the Patient Protection and Affordable Care Act (“colloquially known as ObamaCare, even though the president never submitted his own plan”) would impair competition in a different way—namely, by hampering an effective price system, Wallison argues.

Wallison mentions several provisions of ObamaCare that would undermine competitive prices. One, for example, would require health insurers to “spend at least 85 percent of premiums on ‘activities that improve health care quality’ (the Medical Loss Ratio, or MLR) for large-group insurance,” he writes. Here I found Wallison’s analysis particularly illuminating, if a bit dry (emphasis added to help readers navigate around the wonkier parts):

With the MLR, for example, the government’s rules on what goes into the numerator and denominator of this ratio will determine the profitability of individual companies and whether they will be able to participate at all in a competitive system. Speaking generally, the numerator of the MLR will be only what the government considers as “activities that improve health care quality.” Immediately we see that price competition is impaired because consumers have no choice on this issue; the services they want may not be available simply because the government has determined that they do not “improve health care quality.” In addition, companies will have to price their services to ensure that they meet the minimum MLR in any year or be forced to rebate premiums. This immediately distorts the pricing system by introducing an element that has nothing to do with what consumers are willing to pay for insurance services. Finally, many companies that offer specialized services that do not fall into this category may have to abandon the services entirely, thus restricting not only competition for those services specifically, but also–if those firms sell out to competitors or otherwise leave the business–the competition that comes from the number of competitors in a market. Say, for example, that an insurer offers a doctor-referral service, and that service is not included among the items that the government considers an activity “that improves health care quality.” The insurer, then, would likely abandon that service because its cost would then have to be paid out of its 15 percent of premium revenue that is available for both administration and profits. Abandoning that service would reduce competition among insurers for the most effective referral services.

Both ObamaCare and the Dodd-Frank Act were touted as measures that would give consumers greater “protection” and “affordability.” But if Wallison’s analysis is correct, each of these legislative landmarks will undermine economic competition and thereby act against the interests of consumers.