Perverse Incentives

This econ course handout reports on the experiences of econ prof Judith Thornton, now at the University of Washington. When Professor Thornton was a student in Moscow she noted "...the small, blue metal lamp on my dormitory desk was so heavy it took two people to lift it. The lamp base had been filled with lead ..."

Here are a couple hints about what was going on: (1) This was while the Soviet Union existed; (2) Soviet factory managers were given "output targets" to meet and were incentivized to exceed them. The handout asks:

Predict the basis on which the quota of the lamp factory was set.
What do you think?

Professor Thornton also reported on what happened when the lamp's bulb burnt out and she went shopping for a replacement: all she could find were "...tiny night lights or giant flood lights but not bulbs suitable for a desk lamp." This was the result of a changed output target. The handout asks you to fill in the blanks:

The output target that resulted in thousands of tiny night lights was _________________. When the output target was changed to ______________, the result was giant flood lights.
Again, I don't think you'll have much trouble answering.

I was reminded of that story by a report in the Boston Globe noted by Arnold Kling of EconLog. The story is about Massachusetts' efforts to rescue the health care "reform" it enacted in 2006.

A state commission recommended yesterday that Massachusetts dramatically change how doctors and hospitals are paid, essentially putting providers on a budget as a way to control exploding healthcare costs and improve the quality of care.

The 10-member commission, which includes key legislators and members of Governor Deval Patrick’s administration, voted unanimously to largely scrap the current system, in which insurers typically pay doctors and hospitals a negotiated fee for each individual procedure or visit. That arrangement is widely seen as leading to unneeded tests and procedures.

Think of patients as the Soviet lamps and lightbulbs, and doctors and hospitals as the Soviet factory managers, responding to incentives imposed under a grand "reform" plan.

Then ask yourself: what's the health-care analog of Professor Thornton not being able to find a replacement bulb for her impossibly heavy blue desk lamp?

Arnold's comments are eloquently on target, and I'll just swipe them:

Maybe the commission's proposal is a step in the right direction. Even if it is, I would suggest that perhaps no expert knows how to design the health care system. We may need a lot of trial and error. Government takeover means that you try something new every few years...maybe. Your choices are limited because entrenched interests preclude many options.

With markets, trial and error takes place continuously. A lot more things get tried. Failure gets weeded out more ruthlessly.

Of course, no one on the Left believes that. The core belief there is that experts know best, and that experts are only thwarted by evil corporations and stupid conservatives. The notion that no expert knows very much, and that the evolution of market processes produces better outcomes, is too threatening to contemplate.

I'll extend that: the old Soviet planners were not (exactly) stupid, but they were operating under the worldview that their economic "system" was entirely rational and capable of producing prosperity.

Today, we know they were wrong, but advocates of "health care reform" are operating under a similar hubris: myriads of regulations, subsidies, taxes, and penalties will give us a "system" where everyone will thrive and prosper. Any chance we'll take the right lesson from the Peoples' Republic of Massachusetts, before the country as a whole wanders down that road?

Last Modified 2011-02-04 1:50 PM EST