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By Infometrics economist Chris Worthington

It was only a matter of time before the mounting losses at the Accident Compensation Corporation lead to ideologically-charged plans for opening up the work account to competition.

Opposition parties equate competition with privatisation, or the equally dirty “P” word, profits. Private insurance companies will be, heaven forbid, making money out of providing insurance.

Never mind that this implies some logical contortionist act where private profits are worse than public losses. Never mind that it doesn’t make sense to believe that private insurers will be able to win lots of business off ACC despite supposedly charging more (as their “profit motive” dictates).

It is helpful to separate the imaginary risk from private competition from the real one. It is an illusion that we’re better off when the government provides a public good for “free” rather than when a market provider offers it for profit.

The true cost to society is still always the opportunity cost of resources being employed to provide the good. The people and capital involved with ACC could be put to use in alternative profit-making industries. Or to put it another way, ACC is already equivalent to a profit-making insurer that pays out all its dividends to its owners (the taxpayer) in terms of product rather than money. This wouldn’t be an attractive notion for shareholders in, say, McDonald’s.

There is an added inefficiency in the above process. The price the end users see for the service is lower than the true cost of the service (which included earning normal rent on the assets employed). We can expect, therefore, that we get more of this service than we would in a free market. In this case, ironically, we are making accidents cheaper than they “should” be, and consequently encouraging more of them through less individual responsibility. For this reason alone, it would be preferable if ACC was run as a for-profit institution.

But there is a genuine problem to allowing private competition for ACC, arising from the unfairly tilted playing field for the state provider. ACC effectively operates with a dual mandate of an insurance scheme and a welfare scheme, with a lot of cross-subsidisation between the profitable areas and the money-losing ones.

In these circumstances, if the competition is allowed to charge actuarially fair prices to ACC’s profitable customers, they can easily undercut ACC. This kind of cherry-picking would make ACC’s model unsustainable without massive price hikes or direct subsidies from general taxation.

That outcome is not necessarily a tragedy. A good economic rule of thumb is that people are normally made better off by giving them cash and letting them face true market prices, rather than simply giving them subsidised goods. And making the welfare component of ACC more explicit and transparent would make it easier for us to weight the value versus other social interventions.

After all, we want there to be clear signals that certain activities and jobs carry (expensive) risks, in order to discourage people from pursuing them, without making reasonable attempts to reduce the associated risks.

Realistically, though, it is more likely that the government will instead opt for some way of levelling the playing field. There are two obvious ways: either demand that private insurers cover a similar cross-section of employer types as ACC, or demand that private insurers reimburse ACC for the welfare component of the levies that would have been paid to ACC by their former customers.

If private providers are still keen to play on those terms, we can be more confident that there are needless inefficiencies that can be wrung from the ACC structure, or benefits from employers having more choice as to their level of cover. Neither of these things are bad, even if they do result in profits for the insurance industry.

But competition can go both ways. There is something quite appealing about the government and the private sector going head-to-head in what we might term the “KiwiBank” model, where the government directly competes with the private sector in an attempt to limit pricing power. It is one thing to make the easy claim that government institutions are inefficient dinosaurs, or that private companies are rapacious profiteers. It is another to test this model by allowing competition between the two as a relatively low-cost solution.

This style of government intervention is not pure economics (normally interventions require evidence of market failure), and it is easy to see government franchises extending into all areas of the economy based on optimistic empire building. At the same time, it is silly to deny SOEs the opportunity to expand where there is a business model that compliments its core operations (as banking did for NZ Post).

We shouldn’t be afraid of competition in economic strategies being fought out in the marketplace. The success and failures will be valuable for future policy decisions, provided we take on board one ruthless lesson from free markets – when ventures fail, you have to be prepared to cut your losses.

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* Infometrics is an economic information and forecasting company based in Wellington. To find out more, see its website here. This piece first appeared in the Dominion Post.

Tags: ACC, Accident Compensation Corporation, Chris Worthington, Infometrics, insurance, Private Sector, Public Sector

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This entry was posted on Tuesday, November 10th, 2009 at 10:02 am and is filed under Opinion. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.