Originally Published: February 12, 2014 6 a.m.
The free market does an amazing job at getting some things right, but you might be surprised at how much it doesn't. It does particularly well at supply and demand. If there are too many taxis in town, then some will go out of business. On the other hand, if there are too few, then entrepreneurs will add taxis. We tend to believe the market automatically sorts out everything. It is the best system there is, but it still misses a lot.
One big, key thing it often gets wrong is price. Specifically what it gets wrong, what its balancing magic doesn't work on, is leverage. For instance when you have a medical emergency, you're one little patient, the hospital is part of a big corporate hospital chain - who has the leverage? The market will find a price that accurately reflects the imbalance of leverage, but has no effect on balancing that leverage. The result is that the price is far from what is best for consumers or even for the overall economy.
To think about how pricing works, the easiest examples are simple retail products. How much is a box of detergent? If it costs too much, some competitor will sell for less. If it costs too little, the companies won't make enough to stay in business.
Retail, though, is actually a rather rare case where leverage is about even. That's good for the economy. Consumers get the best reasonable price, and companies make a reasonable profit.
There are many other situations where the leverage is not even. The example of the health emergency is one. But even if there is less rush - for instance, your doctor says you need a new knee soon, you have some time - you have no idea that prices at various hospitals around the state vary widely. Even if you know, your doctor isn't associated with them, doesn't know anyone there, they may or may not be in your insurance network. Emergency or not, you are pretty much at the mercy of the local hospital. (This is has nothing to do with our local hospital. I am describing the general case.)
On the other hand, big insurers typically negotiate with the big hospital chains on prices for most procedures. In that case, the leverage is closer to even. They are two strong parties who will find a middle ground. There is nothing automatically balanced about it, though. If it's a small insurer and a big hospital chain, the price will move one way. If it's the other way around, the price will move the other way. Leverage is pretty random, and the market does little to affect that.
Lots of negotiations have uneven leverage, from the big to the small. On the big end, when we taxpayers need to buy a battleship or a jet fighter, the price has a lot to do with the fact that it is a tiny club of companies that can deliver them. On the small end, if you kept your old car in exceptional shape and it gets totaled and your insurance company wants to pay the standard value for such an old car, good luck in your negotiations. Who has the leverage? All you can do is threaten to take your future business elsewhere. Big threat, when you're one little customer out of a million.
Or consider a family that has never needed legal services but suddenly find themselves in a custody dispute, or in some dispute with a neighbor. They need legal advice now, and locally, preferably from someone friends or family have used, even though friends and family may have no idea if the price is competitive. You simply go to who is recommended because you need help, and you need good help, and you need it now. Price? You just hope it is in the ballpark of what's typical and you swallow hard and pay it. It's not like you go out shopping for legal services every week and next week you'll try here, and the week after you'll try there. Competition is a factor, but a weak one.
When prices are wrong, the impact is far-reaching. Consumers pay too much for some things so they have less to spend on others. The things they don't buy that they would have don't get made, meaning jobs making those things are lost. Consumers either have a lower standard of living or have to work more. It's a drag on the overall economy.
I have no magic solution. I'm not suggesting any change. I'm just pointing out that while the free market system is the best, and amazing at some things, its magic does not apply to everything economic. Save your amazement for the things it does do. Keep in mind that there is much that it doesn't.
Tom Cantlon is a local business owner and writer and can be reached at comments at tomcantlon.com.