Economics, like politics, can make for strange bedfellows, but even I was surprised this week when two guys named George acted to drive home the same economics lesson.
The first George was President Bush, who tried to steal some electoral thunder by proposing new limits on drug patents — something rejected by representatives of his own Republican Party just a few months ago.
The second was George Corporaal, the innovative local auto glass magnate who, some would say, has built a career out of siphoning money out of drivers’ pockets — all aided and abetted by the Minnesota Legislature.
Corporaal announced last week that he would no longer abide by a Minnesota law that bans “free” steaks and other promotional gifts that auto glass companies use to lure customers. The cost of such gifts is, of course, incorporated in bills to insurance companies, which are forbidden by state law to require their customers seek cheap repairs. Insurers, in turn, passed the cost of these “promotions” along to all Minnesota drivers in the form of higher premiums.
These two news items have something in common. Both deal with what happens when government, albeit with good motivation, creates an artificial monopoly that abuses consumers.
The men who wrote the U.S. Constitution recognized the need to motivate innovation by expressly writing the power to grant patents into the new document. The U.S. economy has been among the most innovative for two centuries. Patent protection currently lasts for 20 years. During that time, inventors have a government-created monopoly that lets them charge what the market will bear — without competition — on the patented feature of their product.
Of course, over two decades some inventions can generate huge royalties and others only a pittance. There is nothing magic or just about 20 years — it’s an arbitrary choice that balances society’s need for new products with the need to protect society from undue prices.
Only a few new drugs are ever profitable. But a handful that are widely prescribed — Terramycin, Valium, Seldane, Prozac, Viagra — can reap huge revenues relative to their manufacturing costs. Companies that have such best-sellers are loath to see their sales flee to competing generics, so they use a variety of legal and regulatory maneuvers to extend their patent periods.
President Bush, seizing what had been a Democratic initiative, announced new regulations to limit such extensions to a maximum of 30 months. This is a common-sense measure that protects consumers without unduly reducing the incentives to develop new drugs and it should be welcomed despite the skepticism about its timing.
The “free steaks” pitch came about because the Minnesota Legislature, like the Constitutional Convention, decided to give auto glass replacement businesses a huge helping of monopoly power. But there aren’t many Franklins, Monroes or Madisons in the big white building in St. Paul.
The objective here was to protect smaller glass-repair shops from the coercive power of big insurance companies that sought preferential rates from large local companies and national chains. Legislators also said they wanted to protect consumers from being forced to accept inferior glass and installation because of an insurance company’s insistence on a specific repair company.
But in limiting insurance firms’ ability to direct insured customers to cheaper companies, the Legislature gave repairers a huge slice of pricing power. To ensure people won’t delay safety-related repairs, state law also mandates that insurance firms cannot apply deductibles or co-pay provisions to windshield replacements.
The upshot was that glass companies could charge insurers far more than the cost of labor and materials. Insurers had to foot the initial bill, but passed the cost on to all Minnesota auto policyholders. We now have some of the highest per capita glass replacement costs in the nation.
Repair outfits such as Corporaal’s offered increasingly large incentives to car owners for the privilege of holding up the insurance companies. Competing offers of steaks and cash became so brazen that the Legislature imposed a ban on such “promotions” in 2002.
Now Corporaal wants to exercise what he claims is his constitutional right to promote his business. An industry association spokesman supports Corporaal, noting that glass replacement costs have fallen dramatically as a result of the law.
Lower prices for a good or service should be welcome news to consumers, but in Minnesota, it is dangerous to assume that the Legislature will agree.
I think Corporaal is correct when he argues that promotions “are as American as apple pie.” He should be allowed to promote his business any way he wants, and if that includes giving customers steaks, that is fine.
But the Legislature should also remove any restrictions on the measures that insurance companies use to get competitive prices. This is one area where we should trust the market. The auto insurance business is highly competitive — more so than most other sectors. If drivers feel they are badly treated in repair matters by one insurer, they can seek another.
In sum, there are times, as in the granting of patents to promote innovation, when government-created monopoly power benefits society as a whole. But it is hard to see how society benefits from the abusive rip-offs that the Minnesota Legislature created in the auto glass business.
© 2002 Edward Lotterman
Chanarambie Consulting, Inc.