WHO is Responsible for Drug Shortages?

CNN reports in a breathless headline: The World is Running Out of Antibiotics, WHO says.  

The article is interesting as a whole.  The article begins with a description of the problem:

Too few new antibiotics are under development to combat the threat of multidrug-resistant infections, according to a new World Health Organization report published Tuesday. Adding to the concern: It is likely that the speed of increasing resistance will outpace the slow drug development process.

While the article goes on about these drug shortages, there are no questions as to why too few antibiotics are under development and why the drug development process is so slow.  A major reason for the slow development of drugs is drug regulatory agencies like the FDA!

The purpose of drug regulatory agencies is to slow down development of drugs.  The FDA (and its global counterparts) require extensive (and expensive) testing, large sample sizes, and the like, all which slow down the development process.  If these regulations were loosened, then the speed of development would increase.

However, this is not to say reducing FDA regulations are necessarily desirable.  A cost-benefit analysis would need to be done.  Are the costs of delayed drug developments, like what the WHO complains about here, worth the benefits from the FDA regulations?  It may be, in which case the slow development will have to be accepted.  However, if the costs of the delayed development are too high and exceed the benefits of the regulation, then one would need to accept a higher risk of dangerous drugs getting through in favor of quicker drug development.

In an ideal world, we would have both quick development and safe drugs; there wouldn’t need to be a trade-off between the too.  But in this less-than-ideal world we live in everything is scarce, including time.  Every second spent doing testing and meeting regulatory requirements is one second less to spend on development of new drugs (and vice versa).

The Market Institution in Disequilibrium

The standard supply and demand model is familiar to most people, and especially to economists.  While the model serves an analytical purpose (and an important one at that, in this man’s opinion), if not properly understood in the context of the market mechanism, it leaves a false impression.  The lessons of the model are subtle and the goal of this post is to address some of the popular misconceptions about the model and what it means.

The first misconception that the model gives is that the market is an equilibrium institution; that is, the market is always (absent externalities, interference, taxes, asymmetric information, etc) in equilibrium.  In some sense this is true*, but it is not the whole story.  If the market is in equilibrium, then there is no impetus for change: no profit opportunities (for buyers or sellers).  In short, there is no need for a market.  In equilibrium, all quantity demanded is met with supply and there is no longer any need for the coordinating efforts of the market institution.  The standard supply and demand model in equilibrium is a model without a market!

The misconception that the supply and demand model suggests the market is an equilibrium institution leads people (including economists!) to conclude that when the market is in disequilibrium, whether because of some frictions (ie rigid wages), or asymmetric information, or externality, or even disaster, then the market institution cannot work (or does not work as well).  But this is a misunderstanding both of what equilibrium is and what the lessons of the model are.

Equilibrium, as I discussed above, is the hypothetical point where quantity demanded and quantity supplied meet and thus economic profits equal zero.   I stress hypothetical because of many people, again including economists, assuming this equilibrium point actually exists, it is (or can be) known, and it is just a matter of pulling the right supply/demand policy levers to get to that point.  But the equilibrium cannot be known; both in the model and in real life, it “results” from the interactions of suppliers and demanders exchanging at various prices.  When a supplier raises his prices for his good, he thinks of the profit he earns, not that the current price is below equilibrium.  When the demander consumes more than he had originally planned, it was not because he saw the price was below equilibrium, but because the consumption of one more unit was more valuable to him than the alternative uses of the resources he has to give up.  If these opportunities for personal advancement (ie profit or bargains) do not exist, as they don’t in equilibrium, then there is no desire for exchange and thus no market.

The actions of suppliers and demanders searching for profit brings me to my second point: the market is a disequilibrium institution.  The market operates at its best when there is disequilibrium.  That is the lesson of the supply and demand model.  When the market is not at perfect equilibrium, then there exist opportunities for entrepreneurs to enter the market on either the supply or demand side (I emphasize this point because many people only think of entrepreneurs as suppliers, but consumers can seek to be entrepreneurs as well).  These entrepreneurs are seeking profit (in the supply side, from selling their goods above what they value them and the demand side, from consuming either more goods or paying for goods less than they value them).  The profits these entrepreneurs seek exist only when the market is in disequilibrium.  In other words, the fact the market is not in perfect equilibrium means the mechanisms of the market institution are at their best!

The interesting thing about the conclusion that markets are a disequilibrium institution is that most of what economists call “market failure” are exactly these entrepreneurial opportunities that make the market work!  Transaction costs, asymmetric information, externalities, and the like can all be exploited for entrepreneurial gain!  Efforts to “fix” these market failures block the market mechanism, leading to actual market failure!  The evidence of efforts to fix “market failures” leads to actual market failures is obvious (and can be derived from the supply and demand model): price controls (minimum wage, price gouging legislation) lead to waste, trade barriers lead to poverty, etc.

Markets are not in perfect equilibrium.  That’s why we need markets.

*Explanation of this point will require a second blog post, which I will provide in the near future, but I do not want to distract from the conversation at this point

On Monopolies

Earlier today, my friend Vanessa texted me the following question (small edits made for grammatical purposes):

So almost dr of economics- Am I correct in thinking monopolies are bad for consumers, thus must be bad for the economy?

Vanessa’s intuition on this question is good.  As Bastiat said, we must evaluate economics through the lens of the consumer.  Below is my response to her (sorry for the weird spacing.  I don’t know how to fix it):

“Are monopolies bad for consumers?”  This depends on what the meaning of the word “bad” means.  Monopolies are output restrictiors (that is, they get a higher price by reducing the output they make), and they produce not where price equals the marginal cost of output (ie the “zero profit” level), but the highest price they can get.  So, compared to “perfect competition,” the monopoly produces less at a higher price; they are inefficient compared to the perfect competition model.  Since “bad” is a judgment call. I’ll leave that up to you.

However, there are some situations where monopolies, as inefficient as they are compared to perfect competition, are the preferable option:
1) In economics, the only way a monopoly can naturally arise is if there are natural barriers preventing entry into the market (eg. high start-up costs, geographical barriers, that sort of thing).  We call these, shockingly enough, natural monopolies.  The implication of these conditions is that multiple forms of similar firms could not exist at the same time (ie, competition).  So, breaking up of this monopoly would not lead to lower prices and more output, but no output at all!
2) Imagine we have a firm who is a major polluter of the water.  For every item they produce, they dump a gallon of waste into the local river.  Further, assume (unlike the example in item 1 above), that this firm is not a natural monopoly.  If an effort to break up this company were undertaken, and output was to increase, then one would see an increase in the pollution dumped into the river!  From an environmental POV, this the monopoly is more efficient since it pollutes less!
Just like all economic questions, the answer is ‘as compared to what?”  It’s possible, as I explain here, that monopolies may be the preferable option.  A blanket statement like “monopolies are bad” or “monopolies are good,” depends on the context in which we’re speaking (and also what “good” and “bad” mean).

Institutions Matter

While cruising around Facebook this morning, I came across this argument against immigration by one Jasen Tenney:

Illegal immigration is down over 50% with Trump and now to get legal immigration way down. Glad to see them go. Since these people are so good for an economy they can make their own crappy home country a better place to live.

Jasen’s argument is somewhat typical of many man-in-the-street arguments against illegal immigration (and immigration in general).  If immigration is good for the US, if specifically, these people are really a net benefit to the country) and not, as President Trump said infamously, criminals, rapists, and drug dealers, why don’t they stay in their own country and make it a better place?

The economist’s response to this question is simple: institutions matter.  Institutions like rule of law, secure property rights, impartial judiciary, individual rights, etc (in other words, classically liberal institutions) go a long way in producing economic growth.

A person is more likely to flourish, and help others flourish, in an area with institutions that encourage economic growth than s/he is in an area that discourages or predates upon economic growth.  Why produce in an area where property rights are insecure (eg, roving bandits can just steal your stuff, or government can appropriate anything at will)?  Even the best producer may not produce anything under such circumstances.  But, under a different institutional structure, s/he may thrive.

To return to Jasen’s question that motivated this post: why can’t these immigrants simply return to their “crappy” home country and make it a better place?  Quite possibly, because the institutional arrangements necessary to make the country a better place do not exist (or are sufficiently weaker compared to the country the immigrant was headed to)!

Economics as a Human Science

When discussing a new paper by GMU alum Vipin Veetil and GMU professor Richard Wagner, Scott Sumner makes the following comment:

[Veetil and Wagner] criticize the standard view, which is that in a large diversified economy the impact of micro level disturbances tend to balance out.

It is absolutely true that, at the macro level, micro level disturbances tend to balance out.  That is what’s wrong with macroeconomics.  All this aggregation masks the human element that is the core of economics.  At the end of the day, we are studying what Mises called “human action”, and what Adam Smith called “a certain propensity in human nature…the propensity to truck, barter, and exchange one thing for another.”  We are studying human behavior.  Economics is a social science; to aggregate so far as to balance out micro (ie, human) disturbances is to remove the “social” from the social science.  Our focus as economists should be on these social aspects, on these individual aspects and the institutions that arise to deal with the human element, of economics.  Anything else is, to quote James Buchanan, just applied mathematics; technically interesting, but economically useless.


Welcome, Nate Russell!

Today marks a big day for A Force for Good.  Nate Russell will be joining me as a co-blogger here.  Nate is a brilliant undergraduate economics student at Western Michigan University.  You can see some of his writing at FEE.org.  I look forward to having him on the team!

Coase, Transaction Costs, and Environmental Entreprenureship

Today’s Quote of the Day comes from pages 7-8 of Ronald Coase’s 1988 book The Firm, the Market, and the Law [emphasis added]:

Markets are institutions that exist to facilitate exchange, that is, they exist in order to reduce the cost of carrying out exchange transactions.  In an economic theory that assumes transaction costs are nonexistant, markets have no function to perform and it seems perfectly reasonable to develop the theory of exchange by an elaborate analysis of individuals exchanging nuts for apples on the edge of a forest or some similar fanciful example.

Many readers of Coase (including economists!) misunderstand him.  This is evident in the improperly named Coase Theorem (it’s improper in that it’s not a theorem).  In fact, Coase is so often misunderstood, he felt compelled to write the book this quote is from to clarify his point!  Coase is often understood to say that, absent transaction costs (or sufficiently low transaction costs), externality issues (eg pollution, noise, etc) can be solved by an allocation of property rights and, regardless of their initial allocation, will result in a Pareto-efficient outcome.  This is correct, but only a partial understanding of Coase.

Much of Coase’s work (and work that spun off from him, such as with Armin Alchian, Harold Demsetz, Gordon Tullock, and many others including my own) focus on the role of the market in addressing externality issues.  Detractors from Coase argue that his insights, that markets for externalities can exist only if there are no/low transaction costs, are not applicable to the “real world,” since transaction costs abound and, therefore, government intervention is necessary.  But this argument represents a misreading of Coase.  In a purely ideal world, there would be no transaction costs, but then no market would be necessary.  As Coase says in the above quote, it is in the world of transaction costs that the market is most useful!  The existence of transaction costs gives rise to firms and other means of human collaboration, which in turn reduce transaction costs, and increase the market exchange of individuals (see The Nature of the Firm (1937) for a more in-depth conversation on this point).

Expanding the idea of markets, firms, and transaction costs to environmental issues, we see the rise of “enviropreneurs” (to use the phrasing of PERC), that is people who seek out and find ways to mitigate these transaction costs in order to achieve desired environmental ends; in short, a market process of environmental concerns (for a detailed look at many different kinds of enviropreneurs, see Free Market Environmentalism for the Next Generation, especially Chapter 9).  The fact transaction costs exist is not a detriment to free market environmentalism, like the detractors of Coase argue, but rather what allows it to come about!

Like Coase (and Buchanan and many others) before me, I realize the market is not a panacea.  There may be conditions for government to get involved (namely where involvement by the firm or an individual are too costly).  But the work of Coase (and Alchian and Demsetz and Buchanan and Tullock and Anderson and many others) show us that the mere existence of an externality and transaction costs is not enough to justify intervention.