Markets function under incentive: Is it really beneficial for all?
(I assume) Most of readers on my blog might guess me having a pro-market, liberal-economic mindset. It is true to some extent. However, I have to point out that market system is yet prefect. Only do we extend further the studies on its shortcomings, we could make such system better.
Monitoring mechanism is an important issue. With too strong the monitoring, we might kill initiatives of a business idea at the beginning. With too weak the monitoring, consumers might pay the expenses which should not incur to them. The question now is, to what extent we should impose monitoring and punishment to companies?
The news, exposing the problem in pharmaceutical industry, presents a good case in this issue. True that such drugs passed FDA examination, True that the company offer various "incentives" for doctors introducing new drugs to the patients. This is a prefect market-oriented business model. Government agencies work as a monitor, pharma companies are "entrepreneur" to development new product, doctors are endorsers/marketers.
If this drug were really working well, it would be a win-win-win situation for company-doctor-patient.
Well, the reality is never that simple.
Such drug has more side-effects than expected, yet the monitoring mechanism did not kick in immediately. Therefore, patients suffered from the side-effects might still be subscribed the same drugs. Plus, the doctors are still receiving the benefits offered by companies. At the end, it is a win-win-loss situation, and the losing side is the public.(or the patients who are using this drug.)
Ok, break-down for analysis.
1. Incentives: similar to the "Economic Effect of Mega-games", the one who has the most benefits possess a strong incentive to present "upward-biased" results. Simply put, pharmaceutical companies do not hold incentives to spend the cost to explore negative (side) effects. They want the drug to be passed, and they want it quickly.
Unless.....
2.Punishment/monitoring cost: If the cost of getting caught/punished is really high, then these companies would take it seriously to explore all possibility of negative effects. If they were to face a class action case against them, or even, they would not get the drug into the market, then it should be so clear that they should "invest" more into a thorough examination.
The immediate problem here would be, if the cost is too high, these companies would stop any exploration into new drugs. Then, at the end, it is the public to suffer without new treatments in the markets. However, if the cost is too low, then many bad drugs would flood into the markets.
Furthermore......
3. Cost allocation: Companies could also play a strategy "catch me if you can", then the cost would be incur to the public. Directly, more of the tax money would go to FDA, for them to hire more sophisticate regulators to go through companies' researches. Indirectly, even if the companies get caught, the "likelihood" of class action case, or, the ultimate settlement amounts, is still too contingent for them to care.
In addition, what is monitors' incentive to carry out stringent rules? The monitoring benefits would actually spread toward every of the patients(for a good and safe treatment), not directly to the monitor. Furthermore, regulators would still get a fixed pay from the government. If the pay is too low, they might not exert their best effort. yet if they get paid too generously, they might still not exert their best effort since they could still "enjoy" the good pay without working. An incentive/punishment structure has to be designed here as well.
From all these arguments, we could see there are actually a lot of strategies that companies could play:
1. Do thorough examination(highest cost level)
2. Do intermediate examination(intermediate cost level)
3. Do low examination(lowest cost level)
Which one would the companies choose? I would say most take (2), or even some take (3), the first one? I guess no company could really bear the cost. In other words, they would try to "share" the cost burden to every market participants. (Taxpayers, patients, etc.)
If this drug were really working well, it would be a win-win-win situation for company-doctor-patient.
Well, the reality is never that simple.
Such drug has more side-effects than expected, yet the monitoring mechanism did not kick in immediately. Therefore, patients suffered from the side-effects might still be subscribed the same drugs. Plus, the doctors are still receiving the benefits offered by companies. At the end, it is a win-win-loss situation, and the losing side is the public.(or the patients who are using this drug.)
Ok, break-down for analysis.
1. Incentives: similar to the "Economic Effect of Mega-games", the one who has the most benefits possess a strong incentive to present "upward-biased" results. Simply put, pharmaceutical companies do not hold incentives to spend the cost to explore negative (side) effects. They want the drug to be passed, and they want it quickly.
Unless.....
2.Punishment/monitoring cost: If the cost of getting caught/punished is really high, then these companies would take it seriously to explore all possibility of negative effects. If they were to face a class action case against them, or even, they would not get the drug into the market, then it should be so clear that they should "invest" more into a thorough examination.
The immediate problem here would be, if the cost is too high, these companies would stop any exploration into new drugs. Then, at the end, it is the public to suffer without new treatments in the markets. However, if the cost is too low, then many bad drugs would flood into the markets.
Furthermore......
3. Cost allocation: Companies could also play a strategy "catch me if you can", then the cost would be incur to the public. Directly, more of the tax money would go to FDA, for them to hire more sophisticate regulators to go through companies' researches. Indirectly, even if the companies get caught, the "likelihood" of class action case, or, the ultimate settlement amounts, is still too contingent for them to care.
In addition, what is monitors' incentive to carry out stringent rules? The monitoring benefits would actually spread toward every of the patients(for a good and safe treatment), not directly to the monitor. Furthermore, regulators would still get a fixed pay from the government. If the pay is too low, they might not exert their best effort. yet if they get paid too generously, they might still not exert their best effort since they could still "enjoy" the good pay without working. An incentive/punishment structure has to be designed here as well.
From all these arguments, we could see there are actually a lot of strategies that companies could play:
1. Do thorough examination(highest cost level)
2. Do intermediate examination(intermediate cost level)
3. Do low examination(lowest cost level)
Which one would the companies choose? I would say most take (2), or even some take (3), the first one? I guess no company could really bear the cost. In other words, they would try to "share" the cost burden to every market participants. (Taxpayers, patients, etc.)
Moral would play a role here. We could consider that as a "probability of shirk."If the executives of companies holds a higher moral standards, they might consider to do more jobs then shirk away from such internal monitoring. Yet, it is really hard to quantified. And as we could see from such brief cost structures, if these companies indeed hold a higher moral standards, they probably would go bankrupt before they really could push a drug into markets.
In my corporate finance class, I was told that individuals will behave according to the incentive compatibility and individual rational constraints. These theories are beautiful to work on various occasions. The crucial question here is:
Who is going to exert the effort for monitoring? Are they given the right incentive/punishment scheme to work?
Who is going to exert the effort for monitoring? Are they given the right incentive/punishment scheme to work?
This is really the final remark we should bear in mind while facing these public policy issues.
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