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July 15, 2014
The Dismal Science
The Wait
by Adam Smith

When I was growing up I was always fascinated by the stories about the old Soviet Union. There were stories about long lines outside bakeries for the possibility of buying some bread and the astonishment of defectors from the Soviet when they saw the assortment and variety of goods available in the U.S. grocery stores.

My favorite was a story about a recently built apartment building that was falling apart so the authorities bought some duct tape and wrapped in around the building a bunch of time to try to keep it upright (not sure that was a true story or just myth but still fun).

Then in the U.S., there were the long lines to get gas due to the price controls over gasoline imposed by President Nixon. I remember sitting in the car with my mom and us hoping that there would be some gas left when it was our turn to pump.

Then there have been the many wonderful trips to the state department of motor vehicles. Take a number and wait and wait and wait or worse just stand in a really long line that moves almost literally at a snail’s (a quick one) pace.

The wait lines that have recently been in the news are the lines of veterans waiting for treatment at various Veterans Administration (VA) medical facilities.

The story in summary is that VA medical facilities were fraudulently reporting short treatment wait times.

The reality was that the wait times were unacceptable and that there were people dying waiting to be seen by the doctors.

People were (correctly) outraged. How can it be that something that everyone agrees upon (taking care of our veterans) be so inefficient and uncaring?

I think this is an economic question and easy to understand.

First, I want to stipulate upfront that I am not disparaging all workers at the VA. Most people going into the medical field really do want to make a difference and help people, and I assume that is true of people working at the VA.

To understand the results, you first have to look at what incentives are in place that influence the people involved. I knew someone that worked at VA and spent some days with them at the VA. The environment there has a government feel. People do their work, take breaks at precise times and they work at a slow steady pace.

However, based on the news reports, over time it appears that some of the employees have become complacent. They get paid the same amount regardless of how hard they work, and the union has made it difficult to dismiss anyone that underperforms. Think public education taking responsibility of your healthcare.

So the VA has a workforce where some of the employees are not motivated and management has limited ability to change the work environment.

That was true in the mid 2000’s when these long wait lines were identified. People then were also outraged that our veterans were receiving such poor care. The solution was to spend more money (always the first thought of a politician) and to create incentives for management to solve the problem.

The incentives were based on the wait times. If the wait times were low then management got the bonus. If the wait times were long, then no bonus.

So the incentives, like most incentives, look like a payout of a call option. A call option works as follows.

Someone pays for the opportunity to purchase a stock at a specific price in the future. For instance (completely unrealistic example to show the point) someone pays someone $5 for the right to purchase stock of a company for $60 in a month. The current price of the stock is $50.

In this example, there are two possible outcomes, in a month either the price goes above $60 and the person exercises the option to buy at $60 and the profit they make is the current price above $60 and $60. This is called being “in the money.”

The other possibility is that the price of the stock stays below $60 and the person does not exercise the option and loses the $5. This is being called “out of the money.”

Let’s consider the VA management, they either meet their goals for short wait lines and will get their bonus (in the money) or they do not meet their goals and get nothing (out of the money).

Given this set of options, it is not a surprise that a certain number of management fudged the wait times reported to Washington D.C. so they would be “in the money.” When people face an option payout profile and can affect the possibility of being “in the money,” they will act. Some will act even when the act is not ethical and may be illegal.

The incentive, while it sounds good, creates a moral hazard problem and they do not call them problems because they are benign.

But consider the situation from a management worker at the VA. Congress passes a law that links your bonus to something you have very little ability to affect. Congress wants the wait times reduced but do not give you the tools to do the job. When someone feels like he is not being treated fairly, the odds that he will do something unethical increase dramatically.

The dilemma does not excuse the behavior of VA management. However, the outcome is predictable. When the government decrees something should happen without giving the affected people the correct tools to make it happen and those affected will be damaged if the decree does not happen, then just expect a certain number of people to make bad decisions to try and get themselves “in the money.”

The option payout profile caused the S&L debacle in the 1980’s and almost all of the corporate financial information frauds (including Lincoln Savings, Enron, Healthsouth, and so on). People were fraudulently affecting sales, profit, or wait times so they could be “in the money.” In the future, next time you hear of something like the long wait times for veterans, go ahead and be outraged — just do not be surprised.

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