Why Big Govt Works – Part 2

The reason why big government works in the area of healthcare is the same as why it works for education. These are both vital areas that are poorly served by private markets. And those private markets will fail the larger economy by not creating and sustaining enough human capital, upon which our modern economies are based.

Free markets are a many-splendored thing – but they’re not perfect, and many of their flaws are well known. The private market for healthcare is a textbook case of failure – privately-provided healthcare is relatively costly and ineffective.

Our jumping-off point is the recognition that the typical European spends about half what the typical American spends on healthcare – and enjoys much better health. The typical European government picks up about 75 to 85% of the nation’s health tab – while the US government only pays about 45%. Remarkably, because their costs are so much lower, a European government’s 85% share amounts to less money than the US government’s 45% share! That’s right folks: the US government is already spending more on healthcare, per person, than most European governments. (So who’s the real socialist here?)

What specifically causes the market for healthcare to break down? For starters, while your doctor understands your condition better than you do, he has a natural conflict of interests: while you want health, he wants to get paid – and so doctors tend to create a demand for services that pay better. This is really bad for your insurer – who likely knows less about your condition than either you or your doctor – because he gets stuck with the bill (unless he can wriggle out of it). The end result is doctors billing insurers for services of questionable value, and patients not knowing better than to go along for the ride.

If you dont like your doctor, sad to say but here in the US we have far fewer primary care physicians than in most other countries. You can largely thank the AMA, which has been in the business of NOT accrediting new med schools, and lobbying against licensing foreign doctors for decades. If you dont like your hospital, it may be tough finding another place to get treated – in many parts of the developed world, patients dont have much local choice for providers. Private insurers in many US regional markets are often stuck with a single hospital, and thus cant negotiate lower prices.

Externalities problems in healthcare are much worse in the developing world, where infectious disease is much more common. (Your flu shot, e.g., is of greater cumulative benefit to the 3 people who dont get the flu as a consequence, than it is to you personally. But they didnt pay for the shot – you did.)

When it comes time to obtain health insurance, the grand-daddy of all market problems rears its head: adverse selection. Its seminal description came in a 1970 paper, “The Market for Lemons” – which explains the difficulty of finding a decent used car. (Its authors won the Nobel Prize.) Here’s how it goes: the seller has better information on a car’s quality than the buyer – because of the risk of buying a lemon, the buyer rationally reduces his offer price. Lower prices make the market less attractive for sellers of good used cars – and so the quality of the average used car drops – which forces buyers to lower their offer-price even more – which drives even more good cars out of the market (so to speak). The cycle continues until you’re left with a market for lemons.

This is precisely how health-insurance markets fail. Before the ACA, people could choose to be insured or not. The worse your health, the more likely you’d find health insurance to be a good deal. Recognizing this, insurers would raise their premiums. As premiums went up, healthy people were less likely to buy insurance. As the risk pool got more sickly, insurers would raise premiums more… and so on and so on – until insurance was no longer cost-effective for anyone. We all may want to buy used cars and health insurance – but because of asymmetric information and adverse selection, the market fails to provide.

If you were gonna custom-tailor a market to misbehave, healthcare would be a good blueprint to follow. The good news is that all of these problems have solutions – this is why western Europeans enjoy the best health and the best healthcare in the world, and dont go broke paying for it.

The cure for a provider monopoly is a public-payer monopsony. Even in the US, it’s well known that Medicare – the government insurer – has lower costs than private insurers. One significant reason is that Medicare is a monopsony healthcare buyer for the over-65 population. Given that over-65s are the beneficiaries of a huge fraction of total health expenditures – providers are forced to play ball with Medicare.

The market-for-lemons problem with health insurance is fixed by making everyone participate in the insurance pool – which is a large part of the ACA. Since not everyone can afford insurance, the government has to subsidize it too.

Regulatory changes can better align the interests of doctors, patients and insurers. David Cutler has an excellent article (cited below) detailing some of the new cost-controlling rules in the ACA. The really, really good news is that during the 3 years since the ACA passed, the growth of US per-person healthcare costs has slowed to the lowest rate ever recorded.

The cure for what ails healthcare is well known, and has been in practice in many rich countries for decades, with excellent results. And now it’s coming to the US, which is the best news of all.

Tomorrow, the dramatic conclusion of why big government works, when we take up the big, big money in social insurance –









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