The Use of Knowledge in Health Care

In my own research I am currently focusing on the impact of subsidies (and the ensuing control) on higher education and I’m struck by the basic similarities between higher-ed and health care. Both are heavily subsidized and consequently heavily regulated (though in different ways), and both are far from being free markets. Much of their similarities can be understood by thinking about what Professor Hayek told us in The Use of Knowledge in Society.

In this classic essay, Hayek beautifully describes the role of free-market prices in both communicating relative scarcities and providing incentives to allocate resources wisely. High prices indicate that people want more of something and/or that it’s relatively difficult to provide more. Water is cheaper than diamonds not because diamonds are better, but because it’s hard to get more diamonds, and one more diamond would be valued more highly than one more gallon of water (if you’ve ever seen someone clean a sidewalk with water you should be convinced of this).

Prices are able to serve this role because they balance the value of customers against the costs of sellers. If I want to use an hour of your time I have to pay you enough to make it worth your while. That I’m willing to pay shows that I value your effort (or at least expect to gain on average) more than what I pay you. That you accept it shows that you expect to give up less by selling your labor than you gain in wages. If I value your labor more than your wage and you value your wage more than your cost (what you have to give up in order to work) shows definitively that the benefits to your labor is greater than the cost. This seems simple, but its implications are profound.

Prices change when conditions change, so if I ask you to do a more difficult task I’ll have to pay you more. If there are many people also willing to do this job, your wage will go down (these are two reasons cashiers are paid less than doctors). And so long as prices are set through voluntary transactions, we end up with “efficient” output–situations where buyers value what they get more than it costs sellers to provide it. But when we interrupt the price system we end up with either too little (by preventing mutually beneficial exchanges) or too much (leading to wasting time and resources).

Both schooling and medicine are marred by subsidy, regulation, and a lack of transparency. These factors prevent prices from balancing consumers’ wants against producers’ costs as well as limiting each group’s ability to respond to other changes (such as new technology). As a result, sellers aren’t able to reduce costs (and waste), while consumers use too much of the good. It’s a bitter irony that the subsidies meant to make both schooling and medicine more accessible often have the exact opposite effect.

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