The Paradox of Subsidies: Stuff gets more expensive as BIG GOVT deepens its involvement

Statists like to tell us bureaucracy and government subsidies make life easier and lower the cost of stuff.  Health care costs getting under your skin?  Obama will get the rest of us to pay for your health care.  College costing too much?  Kay Hagan and Barack Obama don’t mind putting you and your kids on the hook for decades to pay back exorbitant student loans.  

Robert Tracinski, writing at RealClearMarkets, shoots a lot of holes in this line of thinking:

President Obama has responded to the spiraling cost of higher education with a proposal that might sound familiar: create a centralized federal bureaucracy to control everything. That’s the upshot of his proposal to create a federal ratings system for universities and steer more federal money to schools that perform well on the ratings. So every school will be homogenized to fit the model preferred by federal bureaucrats.

And Obama’s plan is likely to make the problem worse. As Richard Vedder explains, Obama’s proposal to cap student loan payments to a percentage of the borrower’s income “simply raises incentives for future students to borrow more money, if they know their obligation to pay it back is capped. That, in turn, allows colleges to keep raising costs.”

If all of this sounds like a parallel to ObamaCare–a huge expansion of federal control, a menu of choices dictated from Washington, and no actual impact on controlling costs–that’s not a coincidence. In citing the Obama proposals as an example of the government saying “no” to rising costs–when has that ever happened, exactly?–Ezra Klein explains that what health care and education have in common is that they are special kinds of goods and services that are just, well, different from everything else. So the laws of economics don’t apply to them, and only government intervention can restrain costs.

“Health care and education pose the same basic threat to the economy: How do you keep costs down for a product that consumers must purchase?

“Saying ‘no,’ after all, is how consumers typically restrain costs. If Best Buy Co. wants to charge you too much for a television, you can walk out. You might want a television, but you don’t actually need one. That gives you the upper hand. When push comes to shove, producers need to meet the demands of consumers.

“But you can’t walk out on medical care for your spouse or education for your child. In the case of medical care, your spouse might die. In the case of college, you’re just throwing away your kid’s future (or so goes the conventional wisdom). Consequently, medical care and higher education are the two purchases that families will mortgage everything to make. They need to find a way to say ‘yes.’ In these markets, when push comes to shove, consumers meet the demands of producers.

“The result, in both cases, is similar: skyrocketing costs for a product of uncertain quality.”

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Here’s something to chew on after reading THAT. ObamaCare is expected to boost health care spending by $621 BILLION above what it would have been without ObamaCare.  A study by The Cato Institute finds the major culprit in the seemingly endless rise in health care costs is found to be the removal of the patient as a major participant in the financial and medical choices that are currently being made by others in the name of the patient.

  Also, average published tuition and fees at public four-year colleges and universities increased by 19% beyond the rate of inflation over the five years from 2003-04 to 2008-09, and by another 27% between 2008-09 and 2013-14.  An article published last week in The Atlantic came to this conclusion:  It is now impossible to work your way through college.  Once upon a time, a summer spent scooping ice cream could pay for a year of college. Today, the average student’s annual tuition is equivalent to 991 hours behind the counter.  MORE: 

Back to Richard Vedder, who explains what really makes higher education (and, I would add, health care) different: massive government subsidies.

“Obama proposes to ignore or worsen the root cause of much of the explosion in student costs: the federal financial assistance programs that encourage schools to raise costs and that haven’t achieved their goals of providing college access to low-income Americans.

“Two recent studies highlight the problem. First, the National Center for Education Statistics released data suggesting that federal college financing is growing rapidly. Now 84 percent of full-time undergraduate students get some aid. Average grant assistance for dependent full-time undergraduate students (unmarried, younger than 24) was $10,600 in 2011-12, up 34 percent in just four years-four times the inflation rate.

“Middle-class kids who were previously denied Pell grant aid are now increasingly getting it: In 2011, 17.5 percent of dependent students from families with $60,000 to $80,000 in annual income received Pells, compared with a mere 1.6 percent just four years earlier.

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We can expand this observation to draw a wider principle, something that is, or ought to be, Free-Market Economics 101. Call it the Paradox of Subsidies. Why do you subsidize something? To make it cheaper. What is the actual effect? To make it more expensive.

The greater the subsidy, the more money flowing in to the sellers of a product or service, the less incentive they have to reduce costs–as we can see in all those universities taking in federal loan and grant money and using it to decrease the tuition breaks they would otherwise offer to students. [I]f you offer a national subsidy for flat-screen televisions, that reduces Best Buy’s incentive to offers special sales and discounts. It increases their incentive to offer bigger and more lavish TVs, which people might not have purchased before, but which they can afford now that they are subsidized. As for the buyer, he becomes less demanding about prices when he’s not paying all of the cost, either because of grants or because of easy financing.

Hence the treadmill effect created by the Paradox of Subsidies. The more the government subsidizes something, the more expensive it gets–which requires higher subsidies to get the same results, which increases the costs even more–which requires still higher subsidies, and so on. And then some myopic observer […] comes along to declare that the free market is broken and government needs to take over.

The traditional free-market economist’s explanation would be to chalk this up to the Law of Unintended Consequences. But I’m an advocate of the Law of Intended Consequences, and from that perspective, I ask: What was the actual intention of the subsidy? The actual intention was not to make higher education cheaper. The intention was to hide its cost from the consumer. The intention was to tell the consumer he can buy as much of it as he wants without regard for cost.

This is what explains the paradox, because in shielding the consumer from considerations of cost, subsidies shut down the mechanisms that would actually, in fact, make something cheaper.

Let’s go to the Best Buy example. What drives down the cost of flat-screen televisions is not the fact that you can go without a television. For better or worse, very few of us actually do so. In fact, we have more and bigger televisions than ever, at lower prices. No, what drives falling prices is the fact that you can buy a television from someone else, which means that you can reward the company that finds a way to make a cheaper television or to sell them with a lower markup. What drives down prices in the rest of the economy, outside of government-subsidized bubbles like higher education and health care, is innovation spurred forward by competition. All of that happens because producers and consumers are responding to price signals. But when customers are insulated from prices, they have less incentive to reward the innovator who disrupts the status quo.

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