Tammy Ferrell takes drastic measures to feed her family as inflation hits its highest level in 40 years. Even after replacing meat with noodles and walking to the grocery store to save gas, she found herself skipping meals to make ends meet. Many others are making similar sacrifices.
Prices have risen approximately 8.6% over the past 12 months. The most recent inflation measures predict a 1% increase in prices in May. Energy prices, which impact the cost of manufacturing countless other goods, have been particularly hard hit. The US Energy Index, which measures inflation in gasoline and natural gas prices, estimates fuel prices have risen 34.6% since last April.
The Federal Reserve, which is normally responsible for managing monetary affairs in the United States, has been slow at best in tackling inflation. It’s incredibly frustrating because, as economist John Cochrane writes in a Chicago Stand Review article, we have experienced similar inflation before, and we achieved it with a tight monetary policy.
What is the heist?
Unfortunately, the fight against inflation may be more of an incentive problem than a “what policy should we adopt” problem. Examining the US healthcare industry through the lens of public choice economics provides evidence.
Becker’s Hospital Review notes that the US healthcare sector has been relatively unaffected by inflation (so far). But this is somewhat misleading because health care prices have been rising for decades.
According to data from the U.S. Department of Labor’s Bureau of Labor Statistics, medical inflation has increased 3-4% every year since 2010. Even in 2020, when access to health care was sharply reduced due to COVID -19, medical inflation measured 4.11%. The same data reveals that annual medical inflation exceeded 8.6% five times since 1982. That’s to say nothing of US health care spending, which is about 20% of GDP and is expected to grow about 5.5% annually over the next decade.
Despite enacting countless regulations, politicians have made little headway in reducing health care costs. But their failures were quite lucrative. Politicians and special interests profit from the high cost of health care in the United States while the American public foots the bill.
Public choice economics reminds us that political exchanges, such as those between politicians and health care providers, result in concentrated benefits but dispersed costs. Politicians need funds and votes to get elected. Bureaucracies need resources to retain and expand their influence. Large healthcare providers are willing to trade with both parties if they receive favorable treatment to increase their profits.
Health care is replete with examples of political exchanges that are lucrative in private but harmful in public. Pharmaceutical companies sometimes spend more on lobbying than on research and development. Health insurance providers receive substantial subsidies from the federal government through Medicaid and other more influential state-run programs. Hospital networks are establishing Certificate of Need (CON) laws with government support, which stifle competition. There is a well-established “revolving door” between drug producers and the Food and Drug Administration.
An important consequence of these arrangements is that health care markets become more suited to serve the needs of politicians and special interest groups rather than the needs of patients. Because cronyism increases political influence and the influence of politically connected people, officials and special interest groups have little incentive to change anything.
A similar incentive problem affects inflationary policy. Politicians benefit from lower interest rates from expansionary monetary policy and easy access to loanable funds, as it allows for increased government spending. Public sector spending accounts for 30% of GDP, providing trillions in funds to maintain influence. Special interests within the financial sector also benefit from an expansionary policy and have a “revolving door” with the Federal Reserve banks. Central banks are also benefiting from the expansion of the public sector.
Incentive concerns do not always prevent necessary reforms. The Federal Reserve has already raised interest rates to stop inflation. Some areas of health have been deregulated. But historically, they are much less likely than to grant government more authority to fix the problems it helped create. And greater government influence has increased the demand for government favors, motivating special interests to devote more resources to obtaining and maintaining them.