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You Are Here: Home -> Glossary -> Efficiency


We are told and told to privatize and deregulate because the market is by definition more efficient. Even though common sense and experience would seem to suggest otherwise, it is nevertheless true. However, any honest economist will qualify the market efficiency claim by saying that free markets increase a very special specimen of efficiency called "allocative efficiency." This means that a free market is the best mechanism for moving (allocating) capital to the place where capital gains will be highest (or, similarly, moving money to the place where profits will be highest). Literally, this is what market efficiency means. It does not necessarily mean that the market can do more with less (the more commonsense meaning of efficiency), although sometimes this is the case.

In Canada, there's a long-standing campaign by Canada's big business lobby groups and think tanks to privatize our national health care system. The best argument that the privatization camp can come up with is that private health care would be, by definition, more "efficient" than public health care. Now, given the orthodox definition of allocative market efficiency, this is correct. The capacity to make profits in a private health care scheme is astonishing (American HMOs regularly post profits in the range of 25-30%). But in terms of comparing the resources that go into the system to the care that comes out of it, private care doesn't even begin to compare with public care. In the US, approximately half of all the money that goes into health care is wasted, if you define waste as money that doesn't pay for medical care. HMOs spend at least 25-30% of their revenue on administration, billing, and advertising. Add profits and you realize that over 50% of the money HMOs bring in never goes towards providing care. In a publicly administered system, there's no advertising budget and administration is minimal, since you don't need an army of clerks, accountants, collection agents, insurance agents, etc., to untangle the mess. Of course, there's no profit either. As a result, the same care can be provided to the same number of people for much less money. By any common sense definition, that is more efficient. But it is obviously not efficient at allocating capital where it will turn the biggest profit.

Allocative efficiency is a narrow term describing a narrow phenomenon. For example, the last decade has seen tremendous budget cutting in many key areas of government spending, including environmental monitoring and assessment. These cuts were made in order to increase "efficiency," or the allocation of money to places where it can be profitable. However, is it efficient to cut an organization's budget so much that it can no longer meet its mandate? Is it not better to spend a million dollars on a system that works than half a million dollars on a system that doesn't work? Looked at another way, is a system efficient when it produces results that can only described as perverse? When we allow ourselves to be pushed and pulled in order to accommodate systems that are supposed to be in place for our benefit, can the system possibly be said to be working efficiently?

Of course, the way that allocative efficiency seems to work best is through a wholesale externalization of costs. Clear cutting is a good idea for a logging company as long as the company doesn't have to pay for a destroyed habitat, countless dead animals and plants, and rising levels of carbon dioxide. Similarly, catching tuna in nets that kill dolphins makes economic sense as long as the tuna companies don't have to pay for the dead dolphins. The profit motive would make rather more sense if companies had to pay the real costs for their ways of doing business. Regrettably, trade agreements like NAFTA and the WTO call it "discrimination" if a government tries to ban or otherwise discourage a particular method of producing a good, even if that method is clearly harmful. If we were to force companies to internalize the real costs of their methods, that would be "distorting the market," and we cannot have that. It would not be efficient.

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