David R. Henderson  

Find the Flaw

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Here is a passage from one of my favorite economics textbooks:

When physicians must be licensed and new drugs approved by the Food and Drug Administration (FDA) before they can be marketed, buyers are spared the cost of evaluating goods whose quality most of them would be unable to assess for themselves, except at prohibitive costs. By compelling sellers to obtain certification, government agencies can enable us all to make satisfactory exchanges at lower cost.

Find the unstated assumption and then evaluate this assumption.

If you know the name of the textbook and the authors, please don't reveal it in the comments section. I will do so in an update.

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COMMENTS (36 to date)
Kevin writes:

Assumes consumers still aren't paying for the evaluating costs, and/or that increased wait-times for access aren't a form of cost for evaluation. Both of these assumptions are false.

Michael writes:

Assumption: "buyers are spared the cost of evaluating goods" assumes that the license and FDA stamp of approval equate with the buyer's evaluation process - however, buyers must still process through the many options of doctors and drugs available

DK writes:

The compliance costs associated with FDA approval and certification may increase costs in relation to other methods of assessing a drug's quality, such as a recommendation from a physician. Also, certified exchanges may not be "satisfactory" compared to alternative means.

Daniel Kuehn writes:

Well the "paying the costs" thing I guess... if the authors clarified that they are paying the costs but it's widely distributed and not borne directly by someone in the middle of a medical crisis it would have been stronger.

Glen S. McGhee writes:

The FDA doesn't really approve new drugs -- this is something the drug industry does, because the FDA relies on clinical trials conducted and funded by the pharmaceutical companies to make their decisions. It is, actually, a form of self-regulation.

The assumption is that government licensing does exactly what consumers would do without it.

Fred Foldvary writes:

The statement assumes there is no demand for information that can be supplied by consumers reports, Angies list, WebMD, and other sources. Also FDA could approve drugs without banning non-approved drugs.

Paula C writes:

We're 'spared the costs' of evaluation = the first assumption. The FDA imposes massive costs on the physicians and drug companies, and of course these are passed on to the consumer as part of the total cost of the products. If it wasn't passed on, the physicians and drug companies go out of business and find something better to do with their resources.

Second assumption is right at the end: the government is lower cost.
Comparing FDA evaluation to a single scenario where each consumer would have to go out and individually research on their own is also questionable...there are private sector solutions that work well for assessing the quality of products and services in many other industries.

So the second assumption is that the FDA evaluation costs imposed are less expensive/more efficient than other alternatives that do exist or would exist, if the requirement arose.

raja_r writes:

1. That all buyers share the same minimum acceptable level of quality and that the FDA knows what this minimum level is.

2. That a private company will not provide this service.

MikeP writes:

Indeed, I see two major unstated assumptions:

1. That the state rather than any other third party must do the evaluating.

2. That compelled government certification "can enable us all" when in fact some of us will be quite disenabled by the government's rendering illegal a doctor or a medicine we want.

There are probably many others. Any time you hold up the state as the only solution to something, you are navigating a world of bad assumptions.

Terrier writes:

This passage assumes that compelled certifications provide information about how effective/safe drugs are and how effective/safe doctors are.

The passage ignores the economic literature on occupational licensing, which argues that licensing restricts supply chiefly in order to raise wages, having minimal impact on effectiveness/safety.

It also assumes that there are no entrepreneurs that could provide such information at lower cost than the "prohibitive costs" mentioned. But this point was amply made by Fred above.

RPLong writes:

I am fairly certain Paula C covered everything I would say, but let me try to put it in my own words.

The flaw is that the passage assumes that consumers really are spared those costs. The reality is that all of the following are true:

(a) Regulators must be paid for from the tax base, which costs consumers part of their incomes.

(b) Pharmaceutical companies and doctors bear the brunt of meeting regulatory guidelines, and they themselves are also consumers of these technologies.

(c) Pharmaceutical companies and doctors pass much of this cost on to the consumer in the form of higher prices.

(d) There is a corresponding reduction in the supply of healthcare, which is a cost borne by consumers and producers alike, and represents a deadweight loss.

(e) Regulatory approval and licensing does not definitively spare consumers from having to evaluate these goods and services.

(f) Market mechanisms such as brand names and company successes also serve as a proxy evaluation for the goods and services in question, so it is not necessarily a foregone conclusion that individual consumers would bear any greater a burden in a competitive, unregulated healthcare market than they do under the current regulatory regime.

That's all I can think of right now.

Ted Levy writes:

First, it confuses licensure (which requires a license to legally practice, restricting supply, which may itself harm patients) with certification (which is more along the lines of truth-in-advertising).

Second, it assumes the government agency makes neither type 1 nor type 2 errors, designing mechanisms that both remove no competent practitioners while simultaneously removing all incompetent practitioners.

Third, it assumes this is done costlessly.

Fourth, it assumes all consumers are alike in terms of their trade-offs of risk vs price.

Aidan writes:

The flaw is that it assumes the FDA isn't an entirely captured agency, right?

Redbud writes:

Assumption: FDA approval = quality approval

From what FDA says it does, it appears the assumption is invalid.


Matt Bramanti writes:

The biggest assumption I see is that the approval/licensing mechanism is properly calibrated -- that it keeps out all the bad drugs/docs and approves all the good drugs/docs.

And that statement itself rests on the assumptions that the mechanism's definition of good/bad is the right one, and that that one definition works for all consumers.

Aaron Zierman writes:

The assumption is that there are no possible market solutions available.

John Goodman writes:

Nobody is getting this right, although Aiden and Matt Bramanti come close.

The unstated assumption is that government is pro-consumer. Yet the history of regulation suggests this assumption is false.

Bill writes:

Markets have feedback mechanisms that tend to identify satisfactory vs unsatisfactory goods and services, whether those goods and services are drugs, doctors, lawyers, computers, cars, etc. This mechanism is not prefect in its ability to weed out unsatisfactory items, but neither is the government machinery employed to license doctors or approve drugs for release in the market.

Mark M writes:

Assumption: government can assess quality.

Capt. J Parker writes:

I'm with Fred Foldvary and Aron Zierman (forgive me if I left you out)
I believe the assumption is that market forces are not capable of creating processes by which products or service providers are evaluated and the costs of the evaluation are shared via a nominal cost to all consumers of the product or service. This assumption is false by counterexample. Underwriters Laboratory (UL) is a private product evaluation company that owes its existence to insurance companies (underwriters) who demanded electrical products be evaluated for safety as a requirement to obtain insurance policies for electrified buildings back when electric lighting was a new thing. (The insurance companies did lobby governments to write safety evaluation requirements into building codes and UL does mostly government compelled safety testing now but, this does not negate the fact that market forces initiated the desire for safety evaluation.)

Another counterexample is that I would never buy a car without first checking the Consumer Reports evaluations. A very old and ubiquitous consumer evaluation method is to buy only Branded product.

Medical devices were not regulated in the US until 1976 and in Europe it wasn't until the 80s. We know medical costs have gone up a lot since 1976 (and there has been huge consolidation of medical device suppliers). Has medical device safety increased?

Mark Bahner writes:

There are a bunch of assumptions:

1) That the magic tooth fairy pays the costs,

2) That the costs are lower for the FDA,

3) That the FDA people know better than my doctor and me what I should be putting in my body,

4) That is isn't morally reprehensible for a person at the FDA to deny a dying person access to drugs that could save that person's life, merely because the FDA person hasn't had sufficient time to decide whether or not the drug is effective,

5) That the effectiveness of drugs is actually the only FDA calculation (which it clearly isn't, as demonstrated by examples like medical marijuana and Plan B pills).

I could go on, but it's raising my blood pressure just thinking about these assumptions.

Hazel Meade writes:

I think Mark M has it.
The knowledge problem. Assumes government knows how to assess quality (or make price/risk tradeoffs) better than locally informed consumers.

In this case, the "consumer" isn't necessarily the end-consumer. It could be a middle-man such as a hospital or wholesaler who has to make a determination which products to stock. The hospital has an interest in the quality of it's staff and is better informed about how to assess that (and make appropriate risk trade-offs given it's own knowledge of it's customer base) than the government. Similarly, the grocery distributor can make better informed choices about which foods to purchase given local demands from it's customer base and local knowledge about the cost and relative safety of various suppliers than the state.

MingoV writes:

The unstated assumption is that the drug approval and physician licensure processes select good drugs and good physicians.

The drug approval process is complex, takes many years, costs billions of dollars, and grants approval to drugs thought to be safe (but not necessarily so because subjects are not representative of the groups who will take the drug), and found to be more effective than placebos. The last two aren't big hurdles, resulting in drugs that are somewhat safe and minimally effective.

Physician licensure mostly is about verifying education, training, and lack of felony convictions. It has nothing to due with assessing competence or quality of care. My estimate is that at least half of practicing physicians are incompetent in some of the areas they treat, and that at least one-quarter of practicing physicians are incompetent across the board. Reporting incompetent physicians usually results in no action. I reported two physicians for gross incompetence, and they received no license restrictions whatsoever. The state of Virginia has over 16,000 physicians. The average number of physicians per year who receive any licensure actions due to incompetence is four. (The commonest reason for licensure action is billing fraud.)

Brad D writes:

First, why would a passage like this come from your favorite economics textbook? Surely a quote from a textbook with such shortcomings would not make even your top ten list.

Many have already mentioned that these mechanisms artifically restrict supply driving up prices. And the fact that absent government-sponsored quality ratings, private firms would step in (like Consumer's Report) and do it more cheaply.

Someone has already explained the error in the textbook's reasoning;

The peculiar character of the problem of a rational economic order is determined precisely by the fact that the knowledge of the circumstances of which we must make use never exists in concentrated or integrated form but solely as the dispersed bits of incomplete and frequently contradictory knowledge which all the separate individuals possess. The economic problem of society is thus not merely a problem of how to allocate "given" resources—if "given" is taken to mean given to a single mind which deliberately solves the problem set by these "data." It is rather a problem of how to secure the best use of resources known to any of the members of society, for ends whose relative importance only these individuals know. Or, to put it briefly, it is a problem of the utilization of knowledge which is not given to anyone in its totality.
Joe Cushing writes:

It assumes the government is competent in evaluating quality. It assumes the government knows what you the individual considers to be quality. It assumes that everyone has the same standards of quality. It assumes that those who must get licences won't lobby to use the licensing system against new entrants into the market and against the consumer who the license is supposedly protecting. It assumes the gun is better than consumer choice at keeping bad producers out of the market--You always have to throw a gun in there when talking about the state as everything the state does, it does at the point of a gun.

Others have already hit the major points, perhaps more generically: It assumes that a government monopoly will do a better, cheaper job at tasks than competing private certifications would do, that there is a 1 size fits all evaluation criteria which is appropriate, and it ignores that costs are merely shifted away from the user onto government.

Presumably they view government as magically guaranteed to do a great job at any task just because you ask it to do so and believe it has good intentions. They ignore regulatory capture, the benefits of competing entities trying different approaches and learning from each other and spotting each others mistakes, etc. They ignore the fact that people may have different evaluation criteria for determining safety and quality.

As others note obviously it also isn't doing a complete job at the task since it is merely approval for these things to be in the market (doctors and treatments), it isn't truly evaluating their quality, but its presence in the market undermines the creation of private options which might go further to evaluate quality. Some services are doing that, but since they aren't required for the basic "is it safe" check there is less demand, and so fewer service start up to add that extra bit of info (some entrepreneurs also will be scared away by the perceived risk the government might step into the process further in the future and rate quality and squash them).

The fact that the government has different levels of approval needed for different products.. and none at all for others in overlapping markets, confuses much of the public into thinking that government protects them from harm in every medical related niche. They think: "they are able to sell that snake oil, so the government must think it is ok". Some may of us may have higher standards for evidence for the treatments we would use, others may say prefer to rely on quack alternative medicine journals (even though I think they are being stupid, people have a right to be stupid.. and to suffer the consequences).

J.D. writes:

So many incorrect guesses above. He wants an unstated assumption. There are, in fact, several:

1) that the certifying agency makes mistakes at a rate less than or equal to the general populace (rebuttal: the wisdom of crowds probably knows better than the bureaucrats do);
2) that those regulated by the agency cannot capture that agency to exclude less costly substitutes (rebuttal: they in fact can be captured);
3) there are no other costs besides those reflected in the price (rebuttal: only allowing proven medicine later imposes cost upon those willing to try presently-unproven medications that actually work, but just don't yet have the royal... erm, official... seal of approval).

Gov't shouldn't limit food and drugs in this fashion, but requiring disclosure of such infomation might not hurt.

There are a few unstated assumptions here, so I'm not sure which one you are looking for. Here are some:
1. Accounting cost is the same as economic cost. (From this follows that the economic cost can be measured objectively.)
2. Cost minimization is a valid ethical principle.
3. We are able to observe the counterfactual (the world in which the same consumers obtained the information without the interference of the state).
4. Buyers don't value the freedom to decide on their own how much information they want to obtain (or, if they value it, they don't value it enough to change the result of the cost-benefit analysis).
5. Sellers' preferences are irrelevant.

Andrea Clark writes:

So many great points have been made here. I want to key into the word "satisfactory" in the last line. "government agencies can enable us all to make satisfactory exchanges at lower cost." Even if we allow the assumption that the cost is indeed lower to stand, the rest of the sentence is ludicrous on its face. Government agencies have no power to enable transactions; they do not create but only restrict. Restricting large classes of transactions does not "enable" the remaining unrestricted transactions. The huge, insupportable, assumption in this sentence is that we "all" face the same trade-offs and have the same value scales so that "satisfactory exchanges" can be defined by government agencies who simply apply the universal value scale to transactions and eliminate the ones that no one wants anyway. But if no one wants them, why the huge need to make them illegal?

KTor writes:

It assumes that government has all the information necessary and is in the best position to know what consumers want.

Bill writes:

Richard Epstein offers some interesting comments on the FDA here:


Aaron Zierman writes:

I didn't have time earlier to evaluate the given assumption that there are no possible market solutions available. So here goes.

Once the government has become involved in a certain sector, it becomes increasingly difficult to imagine a world without their interference. After all, what would happen if a company started selling a drug that had ill effects on people? Politicians grandstand and cry out "We need to do something!!" And a new bureaucracy is born.

What would the private sector do in the absence of the FDA? There are a myriad of responses to that question. With very little doubt it would be more efficient and more effective. After all, how often are potentially life-saving drugs delayed or never brought to market because of the heavy regulations of the FDA? And how often are harmful items pulled off the market after the FDA had cleared them? Yes, I think the free market can compete with that.

Eli writes:

It assumes that information does not exist when it claims that consumers evaluating for themselves would be at "prohibitive cost".

One could imagine a world where government provides all the food and the economics textbook explains that everyone growing their own food would be at "prohibitive cost".

It wouldn't be out of line to suspect that the economics textbook would, in fact, say that despite it being terrible economics. One should be very suspicious of all the justifications that only emerge well after the policy was enacted.

Eric Hosemann writes:

The unstated assumption is that government licensure and certification gathers all information necessary for an accurate assessment of the costs and benefits to consumers of rejecting some doctors and medicines. Or as John Goodman said,
"The unstated assumption is that government is pro-consumer. Yet the history of regulation suggests this assumption is false."

Mark Bahner writes:
Richard Epstein offers some interesting comments on the FDA here:


From the Richard Epstein comments:

The best strategy to keep the FDA under control is to block it from banning a drug simply because the drug has not passed stage two or three trials. The removal of FDA oversight will allow these drugs to reach the market more quickly. People who are sick can then decide with the aid of their physicians and healthcare organizations whether to take these drugs in light of the other alternatives available to them. In so doing, they need not fly blind because many independent professional organizations right now do a far better job of evaluating drug efficacy by looking at off-label and overseas usage of drugs.

I dream of the day when a well-spoken and charismatic Libertarian Party candidate for President gets a national stage, even briefly, to make points like this. I'm convinced that such a person could create a dramatic shift in public opinions on a whole range of issues, by saying things like:

Suppose you or your loved one has a disease like advanced pancreatic cancer. Now suppose there is a drug that seems to do miraculous things like a total cure of the pancreatic cancer in lab animals. Your doctors think that it is your only hope, although they are not optimistic that even this will work. Why should the federal government stand in the way of you and your doctors deciding to try this drug? I say the federal government should not stand in your way. My opponents say the federal government should stand in your way.
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