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August 1, 2010

Taking Dean Baker Seriously

David R. Henderson on Taking Economics Seriously by Dean Baker


Dean Baker. Taking Economics Seriously. mit Press. 87 pages. $14.95

Dean baker, a left-of-center economist who is co-director of the Washington-based Center for Economic and Policy Research, is well known for his blog, Beat the Press. On this blog, he regularly criticizes, and often ridicules, in an entertaining way, economics reporting in the mainstream press, particularly in the New York Times and the Washington Post. Now he has written a short book, Taking Economics Seriously, in which he discusses some of the issues he has blogged about.

I take Dean Baker seriously. Why? In part, because many on the left do. But mainly because he is a thoughtful economist who has flashes of wisdom and often an independent take on policy issues. Taking Economics Seriously shows some of this wisdom. Some of his proposals for health care, for example, are refreshingly pro-free-market, and he backs them up well. It also, however, shows his tendency to set up policy issues by excluding certain free-market options. The result is that, with some exceptions, he plays economics between the 40-yard lines.

Baker’s book has four chapters: “The Myth of the Free Market,” “Malpractice,” “The Big Bank Theory,” and a very short final chapter, “An Economy for Everyone.” Baker establishes his way of looking at issues with the chapter on the myth of the free market. He contrasts liberals and conservatives and argues that neither side wants a free market. Both sides want regulation, according to Baker, and what they differ about is the content and goals of the regulation. He writes, “Conservatives support regulatory structures that cause income to flow upward, while liberals support regulatory structures that promote equality.”

Baker’s Exhibit A of such a regulatory structure is copyright and patent law. It is true that copyright and patent laws are examples of regulations that are created by government in a way that, say, real property law is not. If I own property, the most natural thing in the world is that I would want to protect it, and the common law, rather than some government-created regulation, will suffice. But copyright and patent laws are somewhat artificial creations of government. It’s true that those who favor such laws can give reasons for them, the main one being that enforcement of intellectual property rights gives people an incentive to produce intellectual property. But that doesn’t change the fact that such laws are a form of regulation. Score one for Baker.

Unfortunately, though, Baker seems to regard this example as a sufficient argument against the idea that there are any economists who really do favor a totally free, or almost totally free, market. In that first chapter, he writes:

Deregulation can be a principled position held by true believers in a free market. But, to be fair, rarely does either side argue against regulation as such. The real issue is the structure of regulation and its impact on economic outcomes, especially income distribution.

This short paragraph is clever. Start with the first sentence. Baker does allow for there to be people who sincerely believe in deregulation. Notice, though, that he calls them “true believers.” Ever since the publication of Eric Hoffer’s famous book, The True Believer, that term has had a negative connotation. People use it to refer to someone who believes so passionately in a cause or a viewpoint that he is impervious to evidence or argument. By using the term here, Baker subtly gets many of his readers to dismiss such people.

And in case that doesn’t work, with his second and third sentences Baker himself assigns the sincere believers to oblivion. It’s hard to judge whether “either side” argues against regulation as such because he doesn’t name names. When Baker refers to “either side,” does he have in mind the various players in Washington — Republicans, Democrats, and lobbyists? If so, then he’s probably right. Almost all of those people have narrow interests that have little or nothing to do with a principled position on regulation. But to write only about players in Washington is to leave out a large percentage of the people with ideas.

Moreover, his final sentence doesn’t follow. Let’s stipulate that the people whom Baker sees arguing against specific regulations rarely argue against regulation in general. It doesn’t follow that the “real issue” is the structure of regulation. Take a historical example: slavery in the United States, which was a form of extreme regulation, one that government used in order to give and enforce property rights in humans. It might be hard for us to believe today, but it is nevertheless true that in 1830, very few people argued for complete abolition of U.S. slavery. Abolitionists had a bigger presence in Boston than in the rest of the United States, but even in Boston they were rare. Should we conclude that the real issue was only the structure of slavery and not whether some people have the right to own others? The reality is that we can’t, simply by looking at the dominant players in Washington, conclude anything about what “the real issue” is. Instead, we need to consider, and judge, the various positions and arguments themselves, regardless of whether their advocates have strength in numbers.

When he does stick to the arguments, Baker often does a good job. The most refreshing chapter is the one on health care, titled simply “Malpractice.” The title is probably intended to make you think that he’ll discuss liability or tort reform. But he doesn’t. Instead, Baker accuses economists in general, and health economists in particular, of engaging in malpractice by not advocating the same kinds of reforms of health care that they advocate for other industries. Baker points out that, in discussing health care, economists “forget their commitment to globalization and the removal of trade barriers.” He argues for three policies, all of which would move in the direction of free trade. The first is to reduce barriers “for foreign-born medical personnel to work in the United States.” He writes, “the economic argument for hiring foreign doctors who are willing to work for lower wages than their U.S. counterparts is the same as the argument for buying foreign-made clothing that is cheaper than U.S.-made clothing.” His second proposal is to facilitate “medical tourism” so that Americans can seek high-quality, lower-cost care abroad. The third is to “allow Medicare beneficiaries to buy into the lower-cost health care systems of other wealthy countries.” All three are good ideas.

Baker realizes that for foreign doctors to be able to work here, current government licensing restrictions would have to be altered. These restrictions limit mobility even for U.S. doctors moving from one state to another. Baker proposes having U.S.-certified testers test potential doctors in other countries who want to move to America. The result would likely be a substantial increase in the number of U.S. doctors, along with a drop in doctors’ fees. Interestingly, Baker makes no mention of the fact that free-trader Milton Friedman put forth an even more radical proposal 48 years ago in his classic, Capitalism and Freedom. Friedman advocated getting rid of licensure altogether but having private, not government, certification so that consumers could have some assurance of quality. Friedman also pointed out that licensure was what prevented well-qualified doctors escaping from Europe in the 1930s from practicing here. Is it possible that Baker doesn’t mention this because it doesn’t fit his theme that the “real issue” is the structure of regulation?

As someone who criticizes his fellow economists for not advocating free trade in health care, Baker is strangely silent about one of the biggest barriers to free trade in drugs, namely the Food and Drug Administration. Economists and other analysts have documented the fact that the fda has slowed the introduction of drugs by as much as ten years. What makes the process particularly slow is not the requirement for safety, which has existed in the law since 1938, but the requirement since 1962 that the drug company show the drug’s efficacy in a particular use. My own view is that the fda should be eliminated altogether or, at very least, that it should lose all its power over drugs and simply exist as a certifier. I don’t expect to convince Baker that the fda should be abolished. But, given his openness to having foreign-trained doctors practice here, it seems natural for him to accept that it be legal to sell drugs certified as safe and efficacious by a government in another developed country, even without fda approval.

Maybe, you might think, Baker doesn’t discuss the fda because he doesn’t discuss drugs. Nope. Of a 28-page chapter on health care, Baker spends thirteen pages on pharmaceutical drugs. He criticizes the use of patents in the drug industry, pointing out correctly that patents give drug companies temporary monopoly power that they use to charge prices much higher than the cost of production. He recognizes that there are huge fixed costs of developing drugs in the first place, but advocates, instead of patents, a system of government subsidies for drug development. Baker doesn’t say how a government agency would choose which approaches to subsidize and, as important, which not to. Richard Nixon’s failed government-subsidized war on cancer should give him pause, as should various federal subsidy programs for “alternative energy.” Legal scholar Richard Epstein, in his 2006 book, Overdose, points out the standard central-planning problems that a central authority would have in allocating resources. Imperfect as the market for drugs is now, at least it’s a market. A government authority would have no such guide to drug development.

Given Baker’s critique of monopoly, it’s shocking that he says nothing about an agency that does what economists hate about monopoly: restrict output. At least when a private monopoly restricts output, it doesn’t restrict it to zero because zero output gets it precisely zero revenue. But when the fda, with its expensive requirements for tests, discourages a drug company from going ahead with a promising drug, it does keep output at zero. Which would you rather have: a chance to buy an expensive drug that could extend your life by a year or no chance to buy the drug at all?

Baker’s basic criticism of drug pricing is that drug companies charge prices above the marginal cost. A well-known result in economics is that, under certain conditions, an economy reaches the optimum if the price of a good or service equals the marginal cost. The rationale is that then people use the good or service optimally, that is, up to the point where the marginal value equals the marginal cost. There are some important exceptions to this conclusion, the big one being that if the price equals the marginal cost, then companies have very little incentive to innovate because they can’t capture the rewards of innovating. But given Baker’s emphasis on the importance of price equaling marginal cost, it’s surprising that he doesn’t criticize any of the ways in which governments keep prices below marginal cost. Think of Canada, for example, with its single-payer plan. After my father, a Canadian (I was born and raised in Canada), was in the hospital for ten days, he was charged $20 — two dollars a day for tv rental. That’s typical. Prices to patients for health care in Canada are set at zero, which is definitely below the cost of such care.

In Britain, also, the National Health Service typically charges a zero price to patients. The result is waste: People use health care up to the point where their value equals the zero price. The person with a serious infection competes for doctor time with the person who has a cold. It’s true that the U.S. system is not perfect. Here, overinsurance, which happens mainly because employer-provided insurance is tax-free to the employee, often causes people to face an artificially low price of health care and to overuse the system. But it’s strange that Baker points to the most extreme examples of underpricing, Canada and the United Kingdom, and says nothing critical about them. Indeed, he praises the health care systems of those two countries.

In “the big Bank Theory,” his chapter on banking and finance, Baker sticks with his “nothing here but us regulators” approach, writing, “the issue is not and never has been the free market.” To Baker, it’s all about having the right regulations. He points out, correctly, that the government’s system of deposit insurance gives bankers an incentive to take risks that they would otherwise not take. Baker argues for government-provided deposit insurance. Yet some economists, including Charles Calomiris of Columbia University, have made a strong case against deposit insurance. Before deposit insurance existed, private clearinghouses were there to back up banks that were solvent but illiquid. Indeed, Calomiris attributes virtually all of the problems of the banking system to government regulation. He notes, for instance, that the Bank Holding Company Act of 1940 makes it illegal for hedge funds and private investors to own a large percent of a bank’s shares. This takes away an important incentive for the private sector to monitor banks.

Baker mentions none of this and, after a lengthy discussion of how to regulate banks, repeats his mantra, telling us, “No one in this debate really advocates an end to government regulation.” Google “Charles Calomiris,” read his curriculum vitae, and then ask yourself, “Does this sound like a nobody?”

Dean Baker takes economics seriously. But his book could have been better if he had been willing to take seriously the more radical free-market views of some serious economists whose thinking is not always in the mainstream. Baker’s view that we should essentially eliminate immigration barriers for doctors is not mainstream, but it’s a great idea. If he decides to judge other ideas solely on their merits and not on the frequency with which they are expressed, he will take economics even more seriously — and do the world a favor.


David R. Henderson is a research fellow with the Hoover Institution and an associate professor of economics at the Graduate School of Business and Public Policy at the Naval Postgraduate School. He was previously the senior economist for health policy with President Reagan’s Council of Economic Advisers. He blogs at www.econlog.econlib.org.