Several hundred friends of liberty have gathered in Guatemala City for the 2006 international meeting of the Mont Pelerin Society. The Cato Institute is well represented, with numerous Cato authors, adjunct fellows and scholars, officers, board members, and sponsors in attendance. Right now we’re being treated to a great talk on “Latin American Populism” by the brilliant and insightful Alvaro Vargas Llosa. The papers are really of a high order and represent a serious intellectual effort by advocates of freedom and limited government to address new and emerging challenges to classical liberalism. It won’t do just to repeat the same old themes; advocates of individual rights, toleration, free markets, free trade, and limited government have to address new issues and to engage our critics fairly and squarely. I’m really pleased to see that happening here in Guatemala, among participants who have come from throughout the world, from Mexico and Mongolia, Germany and Ghana, India and Ireland, Jordan and Japan. (I’ll post a few times on some of the papers and presentations, at least those that strike me as the most interesting.)

Perplexity over economic statistics – in particular, the decades-long trends of flat median real wages and increasing income inequality, combined with a recent disconnect between productivity growth and wage increases – is provoking serious, sober-minded people on the center-left to worry whether there might be something badly wrong with America’s economic system.

In a well-written piece (subscription required) for The New Republic, Jonathan Chait chronicles how the economic numbers are undermining confidence among Democrats in Clinton-style, pro-growth economic policies. The bottom line: what good is economic growth if it only benefits those at the very top?

Ezra Klein of The American Prospect is among the anxious. He’s written frequently on this point, but here’s a typical formulation of the perceived problem as he sees it: 

What worries me about inequality isn’t what it does, but what’s doing it, namely, a decades-long decline in worker bargaining power and the resultant redirection of productivity increases and corporate profits away from compensation and salaries. 

And here’s another:

[T]hrough mechanisms we’re not entirely sure of, the very richest are siphoning off the economic growth before it flows through the middle and lower classes. 

And here’s yet another that suggests what needs to be done: 

The right has tried to explain this accelerating inequality as an unstoppable structural feature of the new economy: It’s the meritocracy, or computers, or benefits, or global trade. Unfortunately, those explanations are largely bull****. Europe also has computers, and trade, and mobility, and benefits, and has easily avoided the widening chasm we’ve seen. So what makes us different?

In a word, power. Or the distribution of it. Europe has strong unions and active governments; countervailing powers that wrest a portion of the pie for their constituencies. We don’t. 

It’s one thing to be concerned generally about inequality: to hope that all people can participate in the blessings and opportunities that modern capitalism affords, and to look for policies that help those who are lagging. It’s quite another when that concern curdles into a belief that the capitalist system is fundamentally unfair – that workers are failing to get their fair share of the value they create because people at the top are hogging the gains from growth. It’s the difference between being an egalitarian liberal and being a collectivist. Or, in other words, between being a progressive and being a reactionary.

Here’s my question for Ezra et al.: is there something wrong with labor markets? Is there some market failure that is resulting in the systematic exploitation of workers?

I can’t imagine what that market failure would be. Labor markets are pretty vanilla, with lots of buyers (firms) and lots of sellers (workers). Local monopsony problems (e.g., the company town scenario) are unlikely to be significant in a diversified, modern economy with a highly mobile work force. I don’t know of any basis for thinking that firms’ competition for workers is less than robust. Accordingly, there are very strong reasons for thinking that wages and salaries are generally bid into line with the value of the various uses to which labor at a given skill level can be put.

As University of Chicago law professor Richard Epstein puts it:

The single most important thing to understand about the operation of a standard labour market in the world today is that it is immensely boring. It should be thought of in terms of the traditional intersection of supply and demand. It does not present any difficult transactional problems or generate negative externalities that require government control. 

In particular, there is no good reason to think that high earnings for managers and professionals at the top of the pay scale are coming at the expense of everybody else. Firms need workers at various skill levels. Exactly the same incentives guide firms when they are hiring highly skilled workers and when they are hiring less skilled workers. On the one hand, competition will cause them to bid up the price of labor to attract workers away from other job openings; on the other hand, concern with profitability will deter them from overpaying. There isn’t some pot of money in the company safe that’s dedicated to wages and salaries, so that more for some means less for others. Hiring and pay decisions are made at the margin: does adding this worker at this price improve our bottom line? For every new hire, whatever the job description or skill level, firms face strong pressures against either underpaying or overpaying.

(Note: I’m leaving aside for now the question of compensation for top executives, which raises complex issues of corporate governance. For now, it suffices to say that, even if CEOs are being overpaid, the problem affects only a tiny portion of the overall labor market.)

So I just don’t see those “mechanisms we’re not entirely sure of” that Ezra talks about. And just asserting they exist, without providing any theory or evidence of how they might work, won’t cut it as serious analysis.

But what about the decline of private-sector unions? Hasn’t that reduced workers’ bargaining power to their detriment?

Yes, it is true that, through collective bargaining, workers can obtain above-market prices for their labor – just as it is possible for price-fixing cartels to obtain above-market prices for their products. But it is also true that, over the long term, unionization has proved a disaster for affected U.S. industries. By cutting into profits, unions have deterred investment and R&D; the rigid work rules they imposed have hampered innovation and competitiveness; and the unsustainable pension and health care commitments they extracted have turned out to be financially ruinous in the long run.

A resurgence in union power wouldn’t improve the system. Union power distorted the system, ultimately with dismal consequences. Yes, some people came out ahead, but many others have suffered from the effects of underinvestment, inefficiency, and burdensome legacy costs.

Contrary to the fears of Ezra and the rest, America’s labor markets are working fine. Strong incentives are in place for companies to pay people what they’re worth. The system isn’t broken.

Of course you can be disappointed that more people aren’t doing better. In which case, you have a couple of options. Option one is to try to supplement the competitive market system. Let the system work, and accept that the prices it’s generating are offering reasonably accurate information about the economic value of different kinds of work. Then try to find policies that will (a) help people increase their value in the marketplace and (b) mitigate hardships for people with relatively low human capital.

Option two is to try to supplant the system by ignoring market signals and squelching competition. In other words, go against everything we know about how best to encourage innovation and wealth creation. Sure, a lucky minority may get windfalls, but everybody else will suffer from the reduction in economic growth.

Option one is egalitarian liberalism; option two is reactionary collectivism. As a libertarian, I am obliged to point out that perverse incentive effects and political dynamics make it very difficult for option one to work well. But option two is flat out doomed to make matters worse.

In last Friday’s Washington Post, columnist Charles Krauthammer tried to argue that tomorrow’s mid-term elections would not deliver a historic and decisive blow to President Bush’s agenda, particularly his agenda in Iraq.

Krauthammer’s argument is based on his reading of the history of mid-year elections. He noted that the anticipated “anti-Republican wave” — a net pick up of perhaps 20–25 House seats, and 4–6 Senate seats, by the Democrats — is relatively modest by historical standards. Reagan lost more in the 6th year of his presidency; so too FDR. One of the greatest mid-term election disasters (not noted by Krauthammer) occurred in Dwight Eisenhower’s 6th year, 1958. At a time when Eisenhower was personally quite popular, the Democrats added nearly 50 members in the House, and another 16 in the Senate, building upon their already commanding majorities in both chambers. 

I’m all for studying history. But recent history paints a decidedly different picture than what Krauthammer suggests. The GOP was embarrassed by the results of the 1998 mid-term elections, a failure to capitalize on the 6th year itch that Krauthammer attributes to “Republican overreaching on the Monica Lewinsky scandal.” Given low unemployment, modest inflation, and continued strong economic growth, it is not inconceivable that the Bush administration might have been poised to avoid a 6th year setback (if so, would Harold Meyerson be lamenting “Democratic overreaching on the Mark Foley scandal”?).

Instead, the GOP is playing defense, and Iraq war advocates such as Krauthammer are scrambling to avoid blame for any of the ill-effects of their ill-conceived war. (See also the Van​i​ty​Fair​.com article highlighting neoconservative criticisms of the Bush administration’s execution of the war).

The Iraq war is the decisive issue for the vast majority of Americans, exceeding taxes, immigration, health care, and other presumed drivers of voting behavior. Further, the war is unpopular, the costs have far exceeded the benefits, and there is no end in sight. As David Boaz and David Kirby note in a recent Cato Policy Analysis, the Iraq war was a factor — along with “Republican overspending, social intolerance, [and] civil liberties infringements” — in driving many libertarian voters away from George Bush in 2004. “If that trend continues into 2006 and 2008,” they write, “Republicans will lose elections they would otherwise win.” 

On the whole, voters are frustrated, impatient, and angry. If the GOP staves off disaster, they will do so in spite of, not because of, the disastrous war in Iraq.

At yesterday’s Cato policy forum on pay-for-performance (P4P) in Medicare, I argued the Medicare bureaucracy should stay out of P4P largely because Medicare would ruin the idea. A Medicare-administered P4P program would be less flexible than private efforts, more likely to harm patients, and the very providers that P4P aims to discipline would have way too much say in a Medicare P4P program. I recommended confining P4P to private Medicare Advantage health plans. Read my full argument here.

Harvard’s David Cutler argued that Medicare should get involved in P4P because private insurers didn’t have the purchasing power to really force providers to change. At the time, I was unaware of this study by Meredith Rosenthal and her colleagues in this week’s New England Journal of Medicine. They report:

More than half the HMOs, representing more than 80%of persons enrolled, use pay for performance in their providercontracts. Of the 126 health plans with pay-for-performanceprograms, nearly 90% had programs for physicians and 38% hadprograms for hospitals.

That probably doesn’t match Medicare’s purchasing power. But it does suggest that P4P can gain a toehold through the private sector.

Harvard’s David Cutler visited Cato yesterday to participate in a small group discussion about cost-effectiveness in medicine, and also in a panel on improving quality in Medicare. (You can watch the latter event here in a couple of days.) My colleague Arnold Kling blogs about issues discussed at both events. 

I am struck by one issue that emerged, which has to do with price-sensitivity, provider behavior, and health outcomes. Cutler argued that when patients are more price-sensitive (i.e., when they have to pay for more of the cost of their medical care), they tend to cut back both on care that would have done nothing for them, and on care that would have helped them. He postulates that if we were to move all Americans into health savings accounts (HSAs), thereby making patients more price-sensitive, we would see worse health outcomes than we see now. 

I am skeptical of that prediction. I think that if the move to HSAs were confined to a small, randomly selected subset of the population (call it “Rand II”), Cutler’s prediction would be more plausible — though by no means certain. There is precious little evidence that suggests — and it does no more than suggest — that for some patients, greater price-sensitivity leads to worse health outcomes. 

However, even if we assume that Rand II would show that greater price-sensitivity leads to worse health outcomes, it does not follow that we would get the same result were the entire population made more price-sensitive. The reason is that with a population-wide shift, the supply side of health care markets would respond to the enormous change on the demand side. Faced with patients who are less eager to consume medical care, providers would have to do a lot more to sell their services, including:

• conducting research on the usefulness of their services,
• improving the quality of their services,
• lowering their prices, and
• educating patients about the value of their services.

These responses should enable patients to make smarter decisions about what to consume and what to avoid. Instead of having patients cut back equally on beneficial and useless care, they would cut back on useless care more, having more help discerning between the two. Downward pressure on prices should make cutting back on beneficial care even less frequent.

MIT economist Amy Finkelstein demonstrates that the supply side of medical care does respond to demand-side changes. For 30 years, economists believed that the expansion of health insurance (which reduced price-sensitivity) had a relatively small impact on the growth of health spending. That belief was based on the effects of a demand-side study (Rand I), which was too small to induce or measure any supply-side responses to the change in price sensitivity. Using a data set that does capture and allow her to measure supply-side responses, Finkelstein estimates that the effect that the expansion of health insurance had on health spending is six times greater than the demand-side-only experiment Rand I suggests. 

Casual observation suggests that supply-side responses are helping price-sensitive patients make better choices right now. At the same time that HSAs and other insurance options are making millions of patients more price-sensitive, insurers and entrepreneurs are furnishing more of the price and quality information that patients need.

It would be foolish to claim that the supply-side response to price-sensitive consumers would be so great that patients would have perfect information and would never make mistakes. Yet most opponents of making patients more price-sensitive make the equally foolish assumption that there would be no supply-side response to the new incentives coming from the demand side. I say “most” because Cutler and others are not in this group. If I understood Cutler, he acknowledges that there will be such supply-side responses, and that we have no way of knowing whether or how much they would improve health outcomes.

True enough. But it’s something like 50 percent of the debate over HSAs and health outcomes. T’would be nice to have opponents of HSAs and the like acknowledge and engage it.

The growing political infatuation with Sen. Barack Obama (D‑IL) is fascinating, in part because it’s cropping up across the political spectrum.

The Dems’ weakness in the knees is understandable, given the appealing alternative Obama offers to the party’s otherwise underwhelming roster of standard-bearers. On the Right, David Brooks’ Oct. 19 NYT column “Run, Barack, Run” (subscr. required) titters with excitement over a possible Obama ’08 presidential bid. And in our corner of the political universe, a few libertarians have confided that they are also smitten with Illinois’ junior senator.

All of these valentines are surprising, given that they’re directed at a senator who has been in Washington for less than two years, and who has no gubernatorial experience. But perhaps it’s the unknown that’s appealing. Like a Rorschach test, we can look at Obama’s not-yet-established political profile and see the outlines of our own beliefs — whatever those beliefs may be.

His surface appeal is understandable; the senator comes across in interviews as thoughtful, bright, caring and articulate. Just as impressively, he doesn’t immediately start mouthing the usual ideological foolishness that has become standard in the puppet theater of D.C. politics.

However, I’m not sure Brooks is correct when he writes that Obama “has a compulsive tendency to see both sides of any issue” and that he is wonderfully free of narrow-mindedness. Consider the senator’s April 2005 speech to the National Press Club, in which he claims Social Security reformers and HSA proponents are motivated by a belief in Social Darwinism:

There’s something bracing about the Social Darwinist idea, the idea that there isn’t a problem that the unfettered free market can’t solve. It requires no sacrifice on the part of those of us who have won life’s lottery — and doesn’t consider who our parents were, or the education we received, or the right breaks that came at the right time.

But I couldn’t disagree more. If we privatize Social Security, what will we tell retirees whose investments in the stock market went badly? We’re sorry? Keep working? You’re on your own?

[…]

And yet, this is the direction they’re trying to take America on almost every issue. Instead of trying to contain the skyrocketing cost of health care and expand access to the uninsured, the idea behind the President’s Health Savings Accounts are to leave the system alone and give you a few extra bucks to go find a plan you can afford on your own. You deal with double digit inflation by going to the doctor less. Instead of strengthening a pension system that provides defined benefits to employees who’ve worked a lifetime, we’ll give you a tax break and hope that you invest well and save well in your own little account.

Of course, the supporters of private accounts and HSAs are not Social Darwinists who want to throw the sick and feeble to the wolves. The various Social Security reform proposals that have been floated include safety nets (not to mention choice), and HSA plans require the purchase of catastrophic health insurance. A thoughtful criticism of those policies would question their workability and the adequacy of the safety nets — yet, that is not what Obama offered in his speech. It thus seems that either (1) the senator is not really thoughtful about Social Security and health care policy, or (2) he is not the open-minded non-ideologue that Brooks claims.

But perhaps this is being too hard on Senator Obama. His Press Club remarks and other such comments may be instances of him playing the political games and mouthing the ideological mantras that are required of politicians. Perhaps the man behind the Politician Obama curtain is every bit as dreamy as his admirers claim.

And indeed, Democrats interested in the Oval Office have sometimes proved to be great benefactors to free markets and limited government. Would Ted Kennedy have been such a champion of transportation regulation reform in 1977 if he hadn’t wanted to take a shot at the White House in 1980? Would Bill Bradley have been such a strong proponent of the 1986 tax reform if he weren’t angling for a 1988 presidential bid? Would Bill Clinton have signed welfare reform in 1996 if he weren’t worried about winning a second term later that year?

Perhaps a Presidential Candidate Obama will soon be whispering sweet nothings into our ears in the form of Social Security or Medicare reform. Or perhaps a President Obama would nurture a more thoughtful and humble federal government and a civil society that re-embraces the fundamental American ideal of individual liberty.

Or perhaps I’m just lost in the magic of his eyes…

Bloomberg is reporting that American voters will be asked to approve a record $80 billion in bonds next Tuesday to fund an array of state and local spending projects. The previous record was $47 billion in proposed debt in 2002.

As I argued in an op-ed yesterday, state and local revenues have been rising rapidly, so voters should be very suspicious about loading even more debt onto the next generation of taxpayers. For background on state debt see here, and here.