Basic Economics

by Thomas Sowell

  The cost of medical care is not reduced in the slightest when the government imposes lower rates of pay for doctors or hospitals. There are still just as many resources required as before to build and equip a hospital or to train a medical student to become a doctor. Countries which impose lower prices on medical treatment have ended up with longer waiting lists to see doctors and less modern equipment in their hospitals.

  Refusing to pay all the costs is not the same as lowering the costs. It usually leads to a reduction of either the quantity or the quality of the goods and services provided, or both.

  BRAND NAMES

  Brand names are often thought to be just ways of being able to charge a higher price for the same product by persuading people through advertising that there is a quality difference, when in fact there is no such difference. In other words, some people consider brand names to be useless from the standpoint of the consumer’s interests. India’s first Prime Minister, Jawaharlal Nehru, once asked, “Why do we need nineteen brands of toothpaste?”{948}

  In reality, brand names serve a number of purposes from the standpoint of the consumer. Brands are a way of economizing on scarce knowledge, and of forcing producers to compete in quality as well as price.

  When you drive into a town you have never seen before and want to get some gasoline for your car or to eat a hamburger, you have no direct way of knowing what is in the gasoline that some stranger at the filling station is putting into your tank or what is in the hamburger that another stranger is cooking for you to eat at a roadside stand that you have never seen before. But, if the filling station’s sign says Chevron and the restaurant’s sign says McDonald’s, then you don’t worry about it. At worst, if something terrible happens, you can sue a multi-billion-dollar corporation. You know it, the corporation knows it, and the local dealer knows it. That is what reduces the likelihood that something terrible will happen.

  On the other hand, imagine if you pull into a no-name filling station in some little town and the stranger there puts something into your tank that messes up your engine or—worse yet—if you eat a no-name hamburger that sends you to the hospital with food poisoning. Your chances of suing the local business owner successfully (perhaps before a jury of his friends and neighbors) may be considerably less. Moreover, even if you should win, the chances of collecting enough money to compensate you for all the trouble you have been put through is more remote than if you were suing a big corporation.

  In an increasingly global economy, Europeans and Americans might be very hesitant to buy telecommunications equipment made halfway around the world in South Korea. But, once the Samsung brand acquired a track record, people in Berlin or Chicago would just as soon buy Samsung products as buy competing products manufactured down the street. Asian companies in general have only in relatively recent history begun investing much time and money in making their brand names widely known, and still they spend less on this than other multinational companies. However, brand names like Toyota, Honda, and Nikon are recognized around the world, and the Cathay Pacific airline and the Shangri-La hotel chain are also becoming better known internationally.

  Brand names are not guarantees. But they do reduce the range of uncertainty. If a hotel sign says Ritz-Carlton, chances are you will not have to worry about whether the bed sheets in your room were changed since the last person slept there. Even if you stop at a dingy and run-down little store in a strange town, you are not afraid to drink a soda they sell you, if it is a bottle or can of Coca-Cola or Seven Up. Imagine, however, if the owner of this unsavory little place mixed you a soda at his own soda fountain. Would you have the same confidence in drinking it?

  Like everything else in the economy, brand names have both benefits and costs. A hotel with a Ritz-Carlton sign out front may charge you more for the same size and quality of room, and accompanying service, than you would pay in some comparable, locally-run, independent hotel if you knew where to look. Someone who regularly stops in this town on business trips might well find a locally-run hotel that is a better deal. But it is just as rational for you to look for a brand name when passing through for the first time as it is for the regular traveler to go back where he knows he can get the same things for less.

  Since brand names are a substitute for specific knowledge, how valuable they are depends on how much knowledge you already have about the particular product or service. Someone who is very knowledgeable about photography might be able to safely get a bargain on an off-brand camera or lens, or even a second-hand camera or lens. But someone whose knowledge of stereo equipment is far less than that same person’s knowledge of photography might be well advised to purchase only well-known brands of new stereo equipment.

  Many critics of brand names argue that the main brands “are all alike.” Even when that is so, the brand names still perform a valuable function. The question is not whether Campbell’s soup is better than some other brand of soup but whether both are better than they would be if both were sold under anonymous or generic labels. If Campbell’s soup were identified on the label only as “Tomato Soup,” “Clam Chowder,” or “Minestrone,” with no brand name on the label—the pressures on all canned soup producers to maintain both safety and quality would be less.

  Brands have not always existed. They came into existence and then survived and spread for a reason. In eighteenth century England, for example, only a few luxury goods, such as Chippendale furniture, were known by their manufacturer’s brand name. It was an innovation when Josiah Wedgwood put his name on chinaware that he sold and which ultimately became world famous for its quality and appearance.{949} In the United States, brand names began to flourish around the time of the Civil War. In nineteenth century America, most food processors did not put brand names on the food that they sold—a situation which allowed adulteration of food to flourish. When Henry Heinz entered this business and sold unadulterated processed food, he identified his products with his name, reaping the benefits of the reputation he established among consumers, which allowed his company to expand rapidly, and an array of new processed foods bearing his name to be readily accepted by the public from the outset.{950}

  In short, the rise of brands promoted better quality by allowing consumers to distinguish and choose, and by forcing producers to take responsibility for what they made, reaping rewards when it was good and losing customers when it was not. Quality standards for hamburgers, milk shakes and French fries were all revolutionized in the 1950s and 1960s by McDonald’s, whose methods and machinery were later copied by some of its leading competitors. But the whole industry’s standards became higher than before because McDonald’s spent millions of dollars researching the growing, storage and processing of potatoes. Moreover, McDonald’s established a policy of making unannounced visits to its potato suppliers, as it did to its suppliers of hamburger meat, in order to ensure that its quality specifications were being followed, and it forced dairies to supply a higher quality of milk shake mix.{951}

  McDonald’s competitors were of course forced to do similar things, in order to remain in business. Afterwards, some might say in later years that leading hamburger chains were “all alike,” but they were all better because McDonald’s could first reap the rewards of having its brand name identified in the public mind with higher quality products than they had previously been used to in hamburger stands.

  Even when the various brands of a product are made to the same formula by law, as with aspirin, quality control is promoted when each producer of each bottle of aspirin is identified than when the producer is anonymous. Moreover, the best-known brands have the most to lose if some impurity gets into the aspirin during production and causes anyone illness or death. This is especially important with foods and medicines.

  Like many other things, the importance of brand names can be seen more clearly by seeing what happens in their absence. In countries where there are no brand names, or where there is only one producer created or authorized by the government, the quality of
the product or service tends to be lower. During the days of the Soviet Union, that country’s only airline, Aeroflot, became notorious for bad service and rudeness to passengers. After the dissolution of the Soviet Union, a new privately financed airline began to have great success, in part because its passengers appreciated being treated like human beings for a change. The management of the new airline declared that its employment policy was that it would not hire anyone who had ever worked for Aeroflot.

  When it came to consumer products, Soviet consumers tried to make up for a lack of brands by developing their own methods of trying to figure out where a given product was made. As The Economist reported:

  In the old Soviet Union, where all products were supposed to be the same, consumers learnt how to read barcodes as substitutes for brands in order to identify goods that came from reliable factories.{952}

  In effect, Soviet consumers created brands de facto for their own benefit, where none existed, indicating that brands have value to consumers as well as producers.

  Among a business’ assets—its money, machinery, real estate, inventory and other tangible assets—its brand name may be its largest asset, though intangible. It has been estimated that the market value of the Coca-Cola company exceeds the value of its tangible assets by more than $100 billion and that $70 billion of that is due to the value of its brand.{953} That is a very large incentive for them to maintain quality and safety, in order to maintain the financial value of that asset.

  NON-PROFIT ORGANIZATIONS

  We have seen that the role of profit-seeking businesses is better understood when they are recognized as profit-and-loss businesses, with all the pressures and incentives created by these dual potentialities, which force these enterprises to respond to feedback from those who use their goods or services, as well as feedback from those who invested the capital that made the business possible and whose continuing investments are necessary for its continued existence and prosperity. By the same token, what are called “non-profit organizations” can be better understood when they are seen as institutions which are insulated, to varying degrees, from a need to respond to feedback from those who use their goods and services, or those whose money enabled them to be founded and to continue operating.

  The tendency of those who run any organization—whether profit-seeking or non-profit, military, religious, educational or other—is to use the resources of the organization to benefit themselves in one way or another, even at the expense of the ostensible goals of the organization. How far this tendency can go can be limited by powerful outside interests on which the organization depends for its existence, such as investors who will either get a satisfactory return on their investment or take their money elsewhere, and customers who will either get a product or service that they want at a price they are willing to pay or likewise take their money elsewhere. These outside interests are not as decisive in the case of non-profit organizations.

  This does not mean that non-profit organizations have unlimited money or that they do not need to worry about spending more than they take in. It does mean, however, that with whatever money they do have, non-profit organizations are under very little pressure to achieve their institutional goals to the maximum extent possible with the resources at their disposal. Those who supply those resources include the general public, who cannot closely monitor what happens to their donations, and neither can those whose money provided the endowments which help finance non-profit institutions. Much, or sometimes most, of those endowments were left by people who are now dead and so cannot monitor at all.

  Non-profit organizations have additional sources of income, including fees from those who use their services, such as visitors to museums and audiences for symphony orchestras. These fees are in fact the main source of the more than two trillion dollars in revenue received annually by non-profit organizations in the United States.{954} However, these fees do not cover the full costs of the goods and services being supplied.

  In other words, the recipients are receiving goods and services which cost more to produce than these recipients are paying, and some are receiving them free. Such subsidized beneficiaries cannot exert the same kind of influence or pressure on a non-profit organization that can be exerted by the customers of a profit-and-loss business, since these latter customers are paying the full cost of everything they get—and will continue to do so only when they find what they receive to be worth what it costs them, compared to what they can get for the same money elsewhere.

  A non-profit organization’s goods or services may be worth what it costs the recipients—sometimes nothing—without being worth what it cost to produce. In other words, while an enterprise constrained by profit and loss considerations cannot continue to use resources which have a greater value in alternative uses elsewhere in the economy, a non-profit organization can, since it need not recover the full costs of the resources it uses from the recipients of the goods and services it provides. Where non-profit organizations are making grants of money, the recipients of that money are in no position to influence the way the non-profit organization operates, as customers of profit-seeking organizations can and do.

  In the case of non-profit organizations that serve as intermediaries in the transfer of human organs such as livers and kidneys donated to be transplanted to ill patients, these non-profit organizations can impose arbitrary rules, which neither doctors nor patients are in much position to challenge.

  In general, those who run non-profit organizations are in a position vis-à̀-vis those who use their goods and services very similar to that of a landlord during a shortage of housing: There is a surplus of applicants. Under these conditions, where neither the desires of the current users of the non-profit organization’s goods and services nor the original desires of those who supplied their endowments in the past have the kind of leverage that both customers and investors have on a profit-seeking enterprise, those individuals who happen to be in charge of a non-profit institution at a given time can substitute their own goals for the institution’s ostensible goals or the goals of their founders.

  It has been said, for example, that Henry Ford and John D. Rockefeller would turn over in their graves if they knew what kinds of things are being financed today by the foundations which bear their names. While that is ultimately unknowable, what is known is that Henry Ford II resigned from the board of the Ford Foundation in protest against what the foundation was doing with the money left by his grandfather. More generally, it is now widely recognized how difficult it is to establish a foundation to serve a given purpose and expect it to stick to that purpose after the money has been contributed, and especially after the original donors are dead. Much money can be dissipated in creating luxurious surroundings in the organization’s workplace or arranging showy conferences in posh hotels and resorts, held in upscale locations around the country or overseas.

  The aims of the organization can be bent to the aims of its current officials or to decisions and activities that will gain them public visibility and applause, whether or not any of this serves the original purpose for which the non-profit organization was founded or even its current ostensible purpose. British writer Peter Hitchens observed that the government-established Church of England “was more and more being run for the benefit of its own employees”{955} rather than for the benefit of churchgoers or the country. Adam Smith made similar charges against endowed universities in the eighteenth century.

  Smith pointed out how academics running colleges and universities financed by endowments can run them in self-serving ways, being “very indulgent to one another,” so that each academic would “consent that his neighbour may neglect his duty, provided he himself is allowed to neglect his own.”{956} Widespread complaints today that professors neglect teaching in favor of research, and sometimes neglect both in favor of leisure or other activities, suggest that the underlying principle has not changed much in more than two hundred years. Tenure guaranteeing lifetime appointments is common
in non-profit colleges and universities, but is virtually unknown in businesses that must meet the competition of the marketplace, including profit-seeking educational institutions such as the University of Phoenix.

  Academic institutions, hospitals and foundations are usually non-profit organizations in the United States. However, non-profit institutions cover a wide range of endeavors and can also engage in activities normally engaged in by profit-seeking enterprises, such as selling Sunkist oranges or publishing The Smithsonian magazine. In whatever activities they engage, non-profit organizations are not under the same pressures to get “the most bang for the buck” as are enterprises in which profit and loss determine their survival. This affects efficiency, not only in the narrow financial sense, but also in the broader sense of achieving the avowed purposes of institutions. Colleges and universities, for example, can become disseminators of particular ideological views that happen to be in vogue (“political correctness”) and restrictors of alternative views, even though the goals of education might be better served by exposing students to a wider range of contrasting and contending ideas. {xxxvi}

  Employment policies of non-profit organizations have more latitude than those of enterprises which operate in the hope of profit and under the threat of losses. Before World War II, hospitals were among the most racially discriminatory of American employers,{957} even though their avowed purposes would have been better served by hiring the best-qualified doctors, even when those doctors happened to be black or Jewish. Non-profit foundations were also among the most racially discriminatory institutions at that time.

  The same was true of the non-profit academic world, where the first black professor did not receive tenure at a major university until 1948.{958} Yet there were hundreds of black chemists working for profit-seeking chemical companies, {959} years before blacks were hired to teach chemistry at non-profit colleges. Similarly, both black and Jewish doctors had flourishing private practices long before they could practice medicine in many non-profit hospitals.