Tag Archives: market failure

Credit Cards and Irrationality – Protecting Us from Our Brains

Human beings are rational.

It’s a basic assumption of economics. Humans are rational beings. Homo economici. We don’t intentionally try to make ourselves worse off.

In his book How We Decide, Jonah Lehrer cites a wide range of psychological, behavioral, and economic research to argue that emotions guide many of our economic decisions. He makes the case that emotions are not just irrational feelings of love and hate, but instead are the result of how the human brain is wired.

And these emotions can cause us to do things that are bad for us.

Take credit cards. Buying things with cash activates a part of the brain called the insula. We actually feel a sort of subconscious pain – emotional discomfort – when we spend cash, since we’re physically giving up something.

When we pay by credit cards rather, however, our brains don’t feel the same sense of loss. Brain scans show that paying with credit cards reduces activity in the insula, causing us to feel less discomfort about the purchase. We literally feel it costs less with credit than with cash.

Basic economic theory says there shouldn’t be a difference between paying by cash or by credit card. Both involve the same loss, so we should view both the same. If anything we should feel worse about paying by credit card, since that could result in having to pay interest or late fees, .

But that’s not how the brain sees it. Which is why so many otherwise rational people get in over their heads with credit cards.

I remember when I was in college and got my first credit cards. Even as an arguably intelligent and sensible person, I still fell into the trap and over-extended myself. Fortunately for me, I got a steady job and eventually was able to pay off my debt. But it took many years to do so. If anything had gone wrong before I did – if I’d gotten sick or had lost my job – I could easily have fallen into a vicious cycle of debt dependent. And if that had happened, I doubt that I would now be here writing about the dangers of credit card debt.

Credit card companies know about the brain’s weaknesses and use every trick they can – low introductory rates, fine print, hidden fees – to take advantage of them. And they’re really good at it. So good in fact that millions of Americans get into credit card trouble every year.

It’s easy to say that this is their problem. They got themselves into trouble. Let them get themselves out of it. And there’s some truth to that. Society can’t take responsibility for every bad decision. Choices have consequences. People need to learn that and take responsibility for their own actions.

But a good case can be made for trying to prevent the worst abuses, particularly since neuroscience research – actual brain scans – tells us that it is due to the very way the human brain works.

From a self-interest perspective, having so many people getting into credit crises also isn’t good for society as a whole. People who get in over their heads aren’t able to pay their bills, are likely to have psychological problems, will have more trouble holding on to their jobs, and will have difficulty caring for their children. This makes it more likely that their kids will grow up to have problems in life as well, thus perpetuating the problem.

Fortunately, the U.S. government has been taking steps to curb the worst credit card abuses. The recently-establish Consumer Finance Protection Bureau has taken an aggressive stand against credit card companies that use unethical means to prey on consumers.

I’ve always been opposed to unnecessary government regulation and involvement in the economy. Government regulation imposes a burden on businesses and on society, unless there’s a good and overarching need for it.

In this case there is. There are situations where people do need to be protected from themselves, and this is one of them.

Sometimes people need to be protected from the flaws in our own brains.

It’s only rational.


Why Health Care Markets Don’t Work Well By Themselves

I love free markets. Free, unregulated markets are by far the most efficient and effective way of allocating goods and services, bar none.

Except when they’re not.

Much as economists hate to admit it, lots of things can cause markets to fail. Sometimes it’s well-intended government policies. More often it’s characteristics of the market that cause the failure. Health care is a great example. Health care markets, left alone, simply don’t allocate resources efficiently, for reasons that are well-understood by economists.

So why is health care different? What is it about health care that make it such a poster child for market failure?

The answers vary from country to country – U.S. health care markets are more problematic than other countries – but here are some of the reasons.

Health Care Information is Extraordinarily Imperfect.

Information is essential for markets to work – information about prices, quality, costs, benefits, availability, and every other aspect of the good or service.

For a market to be efficient, you’ve got to have good information. Consumers and firms have to know about every aspect of the product and the market. That might not be unreasonable when you’re dealing with corn or wheat. But health care?

The human body is the most complex machine on the planet. So complex that it takes nearly a decade to become a medical doctor. What we know about the body is constantly changing, and even experts disagree about what goes wrong with it and what to do about it.

Because of the volume and complexity of health information, health care consumers have no choice but to rely upon health care providers to tell them what they need to buy. And no matter how ethical and well-intentioned people in the health care industry may be, they’re only human. They can’t help but respond to the incentives they face, whether or not these are in the best interests of the consumer. Economists call this “information asymmetry”, and it leads to unbalanced outcomes in any market.

Your Health Care Decisions Effect Others.

If you’re out sick for a week with the flu, your coworkers will probably have your work dumped on them, and may even catch the flu themselves. If the other children at school don’t get vaccinated, your son is more likely to get sick, whether he is vaccinated or not. If your neighbor doesn’t get the urgent mental health care he requires, he could become a mass murderer, devastating home values in your neighborhood. Economists call these sorts of problems “externalities”, because they involve things that are external to the market relationship been the individual and the firm. Health care markets are full of externalities, and that can be deadly for market efficiency.

Health Care Markets Aren’t Competitive.

Lots of things about health care markets lead to a lack of competition, which in turn causes market failures that are particularly bad for consumers. For starters, providing most types of health care involves economies of scale. This means that larger firms – hospitals, clinics, labs, whatever – can produce it at a lower cost than smaller firms. These economies of scale are no one’s fault, but they result in large firms with lots of market power. This in turn leads to market inefficiencies, to the great disadvantage of consumers.

Efficient markets require that buyers be able to change sellers whenever it makes economic sense to do so. With health care, it’s also difficult change health care providers. It can take a doctor a long time to determine what exactly is wrong with you, and how best to treat it. This decreases health care competition even more.

The information problems in health care (see above) also to less competition in health care markets as well. When you don’t even know what’s wrong with you, it’s pretty hard to know what you need to do about it. That makes it hard for you to make informed choices, resulting in even less competition.

Competition is (virtually) always good for consumers, and the lacks of it is equally bad.

And That Ain’t All.

This isn’t a complete list of market failures involved in health care. Moral hazard, patents, administrative inefficiency, institutional problems, long timeframes, public goods, legal incentives – the list goes on. But even with the market failures discussed here, it should be clear that health care markets are inherently problematic. In fact, they’re the most problematic markets out there.

This is why government is deeply involved in health care markets in every developed country. When a market has so many characteristics that cause it to fail, the only solution is for government to step in a try to make the market work better. Government involvement in any markets is fraught with risks – any government action can produce unintended consequences – But in some cases, outcomes in an unregulated market are so bad that taking these risks are justified.

Given the current situation in U.S. health care markets, we have no choice but to turn to government to regulate these markets more closely. It would be difficult for any well-designed government policy to make things worse.