Rational Action

Here’s a quick line of reasoning for why a very competitive private healthcare system might be less efficient than, say, good ol’ single payer:

1. Managed care assumes that having health insurance served by various competing entities will reduce health care costs by providing incentives for efficiency.
2. Preventive care is a major and perhaps the most important source of efficiency in the healthcare system.
3. A managed care provider would treat preventive medicine like an investment. Induce a covered person to engage in preventive techniques, and this will reduce costs in the long run for the provider.
4. To make the insurance market competitive, people must be able to switch to different health care providers often. Health care providers must be able to compete for patients throughout the life cycle. Otherwise the provider would gain monopoly power and would have reduced incentives to become more efficient.
5. A patient which has engaged in a great deal of preventive medicine has a lower expected long run cost of health care than if he did not engage in preventive medicine.
6. This person would receive offers for reduced premiums from the other managed care providers after he engaged in preventive medicine, and so he would switch to the other provider.
7. As he did this, the “return” on the “investment” in preventive medicine would be wiped out for the patient’s original managed care provider.
8. Thus in a competitive environment, preventive medicine will have a very limited return for the managed care provider Since most efficiency gains in the health care system are going to come from preventive medicine, a managed care system will generally forego this method of reducing costs.

What do you think?

Tonight I had the wonderful opportunity to see three of the greatest living economists speak. The event was practically a showcase for the MIT economics department, as speakers Robert Solow, Jagdish Bhagwati, and Paul Krugman all spent much of their careers teaching there. The topic of the evening was “Coping with Globalization”. *

I don’t have the drive to summarize the whole event, and I doubt you all care anyway. I do want to convey a nice example that Dr. Solow brought up, because he used it to isolate the basic, perfectly legitimate problem that we have with trade. The example was a copper miner in Arizona who awoke to learn that vast copper deposits had been discovered in Indonesia. The copper miner would probably admit that this discovery made the world better off, and probably even made America better off, but he’d know for sure that it made him worse off. Switch copper with low-skill labor, and you have the problem with globalization in the US.

So far, so good. Solow’s is the standard parable economists use for trade: the gains are spread out (they accrue to anyone who’s not low-skill labor) and the losses are concentrated. The textbook rejoinder is that since trade makes the economic pie larger, the winners could compensate the losers such that everyone benefitted. Economists call this change a “Kaldor-Hicks improvement“.

People who have studied economics might be more familiar with the term “Pareto improvement” — a change which makes at least one person better off without making any others worse off. Pareto improvements are unambiguously good, practically by definition. But free trade without recompensation is not Pareto improving! Since it is Kaldor-Hicks improving, and this condition does not actually require that losers be compensated for their losses, free trade is not unambiguously good.

Solow noted that this appeal to ex post compensation rings a bit hollow given what has happened to the welfare state over the past few decades. Can we really be so gung ho about free trade when this compensation fails to materialize? Solow wasn’t so sure, and Krugman agreed with him. Bhagwati admitted that the welfare state ought to be doing more helping out, but questioned whether trade caused such a definite downward pressure on the wages of the unskilled.

I am not so sure where I stand. I value equality, and I think that the richer you are, the less better off an additional dollar makes you. My utilitarian analysis says that the country is worse off if the richest 10% gain $10,000 a year and the poorest 10% lose $5,000 a year. If the distribution of the gains from free trade looks like that, then any expansion of free trade would give me pause. **

According to the Stolper-Samuelson theorem, moving to free trade in a capital intensive country (e.g. the US) will tend to benefit capital and harm workers, although in a Kaldor-Hicks improving way. If we take this theorem as any guide, then alongside tariff reductions we would do well to expand our social support network, perhaps by increasing the Earned Income Tax Credit, providing universal healthcare, or improving public schools. Free trade on its own is good for some people and bad for others. With the right policies, we can make it good for nearly everyone.

** The situation is not so simple because the gains may go the opposite way for the trading partner