Friday, April 29, 2005

Efficiency and Private Enterprise

I was getting started on reading Paul Krugman's column today, when my mind suddenly went off on a tangent. Says Krugman:
American health care is unique among advanced countries in its heavy reliance on the private sector. It's also uniquely inefficient.
America has a unique obsession with privatization--so much so that even our money supply is privatized (American money is issued by privately owned banks who rather sneakily call themselves "The Federal Reserve"). Various excuses exist for this obsession, but one of the most often used is that private enterprise is inherently "more efficient" than government enterprise.

This is true, but only in a limited way. The "efficiency" occurs because of the requirement to maximize profits and shareholder value. However, a company itself has no particular need for that efficiency to extend outside its own confines. From a company's perspective, an increase in "efficiency" would simply mean spending less money on payroll, or raw materials, or various other expenses, while simultaneously producing the same output (or spending the same on expenses and increasing output). This results in increased profits.

However, from an outside perspective, such as that of a customer, things are a bit different. The goal of a company is not to maximize efficiency for its customers--in fact, it is quite the opposite. The goal of a company is to sell as much as it possibly can. This means that efficiency for the customer is not profitable. Efficiency for the customer would mean, for example, selling products that are of good quality and good usefulness, at a low price. But profitability for a company means selling as many products as possible at a high cost, regardless of their usefulness. One way of selling more products is to avoid maximizing quality, because quality is expensive to produce; another is to sell people things that they don't actually need. A third is to gouge people for stuff that they actually do need. [see footnote below]

In other words, when Republicans (and some Democrats) talk about increasing efficiency through privatization, they are feeding you a load of crap. The best example of this, by far, is the American healthcare industry. But for the details on that, I refer you back to the aforementioned column by Paul Krugman.

Footnote: Most companies also plot to increase their market share by lowering their prices, but given the fact that their competitors can all do this too, this is usually not a sufficient strategy. Companies have to strike a balance, and the way that this is typically done is to price their products or services at the highest possible level that they can get away with ("as much as the market will bear"), and then lure people in with promotions and "sales" offering better deals on a temporary basis. A good rule of thumb is, if a company believes it can get away with raising prices without hurting its market share, it will do so, and all its competitors will soon follow suit.


Post a Comment

<< Home