Wednesday, March 18, 2009

A Libertarian Perspective on "Too Big to Fail"

As the government continues to “bailout” failing corporations such as General Motors, Chrysler, American Investment Group (AIG), and a host of other financial institutions, the “too big to fail principle” has been cited as the primary justification for these rescue packages. This is a utilitarian principle that implies that the costs of “allowing” these corporations to fail outweigh the benefits; that is, if they fail others will fail and unemployment will rise. Although most economists seem to accept this utilitarian justification, no one has offered any explanation of how these corporations got “too big to fail.” Let’s explore two alternative explanations. The free market explanation is that corporations get “big” because they offer higher quality products and/or services at a lower cost than their rivals. These natural monopolies get “big” because they defeat their competition. In the absence of competition these monopolies raise prices and earn windfall profits. But natural monopolies are usually short-lived because other corporations can see their success, copy their strategies and/or improve upon those strategies. This process of weeding out the “unfit” (inefficient) competitors and inspiring competitors that are more “fit” (efficient) is called “creative destruction.” Unfortunately, there are other ways for corporations to “destroy” their competition. The second way to “get big” is to raise the cost of competing in a market by artificially raising the cost of others entering the competition. The easiest way for “big” corporations to stifle competition from smaller, more innovative companies is by lobbying government officials to raise the cost of competing by imposing costly regulations. These artificial monopolies can maintain their stature, regardless of their actual “fitness.” In fact, most artificial monopolies are downright inept: U.S. Postal Service, Public Schools, Public Utilities, etc. Now, how did AIG (American International Group) get “too big to fail?” Did it “take-over” its competitors because it was more “fit” or because it was more adept at lobbying government? The basic problem with the “too big to fail principle," is that if a corporation is “too big to fail” in the eyes of the government, it can take risks that other smaller, risk-sensitive corporations cannot. This leads to the proliferation of large, inefficient corporations that are protected from failure. Then, these maladapted corporations proceed to takeover over smaller, more efficient corporations. In short, the “too big to fail principle” tends to undermine “creative destruction.” Libertarians argue that when governments artificially prop up obviously inefficient corporations that take irrational risks, and reward incompetent executives with bonus pay, they also drive good corporations out of business. Would you rather invest in, work for, or buy from an inefficient corporation that is “too big to fail;” or invest in, work for, or buy from an efficient corporation that will probably be driven out of business by an inefficient corporation that is “too big to fail?” If you owned a smaller, more innovative, and more efficient competitor would you rather continue to compete with a corporation that is “too big to fail,” or agree to a lucrative takeover offer? The libertarian view on the “too big to fail principle” is that it undermines “creative destruction,” and leads to endless cycles of future government bailouts. But more than that it gives rise to an enormously destructive corollary the “too small to succeed principle.”

Sunday, March 1, 2009

Nadya Suleman's Octuplets: An Exercise in Moral Hazard

We libertarians rely heavily on the linkage between the concepts of “liberty” and “personal responsibility.” The underlying assumption is that our lives are the product of risk-management. Sometimes our lives are shaped by our own decisions and sometimes by others. Libertarians argue that within the bounds of legality, individuals must be allowed to reap the benefits of “good risk-taking decisions” and/or pay the costs for “bad risk-taking decisions.” But in the real world, we often rescue one another from the painful consequences of our bad decisions under the guidance of morality. Unfortunately, when we exercise beneficence under these circumstances, we encourage future risk-taking on the part of the beneficiary and other aspiring future risk-takers. Economists call this predictable incentive pattern “moral hazard.” Nadya Suleman’s Octuplets provide a valuable case study on how government programs, charitable organizations, and a doting mother can lead to an unfathonable degree of morally hazardous behavior. Because of confidentiality laws, we don’t know all of the details, but here’s what I’ve been able to gather. Nadya is a 33 year-old, unemployed single mother. Before the octuplets were born she already had six children via two separate vitro fertilization procedures. On average IVF yields live births about 30% of the time and costs about $15,000 per cycle. Most “live births” require more than one cycle. In order to increase the odds of having a “live birth,” clinics often insert multiple embryos into the uterus, which can lead to multiple pre-mature births. Premature births require the services of neonatal intensive care units (NICUs), which cost on average about $475,000 per child. Although clinics do not pay NICU costs, the American Fertility Society recommends the insertion of no more than 2-3 embryos at a time. However, desperate mothers with limited financial resources often request more than two embryos to avoid multiple IVF cycles. Inefficient clinics often insert multiple embryos to cover up their inefficiency and/or increase their published “live birth rate” Nadya’s doctor apparently inserted 6 embryos for those two initial multiple birth pregnancies, and for the cycle that yielded the octuplets (which allegedly included 2 sets of twins). So who paid for the IVF and NICU costs of the first two pregnancies, and who will pay for the octuplets? Private insurance companies rarely cover IVF treatments but are required by law to cover NICU costs. They usually limit that exposure to $1 million. Nadya is unemployed so forget about that! If uninsured, Medicaid (and a raft of other state assistance programs) usually covers most of these costs. Again, we don’t know who paid the medical costs for those first two IVF and NICU services, but we do know that she now receives Social Security Disability Payments for three of those children (one is autistic) and that she collects $480 in food stamps. We also know that Nadya also owes $50,000 in student loans. Her mother Angela has been trying to financially support Nadya and her six children. But Nadya’s home, which is owned by Angela, is currently $23,000 behind in mortgage payments and under foreclosure by the bank. The family has filed for bankruptcy. Given the uncertainties surrounding the Nadya’s ability to care for these 14 children, it is not clear if or when Child Protective Services will allow the octuplets to leave the NICU, or where they will live. “Angels in Waiting” a charitable group of nurses offered free 24 hour-a-day assistance (worth $130,000. a month) for all 14 kids, which would have avoided action by Child Protective Services. But self-reliant Nadya refused that offer. So how will she pay for all of this? Back in 1999, Nadya apparently suffered a back injury at work and has filed for permanent disability. She is also planning to take out more student loans so she can return to graduate school at Cal State Fullerton to finish her degree in counseling, while her mother continues to provide free care for her 14 children under six years old. Nadya also hopes land a lucrative T.V. offer and/or book deal. So what can a lifelong libertarian say about all of this? Absolutely nothing!