Is government intervention the appropriate response to market failure: The case of COVID-19 vaccines

 In an interesting blog post, John Cochrane expresses dissatisfaction with the government's allocation of COVID-19 vaccines. He objects to both the government's decision to ban a private market for the vaccine and the criteria used to decide who gets it.

"When I suggested free market vaccine allocation on top of government distribution, critics lambasted me. Only the government can artfully offset externalities and information problems, they say. Implicitly every single dose must be requisitioned to the government's majestic planning effort, not one may be sold letting willingness to pay guide the usefulness of the vaccine. Not even a hospital emergency room treating covid patients may spring money and butt the line."

So what is wrong with the way the vaccine is allocated? 

"If you want to stop a pandemic that is growing exponentially there is one rule. Give it fast to the people most likely to get it and to spread it to others. Over and over Nothing Matters but the Reproduction rate."

However, this is not the criterion used by many governments.

"First it goes to protect old folks in nursing homes. The UK gave its first dose to a 91 year old. Germany to a 101 year old. That's nice. Then to old people in general, even though most non-nursing home old people are retired and doing fine staying home. Well, it appears kind-hearted to protect those who are most likely to die if they get it. It is a purely private benefit, so one might ask why they aren't asked to pay anything for it. So it's really an income transfer to old people in the form of a vaccine."

I can feel "compassionate" people getting triggered. It is important to slow the spread but it is also important to protect the lives of those most vulnerable and the government must weigh both goals, they may say. Except, as Cochrane points out, there is no tradeoff here. 

"OK, I like old people and social justice too. But if that same vaccine were given to a front line health care worker, or to a young partier who just can't seem to help themselves from giving it to 25 other people, including 3 grandparents, we solve the disease, we address the externality, and we protect old people, much more effectively."

So why are officials not seeing this? 

"Do you first give a vaccine to old people who are likely to die if they get it, freeing them to go out a bit and freeing nursing homes from having to implement stringent protection requirements? But in doing so you let the disease run rampant and the economy tank for another six months. Or do you give it in a way that stops the pandemic, to people who individually won't die but will thereby not spread the disease? The overall death rate is lower in the latter case, but only in secondary infections, which you, the CDC cannot claim to have saved."

In the vaccine case, we have what economists call an externality. A person's decision to get vaccinated affects not only their own well-being but also the well being of innocent bystanders, those who come into contact with the person. As every textbook of principles of economics states, when an externality is present, a government may be able to influence the market allocation in a way that improves social welfare. But the fact that government intervention can be welfare-improving does not mean that it will be. The concern here is that a market would allocate the vaccine to those who are willing to pay enough but may not be the ones most likely to contract and spread the virus. But if this is the concern, the government's response should be to direct the vaccine towards the most infectious among us. Due to political considerations, however, this is not the case. 

Several economists, especially in the field of Public Choice, have argued that a less than optimal market outcome, a market failure as we call it, may be second best. They find paradoxical that people who are suspicious of individuals when those individuals work for business, seem to trust that they will do the right thing when they work for the government. Such people either ignore that politicians are just as self-interested as business professionals, or assume that the interest of politicians is aligned with that of the public because to get re-elected they must make socially beneficial decisions. This assumption presupposes, however, that people are capable of correctly identifying not only the direct but also the secondary effects of a decision. This is not always the case. 

In Economics in One Lesson, Henry Hazlitt brings the example of a government that builds a bridge of marginal value to provide employment. He points out that people who are not trained to see "beyond the immediate range of the physical eyes" will only see the bridge and the jobs created by its construction. They will not see that the funds diverted from the private sector to build the bridge could have been used to make things that people value more. They will not see the unmade cars, private houses, etc. and the jobs sacrificed in those industries. If voters cannot properly identify the secondary effects of an action, there is no guarantee that self-interested government bureaucrats will act in ways that improve upon the market outcome. The choice may be between market failure and government failure, and it is not at all clear that an imperfect government is better than an imperfect market. 

Imagine someone grieving the loss of an elderly parent to covid. I can envision news outlets and social media posts holding the CDC responsible for vaccinating a college student with no underlying health conditions instead of the deceased. How easy would it be for a government bureaucrat to convince people that vaccinating the college student saved lives? How easy would it be to divert attention from the specific person who died to the abstract elderly people who were spared because they did not contract the virus? Such considerations can lead self-interested government bureaucrats to allocate the vaccine in sub-optimal ways, as it seems they have. As Cochrane remarks, 

"The government is basically not even thinking about the prime market failure -- the externality that if I get it I might give it to you.  In doing that it is mostly just achieving an income transfer to favored groups." 

It is not at all clear that this sub-optimal government allocation of vaccines is any worse than the sub-optimal allocation that would have been achieved under a private market. And this risk carries over to every government intervention. It is important to remember that.

Roberts' interpretation of the ACA mandate and my concerns about Barrett

From an economics standpoint, John Roberts' interpretation of the ACA's mandate in the SCOTUS's decision is much more insightful than Barrett's interpretation in a 2017 article.  The effect of a fine imposed on an activity is equivalent to taxing that activity. Vice versa, any tax imposed on an activity is equivalent to fining that activity. Taxing pollution is similar to making pollution illegal and subject to a fine. Fining those who pollute is similar to keeping it legal and taxing it.  In both cases, those who value polluting more than the cost associated with doing so will continue to pollute. Those who value it less, will refrain. Whether the law describes the cost as a fine or a tax is semantics. Roberts seems to get that, Barrett doesn't.

Many of my disagreements with lawyers and law-makers stem from their lack of understanding of basic economics. Legally, the payroll tax is supposed to be split evenly between employer and employee. But this only determines who writes the check. Several studies show that the majority of the tax is effectively paid by employees because, to pay their portion of the tax, employers offer lower salaries. Hence, employers are able to roll over some of their tax burden to employees. On paper, of course, employers are writing a check for half the tax, in accordance with the law. In practice, however, they are paying far less than half. How the tax is split between two trading parties is determined by the forces of supply and demand, not by the desires of lawmakers. And judging the constitutionality of a law should depend on how the law works in practice, not on its claims. If Barrett gets confirmed she should better be much less literal and much more analytical.

As a side note, while many Republicans dislike the ACA mandate, ruling that it is unconstitutional would likely push us closer to government insurance. Every country that has achieved near-universal coverage, has done so by coercing people into buying health insurance. The ACA hoped to achieve universal coverage while keeping insurance mostly private, by coercing people into buying private insurance. If fining people who refuse to purchase insurance in the private market is deemed unconstitutional, then the only other way to achieve universal coverage is by having the government provide it to everyone and forcing people to pay for it through taxes. The effect will be the same and, as per Barrett's judgement, in accordance with the letter of Constitutional law. If those of us who want universal coverage through a private market are forced to choose between the two, at least some of us will be inclined to lean towards universality at the expense of keeping the insurance market private. Many Republicans wish that the mandate is deemed unconstitutional. I say to them, be careful what you wish for.

Why Economics (at Hofstra)

I prepared the video below for an event organized by Hofstra for high schools students who have an interest in economics and are considering applying to Hofstra. I cover several diverse topics, from Africa and why some countries are so much poorer than others to the BLM movement and why race-neutral laws may be responsible for racially biased outcomes in police interactions, to Uber and how its surge pricing allows drivers to allocate their time more efficiently, to fourth downs in football and why Bill Belichick is such a successful coach. I highlight how someone can better understand these issues if they have a training in economics, and how eye-opening such a training can be. During the presentation, I share information about my personal background including what motivated me to study economics, and close with what is special about teaching economics at Hofstra.

The drop in US GDP in Quarter II: You too could have predicted it

The GDP numbers for the second quarter of 2020 came out today, and they are ugly. During the months of April, May, and June, the US economy contracted at an annualized rate of about 33%. The first graph below shows real GDP, which measures production by controlling for changes in the price of the produced goods and services. The drop during the second quarter is unprecedented and makes the Great Recession look like a small road bump. The second graph, which shows the percentage quarterly change in real GDP on an annualized basis, is even more shocking.

This terrible outcome is not completely surprising. In my introductory remarks during a recent panel discussion, I had mentioned that in the second quarter the decline in GDP would be much bigger that that in the first quarter, and far greater than what we saw during the Great Recession. I was correct not because of some supernatural fortune-telling ability, but because of Okun's Law. The law takes its name from Yale professor of economics Arthur Okun, who in the early 1960s estimated a relationship in the data between changes in unemployment and the deviation of output from its potential. Okun's original estimate suggested that every 1 percentage point increase in unemployment above its natural rate should be associated with a 3.33% drop in GDP below its potential.

Since Okun's pioneer work, several researchers have tried to estimate the relationship between changes in unemployment and the growth in GDP using different techniques and more recent data. Much of the work finds that the estimate is unstable over time and that the coefficient has fallen to around 2% since the 1980s, meaning that a 1 percentage point increase in unemployment should be associated with only a 2% drop in GDP. This time, however, Okun got closer. As the graph below shows, the rate of unemployment rose by 9.2 percentage points, from 3.8% in quarter I to 13% in quarter II. By Okun's original estimate, if each percentage point increase in unemployment is associated with a 3.33% drop in GDP, then an increase in unemployment by 9.2 percentage points should be associated with a drop in GDP by about 29% after we take into account that GDP should have increase by about 2% (9.2 times 3.33 minus 2%). The drop was actually greater than what Okun's estimate suggests, not lower as the more recent estimates would claim. In that respect, the news are worse than what one would have expected. Nevertheless, using the change in unemployment during April and May, one could have predicted in June, a month before the GDP numbers were released, that the drop in the second quarter would be enormous. So why don't you try some predictions yourselves from now on and see how well you do? It could be fun!

The pandemic's impact on the global economy

That was the title of an online discussion organized recently by Hofstra University's departments of Economics and Global Studies. I was one of three participants. If interested, and have a little less than two hours to spare, here is a recording of the event:

Justifying lockdowns: Does the externality argument hold water?

In economics, a negative externality is a cost that two transacting parties impose on a third party, and for which the transacting parties pay no compensation. Economic theory suggests that if the transacting parties can ignore that cost, they have an incentive to engage in too many transactions compared to what they would have done had they been forced to take the cost to the third party into account. Hence, under certain conditions, the government may be able to improve social welfare by restricting the number of transactions, for example, by taxing them, regulating them, etc. Those who favor shutting down non-essential business in response to the pandemic seem to be making a similar argument. We are told that people who engage in in-person transactions put at risk not only themselves but also the healthcare workers who will have to treat them if they get sick. Hence, that choice should be taken away from them. The extreme version of the argument suggests that people who choose to engage in in-person transactions should have no expectation of receiving treatment if they get sick. But does this and other arguments that invoke negative externalities hold water?

Let us start with whether a negative externality is, in fact, imposed on healthcare workers. The definition in the first paragraph and a brief analysis suggest that it is not. If I go to a bar and contract any sickness, by itself this transaction does not impose a risk on any healthcare worker. The risk comes from the healthcare worker treating me. But this a separate transaction that involves a risk that healthcare professionals implicitly agree to undertake when they choose to enter this line of work. It is also a risk for which they are compensated. There is no externality here. Imagine if police officers wanted to impose a curfew on people living in high-crime neighborhoods to reduce the risk from having to enforce the law there. Imagine if they refused to respond to a call because the victim was acting risky by choosing to walk alone late at night. Obviously, anyone who is unwilling to undertake the risk associated with being a police officer should not become one. The same applies to healthcare workers. And the argument of using lockdowns to protect healthcare workers is weakened further by data showing that, at least in New York, the COVID infection rate among those in healthcare is lower than that of the general population (12% versus 14%), which suggests that healthcare workers can mitigate the risk by properly using Personal Protective Equipment (PPE).

A more substantive case can be made that a person who engages in in-person transactions imposes a negative externality on those who come into contact with them accidentally, for example, because they live in the same apartment complex. As well, because of how our healthcare system is structured, a patient may pass some of the cost of treatment to the insurance company, or to taxpayers when the government picks up the bill. While these observations are valid, it is important to remember that according to economic theory, the optimal level of a negative externality is not zero if there are strong enough benefits associated with the activity causing the externality. Pollution is another example of a negative externality, but banning it would require us to give up so much of human activity as to seriously compromise the standards of living and perhaps the survival of billions of people. Instead, the prescription is to make those responsible for the external cost pay for it. Doing so motivates them to engage in only those transactions whose benefit is large enough to justify the cost not only to themselves but also to others. But is this not the case already? Someone who chooses to keep their business open will pay a penalty proportional to their volume of business through the sales, income, and other taxes. A person will want to work only if the benefit from working exceeds the cost of their time and risk to their health as well as the tax. For the externality argument to stick, one would have to show that the tax on work is less than the expected cost that working imposes on others, and it is not at all clear that this is the case. As well, we should consider that there is also a positive externality from someone getting sick, to the extent that they develop immunity to the virus thereby contributing to herd immunity. For example, if you stayed at home for a month and during that month everyone else contracted the virus and either developed immunity or died, you could then exit your home without fear of contracting it. You would have benefited from other people's suffering free of charge.

This, of course, does not mean that a lockdown or a shutdown are never justified. When health facilities are overwhelmed, the marginal cost (cost or treating one more patient) can get very high. Hence, it may be reasonable for a government to enact temporary measures to slow down the rate of infection and buy itself time to increase the capacity of the healthcare system. But the key word is "temporary". Once healthcare facilities operate well below capacity, there is no reason why the government should prohibit in-person transactions instead of allowing people to choose for themselves. This is important to remember given that the political incentive for many governors is to minimize the grim statistics of the pandemic, especially since the economic cost from a lockdown to their state may be mitigated by any assistance the state and its residents receive from the federal government. Claiming that one saved people's lives, even of those who did not want to be saved, makes a good political slogan, but it is not sound economics. Loggers, fishers, roofers, coal miners, undertake an unusually high risk when they decide to go to work. Yet we don't shut them down because their accidents reflect negatively on us. Staying open during a pandemic should not be any different.

A historical note on Brexit

Brexit has become a mess. Yet some Britons, mostly supporters of the conservative party, remain adamant about leaving the EU. In social media, they often object to the prospect of the UK having to constrain some of its domestic policies according to the will of other European nations and especially Germany, which they feel they defeated in WWII. In light of this attitude, it is important to note that the first European politician to speak about a United States of Europe was British, and not just any Brit. It was the man who led not only the conservative party from 1940 to 1955 but also the UK in its resilient fight against Nazi Germany. If you guessed that his name was Winston Churchill, you would be correct.

Below is a short clip from Churchill's speech delivered on September 19, 1946 at the University of Zurich in Switzerland. In it, Churchill urges Europeans to pursue the creation of a federal political entity even if this means leaving behind countries that may not be ready to follow. It is ironic that decades later, one of the few European countries that would turn down membership to a United Europe and the party that would opt against it would both be his own. But maybe it is not ironic after all. Churchill witnessed the horrors of two world wars. He led his country during one of them, and spent a good chunk of it fighting Nazism nearly single-handedly. He could never be a nationalist isolationist. Unfortunately, the current generations may remember the victory, but it seems that they have forgotten the hardship, sacrifices, and alliances that forged it.