Sorry About That

Republican Representative Joe Barton apologized to BP for the "shakedown" the company has received from the White House. Then he apologized for apologizing and took back the word "shakedown."

What was he thinking? Look, the minimum penalty for causing an environmental catastrophe has to be forcing the company to internalize the cost that it has imposed on the rest of us. We don't know exactly how much it's going to cost to clean everything up and compensate those who have lost income, but something in the billions seems highly likely. I don't know if it'll be more or less than $20 billion, which is the amount of the compensation fund BP has set up, but that seems like it's in the ballpark.

The compensation fund seems right on target. People are calling for criminal penalties, but there's nothing like good old money to motivate profit-seeking corporations. Let's say BP saved a couple of million dollars by taking safety shortcuts when building the well. Socking them up for $20 billion, which is 10,000 times that amount, is a powerful incentive. It would cause a rational company to tell its employess, "don't try to save a couple of million by taking safety shortcuts if there's even a 1 in 10,000 chance that it might go wrong and cost us $20 billion."

If we could force profit-seeking companies to perfectly internalize all the external costs that their operations impose, they'd have exactly the right incentives. Of course, the external costs can never be perfectly measured and in most cases there's a lot of litigation costs and uncertainty. But a $20 billion compensation fund seems like a good start.

Your Share of the Debt

With the national debt at $13 trillion and counting, it was interesting to hear a story on NPR this morning about one woman's efforts to get people to contribute voluntarily to help pay it off. Kay Fishburn, a nurse from Wisconsin, founded "Citizens for a Debt-Free America," which encouraged people to send in money voluntarily. (If you're inspired to do so, the government bureau that will accept your gift can be found here.)

I can't help but admire someone who actually makes an effort to do something about our nation's tremendous debt, and I don't want to sound mean-spirited or curmudgeonly, but I don't think voluntary contributions are the answer to our debt problem, and I'm not sending in anything myself. Good work, Ms. Fishburn, I don't mean to criticize you for trying, but I see some huge problems with your efforts:

First, it's inconceivable to me that voluntary contributions could ever make even a minor dent in the public debt. According to the story, Fishburn's organization managed to raise about $3 million in contributions in its best year. That might seem like a good haul, but when the public debt is in the trillions, $3 million isn't even a rounding error.

Second, the fair and just way to deal with the public debt is for the burden of it to fall on everybody. When I pay income taxes, I know everyone else has to pay them too. The burden of the public debt shouldn't fall only on those who are public-spirited enough to make an extra contribution. What makes taxes tolerable is the knowledge that each individual's contribution is joined with those of everyone else. (Of course there are a lot of infuriating loopholes and special deals in the tax system, which detract from this sense of shared sacrifice, but at least that's the idea and it achieves the goal better than voluntary contributions.)

Finally, and most insidiously, there is a danger in presenting the government with new, free revenue -- it might just spend it. Again, I don't want to sound too curmudgeonly, but really, even if everyone started voluntarily chipping in a bunch extra to pay off the national debt, there's no guarantee that it would work, because Congress might then feel less pressure to control spending. Looking at the performance of Congress in this regard over the past decades, it does seem that, with rare exceptions, substantial deficit spending is a constant in our government, regardless of which party controls Congress or how well the economy is doing. The government managed to run a surplus for a little while under President Clinton, but that was exceptional.

So while I admire and thank anyone who's willing to chip in extra to help pay of the U.S. national debt, I would think that the problem can only be solved by an appropriate mix of tax policy, spending control, and good economic performance at the national level.

Medicare and Cost

I usually try to blog about subjects where I have some value to add based on expertise. But most pundits today seem happy to mouth off about subjects they know nothing about, so why not me?

Mr. Rick Pollack, executive vice president of the American Hospital Association, expressed concern yesterday about the Senate proposal to allow persons age 55 or older to buy into the Medicare system. He explained: "Medicare pays less than the cost of delivering services. And as more patients are reimbursed at levels that are below the cost of providing the service, it obviously makes it difficult to maintain essential public services that patients and communities depend upon."

Now, can this possibly be true? If Medicare really pays less than the cost of delivering a service, then why would hospitals serve Medicare patients? They're losing money on each one.

Apparently, as summarized by Pollack's interviewer, part of the answer is that "Hospitals typically make up that shortfall by passing the cost to privately insured patients who pay more." But if other patients are willing and able to pay some higher cost that is necessary to make up for the loss hospitals incur on Medicare patients, then hospitals could make even more money by charging other patients that higher rate and still not serving the Medicare patients.

Do hospitals serve Medicare patients out of a sense of civic responsibility? Is it a public service? Or do they actually make money on Medicare patients but hide it with complicated accounting?

Are they just confusing marginal cost with average cost? If you imagine that each patient has to bear part of the cost of keeping the heat and lights on and paying the hospital's debt service -- all of which the hospital would do whether or not that patient showed up -- you can easily show a loss on patients when actually you're making a profit on them. The correct calculation would consider only the marginal (i.e. additional) costs that the hospital incurs because of treating that patient.

Here's a skeptical take on this costs question. But I don't really know the answer. Perhaps someone can elighten me.

Economics Redux

I mentioned the other day that -- gasp! -- the free market does not perfectly regulate the salaries of executives at public companies, and I pointed out the error in a conservative pundit's analogy between executive salaries and baseball player salaries: the latter are determined by arm's-length negotiation; the former may be corrupted by market failure.

Today's piece by Adam Liptak in the NYT shows that Judge Posner agrees with me. Here's an excerpt from Posner's opinion (dissenting from denial of rehearing en banc) in a case challenging executive compensation:

"[E]xecutive compensation in large publicly traded firms often is excessive because of the feeble incentives of boards of directors to police compensation. . . . Directors are often CEOs of other companies and naturally think that CEOs should be well paid. And often they are picked by the CEO. Compensation consulting firms, which provide cover for generous compensation packages voted by boards of directors, have a conflict of interest because they are paid not only for their compensation advice but for other services to the firm--services for which they are hired by the officers whose compensation they advised on. Competition in product and capital markets can't be counted on to solve the problem because the same structure of incentives operates on all large corporations and similar entities."

Let's remember that Judge Posner is one of the leader's of the law-and-economics movement, and that, if anyone understands when the free market can be counted on to get something right without regulation and when it can't, it's him. Moreover, his dissenting opinion got five votes in the Seventh Circuit and the Supreme Court has just granted cert in the case.

Take that, Amity Shales.

Pros Acting Irrationally

Fascinating article in yesterday's NY Times: a study of over 1.6 million putts made by professional golfers shows that the pros are slightly more likely to make a par putt than to make a birdie putt of identical length. The study's authors believe that the data demonstrate the psychological phenomenon of "loss aversion": golfers try harder on par putts because they don't want to lose a stroke to par; whereas on birdie putts they have the psychological comfort of knowing that if they miss they can still make par.

The study is fascinating because it shows golfers acting irrationally. The golfer's goal is to do as well as possible in the tournament, and this goal is backed up by a large financial incentive. Whether a stroke is for birdie or par is irrelevant to the golfer's best strategy for the stroke. The study controlled for relevant factors, such as the golfer's current position in the tournament or the number of holes remaining. But the number of strokes taken on the hole so far and the relationship between that number and par are irrelevant -- a stroke is a stroke whether it's for birdie, par, or double bogey.

One expects casual players to make strategic misjudgments, just as a casual poker player will fall for the "sunk cost" fallacy and tend to stay in a pot to "protect" the amount he's bet so far, even though paying attention to that irrelevant figure may cause him to throw good money after bad. But professional poker players should be keenly aware of and should know how to avoid that error. Similarly, economists would predict that, with the big sums at stake, professional golfers would act rationally and learn to overcome the psychological pressures identified in this study. But they apparently don't. Humans befuddle economists again.