Baumol's Cost Disease

Moneybox:

The most important disagreement between Romney and Obama that keeps not getting covered properly is the dispute over Medicaid. The Obama administration wants to spend a lot of new money to provide Medicaid coverage to a much larger set of the working poor. Romney, by contrast, wants to spend drastically less money on the program... Notionally, Romney's idea is that by not merely implementing huge cuts in funding levels but also offering states more flexibility about the rules that he'll be able to usher in a bright new era of innovation.
In the real world, what happens if you're given less money to cover people with and more flexbility about what to do with it what you're going to do is simply cover fewer people. In particular, care for the elderly and disabled are likely to get hammered over the long-term thanks to productivity issues. Medical technology does advance and that sometimes leads to great new things—pills that treat illnessness, machines that help us test for disease—but the foundation of long-term care for the elderly and the disabled is human attention. People who need help caring for themselves on a day-to-day basis need help from other human beings. If you take the main public program for financing that kind of care and insist on its budget shrinking as a share of GDP, then the people who need help are out of luck. As economy-wide productivity rises, it'll get harder and harder to "afford" programs that provide labor intensive care even in the real world society will be richer than ever.

 Not only will labor-intensive human care get relatively expensive as productivity increases elsewhere, but Medicaid administrators will be increasingly tempted to shift resources away from labor-intensive services and towards things like cheap new drugs that do see costs declining as technology advances. A similar dynamic is happening with military spending:

Many... are upset that military spending as a share of U.S. GDP is far lower today than it was during the Cold War era. A conventional... reply is to note that the objective threat environment is very different. But perhaps a better way of looking at this issue is through the lens of productivity. If you have an industry where productivity advances slower than average then spending as a share of GDP needs to rise to keep quality constant. ...In the military sector you see some interesting dynamics. Thanks to technology, we're way better at a task like "make this guy's house explode" than we used to be. First airplanes and then precision munitions and now unnmanned aerial vehicles have made this vastly cheaper and easier than it was in 1912.

But for other kinds of tasks, technology progress hasn't helped much. In particular "boots on the ground" occupation-and-administration of foreign territory suffers from a similar [labor-intensive] dynamic as kindergarden. ...If we want to maintain a roughly constant level of boots on the ground operations then spending as a share of the economy has to steadily rise, while if we're content to explode things from afar it can steadily fall.

Which is perhaps a roundabout way of saying that on both the military and civilian sides of the government, I think there's too much talk in D.C. about "budget math" and not enough talk about what specifically we're trying to accomplish and why.

Intellectual Property

Pharmaceutical companies spend $19 for promotion and marketing for every dollar they spend on basic research.  Even if you include all spending on drug development, they still spend more than twice as much on marketing as on research and development.  The tech industry is similar.  Charles Duhigg and Steve Lohr report that:

Last year, for the first time, spending by Apple and Google on patent lawsuits and unusually big-dollar patent purchases exceeded spending on research and development of new products, according to public filings.

 Even if patents increase innovation, it is costly and in some cases, innovation can be bad for society. For example, Apple computer won a billion dollar verdict against Samsung.  It is hard to imagine that Samsung really did a billion dollars of damage to Apple, the world's most profitable company, and Samsung has clearly benefited consumers which is the whole point of patents in the first place.  Governments should be encouraging competition with Apple rather than stifling it. 

What troubles me [with the Apple-Samsung verdict is upholding the idea that] Apple should have a legal monopoly on the pinch-to-zoom feature which I think is a great example of how the modern-day patent system has gone awry.

Think about cars and you'll see that, of course, lots of different companies make cars. But they all have some very similar user interface elements. In particular, there's a steering wheel that you turn left and right to shift the wheels and there's a gas pedal and brakes that you hit with your right foot. Imagine if the way the automobile industry worked was that each car maker had to devise a unique user interface. So maybe GM cars would have a steering wheel, but Toyotas would have a joystick, and Honda you would steer with your feet and use your hands to control the gas and brakes.

In some sense there'd be "more innovation" in this world since there'd be this kind of arbitrary proliferation of user interfaces. But in a more important sense there'd be less competition, since there are only so many viable ways for a person to interact with a car and a lot of those ways suck. You'd have few new entrants, and those entrants would be hobbled from the get-go. Meanwhile, UI proliferation would make it much harder for people to switch car brands or launch car rental companies since with each brand reinventing the steering wheel you'd constantly need to be learning to drive again.

Software has particularly bad intellectual property  laws

Large firms like Apple, Microsoft, Motorola, and Samsung are suing one another over mobile phone patents. And as a recent episode of This American Life documented, there are entire office buildings full of "patent trolls" that produce no useful products but sue other companies that do. What has gone largely overlooked in the coverage of the “patent wars,” however, has been the disproportionate burden placed on small firms—which has enormous consequences for the movement toward DIY innovation.

Software is unusual because it is effectively eligible for both copyright and patent protection. Patents traditionally protect physical machines or processes, like the light bulb, the vulcanization of rubber, or the transistor. Copyrights protect written and audiovisual works, like novels, music, or movies. Computer programs straddle this boundary. They are written works, but when executed by computers, they affect the real world. Since the 1990s, courts have allowed software creators to seek both copyright and patent protections.

While copyright law has served the software industry well, the same is not true of patents. Copyright protection is granted automatically when a work is created. In contrast, obtaining a patent is an elaborate, expensive process. Copyright infringement occurs only when someone deliberately copies someone else's work. But a programmer can infringe someone else's patent by accident, simply by creating a product with similar features.

The patent system doesn't even offer software developers an efficient way of figuring out which patents they are in danger of infringing upon. It’s a matter of arithmetic: There are hundreds of thousands of active software patents, and a typical software product contains thousands of lines of code. Given that a handful of lines of code can lead to patent infringement, the amount of legal research required to compare every line of a computer program against every active software patent is astronomical.

Little wonder, then, that most software firms don't even try to avoid infringement. Defending against patent litigation is simply seen as a cost of doing business in the software industry. Startups hope that by the time the inevitable lawsuits arrive, they will have grown large enough to hire good lawyers to defend themselves. But as the number of software patents—and with it, the volume of litigation—has soared, smaller companies have become targets.

These startup firms face legal threats from two directions: patent trolls and large incumbents like Microsoft and IBM that demand small firms pay them licensing fees.

The contrast between Microsoft and Google helps to illustrate the problem. The U.S. Patent Office has issued Microsoft more than 19,000 patents since 1998, the year Google was founded. In contrast, Google has been issued fewer than 1,100. While Microsoft is undoubtedly an innovative company, it's hard to argue that it has been almost 20 times as innovative as Google in the last 14 years. Rather, Microsoft's larger portfolio reflects the fact that a decade ago, Microsoft was a mature company with plenty of cash to spend on patent lawyers, while Google was still a small startup focused on hiring engineers.

Most of Microsoft's patents cover relatively pedestrian features of software products. In a pending lawsuit against Barnes & Noble, for example, Microsoft asserts that the Nook infringes patents on the concept of selecting text by dragging "graphical selection handles" and the idea of displaying a website sans background image while waiting for the background image to load. Individually, these patents are unremarkable. But when consolidated in the hands of one firm, they form a dense "patent thicket." Microsoft's vast portfolio—reportedly numbering about 60,000 when acquisitions are taken into account—allows the Redmond, Wash., software giant to sue almost any software firm for patent infringement.

And that makes Microsoft a de facto gatekeeper to the software industry. This isn't a problem for other large incumbents, such as Apple and IBM, which have thousands of their own patents and use them to negotiate broad cross-licensing agreements. But small firms haven't had the time—or the millions of dollars—to acquire large portfolios.

And that's troubling because Silicon Valley has traditionally been a place where new firms can come out of nowhere to topple entrenched incumbents. Yet new firms wanting to compete against Microsoft, Apple, or IBM are increasingly forced to first license the incumbents' patents. It’s hard to win in the marketplace when you're forced to share your revenues with your competitors.

The patent system is a poor fit for the software industry. We shouldn't force the small, nimble firms (which make the field so dynamic) to divert scarce capital to defending themselves against patent lawsuits or amassing patent portfolios of their own. And computer software is already eligible for copyright protection, so patent protection is superfluous for rewarding software innovation.

Zach Carter shows that patent reform is needed, but that it is unlikely.

Today, the patent bill looks like a scorecard tallying points for powerful corporations: a win for pharmaceutical companies whose monopolies are driving up Medicare costs; a win for Wall Street's battle against check-processing patents; a loss for tech giants who had hoped to curb costly lawsuits.
Left out of the tally is the public, even as the economic landscape for American families grows darker. Historian Richard Hofstadter famously observed that Congress during the Gilded Age busied itself with dividing the nation's spoils among the rich and powerful. But as the current patent struggle suggests, the spoilsmen are back and Washington is once again an arbiter of who lands the lucre.
"Congress has lost any capacity to piece together these private interests into a public-welfare-promoting change to the patent system," says Christopher Sprigman, an intellectual property expert at the University of Virginia Law School. "It's really not about optimization anymore, it's about which faction is going to win out."
When legislators first introduced a patent bill in 2005, they designed it to lower the costs of lawsuits burdening Internet and software companies. Lured by the big, juicy settlements to be won by suing huge companies for intellectual property theft, an entire industry had emerged around patent chasing alone. These so-called "patent trolls" don't produce any goods. Instead, they secure unclaimed patents for ideas in use and try to cash out in court.
Trolls file hundreds of lawsuits a year over "low quality" patents -- lobbyist legal jargon for the questionable or downright bizarre patents routinely granted by the understaffed Patent and Trademark Office. In recent years, patents have been approved for products including a wheeled flower pot (patent No. 7,908,942), the crustless peanut butter and jelly sandwich (patent No. 6,004,596), a decorative box that can be placed in a casket (No. 7,908,942) and an accounting scheme that helps people dodge taxes by moving stock options around (No. 6,567,790). Once approved by the patent office, it's difficult and costly to overturn the patent in courts, which grant significant deference to the office's decisions.

...
The United States has always granted patents to new gadgets. Someone who builds a better mousetrap can patent it and secure rights to decades of exclusive production. But in the late 1990s, a Federal Circuit ruling, State Street Bank v. Signature Financial Group, permitted the rise of new "business method" patents, rights applying to the way a business operates. This has led to a host of patents being granted on very broad abstractions: A company called Phoenix Licensing is currently seeking millions from banks for allegedly infringing its patent on printing marketing materials on billing statements.
"They're giving out patents as property rights that have fuzzy boundaries," says James Bessen, a lecturer at Boston University's law school and a fellow at Harvard's Berkman Center on Internet and Society. "Particularly for a software patent and a business method patent, it's very unclear what it covers and what it doesn't. We have this terrible situation where there are thousands and thousands of patents filed each year where we don't know what they cover until somebody's been through a lawsuit."
The Section 18 language to swat away pesky business-method patents -- for banks -- was dropped into the Senate version of the bill by prolific Wall Street fundraiser and third-ranking Democratic Sen. Chuck Schumer (N.Y.), who declined to comment.
"This [is] the sort of gift to major corporations that is the hallmark of bad legislation," says Tom Giovanetti, president of the Institute for Policy Innovation, a conservative think tank that works extensively on intellectual property issues. "Any time you're singling out a particular industry, that's a red flag. This is a case of the banks using their raw political clout."
Schumer's move was the latest of several efforts from the too-big-to-fail crowd to overturn two patents on check processing owned by a company called DataTreasury, which has leveraged huge settlements from megabanks, including JPMorgan Chase, and remains embroiled in legal battles with others.
"This is something that's being pushed by big banks so they can basically railroad a couple of guys who they don't want to pay licensing fees on anymore," says an aide to a Senate Democrat who voted against the patent bill.
In 2007, Congress made a more direct attempt to eliminate DataTreasury's patents, but that effort fell short. This year, Wall Street resorted to broader language that could have implications for other patents. The current language on "business method" patents for "financial services" would also help banks fend off lawsuits like the one filed earlier this year by Phoenix Licensing, the owner of the patent for marketing materials on billing statements.
Schumer's provision infuriates software companies, which have spent years advocating a similar program for tech firms to no avail. "There's been a lot of dodgy business method patents, and I think my industry, the tech industry, has much more claim to being victims of ridiculous business method patents than this check clearing patent that caused a lot of anxiety in the financial services sector," one disgruntled tech lobbyist says.
And, of course, DataTreasury hates it.
"This provision isn’t about reforming the patent process or creating jobs," says DataTreasury President and CEO Claudio Ballard. "It’s about Congress doing a big favor to the banking industry at the expense of inventors and small business entrepreneurs."
DataTreasury's twin cash cows are patent No. 6,032,137 and patent No. 5,910,988. They essentially patent the ability to scan a check and transmit it to a database over the Internet or a fax line. Both fit a long-established pattern of questionable patents issued during times of technological upheaval. "Internet plus thing-that-already-exists equals patent," as one tech lobbyist put it.
"They're generally viewed as patent trolls," says Stanford law professor Mark Lemley, a patent law expert, referring to DataTreasury, which has no employees and over 1,000 shareholders.

Privitizing Medicare

Moneybox points out that 'privatization' is simply not truly possible for some government functions which cannot be outsourced.  You can privatize (outsource) the paper production for paper that the government uses, but outsourcing the military to a private company is a bad idea.  The same is true of any for-profit company.  If Microsoft completely outsources its coding, it ceases to be a software company.  It can outsource bits and pieces of coding, but not the strategic parts.  Similarly, when the government is 100% paying for Medicare health insurance, there is no evidence that adding another middleman reduces bureaucracy.  Private companies are less cost-effective than Medicare:

I agree with today's David Brooks column on one important point, namely that the Obama administration's criticisms of the current version of the Romney/Ryan plan for Medicare are overstated. But by the exact same token and for similar reasons, I think Brooks' criticisms of the Obama plan for Medicare are wildly overstated. The thesis of the column—which is shared by Romney and Obama—is that it's very important to reduce the growth rate of aggregate Medicare spending.

Brooks says Obama's plan to do this with price controls is doomed for political economy reasons. A politically powerful coalition of elderly people and health care providers will block it. That's certainly plausible. But what's the alternative?

Brooks says the alternative is to insert an additional layer of rent-seekers into the dynamic by contracting Medicare services out to private health insurance companies. There are certainly situations in which it makes sense for the government to contract things out. It would be absurd for the GSA to be manufacturing paper for use in government offices, and doubly absurd for the GSA to be operating tree-cutting operations to procure the wood for use in paper manufacturing. Across government functions there always comes a point where you end up saying "it makes more sense to buy this service from the private sector than to do it ourselves" and people disagree about where that point is. But I don't think there's any other context in which Brooks would say that this form of contracting-out alters the political economy of the situation in the way he seems to think it does here.

Right now both the elderly and health care providers lobby for higher Medicare spending. Creating a new set of Medicare sub-contractors whose industry-wide revenue level is determined solely by their success in lobbying Congress to increase Medicare spending is not going to fix this problem. And I dare say it's obviously not going to fix this problem.

If you read the column, I think that what you'll find is that basically all the analytical work is being done by a project of ideological labeling. Brooks describes this as a plan that works "through a market system" featuring "normal market incentives." He twice calls it a "market-based approach" and once refers to critics as scoffing at "market-based strategies." The idea of a market has positive emotional resonance with many people, so if you convince them that you have a "market-based" alternative to price controls that will sound good. But a system of government-funded subcontractors is only market-based if you squint at it really funny. Or, rather, it's very much a market but it's a market for political influence. Medicare subcontractors will have access to detailed demographic and health status information about their clients which they'll be able to use to create customized mailers in favor of their preferred political agenda which, naturally, will be one of higher levels of government spending and lower levels of government accountability.

Last but by no means least it's simply not the case that contracting out lets you do away with the unelected panel of experts that Obama needs to make his price controls work. The premium support model of Medicare has at its heart a panel of experts determining the value of each person's voucher since absent demographic and health status adjustment the whole system will be ruined by adverse selection.

Chinese manufacturers outsource the retailing and distribution of their products to a 'middleman' like Walmart because Walmart can get their goods to customers much cheaper than the Chinese could do it.  Walmart does not merge with its Chinese suppliers because they would see diseconomies of scale.  But there is no evidence that privitizing jails saves money.  In the long run it just creates another concentrated interest to lobby for increased jail budgets.