“And so you’ve got higher administrative costs, plus profit on top of that. And if you are going to save any money through what Governor Romney’s proposing, what has to happen is, is that the money has to come from somewhere.” – President Barack Obama.

President Obama made the above remark in last week’s (10/3/12) presidential “debate” (aka joint press conference) comparing the cost structure of Medicare to that of private insurance. His remarks rely on a grade school understanding of profit that is sadly shared by many.

Let’s dissect the error of his ways. “And so you’ve got higher administrative costs”: The president is being a bit deceptive here. Medicare’s administrative costs are lower because it has virtually no checks against fraud prior to payment. The system is designed purposefully this way in order to entice doctors with an easy claims process. Unfortunately it leaves the system vulnerable to every type of conman and charlatan. Kind of like saying a government-run unmanned honor system bank operates with lower costs than a private bank full of tellers and security guards.

Next he says “plus profit on top of that” in reference to private insurance: Implicit in this statement is the notion that without profit (or perhaps just “excess” profit, “excess” being defined in the liberal dictionary right next to “fair share”) everything would cost proportionately less. If he is going to be intellectually honest then using this logic there is no other conclusion then that government should run everything profit-free. Considering how well that system (communism) has worked, it is unlikely he will be intellectually honest.

However the last statement, “the money has to come from somewhere” reveals his ignorance of business. This ignorance renders him incapable of comprehending how a business could enhance profit by any method other than cutting corners. The method that eludes him is productivity improvements. These are achieved by (a) identifying inefficiencies and removing them and (b) utilizing new or existing tools. With productivity gains the consumer receives the same or a better product for a lower price while the business earns a greater profit. The profit motive encourages good businesses to enhance productivity, which benefits both themselves and their consumers. The profit motive can also encourage some businesses to cut corners on product quality. However these businesses can only cut corners to the extent consumers are willing to accept the tradeoffs. If they go too far they risk going out of business at the hands of more efficient competitors. In the long run the profit motive strengthens good businesses and weakens bad businesses.

If government operates without a profit motive (as the President implies is a superior route for purposes of saving money) it operates in an information vacuum, like a ship adrift beneath a cloudy sky with no stars to guide it. It is not possible to know if one is adding or degrading value if they never ask “what is this worth?” A prime example: baking apple pies adds value, but burning apple pies degrades value. Both involve the same use of resources (apples, labor, oven) however one process is wasteful while the other beneficial. There is no non-arbitrary method to determine which process adds value or degrades value and by how much. The only way to know is to offer each on the market and see which one more people are willing to give more in exchange for. To those that might say healthcare is different, then I ask you this: if the consumer does not directly bear the cost of the healthcare they consume, then on what basis can they draw a line and say “this is too much to spend?” Is there no amount that is too much? There is only one tool government has to maintain product access when it forces prices for scarce goods below their market rate: rationing. Rationing through waiting lists (a common practice in the single-payer no profit systems) gives the false illusion of lower nominal costs by simply ignoring the costs in terms of quality of life for those suffering while they wait or the cost of lives cut short. It may seem like voodoo to President Obama, but the desire for profit is a powerful motivator to increase efficiency and thus lower costs.