The ability of providers to enter and exit a market has been demonstrated in multiple circumstances as an integral element of market efficiency. But what happens when the service providers exiting the market are service providers that have forged a strong bond with the public?
Regarding public affection as a problem may seem a little counter-intuitive, but this is an old problem, one that both markets and quasi-markets experience. The issue is that injecting choice and competition into the funding mechanisms that these service providers sets the stage for creative destruction that sees old providers bow out to make room for new ones. Unfortunately, many such services capture the public heart during their respective lifespans, paving the way for outrage, protest and bailouts when they fail.
Julian Le Grand summarised one such incident in relation to hospitals in his book “The Other Invisible Hand”:
“Relatively early on in the market’s lifetime, a major teaching hospital in London got into trouble because it was losing business to outer-London hospitals. There was considerable political protest, a consequence of which was that the hospital concerned was bailed out and the internal market in London suspended.
As a result, not only was the incentive for that hospital to improve removed, but, even more seriously, it had the effect of serving notice on hospitals, managers and consultants round the country that financial failure not only would not be penalized, but may even be rewarded—with a consequent dramatic weakening of incentives throughout the system.”
Aside from creating a counter mob of economists, there are a number of ways to help politicians resist such public pressure. One solution is to handball the problem, placing the regulation of the market under the authority of an independent agency, providing politicians with a scape goat and the ability to claim that said independent regulator has chosen (outrageously of course) not to act. This strategy has a successful track record in keeping enough political pressure at bay to allow some markets and quasi-markets to survive unmolested.
So what’s the solution? Well, perhaps Le Grand alluded to it in a discussion about capitation funding.
Capitation funding is a hospital funding strategy where demographic statistics are used to estimate the costs associated with the treatment and diagnosis of patients, from which funding is allocated accordingly.
One of the issues with capitation funding is that service providers try to avoid treating the most expensive patients, or patients that are more expensive than the compensation the hospital receives for their treatment. This might involve putting the most complicated patients at the back of waiting lists, referring them elsewhere or trying to get them to come multiple times so that they can be compensated for each diagnosis separately.
What’s interesting is that one factor which inhibits the hospitals ability to do this is ignorance. Because service providers don’t know what the cost of a patient will be until after diagnosis or treatment, they can’t know who to discriminate against. Their lack of information stops them from advancing their interests at the expense of the market.
Consider the following. An oversight body is created with the same auditing powers as a regulator, except that it cannot enforce any reforms, and does not publish all its reports and recommendations straight away. Instead, the body reports directly to the minister when it thinks a set of reforms need to be implemented within a specific time frame in order to facilitate creative destruction.
The subsequent decision about when to implement the reforms associated with some providers exiting the market is then left to the minister. Primarily because the failure of certain providers is more often due to political factors rather than technical ones, making the minister the most qualified party to deal with the fallout. The status quo is that the oversight body publishes the proposal as soon as it is finished, however, this may fail to deal with the initial problem.
Within this model the minister has the discretionary power to either make the announcement at a time when these reforms could be passed easily, and/or very close to the intended implementation of the proposal. By limiting, or extending, the time between announcement and implementation one can limit the ability of interest groups to oppose the change or give the minister more time to make his case. This provides the minister with an ability to claim that they are simply implementing changes advised by the statutory body whilst giving him/ her more of a chance of implementing the reforms.
If secrecy is maintained then entrenched interests will have less power to resist creative destruction in quasi-markets, in much the same way as the hospitals ignorance of complicated patients prevented them from using their power to sabotage the market.
A public friendly —perhaps even long term— alternative may involve trying to reason with interest groups, or even to attempt to educate the people at large about the value of creative destruction in markets. This would rob service providers of the ability to use emotional attachment to their institution to undermine the effective working of the market. The prevalence of this problem in regular markets (Cadbury, car manufacturing, Tasmanian timber) suggests this is not easily done. However, in quasi-markets where creative destruction is necessarily orchestrated, so as to avoid the complete shutting down of a hospital or school, one may be able to avoid a problem that also plagues regular markets by using the sly nature of politics for good.
razipilli 