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Promoted from the diaries by streiff. Promotion does not imply endorsement.
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A new proposal under discussion by the Senate Finance Committee is a perfect example of the folly of trying to centrally design the economy — in this case by a ham-handed attempt at price controls.

The proposal, from Sen. Ron Wyden (D-OR) and under consideration by Chairman Chuck Grassley (R-IA), would change the Medicare Part D prescription drug rebate to penalize drugs whose prices rise faster than the rate of inflation.

It’s ironic the proposal targets Part D, one of the few islands of economic sanity to be found in the health care sector, which, beset by rampant government intervention, suffers from a wide variety of perverse unintended consequences.

Part D is one of the few government health care programs to successfully foster price-based productivity increases. In most parts of the economy, over time, prices go down and quality goes up, due to increases in productivity. The underlying mechanism driving this is competition.

One sign of how successful Part D has been in wielding competition is that in its first decade of existence, it cost over 40% less than what the Congressional Budget Office estimated it would, a historical and underappreciated achievement.

Tacking on feel-good, one-off pricing rules like Wyden’s “faster than inflation” penalty could easily disrupt the market-based dynamics that enabled Part D to flourish in the first place.

It’s just silly to think that something as complex, distributed and organic as a worldwide market for pharmaceutical drugs could be controlled by something as ramshackle as a “faster than inflation” rule.

Consider the variety of pricing mechanisms that exist in well-functioning markets. In retail, there are coupons, package deals, membership plans and other discounts. In the stock market, there is the “continuous auction,” providing ongoing price discovery that can react to new information in a matter of seconds.

Amazon’s server rental business offers clients a tremendous range of pricing options, split by eighteen datacenter regions, dozens of server types, and several tiers of availability.

There is a whole world of financing, from store-offered, no interest payment plans to credit cards to mortgages. Stores employ all manor of psychological pricing tricks, such as charging 99 cents instead of $1. One of the more incredible such tricks, which would be hard to believe without the well-established research backing it up, is that prices that contain fewer syllables (when read out loud) are more attractive than those with more syllables. For instance, $28.16 (five syllables) is better than $27.82 (seven syllables).

The incredible diversity in pricing practices stems from the decentralized nature of the market. You could never ask a single committee, or even a large organization, to come up with this level of creativity and variety on its own. It’s only from the organic interaction between millions of businesses and billions of customers, each expertly seeking their own interests, that it can ever arise.

You might compare Wyden’s “faster than inflation” proposal to the fences in Jurassic Park — “life finds a way,” as Dr. Ian Malcolm tells us, foreshadowing the inability of the park to contain the beasts contained within. Except, at least the 40-foot electric fences were a good faith effort. Wyden’s proposal is more like if they attempted to keep the T-Rex at bay with only the thin walls of the bathroom hut the hate-able lawyer ran and hid inside, shortly before becoming a dinosaur’s dinner.

In other word’s this “faster than inflation” rule is a laughable, pitiful attempt at something that isn’t even achievable by the most expert, determined effort — something like, say, the Soviet Union, which tried, and failed, to put price controls into practice at super power scale.

But that’s not to say it can’t do harm. At the very least, it will increase the cost of participating in the market, both in terms of compliance costs, and in the changed incentives and their inevitable unintended consequences. For example, a company that requires more revenue to survive might raise the prices slightly on all its products, instead of steeply on just one. How this all plays out is impossible to predict. What can be said for certain is the market’s “logic” would now be less about providing the most value for customers at the lowest price, and now more about the political ramifications of pricing decisions.

More specifically, as it relates to the Part D drug market in particular, the rule could crowd out existing rebates negotiated by the plans buying the drugs. Many plans have already secured “price protection rebates” which kick in if prices increase more rapidly than some agreed-upon threshold. In other words, the market has already invented, in a much more sophisticated and dynamic way, the “faster than inflation” rule on its own.

The worst case scenario is more dire. Generally speaking, fostering well-functioning markets in the health care sphere is exceedingly difficult, given the immense government intervention at every level. Part D’s success in doing so is nearly unique. Additional rules that make supply and demand less important to how the market functions could result in it ceasing to function as a market entirely. It certainly would not be the first time the government accidentally killed a market.

Wyden’s proposal exemplifies the folly of centrally-designed price controls. It will harm one of the only well-functioning parts of the federal government’s health care policy. For those reasons, Chairman Grassley and Committee Republicans should cast it in the dustbin of bad socialist ideas.