Health Insurance and Labor Supply

I just ran across an interesting paper, "Public Health Insurance, Labor Supply, and Employment Lock" by  Craig Garthwaite,  Tal Gross and my Booth colleague Matthew Notowidigdo.

They study an interesting event

... In 2005, Tennessee discontinued its expansion of TennCare, the state’s Medicaid system. ... Approximately 170,000 adults (roughly 4 percent of the state’s non-elderly, adult population) abruptly lost public health insurance coverage over a three-month period.

The result was

a large and immediate labor supply increase....we find an immediate increase in job search behavior and a steady rise in both employment and health insurance coverage. 

They call the phenomenon "employment lock." This is different from "job lock," people with preexisting conditions who stay with jobs they didn't want in order to keep health insurance. "Employment lock" is the choice by healthy people to work at all in order to get  insurance, or put in academic prose, "strong work disincentives from public health insurance that are unrelated to strict income-based eligibility limits."

The converse is a new danger for the ACA

Additionally, our estimates may provide useful guidance regarding the likely labor supply impacts of the ACA...

If such individuals could instead acquire affordable health insurance apart from their employer, many of them would exit the labor force entirely. As a result of employment lock, policies that expand access to health insurance apart from employers (such as the ACA) may have large labor market effects

... Using CPS data, we estimate that between 840,000 and 1.5 million childless adults in the US currently earn less than 200 percent of the poverty line, have employer-provided insurance, and are not eligible for public health insurance.Applying our labor supply estimates directly to this population, we predict a decline in employment of between 530,000 and 940,000 in response to this group of individuals being made newly eligible for free or heavily subsidized health insurance. 

They are quick to point out that this is not necessarily a bad thing."the effects do not necessarily imply a welfare loss for individuals choosing to leave the labor force after receiving access to non-employer provided health insurance." If people only work at a job they hate in order to get health insurance, then people may be better off not working. The policy world often just assumes more employment is always a great thing, which isn't true.

However, less employment is not necessarily a good thing either. These are childless adults. How are they supporting themselves if they don't work? Can it possibly be optimal for them to just sit around the house? We surely don't want to compare employer-provided health insurance with highly subsidized individual insurance for the unemployed-- that's a subsidy to leisure and obviously skewing the scales.

Most of all, low-income single people face extraordinarily high marginal tax rates and other disincentives to work. So, an artificial incentive to work in order to get health insurance may offset some of the otherwise irresistible incentives not to work. (A good calculation for Casey Mulligan!)

And whether the people are in the end better off working or staying home and receiving larger subsidies, the government and taxpayers are clearly worse off, as the people and their employers are not paying taxes any more.

In sum, academic caution aside, inducing a million childless adults to leave legal employment doesn't look like a good thing to me.  

The evidence is pretty cool. Here are some pictures lifted from the paper.

A Ray of Hope? Hospitals Post Prices

I was intrigued by news stories of an Oklahoma hospital posting prices for surgery -- prices far below those offered by its competitors. Here is the article and the surprisingly low price list.  Several competitors felt the pressure to slash and post prices.


A fascinating tidbit: "Surgery Center of Oklahoma does accept private insurance, but the center does not accept Medicaid or Medicare. Dr. Smith said federal Medicare regulation would not allow for their online price menu. They have avoided government regulation and control in that area by choosing not to accept Medicaid or Medicare payments."  Well, so much for the idea that regulations encourage competition and lower prices.

This is a ray of hope -- that the sort of competitive free market health care I envisioned in "After the ACA" can emerge as people abandon the complete dysfunctionality of the highly regulated system.

I had seen the emergence of "concierge medicine," and cash and carry doctors, who step off the highly regulated insurance and government treadmill. But if you get really sick, you need a hospital. And traveling abroad isn't always an option. So the emergence of US cash and carry hospitals is interesting and encouraging.

This innovation clearly undermines the regulated system. A healthy young person knowing there are doctors who post reasonable prices and take cash, and now similarly reasonable cash and carry surgery, might be well advised to pay the Obamacare tax and skip out of the whole system. A bit of savings or a catastrophe only policy is enough. 

But before you cheer that Obamacare will die of its own weight, look hard at the other side. The government needs everyone in the system, especially the relatively healthy and solvent customers of this hospital.  It also needs hospitals and doctors to take medicare patients. The emergence of a two-track system is a financial and political disaster. So, how long can it last before the government bans it? Other countries have banned private practice to support their government health systems.  Ours will likely go down fighting, and this is the obvious move. In addition, the hospitals that don't want to compete have strong political power to shut this down, and will make the same cherry-picking complaints that airlines and phone companies used to keep their protections in place. It will not survive easily. 

Readers: I'm back from a short vacation (national gliding contest), sorry for the silence.

Doctor-owned hospitals

In writing about the ACA and our health-care problems, I started to think more and more about supply restrictions. In every other industry, costs come down when new suppliers come in and compete. Yet our health-care system is full of restrictions and protections to keep new suppliers out, and competition down. Then we wonder why hospitals won't tell you how much care will cost, and send you bills with $100 band aids on them.

In that context, I was interested to learn this week about the ACA's limits on expansion of doctor-owned hospitals. The Wall Street Journal article is here, and I found interesting coverage in American Medical News. The text and analysis of the amazing section 6001 of the ACA is here

In astouding (to me) news, the ACA prohibits doctor-owned hospitals from expanding, and prevents new doctor-owned hospitals at all, if they are going to serve Medicare or Medicaid patients. From WSJ

The Affordable Care Act aimed to end a boom in doctor-owned hospitals, a highly profitable niche known for its luxury facilities. Instead, many of the hospitals are wiggling around the federal health-care law's growth caps and even thriving. 

Only in medicine is "highly profitable niche known for its luxury facilities" a bad thing. Didn't the left like employee-owned companies, worker cooperatives and all that? And when is getting around silly restrictions "wiggling?" Et tu, WSJ?

The law,  passed in 2010, blocked building any new physician-owned hospitals and prevented existing ones from adding beds or operating rooms in order to qualify for Medicare payments

Now, let's see if it takes you more than 10 seconds to figure out the unintended consequences of this brilliant idea. Don't peek...

...to grow without running afoul of the rules, some of the country's roughly 275 doctor-owned hospitals are expanding their operating hours, increasing procedures in ways not restricted by the law and rejecting patients on Medicare...

"they are scheduling operations later and on weekends, instead of 7 a.m. to 5 p.m." North Cypress Medical Center outside Houston is building up practice areas, such as same-day surgeries, that don't require admitting patients overnight...  Forest Park Medical Center in Dallas has stopped accepting Medicare patients, allowing it to escape the law's restrictions entirely.

Then, some try to give up and do what the government wants....

The Surgical Institute of Reading in Pennsylvania tried to sell itself to a local community hospital. "We couldn't expand, but we thought a partnership would allow us to continue our practice," said its board chairman, Charles Lutz.

But the Federal Trade Commission blocked the merger, saying the sale would decrease competition and could lead to higher costs for patients and the government.

Let's see, reorganizing so you are allowed to expand decreases competition? You just can't make this stuff up.

As a reader of this blog might expect, for-profit institutions, run by crucial employees, are run efficiently, make money and serve their customers

...many physician-owned hospitals have enjoyed 20% to 35% profit margins in recent years. U.S. community hospitals' profits hovered around 7% in 2010... new Medicare measurements showing that doctor-owned hospitals represent about half of the top 100 facilities whose performance will merit bonus Medicare reimbursements because of their cost efficiency and patient satisfaction.

They even provide a

"5-star atmosphere" and a gourmet restaurant with a wine list and cigars

From American Medical news,

When the federal government sorted through the first round of clinical information it was using to reward hospitals for providing higher-quality care in December 2012, the No. 1 hospital on the list was physician-owned Treasure Valley Hospital in Boise, Idaho. Nine of the top 10 performing hospitals were physician-owned, as were 48 of the top 100.

So why in the world does the government want to restrict them? WSJ:

But any effort to undo the expansion limits faces an uphill battle with Democrats, because the restrictions were a deal-breaker for hospitals when the White House sought their support for the law in 2009, industry lobbyists say.

and AMN:

The American Hospital Assn. and the Federation of American Hospitals continue to back that section of the ACA. Several key lawmakers, including Senate Finance Committee Chair Max Baucus (D, Mont.) and panel member Chuck Grassley (R, Iowa), are in strong support of community hospitals in the debate.

Aha. In return for political support for the ACA the major hospitals put in this blatant supply restriction against efficient competitors. And we wonder why health care is so expensive.

In related news, what's with the crazy hospital bills which nobody pays? A New York Times article has two tidbits.

Until a recent ruling by the Internal Revenue Service, ... a hospital could use the higher prices when calculating the amount of charity care it was providing, said Gerard Anderson, director of the Center for Hospital Finance and Management at Johns Hopkins. “There is a method to the madness, though it is still madness,” Mr. Anderson said.

Aha. Quote $100 for a band-aid, and when the patient doesn't pay it, write it off as a tax loss. The next one is really clever.

To make money from Bayonne Medical, the new buyers made some big changes in the hospital’s business strategy. 

First, they converted Bayonne Medical from a nonprofit to a for-profit hospital...Next, they moved to sever existing contracts with large private insurers, essentially making Bayonne Medical an out-of-network hospital for most insurance plans.

Under New Jersey law, patients treated in a hospital emergency room outside their provider’s network have to pay out of pocket only what they would have paid if the hospital was in the network. But an out-of-network hospital can bill the patient’s insurer at essentially whatever rate it cares to set....

In recent years, Bayonne Medical put up digital billboards highlighting the short waits in its emergency rooms in an effort to attract more patients....

While the law was aimed at giving patients more hospitals to choose from, it “has had the unintended consequence of rewarding folks for these inflated charges,” said Wardell Sanders, president of the New Jersey Association of Health Plans...

Community leaders in Bayonne...said the buyers were always candid about the methods they intended to use to make the hospital a profitable enterprise.

Really, does nobody every think for a minute, "Hmm, if we pass this law, what awful unintended consequences will it have?"

Surprising candor at NYT on health care

The New York Times published a surprisingly sensible piece on health care on Sunday, "The health care benefits that cut your pay" by David Goldhill. A sample

We manage health care as if our needs were always urgent and unpredictable, ignoring how deeply this industry is integrated into our lives, with a vast amount of care now devoted to treating ongoing, chronic conditions.

Our system takes resources from all of us, pools the cost of certainties disguised as risks, extracts enormous costs of administration and complexity and then returns — to almost all of us — a fraction of the money we’ve put in.

Try to imagine what homeowners’ insurance would look like if we expected everyone’s house to burn down and then added coverage for each homeowner’s utility bills and furniture wear-and-tear. This would be insanely expensive without meaningfully reducing anyone’s risk. That, in short, is how health insurance works.

...Traditional health experts may repackage their ideas, but they are never discouraged by past failure. So the new Accountable Care Organizations are a reinvention of H.M.O.’s. The Independent Payment Advisory Board is the new Medicare Payment Advisory Commission, or MedPAC. Bundled payments are the new Prospective Payment System.

We often see some early benefit from the introduction of new ideas, but over time such initiatives are always subjugated by our system’s nefarious economic incentives. Implement cost control reforms and watch providers circumvent new rules and guidelines. Reduce reimbursement rates for procedures, and witness providers expand the definition of required services. Convert fee-for-service reimbursements into bundled payments, and soon more severe diagnoses are given. Attempt to use government buying power, and see providers turn to lobbyists to keep prices up. We are approaching a half-century of fighting this losing battle

...

Here’s a completely different idea, one that might actually work. Let’s give every American health insurance, but only for truly rare, major and unpredictable illnesses. In other words, let’s cover everyone but not everything. It would take a generation to transition fully to such a system, but eventually the most routine and expected medical treatments, from checkups and minor illnesses all the way to common chronic conditions and expected end-of-life care, would be funded from our individual health savings; only the most major needs — for example, cancer, stroke and trauma — would be paid out of insurance.

Defining insurable events more narrowly and enabling Americans to use the premium savings to build health savings would reduce the distortions inherent in our insurance approach. Most importantly, it will also compel providers to compete on the basis of price, quality and service, as they meet the one force that creates real incentives for good performance, innovation and safety: the consumer.

Sheer poetry, in few words accomplishing what took me many pages of "After the ACA."  Newspapers often publish contrary views to show they are balanced (or so a WSJ editor once told me when I complained!) But that this can even get aired at the Times is pretty remarkable.

Billing codes

A while ago, an acquaintance saw her dermatologist for an annual check. She said, "oh, by the way, take a look at the place on my foot where we removed a wart a while ago." The doctor looked at her foot, said everything is fine, then finished the exam. Checking the bill, there was a $400 extra charge for the wart examination!

This nice audio story from NPRs "third coast festival"  tells the story of billing codes. Answer: As insurers and medicare/medicaid reduce payment for services, doctors respond by writing up every billing code they legally can. There are whole conferences devoted to billing code maximization. It's a lovely unintended-consequences story. Good luck with that "cost control."

The piece quotes the Institute of Medicine that there are 2.2 people doing billing for every doctor, at a $360 billion dollar cost. I couldn't find the source of these numbers. If any of you can, post a comment.

Of course, being NPR, the program leaves the impression that all this will be fixed in our brave new world of the ACA. But it wasn't even that heavy handed on the point. Perhaps experience is gaining on hope.

Health economics update

Russ Roberts did a podcast with me in his "EconTalk" series, on my "After the ACA'' article. Russ also put together a really nice list of readings with the podcast, at the same link.

I also found this very informative editorial "What the world doesn't know about health care in America" by Scott Atlas. It goes a good way to answering the persistent "What about how great health care is in Europe" comments. Some choice quotes:

Affirming 2005’s Chaoulli v. Quebec, in which [Canadian] Supreme Court justices famously concluded “access to a waiting list is not access to health care,” [my emphasis] countless studies document grave consequences from prolonged waits...

I love this little quote, because the deliberate confusion of "insurance" with "access" has long bugged me about the US debate.

Lots and lots of things are dysfunctional about US health care, but not the long waits that others endure

...“waiting lists are not a feature in the United States,” as stated in a 2007 study and separately underscored by the OECD .

They're talking months here, not 6 hours in the ER.

Americans would be stunned to hear the reality of nationalized insurance:

• In its latest “care guarantee,” Sweden found it necessary to stipulate that patients must be able to see a doctor within seven days; patients should not wait more than 90 days to see a specialist; and treatment should be scheduled within 90 days…six months from presentation;...

• England’s 2010 “NHS Constitution” declared that no patient should wait beyond 18 weeks for treatment (after GP referral). Even given this long leash, the number of patients not being treated within that time soared by 43% to almost 30,000 in January.

How about all those wellness visits, the idea that under socialized medicine, people will get lots of cost-effective preventive care so they don't  wind up at the ER with something expensive? It turns out that's better in the US despite our chaotic system:

...treatment of diagnosed high blood pressure, the focus of preventing heart failure and stroke, was highest in the US (53%), lowest in England (25%), then Sweden and Germany (26%), Spain (27%), Italy (32%), and Canada (36%). In 2010, drug treatment was higher in the US than all European countries, including Austria, Denmark, France, Germany, Greece, Italy, Netherlands, Spain, Sweden, and Switzerland. In 2011, nearly 70% of Britons with known hypertension were left untreated.

And when you do get something serious?

Waits for diagnosis and treatment of heart disease, the leading cause of death in the US and Europe, plague nationalized health systems. OECD reported delays of several weeks to months for treatment in Australia, Canada, Finland, England, Norway, and Spain – not including waiting for specialist appointments. In 2008-2009, the average wait for CABG (coronary artery bypass) in the UK was 57 days. Swedes waited a median of 55 days, even though 75% were “imperative” or “urgent.” Canada’s heart surgery patients wait more than 10 weeks after seeing the doctor, and two months for CABG even after cardiologist appointments. 

The obvious point: Of course, under the ACA, many new patients and "cost control" price caps, we are surely heading in the same direction: rationing by wait time.

The less obvious point: Remember all the critics I cited in "After the ACA'' painting the picture that sick people need treatment now, and can't possibly shop? That really is a misleading picture.

The bottom line

..gradually, Europeans are circumventing their systems. Half a million Swedes now use private insurance, up from 100,000 a decade ago. Almost two-thirds of Brits earning more than $78,700 have done the same. But what might really surprise those who assert the excellence of nationalized insurance systems is that throughout Europe, from Britain to Denmark to Sweden, when faced with their inability to deliver timely access, the government’s solution is increasingly to enable access to private health care.

I don't know enough about European "private health insurance" to know how it works. Individual, private health insurance is so screwed up in this country that it's not clear we will have this option.  And, the point of After the ACA, paying with your own money doesn't do much good if there is not a competitive market supplying health services.

Predictions

I did a short spot on NPR's Marketplace this morning (also here). The announced topic was what I thought would happen to economic policy after the election. Jeff Horwich, the interviewer wanted to stitch together a story about everyone is going to get together and play nice now, which seemed like a fairly pointless line to pursue. What "I would do" is now off the table, and I didn't think it worth arguing with Jared Bernstein's repetition of Obama campaign nostrums.

But it gave me a chance to put some thoughts together. I usually don't predict anything, because I (like everyone else) am usually wrong. But I'll make an exception today

Forecast in three parts: The sound and fury will be over big fights on taxes and spending. They will look like replays of the last four years and not end up accomplishing much. The big changes to our economy will be the metastatic expansion of regulation, let by ACA, Dodd-Frank, and EPA.  There will be no change on our long run problems: entitlements, deficits or fundamental reform of our chaotic tax system.  4 more years, $4 trillion more debt.


Why? I think this follows inevitably from the situation: normal (AFU). Nothing has changed. The President is a Democrat, now lame duck. The congress is Republican. The Senate is asleep. Congressional Republicans think the President is a socialist. The President thinks Congressional Republicans are neanderthals. The President cannot compromise on the centerpieces of his campaign.

Result: we certainly are not going to see big legislation. Anything new will happen by executive order or by regulation.

1. Taxes and spending

The tax negotiations fell apart last summer. Why should exactly the same deal revive now? The President will not give in on raising taxes on  "the rich," and go for a revenue-neutral reform, especially after campaigning on it. The house will not give in: They will note that even the President's rosy revenue forecast of $1 trillion in 10 years is $100 billion a year, 1/10 of our deficit. They will look across the ocean and see that every European country that has tried to balance its books by raising (marginal) taxes, especially on investment, is raising pathetic amounts of revenue and creating a double dip recession.

If you have the same situation, you have the same outcome: every January a free-for-all chaos to plug the holes for one more year. Every lobbyist comes to Washington to get his piece renewed. Occasional debt ceiling fights. No budget for 4 more years.

2. Regulation:

With no big legislation coming, the unfolding of regulation will be the big story. It is news to most Americans, but the ACA and Dodd-Frank are not regulations written in law. They are mostly authorization to write regulations. They are full of "the secretary shall write rules governing xyz" with a timetable. Most of that timetable starts today, November 7 2012. You don't have to think the administration is a bunch of willy nilly regulators to foresee a metastatic expansion of regulation. You just have to look at the time-table of regulations already legally mandated and pending.

I fished around a little on the net. The EPA has regulations under development that by its own estimates will cost hundreds of billions of dollars a year.  I'm all for clean air, but there is a question of just how clean and at how much cost. A few small examples, picked for their obviously intrusive nature, questionable cost/benefit or humorous values

• Greenhouse gases. Detailed industry controls focusing on greenhouse gas emissions.  They're even going to regulate cow farts. Sorry, Farm Methane Emissions. It's funny unless you're a dairy farmer.  Hundreds of billions
• Between greenouse gases, much tighter mercury limits, and  designating coal ash a "hazardous substance" like nuclear waste (I'm exaggerating, but that's the idea), the end of coal.
• Tight fracking regulations.
• Much tigher ozone standards. Many cities are now way over the limit.
• Cut sulfur in gas from 30 ppm to 10 ppm. EPA: $90 billion a year
• Temperature standards to protect fish in powerplant cooling ponds
• Tighter standards for farm dust. Farms have to submit mediation plans.
• Water quality control for every body of water in the country.  
• Strict regulation of industrial boilers ($10-20 billion)
• Formaldehyde emissions from plywood. I didn't know Home Depot was a dangerous place to hang out. 

ACA/Obamacare. The big parts are all coming in the next four years.  Medicaid expansion, Exchanges, the mandate to buy insurance, the ban on charging people different amounts based on preexisting conditions, “accountable care organizations,”  and most of the regulatory bodies are all coming.

Dodd Frank. For number of rules that a law commands be written this takes the cake. If you want to scare your libertarian kids on Halloween, just read from the Fed's admirably transparent regulatory reform website. Just for fun here is a sampling of Final Rules Due in one three day period,  Dec 31 – Jan 2

• Expiration date for CEA exemption for swaps 
• Broadened leverage and risk based capital requirements 
• FDIC Investment grade definition 
• Final rule OCC credit rating alterinatives 
• Joint final rule Market risk capital 
• OCC lending limit rule compliance 
• Supervision of consumer debt collectors 
• Incorporating swaps 
• Clearing agency standards

I have no idea what any of this means either. I do know that hundreds of billions of dollars are at stake, and the involved industries, their lawyers and lobbyists, are furiously "helping" to write all these rules.

This is the real news. It's baked in. Any new regulatory agendas come on top of this. And it will remake the American economy in the next four years.

The point here is not good or bad. I'm just forecasting what is going to happen -- and it seems clear to me that writing, haggling over, implementing, challenging, and repairing all this regulation is going to be the main story about actual economic policy for the next four years.

With no legislation forthcoming, any new initiatives will be by new regulations, or by executive orders.

3. Deficits, entitlements, reform

I see no chance that the new government, a repeat of the old government, will make any substantial progress. I wish they would, but hope is not a forecast.  Deficits will be $1 trillion per year, plus or minus due to the usual effects of any economic growth or lack of it on taxes and spending, so long as some chumbolones somewhere are willing to lend our government the money at negative real interest rates.  4 more years, $4 trillion more debt.  Entitlement bomb 4 years closer.

4. Economic forecast

Slow growth. Recovery is a bit natural, no matter how much sand the government puts in the gears. So, sclerotic but positive growth is the baseline. That's all conditional on my forecast that not much new comes out of Washington. With big tax hikes, slower growth or a double dip recession. With (in my dreams) a revenue-neutral, marginal-rate cutting dramatic simplification, or a miracle of sanity hitting our regulators, we get much more growth.

We're still sitting on a debt bomb. Remember 2004, when a few chicken-littles were saying "there is trouble brewing, there is a huge amount of debt (mortgages) that is in danger of defaulting, and the banks are stuffed with it?" And how everyone made fun of them? That is our situation now, but it's sovereign debt. (There's an interesting tidbit in today's news that Exxon and Johnson and Johnson bonds are trading with prices above / yields below US Treasuries)

Advice? If you run a business, get a lot of lawyers and lobbysists. He who writes the regulations will make a lot of money. He who does not will lose.  Make sure you make the right political contributions and don't say anything critical of those in power. You will need a discretionary waiver of something, and these rules are so huge and so vague, the regulators can do what they want with you. Don't be the one to get "crucified" (EPA). We live in the crony-capitalist system that Luigi Zingales describes so well. Live with it. Political freedom requires economic freedom, taught us Milton Friedman. You don't have the latter, don't expect the former.

If you're an investor, get out of long term nominal government debt. I have no idea who is holding 10 or 30 year treasuries at slightly negative real rates of interest, and bearing the risk of inflation and interest rate rises. Not me.

I hope I'm wrong. I really, really hope I'm wrong.

OK, no more grumpy, and no more forecasting.

DeMuth on Obamacare

Christopher DeMuth has a nice Oped in the Wall Street Journal. Thesis: Obamacare is the big question for the election.

He makes two points that I haven't seen expressed this well before, including by me despite 25 pages of trying:

A striking (and ominous) development in American politics in recent decades has been the emergence of government as an aggressive promoter of routine middle-class consumption... The tendency—already evident at the state level—will be to require generous, subsidized coverage of routine health and "wellness" services involving lifestyle, cosmetics, amenity and child development; of "preventive medicine" such as weight-reduction programs; and of "alternative medicine" such as massage and herbal therapies. At the same time (as already evident under Medicare) the treatment of infrequent but costly catastrophic diseases and conditions will be limited in the name of cost control, and the case-by-case discretion of doctors and other providers will be closely monitored and restricted.

This is, of course the opposite of the economic function of "insurance."

America is a large, wealthy, dynamic and heterogeneous nation. It is also the only major country that continues to maintain a health-care system with substantial elements of competitive supply, pricing freedom, patient choice, and diversity in approaching complex and uncertain medical problems

No, health care is not a stable good like asphalt, where the government can just come fix your potholes the same way now as they did 30 years ago. But "competitive supply, pricing freedom, patient choice" are already vanishing, and quashing diversity is the direct point of Obamacare.

Debate with Goolsbee

Last Tuesday, Glen Weyl asked me to debate economic policy issues in the current election with Austan Goolsbee, in the famous "rational choice" workshop. Here's my 10-minute opening statement. Austan did a great job in a tough audience.

Economic Policy and the Election: 

Growth is our number one economic challenge. Here’s how recoveries are supposed to look. We get a period of very strong growth rates, until the economy recovers to “trend,” or potential.”

Here we are. Not only have we failed to bounce back, growth is slowing down. We seem headed for a permanent loss of about 8% and sclerotic 1-2% growth.

I’m not the only one who thinks we should have bounced back. This nice graph comes from the administration’s 2010 budget, to document the same point that we should bounce back. (Note the great depression. It was not 10 years of steady stagnation. It had a strong recovery, then a double dip in 1937.)

And here, I’ve plotted the Administration’s successive forecasts in blue. They thought we should have bounced back, and you can see the tragedy of their slowly diminished expectations. So much for “recessions after financial crises are inevitably [and hence predictably] long.”

Growth drives everything. Before this recession, 63% of population was working. That ratio plunged to 58%, and is stuck there. New “jobs” just match the new people. About 5% of the working-age population – 12 million people – are out of work, apparently, permanently.

Only growth will bring back 12 million jobs. 10 more green energy boondoggles, 100 more job training programs or 100,000 teachers won’t do it. In the short run, capital and technology are pretty fixed, so you hire more people when you produce more output. Or, as Casey Mulligan argues in his great new book, you produce more output when the government stops putting sand in the gears of hiring people.

Our second huge problem is debt. The Federal government takes in about $2 trillion a year, spends $3 trillion and is $16 trillion in debt. This simply cannot last.

To get out, we need growth. The graph shows the surplus/deficit along with detrended GDP. Our government takes in about 18% of GDP year in and year out, no matter what tax rates are. Tax revenue rises when income rises. If income does not rise, we become Greece.

Growth, growth, growth. It’s not a secret. Growth ultimately comes from productivity. New ideas, products, technologies, businesses, and processes. The dismal 1970s coincided with a sharp productivity decline. Following the Reagan recovery, perhaps sparked by deregulation and tax reform, economic growth, trended up for two decades, which, as you see in the previous graph, is what paid off the Reagan deficits.

But we seem ominously set to repeat the 70s.

I’m sure we all have good ideas about what to do. But we’re here to think about what our two presidential candidates are proposing.

Every sensible observer agrees that we need to reform our chaotic tax system. And how: lower marginal rates, but eliminate the forest of deductions, credits, expenditures and subsidies to keep revenue at least neutral.  This is what Mr. Romney is proposing.

No, marginal tax rates are probably not the central thing driving our sluggish growth, and yes, the economy has grown reasonably despite higher rates in the past. But we know the direction of the effect! Margins matter. This is econ 101.

By contrast, the administration has one idea: a monomaniacal focus on raising taxes on “the rich.”

We don’t need to argue about “fairness,” who “made it,” how progressive our tax and benefits system is already. Let’s just ask if it will work.

Even if there is no avoidance or disincentive, this can raise maybe $50 billion, out of $1.2 trillion deficits. No, it will not fund “investments” or bring down deficits, as the President claims. That’s arithmetic, not economics, and it’s off by two orders of magnitude.

And, by what economics is the central key to escaping sclerotic growth that we should sharply raise marginal tax rates on investment and business formation? When, ever, has a society experiencing sclerotic growth restored robust prosperity by a tax-based redistribution? The last time we tried it was 1937. Roosevelt raised taxes on “the rich” to 70% and sent his attorney general off on a “war on capital.” He got a “capital strike” and his big recession became the great depression. President Obama will follow his hero’s footsteps.

The utter chaos of our tax and spending is more important than the rates. The government has not passed a budget in years. Spain and Greece pass budgets! What serious country decides its taxes every year, in late-night sessions in the middle of January, with thousands of special deals up for grabs?

For the first time ever, this administration doesn’t even pretend that it will balance the budget! Despite all the rosy scenario they can muster, they are proposing trillion dollar deficits forever. Forget the games of “scoring” various plans – does anyone really believe that the actual outcome of a Romney administration is going to be higher deficits than under a second Obama term?

Entitlements are the long-run budget catastrophe. Like it or not, at least Ryan and Romney are advocating a serious entitlement reform. The administration promises, not one penny cut from your Medicare and Social security. But we don’t have that money – this promise must be broken. The only question is how.

Rather than get the long-run right, the administration has indulged in a patchwork of short-run meddling. Stimulus. Cash for clunkers, which destroyed the market for used cars that low-income people depend on. Temporary tax breaks, with the constant threat of higher future taxes. 100 mortgage writedown programs that don’t work. Bankrupt solar panel factories, yet Al Gore walks away with $100 million bucks.

I would not mind if any of this worked. It demonstrably did not.

Source: John Taylor

Dodd Frank and Obamacare are the administration’s singular achievements. With the house in Republican hands, it’s clear there will be no big legislative initiatives in a second Obama term.

Thus, the main story of the second Obama term will be Dodd-Frank and Obamacare “implementation,” writing tens of thousands of pages of rules and creating the hundreds of new agencies those measures mandate, along with expansion of the other regulatory agencies.

I would not mind if these had a chance of working. Health care is a mess. And financial regulation needed to be rethought. But Dodd Frank and Obamacare are disasters. Beyond the well-reported costs.

Obama care and Dodd Frank are not really laws or rules. Instead, they send appointed officials off with huge power and discretion, to run businesses and markets as they see fit. (There are “rules” but they are so massive and so vague, that discretion is their effect.)

A microscopic example: “stress tests.” The Fed staffers in charge are not writing rules – they’re open about it: If they write rules, the banks will work around the rules. So each quarter they dream up something new and challenging to surprise the big banks with. And hundreds of billions of dollars hang on the results. George Stigler is turning over in his grave.

Another: Obamacare is so onerous, that thousands of discretionary waivers are already being handed out. Better not contribute too loudly to Republican causes.

Another: the EPA official caught wanting to “crucify” a few businesses. Here’s a guy dispassionately enforcing clear rules, eh?

Now, telescope. There are tens of thousands of these stories. Regulation is not “more or less” it’s smarter or dumber, more or less prone to evasion, economic stagnation, unintended effects, anti-competitive capture, and crony capitalism.

Our only hope is to replace these with clear, simple, rule-based regulations. Individual, portable, renewable health insurance and a competitive health-care market. Simple effective financial regulation. After four more years of Dodd-Frank and ACA metastasis, the chance to do that will have passed.

None of this was a mistake. The last four years of disastrous economic policy came from a deeply ingrained philosophy: that detailed discretionary control by government bureaucrats is the way to run the macro and micro economy. That growth comes from a one-year special tax break for this or that, a $7000 credit for silicon valley tycoons to buy electric sports cars, and sending the staff of HHS to tell each of us what medicine we need and the Fed to tell each bank who it should lend to.

No. Prosperity comes from property rights, rule of law, simple clear and stable taxation and regulation, which is hard to bend to crony capitalism and protection, and competition.

Not everything in Romney’s plan is perfect. I won’t defend “energy independence” and a fairly mercantilist attitude towards trade. But again, our task tonight is to pick from the menu, not to roll our own. The outlines of what Romney is proposing – and more importantly he, Ryan, the economic advisers I know, and what seems likely to emerge from their administration -- are a lot closer to that philosophy.

(Notes:  This is more political than what I usually write here, so I turned comments off. I don't want to fight about politics or deal with moderating the hate-filled comments I know are coming.

Many graphs and points have shown up in previous blog posts with more detailed explanation, especially "Just how bad is the economy?" "Inevitably slow recoveries?,and  Recoveries after financial crises".

I deliberately kept the graphs simple so the facts would be transparent. Yes, GDP per capita, consumption per capita, etc. might be better measures, labor force should adjust for demographics, I used output per worker to measure productivity, etc.  All can be done better, getting the same basic result, but at the cost of a bit of obscurity.)

Pile of paper

In response to my long health-care essay, a friendly doctor sent me the image at the left, with an explanation:

"You want to talk about filling out forms? Here are two hospital privilege renewal applications. Most of my info - such as where I graduated from, where I trained, license #, etc - has not changed. That includes my face, yet they want a new photo. My staff tabbed all the places where I have to sign or initial. This is a standardized form, yet I have to fill one out for every hospital and they all want extra information (including a copy of my signature on a check made out to the hospital)."

Comment: And, amazingly this is all on paper!  

After the ACA: Freeing the market for health care

This is an essay, based on a talk I gave at the conference, “The Future of Health Care Reform in the United States,” at the University of Chicago Law School. The pdf version on my webpage may be easier to read than this version, which is a bit long for a blog post. Also, I'll update the pdf over time as I collect comments, but not this blog post.

Update 2/6/2013 I revised the essay on my webpage which is now better than this one. 

Clearly, two important items on the policy agenda are, if we could get rid of the ACA and Dodd-Frank, what would we replace them with? This essay thinks about ACA, I'll be back on Dodd-Frank. Here goes:

After the ACA: Freeing the market for health care
John H. Cochrane¹
October 18 2012

Most of the current policy debate, and the optimistically-named “Affordable Care Act,” focuses on health insurance. I think we need to move on to think about the economics of health care. If the ACA is repealed, we still have a mess on our hands, and just fixing insurance will not be enough to clean up that mess.

Insurance

I’ve written a lot about how to fix health insurance, so I won’t repeat that all here.² To summarize briefly, health insurance should and can be individual, portable, life-long, guaranteed-renewable, transferrable, competitive, and lightly regulated, mostly to ensure that companies keep their contractual promises. “Guaranteed renewable” means that your premiums do not increase and you can’t be dropped if you get sick. “Transferable” gives you the right to change insurance companies, increasing competition.

Insurance should be insurance, not a payment plan for routine expenses. It should protect overall wealth from large shocks, leaving as many marginal decisions unaltered as possible.

Preexisting conditions, lack of insurance by the young and healthy, and spiraling insurance costs– the main problems motivating the ACA -- are neatly addressed by this alternative. Why do we not have a system? Because law and regulation prevent it from emerging. Before ACA, the elephant in the room was the tax deduction and regulatory pressure for employer-based group plans. This distortion killed the long-term individual market and thus directly caused the pre-existing conditions mess. Anyone who might get a job in the future will not buy long-term insurance. Mandated coverage, tax deductibility of regular expenses if cloaked as “insurance,” prohibition of full rating, barriers to insurance across state lines – why buy long term insurance if you might move? – and a string of other regulations did the rest. Now, the ACA is the whale in the room: The kind of private health insurance I described is simply and explicitly illegal.

So, the alternative is clear. Getting there will be a long hard road. It’s not a simple matter of “deregulation,” given how deep and widespread the offending restrictions are, and the many legitimate purposes which they purport to serve, and sometimes do. We need to construct a different, but wiser, legal and regulatory regime. I know an interest group when I see one: Don’t worry, there will be lots of jobs for health economists, policy analysts, and lawyers.

Problem solved? Not really. Solving health insurance – who pays -- will not solve the evident inefficiencies and absurd cost of our health care markets.

Health care supply

We all agree what we’d like to see: Health care needs to become efficient, innovative, and provide high quality care at lowest possible cost.

Cost reduction and innovation: some examples

How will this happen? Well, we have before us many good examples. Walmart and Home Depot revolutionized retail. Airlines are dramatically cheaper than in the 1970s. Consumer electronics, telecommunications, computers, and even cars are much better and cheaper, for what you get, than ten or twenty years ago.

These revolutions are not just about technology. In most of these cases, we see process innovation, reorganizing activities to deliver complex services at lower cost and with better and more uniform quality. This process efficiency is most glaringly absent in health care .

Southwest Airlines turns a plane around in 20 minutes, and has finally figured out how to get people on it without the chaos at United and American. Walmart and Home Depot are as much about organizing and standardizing the motion of people and inventory as they are about adopting technology, outsourcing supply, or negotiating lower prices. Honda assembles a car with 30 hours of labor. As Atul Gawadne puzzled⁴ in the New Yorker, the Cheescake Factory delivers a complex service-oriented product with remarkable quality, efficiency and cost. Why can’t hospitals do the same?

Beyond stories: Amitabh Chandra and Jonathan Skinner⁵ summarized the academic literature, writing “there is increasing evidence of the potential for cost-saving technologies (with equivalent or better outcomes) in the management and organization of health care to yield substantial productivity gains. But these types of innovations are unlikely to diffuse widely through the health care system until there are much stronger incentives to do so”

But our hopes for health care go beyond the obvious need to streamline of process and delivery and adopt cost-saving technology. We don’t want 1950s care at cheaper prices. Technical innovation is, fundamentally, why we can be so much healthier than our grandparents. Health care markets need to bring that innovation as fast as possible-- and then diffuse it quickly down to the mass market.

My example industries are also great at technology innovation and diffusion. Health care is a paradox, that innovation is widely reviled as a cause of increased costs, where by any economic definition the opposite is true. The answer that you’re mistaking “cost” for “price,” and that a new $500,000 treatment represents a reduction in cost over a less effective but still available $50,000 older treatment is correct as a matter of economics. But it’s unsatisfying, because we all see the monstrous inefficiencies in health care.³

Why does Moore’s law not apply to medical devices? Why has the price of cell phones, GPS, and computers come down so fast relative to the prices of medical technology? Where is the home MRI? There is nothing deeply different about medical and other technology. The answer is that supply and demand – in the current highly regulated system – is not producing the Moore’s law incentives.

In my examples, innovation doesn’t always mean lower cost. I paid $1500 in 1982 for an IBM PC with 16 k and one floppy disk drive. I paid about the same (nominal) for my most recent laptop, with vastly more power. Nissan is going to sell⁶ $3,000 cars in China and India – with no airbags. We have chosen much better cars for slightly higher prices.

In each case, however, the industry has done a good job of pushing the cost/innovation/quality frontier out to its limits, and then discovering where people really want to be. If we “spend more” today, we know we’re getting a good deal, and simply choosing a different point on a far better frontier than we faced 20 years ago. What we need in health care is to push that quality-cost-innovation frontier back. If we then choose higher cost, it will indeed be cause for celebration, not hand-wringing.

These industries do not cut costs by selling shoddy products. Instead, they provide consistent quality on the dimensions people turn out to really care about, and save on those that people don’t really care about. Southwest gets you where you want to go at convenient times, with a good on-time record, and admirable safety. And seats 27 inches apart, feeding you peanuts. The iphone error rate is a lot lower than the medical error rate. Walmart shirts use inexpensive materials, and they are sold in environments far less sexy than Michigan Avenue boutiques, but it’s rare to find one torn, or missing buttons. The fear, so often expressed in medical contexts, that unregulated competitive suppliers will pawn off shoddy merchandise on consumers seems exactly false. Restaurants tremble at a poor yelp review. The corporatization and standardization, which we to some extent bemoan, is a good part of their ability to deliver consistent quality. If each airplane and pilot were a different practice, quality would vary a lot more!

How will this change come about? My examples share a common thread: Intense competition by new entrants, who put old companies out of business or force unwelcome and disruptive changes. Microsoft displaced IBM, and Google is displacing Microsoft. Walmart displaced Sears, and Amazon.com may displace Wal-Mart. Typewriter companies didn’t invent the world processor, nor did they adapt. The post office didn’t invent FedEx or email. Kodak is out of business. Toyota gave us cheaper and better cars, not Ford/GM/Chrysler competition. When the older businesses survive, it is only the pressure from new entrants that forces them to adapt.

My examples share another common thread. They remind us how painful the cost-control, efficiency, and innovation processes are. When airlines were regulated, artificially high prices didn’t primarily go to stockholders. They went to unionized pilots, flight attendants and mechanics. Protection for domestic car makers supported generous union contracts and inefficient work rules, more than outsize profits. A look at a modern hospital and its supply network reveals lots of similar structures. “Bending down cost curves” in these examples required cleaning out these rents, through offshoring, elimination of union contracts and work rules, mechanization, pressure on suppliers, and internal restructurings.

The fact that so much cost reduction comes from new entrants, not reform at the old companies, is testament to the painfulness of this process, and the ability of incumbents to protect the status quo. The big 3 still take 40 hours to build a car relative to Toyota’s 30. And two of them went bankrupt, while Toyota sits on a cash reserve. American and United are still struggling to match Southwest’s efficiencies, after 30 years. The parts of Kodak invested in film simply couldn’t let the company exploit its technical knowledge in optics and electronics. Chicago’s teacher unions are fighting charter schools tooth and nail. And a quick look at a modern hospital, and its suppliers, suggests just how wrenching the same transformations will be.

Supply and Competition

So, where are the Walmarts and Southwest Airlines of health care? They are missing, and for a rather obvious reason: regulation and legal impediments.

A small example: In Illinois as in 35 other states⁷, every new hospital, or even major purchase, requires a “certificate of need.” This certificate is issued by our “hospital equalization board,” appointed by the governor (insert joke here) and regularly in the newspapers for various scandals. The board has an explicit mandate to defend the profitability of existing hospitals. It holds hearings at which they can complain that a new entrant would hurt their bottom line.

Specialized practices that deliver single kinds of service or targeted groups of customers cheaply face additional hurdles, as they undermine the cross-subsidization provided by “full service” hospitals. For example, the Institute for Justice is bringing a major suit⁸ by a specialty colonoscopy practice in Virginia, which local “full service” hospitals managed to ban.

This is exactly the form of regulation put in place by the Civil Aeronautics Board until the late 1970s, which produced airline prices much higher than they are today. Airlines had to show “need” for a new route, and incumbents defended monopoly rents on the grounds that they cross-subsidized service to small airports. Its removal is pretty much centrally what brought us cheap airlines now.

Revealingly, CON laws were an earlier round of “cost containment,” and were federally mandated for a while. The idea was sensible enough, and you could imagine it echoing through conferences such as this one. On a fee-for-service system, there can be an incentive to buy too many MRI machines, and then prescribe “needless” scans, which insurance companies and the government would be forced to pay for. Well, said an earlier round of health-policy experts, we’ll patch that up by having a regulatory board review the “need” for major investments or hospital expansion to avoid “needless” overinvestment. Even if the theory is true, it’s an interesting story how an attempted regulatory patch to one broken system (poor incentives in fee-for-service reimbursement) turned in to a barrier to competition and wound up increasing costs.

How occupational licensing is captured to restrict supply and push up prices should be obvious by now – Milton Friedman wrote his PhD dissertation on it. If you’re a parent, you’ve been through it. It’s 2 am in a strange city. The kid has an ear infection. He needs amoxicillin, now. Getting it is going to be a 3 hour trip to an emergency room, hundreds of dollars, so a “real doctor” can peer in his ear, then off to the pharmacy to fill the prescription. A nurse practitioner at the Wal-clinic could handle this in 5 minutes for $15.

I’m not arguing that we have to get rid of licensing. But licensing for quality does not have to mean restriction of supply to keep wages up, including state-by-state licensing, restriction of residency slots, or restrictions that encourage overuse of doctors where they are not needed.

Einer Elhauge ⁹ examines “fragmentation” of medical care in detail, the fact that even in hospital settings care is bought essentially from different doctors and specialists rather than in an integrated manner, as, say airline travel is, where you do not separately purchase pilot, flight attendant, fuel and baggage services. My examples suggest a consolidation, integration, and corporatization of overall health service provision, as restaurant chains displace individual stores. What stops this defragmentation? He surveys research concluding that nothing in the nature of health care seems to require this structure, as hospitals in other countries have salaried doctors, and concludes instead (p. 11):

The dominant cause of fragmentation instead appears to be the law, which dictates many of the fragmented features described above and thus precludes alterative organizational structures.

He lists a long string of legal impediments, including Medicare reimbursement rules, laws against corporate medicine and tort doctrines. Referring to private insurance (p.12):

…State laws generally make it illegal for physicians to split their fees with anyone other than physicians with which a physician is in a partnership. More important, alternative payment systems, such as paying a hospital (or other firm) to produce some health outcome or set of treatments, would make sense only if it has some control over the physicians and other contributors to that outcome and treatments. And other laws preclude such control, as detailed in the chapters by Professors Blumstein, Greaney, Hyman, Madison, Cebul, Rebitzer, Taylor, and Votruba. The corporate practice of medicine doctrine provides that firms—whether hospitals or HMOs—cannot direct how physicians practice medicine because the firms do not have medical licenses, only the physicians do. Although some states allow hospitals to hire physicians as employees, that change in formal status does not help much if the employer cannot tell the employee what to do. Even if the law did not prohibit such interference, tort law generally penalizes firm decisions to interfere with the medical judgments of individual physicians, making it unprofitable to try, as Professor Blumstein observes. Further, hospital bylaws usually require leaving the medical staff in charge of medical decisions, and those bylaws are in turn required by hospital accreditation standards and often by licensing laws. By dictating autonomy for the various providers involved in jointly producing health outcomes, these rules largely dictate separate payments to each autonomous provider.

Private insurer efforts to directly manage care have likewise been curbed by the ban on corporate practices of medicine and the threat of tort liability. In addition, states have adopted laws requiring insurers to pay for any care (within covered categories) that a physician deemed medically necessary, banning insurers from selectively contracting with particular providers, and restricting the financial incentives that insurers can offer providers.

My cost-cutting examples are all for-profit companies. About 70% of hospitals and 85% of health-care employment is in non-profits,¹⁰ whose legal and regulatory treatment protects much inefficiency from competition.

If United didn’t have to pay taxes, Southwest’s job would have been that much harder.

Maybe for-profit companies pay too much attention to stock prices. But non-profits can go on inefficiently forever, with no stockholders to complain. The whole point of a non-profit is to pursue goals other than economic efficiency.

More importantly, if a for-profit company is inefficiently run, another company or a private-equity firm can buy up the stock cheaply, replace management, and force reorganization. Non-profits (and their management especially) are protected from this “market for corporate control¹¹.”

Many non-profit hospitals are too small or, by definition unable to issue equity, undercapitalized.

Recognizing some of these pathologies, there is a wave of mergers, and transfers between for-profit and not-for-profit status. But there is lots of gum in the works. When a nonprofit is sold or converts to for-profit, the state attorney general and courts can weigh in on the sale; legally to ensure that the proceeds benefit a charitable cause related to the non-profit’s original mission. This is a great opportunity for competitors to block the change.¹

The FTC is ramping up antitrust action against hospital mergers.¹³ Hospitals need economies of scale for expensive, specialized modern medicine and to comply with the avalanche of regulatory and insurance regulation. The FTC worries about local monopolies able to raise prices, especially given the inelastic demand by insurers and government reimbursement. So here we have the government forcing small size in order to boost competition with one hand, stopping entry to protect hospitals from competition with another, trying to force larger “networks” through “Affordable Care Organizations” to obtain the needed economies of scale with the third, but laws preserving doctor independence with the fourth.

On reflection, it’s amazing that computerizing medical records was part of the ACA and stimulus bills. Why in the world do we need a subsidy for this? My bank computerized records 20 years ago. Why, in fact, do doctors not answer emails, and do they still send you letters by post office, probably the last business to do so, or maybe grudgingly by fax? Why, when you go to the doctor, do you answer the same 20 questions over and over again, and what the heck are they doing trusting your memory to know what your medical history and list of medications are? Well, this is a room full of health policy wonks so you know the answers. They’re afraid of being sued. Confidentiality regulations, apparently more stringent than those for your money in the bank. They can’t bill email time. Legal and regulatory roadblocks.

So, medical records offer a good parable: rather than look at an obvious pathology, and ask “what about current law and regulation is causing hospitals to avoid the computer revolution that swept banks and airlines 20 years ago,” and remove those roadblocks, the government adds a new layer of subsidies and contradictory legal pressure.

The impediments to supply-side competition go far beyond formal legal restrictions. Our regulatory system has now evolved past laws, past simple, explicit, and legally challengeable regulations, to simply hand vast discretionary power to officials and their administrative bureaucracy, either directly (“the secretary shall determine..” is the chorus of the ACA) or through regulations vague enough to let them do what they want. Witness the wave of discretionary waivers to ACA handed out to friendly companies. Those administrators can easily be persuaded to take actions that block a disruptive new entrant, and with little recourse for the potential entrant. (Lobbying government to adopt rules or take actions to block entrants is legal, even if those actions taken directly would violate anti-trust laws, under the Noor-Penington doctrine.)

Forget about Wal-clinics; Chicago and New York kept the food and clothes part of Wal-Mart out for years, at the behest of unions and competitors, by denying Wal-Mart all the necessary permits and approvals. So many citizens, especially our poor and vulnerable, continue to live in employment and retail deserts.

The increasing spread of medical tourism to cash-only offshore hospitals is a revealing trend. Why does this have to occur offshore? What’s different about the hospital location? Answer: the regulatory regime.

So, what’s the biggest thing we could do to “bend the cost curve,” as well as finally tackle the ridiculous inefficiency and consequent low quality of health-care delivery? Look for every limit on supply of health care services, especially entry by new companies, and get rid of it.

The reregulation path

Now, this is of course not the way of current policy. The ACA and the health-policy industry are betting that new regulation, price controls, effectiveness panels, “accountable care” organizations, and so on will force efficiency from the top down. And the plan is to do this while maintaining the current regulatory structure and its protection for incumbent businesses and employees.

Well, let’s look at the historical record of this approach, the great examples in which industries, especially ones combining mass-market personal service and technology, have been led to dramatic cost reductions, painful reorganizations towards efficiency, improvements in quality, and quick dissemination of technical innovation, by regulatory pressure. I.e., let’s have a moment of silence.

No, we did not get cheap and amazing cell phones by government ramping up the pressure on the 1960s AT&T. Southwest Airlines did not come about from effectiveness panels or an advisory board telling United and American (or TWA and Pan AM) how to reorganize operations. The mass of auto regulation did nothing to lower costs or induce efficient production by the big three.

When has this ever worked? The post office? Amtrak? The department of motor vehicles? Road construction? Military procurement? The TSA? Regulated utilities? European state-run industries? The last 20 or so medical “cost control” ideas? The best example and worst performer of all,..wait for it... public schools?

It simply has not happened. Government-imposed efficiency is, to put it charitably, a hope without historical precedent. And for good reasons.

Regulators are notoriously captured by industries, especially when those industries feature large and politically powerful businesses, with large and politically powerful constituencies, as in health insurance or as in most cities’ hospitals. In turn, regulated industries quickly become dominated by large and politically powerful businesses. See banks, comma, too big to fail. (Several insurance companies were bailed out in the financial crisis, so too-big-to-fail protection is not a distant worry.) This is not to say that regulators are not well-meaning and do not put great pressure on many industries. But the deal, “you do what we want, we’ll protect you from competition” is too good for both sides to resist.

Needless to say, price controls have been an unmitigated disaster in every case they have been tried. Long lines for gas in the 1970s are only the most salient reminder. Their predictable result is, vanishing supply. Try finding a doctor who will take new Medicare or Medicaid patients.

The current regulatory approach is not really well described as simple price controls, e.g. $3 per gallon of gas, but rather as fiddling with a payment system of mind-numbing complexity and endlessly discovered unintended consequences. The past record of “cost control” and “incentive” efforts should warn us of how likely adding more complex rules is to work.It seems instead to be a challenge to the next generation of planners.¹⁴

But that’s only the beginning. Real cost reduction is a hard process, as my examples remind us.

Can a regulator in a democracy really become a union-buster, force painful concessions on workers, suppliers, and other “stakeholder” beneficiaries of rents? Can a regulator realistically demand that jobs be outsourced or replaced by software? Can a regulator really preside over a wave of turnover in which new businesses send old ones to the dustbin, firing their management?

Consider a small example now in the news. Hospitals are starting to outsource the reading of x rays, even to India. This is still heavily regulated – the radiologists are still US trained and certified. But already it’s a cause celebre for the potential to cost jobs. When the obvious happens – Hmm, we have some good Indian doctors who can read the x rays just as well – you can imagine the scandal. And doesn’t every American deserve the best – a US radiologist on staff and present 24 hours a day, ready to consult with the doctor? Personal-injury law firms are already lining up to sue based on the “inferior quality” of outsourced readings, with requisite horror stories.¹⁵ How could a regulator demand outsourcing radiology and using Indian doctors?

My examples also do a remarkable job of getting rich people to voluntarily pay through the nose, covering fixed costs for medium-income consumers. Two words: Business Class. A politician who proposed taxing people this way to provide air travel would be hanged as a socialist. And a regulator who consigned middle-income patients to seat 25d while wealthier patrons got business class would be hanged as a fascist.

Our current system tries to accomplish such cross subsidies, but at massive inefficiency: to cross-subsidize Medicare, Medicaid and emergency rooms, we overcharge cash customers and private insurance, and protect inefficient hospitals from competition.

Realism

Now by being concrete, and therefore realistic, I invite obvious complaints. What, I like airlines and Walmart? Have I been to an airport lately or shopped at Walmart? (Yes to both, incidentally.) But I think the examples are good to remind us what efficiency looks like, how it is achieved, and to keep us from fantasies about what health-care can look like and what outcomes regulators are likely to be able to achieve.

We love to complain about airlines. But aside from the TSA’s security theater and air traffic control – both run by the government – what we really want is 1970s service at 2010 prices. Sorry, we can’t afford private-jet medicine for everyone. Southwest medicine has to be the goal.

Shop at Walmart? Walmart is putting all those cute mom and pop stores out of business. It’s putting pressure on union jobs, the main reason Chicago kept it out all these years. It pushes suppliers relentelessly. It buys from China. Aren’t I being heartless?

No. I’m being realistic. The lesson from all our experience with other industries is that “cost control” and innovation are a hard and brutal process.

Many of you are probably still squirming in your seats. You want some other way. You want to keep unionized jobs, “living wages,” “worker protections,” or “keep our community hospitals going.” Perhaps you mourn the bank tellers replaced by ATM machines, and jobs sent to China.

More deeply, you are probably squirming in your seats at my observation that quality varies enormously in efficient industries: some fly economy middle seat, and some fly in private jets. Some get shirts from Walmart and some get shirts from Macys. Surely, doesn’t every American deserve the best when it comes to health care?

If so, you’re not serious about reducing costs, i.e. finding the efficient point on the quality-cost curve. This is simply a fact: you’re adding other goals to the mix, so you’re accepting rising costs to fund those other goals. Or you’re fantasizing that you can have it both ways.

And if you’re having trouble putting those other considerations aside and accepting a Walmart / Southwest airlines model for health care, imagine how unlikely it is that the department of health and human services will force that model to emerge through its regulatory power.

Health-care demand

The demand side of the health care market is also severely distorted.

Most basically, with either government provision or private insurance, health care is bought in “payment plan.” You pay a tax or a premium, then your expenses are “covered.”

We all understand that when somebody else is paying, people don’t economize on expensive services shop for better deals, or accept less convenient but cheaper alternatives. More importantly, I think, demand affects supply: it’s a lot harder for new entrants to attract business in the current payment system.

Is there something about the nature of health care, as an economic good, that necessitates payment-plan provision? Thinking about it, I think the opposite is true: Health care, as an economic good, is a particularly poor candidate for payment-plan provision.

I think people have in mind a simple wound, or a broken arm. Even if it’s free, nobody is going to overuse that—nobody will have a good arm put in a cast or have stitches just for fun. Pretty much any qualified doctor can handle it; you don’t need to find one that’s “really good at setting bones” but charges a higher price. So, the “good” is well defined, it’s a pretty generic commodity, the demand curve is very steep, and what you “need” is clearly observable.

But this is a very misleading anecdote. The actual demand curve for health care is incredibly elastic. When provided at low cost, people consume prodigious amounts of health-care services. Every cost estimate for government provision or subsidy, from the UK NHS, to medicare, medicaid, and beyond has missed the mark by orders of magnitude. And, though it’s common to disparage “overuse,” in health policy circles, the elastic demand curve is real. These are real people, with painful illnesses, and the “extra” test or visit to the specialist might just be the one to finally help them. Conversely, when asked to pay more, consumers economize rapidly, refusing “too much” care in the judgment of the medical community.

So, we have attempted payment plans with limits – insurance rules, managed care, effectiveness panels, “affordable care organizations” and so on – to cut off the flat demand curve. Ezekiel Emanuel, Neera Tanden, and Donald Berwick, writing in the Wall Street Journal ¹⁶ explained the idea: “Instead of paying a fee for each service, providers should receive a fixed amount for a bundle of services or for all the care a patient needs.”

Hmm. “From each according to his ability, to each according to his need.” It has a nice ring to it. Why do I feel a certain foreboding?

Would this work for clothes? Your employer gives you “access” to clothes by including it in your benefits. Then your primary style consultant will determine how many shirts you “need,” which you can pick from the preferred provider network (K mart). Home repair? The home-repair effectiveness board will conduct peer-reviewed research on material for kitchen counters. Sorry, granite is off the approved list, you don’t “need” it.

Health care? For many patients, just getting through the diagnosis to decide what treatment they might try is an expensive and inconclusive nightmare. How much diagnosis do you really “need” in these circumstances?

Many diseases are chronic, requiring widely-varying and individual-specific treatment plans. Nothing really works, and we’re trading off different options with different bad side effects, and needing different levels of commitment from the patient.

End-of-life care, care for elderly, infirm, and handicapped, are very expensive, and all lie on a long string of quality vs. quantity choices. Does grandma really “need” a 5 star nursing home, a helper (a highly personal service! – could insurance or government “provide” housecleaning services successfully?) or just support from family? Does “need” without considering cost, i.e. willingness to pay, really even begin to describe the economics of this decision? Should a family that decides to provide care, saving the nation hundreds of thousands, receive no benefit?

I had a back pain episode recently. (Somehow health policy always ends up with here’s-where-it-hurts personal anecdotes!) Did I “need” an MRI to really see the structural problem? Cortisone shots? Surgery? Physical therapy, or just a Xerox of recommended exercise? Therapy at the hospitals here, or at the specialty sports-rehab clinic that patches up the Bears? Or just a handful of ibuprofen and let it heal? Did my planned trip to Europe matter in this medical “need?”

And now the dirty little secrets. For most patients, “stop smoking, exercise and lose some weight” is the best advice they could take. Patient’s awful compliance is an open secret. How much drugs and treatment do patients “need” who won’t stop smoking, lose weight, exercise, do the physical therapy, or comply with drug regimes?

Another dirty little secret: Quality, both actual and perceived, varies enormously. Rates of medical errors, infection rates, rates of success in difficult procedures, just getting basic diagnoses right, or even washing hands often enough, vary widely. The quality of service provided, including everything from waiting times to convenience of making an appointment and whether the doctor answers emails varies as well. Concierge medicine is emerging really targeted to people tired of the whole runaround. And medicine is not perfect. For a range of conditions, we have imperfect treatments, and scientific knowledge of what works or doesn’t is changing fast.

If only it were so simple to determine “need.” If only people like me went away quickly when told we don’t “need” an MRI to find out why our backs hurt. Or if people with hard to diagnose illnesses like food allergies quietly went away rather than hold out hope that the next specialist will figure out the problem.

So what does “need” really mean for services like this? The only sensible economic definition I can think of is that “need” is the bundle of services you would choose if you were paying with your own money at the margin. You “need” that MRI to make sure your back pain won’t just heal after 6 weeks of ibuprofen if you’d be willing to shell out $1,000 of your own money to get it. (I am!) And you “need” it delivered at a convenient hour, tomorrow, rather than next week across town if you’re willing to pay that extra cost.

“At the margin” is important because intuitive thinking soon mixes up “what you’d rather spend money on with “what you can ‘afford.’” Suppose we offered each patient the choice, “well, your doctor prescribed this MRI. You can have the MRI or you can have $1000 in cash.” You “need” the MRI if you forego the cash and go through with the MRI.

This is an important and unsettling conceptual experiment. If I offer the cash and the patient decides if he wants to take the treatment or find a cheaper alternative, you can’t argue the patient “can’t afford” treatment. It’s unsettling, because we may suspect lots and lots of people would take the cash. So there is a lot of paternalism in health care, which we might be more upfront about.

In any case, once defined, it’s pretty clear that this “need” is essentially impossible to measure externally for a personal service with so much variety, and imperfection, as health care.

Moreover, many more people would “need” MRIs if competition and innovation drove the price down to $50, by any definition of “need.”

So, we’re just arguing about who makes the cost/benefit decision. What you “want” is where you make the cost/benefit decision. What you “need” is what I – or some panel of bureaucrats -- think you should get.

I think the word “need” also has a moral tone, “what society owes you.” This seems even harder to define or measure. How much back treatment did society owe me?

(A little digression for economists: You could quibble with my definition of “need” as “what you are willing to pay for,” because I left out income effects. Perhaps “need” can mean “what you would be willing to pay if you earned $500,000 a year?” Alas, we, as a society don’t have the resources to pay for that definition of “need.” We simply cannot all fly on private jets.

So, while private jet stories are fun, given the budget constraint, the relevant question is whether someone earning $50,000 a year would give a much different answer than someone earning $80,000 per year. And remember that the question is on the margin, with an insurance payment, voucher other lump-sum subsidy to offset income effects. Care for the very poor and indigent is a separate question, which I discuss below.

Now it’s not so obvious that income is the greatest source of variation in “willingness to pay,” in this relevant range. Variation across people within income categories is far greater for every other good, and complex service, so is likely to be greater for health care as well. So, while a relevant quibble, in the end I think an argument based on income effects in the definition of “need” is distraction.)

Bottom line

In sum, health care is a complex, highly varied personal service, not a simple well-defined commodity. The demand curve is as elastic as any in economics. When, where, how, how much, by who are vital components of that service. Objective and subjective quality, and corresponding cost, varies tremendously. The distinction between “need” and “want” is at best unmeasurable and at worst simply meaningless. The broken arm is a horrendously misleading anecdote.

But health care is an economic good. Health care is not that different from the services provided by lawyers, auto mechanics, home remodelers, tax accountants, financial planners, restaurants, airlines or college professors.

Payment-plan provision, with rationing by some external determination of “need,” is based on the opposite and false assumptions and thus pretty hopeless for health care. No planner can mimic the market outcome in which what you need is what you’re willing to pay for.

To some extent, private unregulated insurers can offer high quality vs. generic plans to sort patients ex-ante by quality vs. wiliness to pay. But regulation makes that sorting much harder: Once we force guaranteed issue at the same price, it’s next to impossible for insurers to maintain bare bones vs. fancy plans. The minute a bare-bones customer gets sick, he will demand to be issued a fancy plan at the same cost as everyone else. And health insurers will respond by tailoring plans to attract healthy consumers – free health club benefits – and discourage sick ones. The whole guaranteed issue + mandate arrangement assumes that health insurance is a generic good, not one with good-better-best quality and price points. Or it will soon be forced to be generic! And regulatory rationing cannot say that anyone should shop at Walmart.

The whole stated point of regulation is to ensure quality, of course, but it does a poor job on the dimensions we care about. Regulators can impose minimum standards, requiring degrees, certification, inspections, etc. and keep out really dangerous quacks. But beyond that they are terrible at pushing for higher quality, especially when quality is so much in the experience of a customer in a service-oriented business. Restaurant regulation keeps restaurants reasonably safe, but there’s no pressure for Joe’s Tacos to use better cuts of beef, let alone to adopt molecular gastronomy. Yelp ratings do that in a way no regulator can hope to do.

I conclude that at the margin, the consumer needs to be paying a lot closer to full marginal cost of health care, or, equivalently, receiving the full financial benefits of any economies which he is willing to accept.

The health-care market – supply and demand

The obvious problem here is that the cash market is dead. Making people pay, and shop, is unrealistic.

If you walk in to the University of Chicago Hospitals and say, “I don’t have insurance. I have a bank account. I’ll be paying cash,” their eyes will light up. “We’ll pay for 100 Medicare patients with this guy.” That’s like walking up to United Airlines and saying “I want to go to Paris, first class. Sell me a ticket.” Actually, it’s worse – at least United will quote you a price up front and on its website, and let you compare with American. So, insurance companies now function as purchasing agents, negotiating complex deals on our behalf.

Nobody in this room really needs health insurance for anything less than catastrophes. We pay for transmission repairs, leaking roofs, and vet bills out of pocket. Most people in this room send our kids to private schools, throwing away our right to expensive public education. We could easily “afford” most of our routine medical expenses, and even pretty big unplanned expenses, especially if we were paying commensurately lower health-insurance premiums.

But we all have health insurance, and deal with the paperwork nightmare.

Why? You don’t need an “insurance” company to negotiate your cellphone contract, home repair and rehab, mortgage, airline fare, legal bills, or clothes, and pay as we do for health. Why do you and I need a professional negotiator masquerading as an insurance company? Moreover, Dr. Jones is in Humana’s network, Dr. Smith is in Blue Cross’. What economic principle means I shouldn’t see Jones, just because some arcane negotiation took place behind the scenes? And what about the new low-cost specialty clinic that Dr. Thomas is setting up, which can’t get into either network?

The answer: we’re missing robust supply-side competition. Hospitals would never get away with obscure pricing, hidden rebates, or massive cross-subsidies if they were facing serious competition from new entrants who could peel you away – and peel you away from your expensive “price negotiator” as well.

The cash market is also dead because of the demand-side distortion: too many people have payment plans. Competing for cash customers just does not make enough money to keep a hospital going, and the pool of such customers is a lot sicker.

And a hospital must choose, basically to be all insurance or all cash. If it offers clear transparent prices to consumers, it can’t also play the game with insurance companies. (The spread of “concierge medicine,” the equivalent of private schools for people so fed up they just throw away health insurance, is an interesting phenomenon. But it’s still too small to affect the overall market. There aren’t any concierge, cash-only hospitals. That business seems to have to be off-shore. )

In a vicious circle, the absence of a functional cash market lies at the heart of many insurance and government “cost control” problems. Insurance functions best when it is a small part of a market, in which prices are set by “marginal consumers” paying cash, and competitive businesses supplying them.

With little price discovery left in health care, health insurers have to do all the price negotiation in a vacuum.

Airlines, restaurants, and car repair work reasonably well even though in each case a large fraction of consumers are not paying with their own money. Each has competitive supply, and a remaining fraction of consumers who feel marginal decisions, enough to allow price discovery and competitive pressure for efficiency.

The cash market is also dead, because of the vast system of cross-subsidies and implicit taxes in our health-care markets. Medicare and Medicaid pay less than cost. Protected insurance companies go along with partially cross-subsidizing them. The poor solvent cash customer cross-subsidizes everyone else.

Part of the reason for phony pricing is that hospitals know most “cash” customers won’t end up paying, so they will end up negotiating charity care. Nicholas Kristof’s story¹⁷ in the New York Times, of the travails of an uninsured friend who got cancer, unwittingly illustrates my point beautifully. The article cites completely ridiculous prices, then explains how his friend applied for charity care and had a $5500,000 bill knocked down to $1,339. But, just to reiterate how ridiculous the cash pricing is, wanted to charge $1,400 for an ambulance ride.

In sum, freeing up either supply or demand without freeing up the other will do little good. Increasing copays can help to ration expensive or overpriced services, but does not stimulate supply or efficiency as long as new entrants can’t come in and compete for business. And allowing new entrants in doesn’t do any good as long as few consumers are able to vote with their money.

We need to free up supply, demand, and health insurance!

Health Insurance

If cash markets were functional, health insurance could become what it should be: a way of protecting lifetime wealth from catastrophic shocks, like life insurance. Such insurance would, of course, be a lot cheaper. It would not have to be a negotiator and payment plan for routine expenses.

“Access” should mean a checkbook and a willing supplier, not a Federally Regulated payment plan. Insurance means your large-scale standard of living isn’t enormously impacted by rare events.

If there were functional cash markets, health savings accounts could substitute for much of the necessarily cumbersome functions of insurance. Health borrowing accounts, i.e. HSAs with a preapproved line of credit, which you can tap for unexpected expenses but are not insurance in the sense of transferring overall wealth, would help even more. Without functional (competitive) cash markets, HSAs are not that helpful.

Generic objections

The idea that health care and insurance can and should be provided by deregulated markets, and that existing regulations are the main source of our problems, is, perceived to be fairly radical within the current policy debate. Let me deal with a few of the standard objections.

The poor

“What about the homeless guy with a heart attack?”

Let’s not confuse the issue with charity. The goal here is to fix health insurance for the vast majority of Americans –people who buy houses, cars, and cell phones; people who buy insurance for their houses and life insurance so their families.

Yes, we will also need charity care for those who fall through the cracks, the victims of awful disasters, the very poor, and the mentally ill. This will be provided by government and by private charity. It has to be good enough to fulfill the responsibilities of a compassionate society, and just bad enough that few will choose it if they are capable of making choices. I wish it could be better, but that’s the best that is possible. For people who are simply poor, but competent, vouchers to buy health insurance or to refill health savings accounts make plenty of sense.

But supplying decent charity care does not require a vast “middle-class” entitlement, and regulation of health insurance and health care for everyone in the country, any more than providing decent homeless shelters (which we are pretty scandalously bad at) or housing subsidies for the poor (section 8) requires that we apply ACA style payment and regulation to your and my house, Holiday Inn or the Four Seasons. To take care of homeless people with heart attacks, where does it follow that your and my health insurance must cover first-dollar payment for wellness visits and acupuncture? The ACA is hardly a regulation minimally crafted to solve the problems of homeless people with heart attacks!

The straw man

There is a more general point here, which will appear time and again as I answer each criticism. The critics adduce a hypothetical anecdote in which one person is ill served, by a straw-man completely unregulated market, which nobody is advocating, with no charity or other care (which we’ve had for over 800 years¹⁸ , long before any government involvement at all). They conclude that the anecdote justifies the thousands of pages of the ACA, tens of thousands of pages of subsidiary regulation, and the mass of additional Federal, State, and Local regulation applying to every single person in the country.

How is it that we accept this deeply illogical argument, or that anyone in making it expects it to be taken seriously? If you can find one person who falls through the cracks, the government gets to regulate the whole market, not that we craft a minimal solution to fix that person’s problem.

But wait, will not one person fall through the cracks or be ill-served by the highly regulated system? If I find one Canadian grandma denied a hip replacement, or someone who can’t get a doctor to take her as a medicare patient, why do I not get to conclude that everyone must be left to the market?

Adverse selection

We all took that economics course, in which asymmetric information makes insurance markets impossible due to adverse selection. Sick people sign up in greater numbers, so premiums rise and the healthy go without. George Akerlof’s justly famous “Market for lemons” proved that used cars can’t be sold because sellers know more than buyers. Interestingly, Car Max is still in business.

Does a patient, with knowledge of aches and pains, really know so much more about likely cost than an insurance company, armed with a full set of computerized health records and whatever tests it wants to run? Life, property, and auto insurance markets at least exist, and function reasonably well despite the similar theoretical possibility of asymmetric information. Life insurance is also “guaranteed renewable,” meaning you are not dropped if you get sick.

Now, the “adverse selection” phenomenon, that sick people are more likely to buy insurance, and healthy people forego it, is a big problem. But the insurance company charges the same rate, not because it can’t tell who is sick – a fundamental, technological, and intractable information asymmetry. The insurance company charges the same rate because law and regulation force it not to use all the information it has. If anything, we have the opposite information problem: insurers know too much.

This source of adverse selection is a legal and regulatory problem, not an information problem, and easily solved. If insurance were freely rated, nobody would be denied. Sick people would pay more, but “Health status” insurance shows how to solve that. See footnote 2 for references.

Shopping paternalism.

Defenders of regulation reiterate the view that markets can't possibly work for health decisions,¹⁹

“A guy on his way to the hospital with a heart attack is in no position to negotiate the bill.” “One point I cannot agree with is that competition can work in health care, at least as it does in other markets. I cannot fathom how people faced with serious illness will ever make cost-based decisions”

“What about those who currently don't have the background and/or the economic circumstances to consume health care, (e.g. take anti-hypertensive medicine instead of [buying] an iphone)?”

Ezra Klein,²⁰ trying to understand why health-care prices are so high and so obscure,

Health care is an unusual product in that it is difficult, and sometimes impossible, for the customer to say “no.” In certain cases, the customer is passed out, or otherwise incapable of making decisions about her care, and the decisions are made by providers whose mandate is, correctly, to save lives rather than money.

In other cases, there is more time for loved ones to consider costs, but little emotional space to do so — no one wants to think there was something more they could have done to save their parent or child. It is not like buying a television, where you can easily comparison shop and walk out of the store, and even forgo the purchase if it’s too expensive. And imagine what you would pay for a television if the salesmen at Best Buy knew that you couldn’t leave without making a purchase.

New York Times columnist Bill Keller put it clearly, in “Five Obamacare Myths:²¹”

[Myth:] The unfettered marketplace is a better solution. To the extent there is a profound difference of principle anywhere in this debate, it lies here. Conservatives contend that if you give consumers a voucher or a tax credit and set them loose in the marketplace they will do a better job than government at finding the services — schools, retirement portfolios, or in this case health insurance policies — that fit their needs.

I’m a pretty devout capitalist, and I see that in some cases individual responsibility helps contain wasteful spending on health care. If you have to share the cost of that extra M.R.I. or elective surgery, you’ll think hard about whether you really need it. But I’m deeply suspicious of the claim that a health care system dominated by powerful vested interests and mystifying in its complexity can be tamed by consumers who are strapped for time, often poor, sometimes uneducated, confused and afraid.

“Ten percent of the population accounts for 60 percent of the health outlays,” said Davis. [Karen Davis, president of the Commonwealth Fund] “They are the very sick, and they are not really in a position to make cost-conscious choices.”

Now, “dominated by powerful vested interests and mystifying in its complexity” is a good point, which I also just made. But why is it so? Answer: because law and regulation have created that complexity and protected powerful interests from competition. And is the ACA really creating a simple clear system that will not be “dominated by powerful vested interests?” Or is it creating an absurdly complex system that will be, completely and intentionally, dominated by powerful vested interests?

But the core issue is these consumers who are “passed out, or otherwise incapable of making decisions about her care,” ”strapped for time, often poor, sometimes uneducated, confused and afraid,” and “not really in a position to make cost-conscious choices.”

Yes, a guy in the ambulance on his way to the hospital with a heart attack is not in a good position to negotiate. But what fraction of health care and its expense is caused by people with sudden, unexpected, debilitating conditions requiring immediate treatment? How many patients are literally passed out? Answer: next to nothing.

What does this story mean about treatment for, say, an obese person with diabetes and multiple complications, needing decades of treatment? For a cancer patient, facing years of choices over multiple experimental treatments? For a family, choosing long-term care options for a grandmother?

Most of the expense and problem in our health care system involves treatment of long-term, chronic conditions or (what turns out to be) end-of-life care, and involve many difficult decisions involving course of treatment, extent of treatment, method of delivery, and so on. These people can shop! We actually do a pretty decent job with heart attacks.

And even then... have they no families? If I’m on the way to the hospital, I call my wife. She’s a heck of a negotiator.

Moreover, health care is not a spot market, which people think about once, at 55, when they get a heart attack. It is a long-term relationship. When your car breaks down at the side of the road, you’re in a poor position to negotiate with the tow truck driver. That’s why you join AAA. If you, by virtue of being human, might someday need treatment for a heart attack, might you not purchase health insurance, or at least shop ahead of time for a long-term relationship to your hospital?

And what choices really need to be made here? Why are we even talking about “negotiation?” Look at any functional, competitive business. As a matter of fact, roadside car repair and interstate gas stations are remarkably honest. In a competitive, transparent market, a hospital that routinely overcharged cash customers with heart attacks would be creamed by Yelp reviews. Competition leads to clear posted prices, and businesses anxious to give a reputation for honest and efficient service.

It’s not even a realistic anecdote.

OK, some conditions really are unexpected, and incapacitating. Not everyone has a family. There will be people who are so obtuse they wouldn’t get around to thinking about these things, even if we were a society that let people die in the gutter, which we’re not, and maybe some hospital somewhere would pad someone’s bill a bit. But now we’re back to the straw man fallacy. The idea that ACA is a thoughtful, minimally designed intervention to solve the remaining problem is starting to look more and more ludicrous.

Take a closer look at Keller and Davis’ statement, ”strapped for time, often poor, sometimes uneducated, confused and afraid,” and “not really in a position to make cost-conscious choices.”

We’re talking about average Joe and Jane here, sorting through the forms on the insurance offerings to see which one offers better treatment for their diabetes-related complications. If Joe and Jane can’t be trusted to sort through this, how in the world can they be trusted to figure out whether they want a fixed or variable mortgage? Which cell phone or cable plan to buy? To deal with auto mechanics, contractors, lawyers, and financial planners? How can they be trusted to sign marriage or divorce documents, drive, or ... vote?

We have a name for this state of mind: legal incompetence. Keller, Davis, and company are saying that the majority of Americans, together with their families, are legally incompetent to manage the purchase of health insurance or health care. And, by implication, much of anything else.

Yes, there are some people who are legally incompetent. But straw man again, Keller and Davis are not advocating social services for the incompetent. They are defending the ACA, which applies to all of us. So, they must think the vast majority of us are incompetent.

This is a breathtaking aristocratic paternalism. Noblesse oblige. The poor little peasants cannot possibly be trusted to take care of themselves. We, the bien-pensants who administer the state, must make these decisions for them.

Let me ask any of you who still agree, does this mean YOU? When you are faced with cancer, do you really want to place your trust in the government health panel? Or is this just for the benighted lower classes, and you, of course, know how to find a good doctor and work the system?

And choice is always between alternatives. Sure, some people make awful decisions. The question is, can the ACA bureaucracy and insurance companies really do better? Yet you would not trust them to buy your shirts?

Really? Does this entire bureaucratic garganuta follow, not on the proposition that there is some fundamental economic market failure, but because…Americans are no good at shopping?

If anything, the opposite seems to be true. Where is it easier to shop, Southwest Airlines, or your average hospital? In the name of the consumer, who finds it hard to shop, we have created an arcane system where it is, in fact, nearly impossible to shop.

No. It’s not “health is too important to be left to the market.” It’s “health is so important --and so varied, so personal, and so subjective – that it must be left to the market.” If you don’t trust the vast majority of people to make the most important decisions of their lives, you’re a devout patrician, not a “devout capitalist.”

Theory and experience

I’m often told, “Well, fine, but this is just theory. Free market health care hasn’t been tried in a modern economy. All countries regulate health care or governments provide it.”

That’s the point of my extensive examples of other industries. As an economic good, there really isn’t much difference between health care and other complex personal services such as auto repair, legal services, home repair and remodeling, or college education. Yet these markets no not require “insurance” for access, nor must bureaucracies decide what every American “needs” even though the providers have considerably more expertise than the customer. Once upon a time all governments had monarchies. That observation didn’t prove monarchy was a better system.

Moreover, the pockets of health care that are out of the insurance system and allowed relatively competitive free entry operate reasonably well. Plastic surgery and dentistry are not disasters. Radial keratotomy (corrective eye surgery) is a good example, as specialization and competition has led both to lower costs and increased quality. I am not the first dog owner to notice how easy and relatively inexpensive cash-and-carry veterinary medicine is compared to the same treatment for humans. Concierge medicine is taking off.

If anyone is guilty of theorizing, it would seem to be the faith that the next round of brilliant ideas for layering on ACA-style regulation will lead finally to successful “cost control” that is not simply rationing, or will induce the radical quality improvement and innovation that we need, where the past ones have all failed.

Realistic freedom, help and vouchers

I do not require that you follow me to some unrealistic libertarian nirvana. “The unfettered free market,” where the improvident die in the gutter is another ridiculous straw man. Southwest’s pilots have FAA licenses. Walmart’s products pass the consumer product safety commission. We can argue about this stuff, but we don’t have to. A little freedom will go a long way. The market can survive a lot of regulation, even silly regulation.

In addition to the need for genuine charity care, there can stlll be lots of help in various places.

But a central principle of economics is, “don’t transfer income by distorting prices, or providing services.” The vast majority of any help and transition-smoothing can and should be given in the form of on-budget, lump-sum subsidies or vouchers, leaving marginal incentives intact.

When we transition to freely-rated lifelong individual insurance, individuals who are already sick face high premiums. That problem is easily solved with a voucher, or a lump-sum payment to their health savings accounts

The same principle applies to genetic diseases. Economics has long recognized the principle that insurance can’t insure events that have already happened, so lump-sum transfers are appropriate. But one-time, lump-sum transfers based on clearly defined events over which no one has control, such as a DNA marker, are much less distorting, or subject to abuse, than perpetual regulation and intervention in a market.

If we want to subsidize health care or insurance for old or poor people, give them a voucher. There is no reason the government should try to run an insurance company, and less reason to do it pass an implicit tax, by mandating that businesses “provide” insurance.

If we want to subsidize emergency rooms, let’s just do it. That will be much more efficient than forcing a big cross-subsidy scheme and blocking competition to keep them afloat. (Letting Walmart set up clinics would be a lot cheaper too!)

If you think people don’t get enough checkups when paying with their own money, give them a voucher. That’s much easier than passing a mandate that every company must provide first-dollar health payments with a long range of mandated benefits.

More generally, there is an income paternalism at work in health care policy, somewhat more reasonable than the “they can’t shop” paternalism I decried above, worth making explicit. Most people, when spending their own money at the margin, are likely to choose less health care than we, the self-appointed advisers to “policy-makers” would like. Already, they evidence tradeoffs that imply less health than we would like – they drink sugared sodas, eat fast foods, and don’t exercise enough. In my example that patients were offered an MRI or $1,000 in cash, I think we suspect that a lot of patients would choose the cash.

A good libertarian would say, well, let people choose more iphones and less health if that’s what they want. But we don’t have to have this argument. If you think people will spend too little on health overall, give them vouchers in a health-savings account. This maintains the efficiency of patient-driven choice, distorts the overall health vs. non-health price, without distorting relative prices or writing ten thousand pages of regulations and supply-side restrictions that gum up the entire system.

Now, you might object, that all these subsidies and vouchers will raise “costs” on the budget. But this happens simply because of phony accounting. If the government mandates that cardiac patients cross-subsidize emergency rooms this is exactly the same as a tax on cardiac services and an expenditure on emergency rooms. Actually, it’s a lot worse because the distortion of the current system is much greater. So any economically relevant accounting would recognize that we save money overall. Fixing the accounting is a lot better and cheaper project than keeping our ridiculously inefficient health care system.

"Politically feasible"

Well, my typical critic concludes, maybe you’re right about all this as a matter of economics, but it’s not politically feasible.

No, not now. But the alternative is not economically feasible, a sterner taskmaster. And what was not feasible today, can quickly become feasible tomorrow if it is correct, and once people understand it, and understand there is no option. Our job as economists is to figure out what works and explain it, not to bend reality to some notion of what today’s politicians are willing to say in public.

Our political conversation is truly lunatic. It is taken for granted in policy discussion that no American can be asked to “pay for” (directly, rather than through taxes) one cent of health cost risk. While they routinely pay for broken and crashed cars, destroyed houses, suffer huge risks in the job market, and shoulder housing, transport and other expenses much greater than the cost of health care. Yet while pretending nobody should pay for things, unfortunates who fall through the cracks can be handed ridiculous $550,000 bills for cancer treatment.

We can start by saying, out loud, health care is a good like any other. It is ok to ask Americans to pay for it, and to allow American companies to competitively supply it, just like any other. It is ok for insurance to retreat to its proper role, of protecting people from large shocks to wealth, rather than being a hugely inefficient payment plan. As car insurance does not pay your oil changes – after you fax in the forms in quintuplicate, obtain permission from your mechanic, go to the in-network mechanic, and wait 6 weeks, and answer a 20 page questionnaire about your repair history and driving habits.

Bottom line

Health care is a complex personal service, with wide variation in quality, both along measures of health outcomes and along more subjective dimensions of satisfaction. Its demand curve is very elastic – people will consume a lot at subsidized prices. The distinction between “want” and “need” is conceptually fuzzy, and nearly impossible to measure.

The big improvements in health care come from better technology. But big improvements in its delivery and average quality are also attainable. They come from much better human organization, as has happened recently in many other industries that have witnessed revolutionary supply competition. Yet achieving those improvements will displace lots of entrenched interests.

From these observations, simple conclusions follow.

Health care markets need a big supply-side revolution, in which the likes of Southwest Airlines, Walmart and Apple enter, improving business practices, increasing quality and transparency, and spurring innovation. And disrupting the many entrenched interests and cross-subsidies of the current system.

I outlined a long string of restrictions on competition that can be repealed, or modified to allow competition. At a minimum, every new regulation should be evaluated by its effect on competition by new entrants, or protection of incumbents, a consideration not even spoken in policy discussion today.

Health care is singularly ill-suited to payment-plan provision, either by government directly or by heavily regulated insurance by a few large well-protected businesses. A functional cash market must exist in which patients can realistically feel the marginal dollar cost of their treatment, or (equivalently) enjoy the full financial benefits of any economies of treatment they are willing to accept, and are not patsies for huge cross-subsidization and rent-seeking by an obscure system negotiated behind the scenes between big insurance companies, hospitals, and government.

Both supply and demand must be freed. Without supply competition, asking consumers to pay more will do little to spur efficiency. Without demand competition, new suppliers will not be able to succeed.

The alternative, doubling down regulations on an already highly regulated system, full of protected and politically connected incumbents and rent-seekers, has little chance of achieving these goals. Whether in the post-office model (government provision), or the 1950s-style regulated airline, utility or bank model (the ACA) this effort will just produce less efficiency, more costs, and another generation of bright ideas dashed. Oh ye reformers, remember that the last 20 bright ideas did not fail simply because the people in charge weren’t as smart as you are, or as well-meaning!

Footnotes

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1 John Cochrane is a Professor of Finance at the University of Chicago Booth School of Business, Adjunct Scholar of the Cato Institute, Senior Fellow of the Hoover institution and Research Associate of the NBER. Address: 5807 S. Woodlawn Chicago IL 60637, john.cochrane@chicagobooth.edu, http://faculty.chicagobooth.edu/john.cochrane/. This is an expanded version of remarks given at the conference, “The Future of Health Care Reform in the United States,” at the University of Chicago Law School, October 12 2012. I am grateful to Anup Malani for extensive and very helpful comments. ^↩
2 “Health-Status Insurance.” Cato Institute Policy Analysis No 633.(2009); “Time-Consistent Health Insurance” Journal of Political Economy, 103 (1995), 445-473; "What to do about pre-existing conditions Wall Street Journal August 14 2009; “Forget about the mandate” Bloobmerg Business Class July 12 2012; What to do on the Day after Obamacare Wall Street Journal April 2 2012; “The Real Trouble With the Birth-Control Mandate” Wall Street Journal February 9 2012; all available on my website, see footnote 1. ^↩
3 If personal experience is not enough to remind you how inefficient the current system is, I recommend Jonathan Rauch’s YouTube video, “If air travel worked like health care” http://www.youtube.com/watch?v=5J67xJKpB6c. Hat tip to Einer Elhauge who showed it at the conference. ^↩
4 Gawadne, Atul, 2012, “Big Med: Restaurant chains have managed to combine quality control, cost control, and innovation. Can health care?” New Yorker (August 13) http://www.newyorker.com/reporting/2012/08/13/120813fa_fact_gawande^↩
5 Chandra, Amitabh, and Jonathan Skinner, 2012, “Technology growth and expenditure growth in health care,” Journal of Economic Literature 50, (September 2012) 643-680.^↩
6 http://online.wsj.com/article/SB10000872396390443890304578009284279919750.html^↩
7 http://www.fff.org/comment/com1206y.asp^↩
8 http://www.ij.org/vacon^↩
9 Elhauge, Einer, ed. (2010) The Fragmentation of U.S. Health Care -- Causes and Solutions Oxford: Oxford University Press, quotes from the introductory chapter available at http://www.law.harvard.edu/faculty/elhauge/^↩
10 Lakdawalla, D., and T. Philipson (2006), “Non-Profit Production and Industry Performance”, Journal of Public Economics, v 90 (9), 1681-98. ^↩
11 Fama, Eugene F. and Michael Jensen, 1983, “Agency Problems and Residual Claims” Journal of Law and Economics, 26, 327-349. Fama and Jensen note that the presence of donors on boards of directors is an imperfect substitute for knowledgeable insiders and market discipline.^↩
12 For a description of the process, with however a view that it needs more not less regulation, see, Horwitz, Jill R. 2012, “State Oversight of Hospital Conversions: Preserving Trust or Protecting Health?” The Hauser Center for Nonprofit Organizations, The Kennedy School of Government, http://www.hks.harvard.edu/hauser/PDF_XLS/workingpapers/workingpaper_10.pdf.^↩
13 For an example of recent news coverage see “Regulators Seek to Cool Hospital-Deal Fever” Wall Street Journal, March 18, 2012. ^↩
14 At the conference, Meridith Rosenthal gave a wonderful presentation highlighting a wide range of complex payment schemes, and how they didn’t work out, a wider range of bright new ideas, and how little we know about how they work. Her conclusion was that lots more research will lead to something workable to patch up each leak. Mine was that jiggering health payment systems is the best modern example of the hopelessness of central planning. You can get some idea from Rosenthal, Meredith B., 2009, “What Works in Market-Oriented Health Policy?” New England Journal of Medicine 360, 2157-2160 (May 21) http://www.nejm.org/doi/full/10.1056/NEJMp0903166 And especially the table in Rosenthal, Meredith B., 2008, “Beyond Pay for Performance — Emerging Models of Provider-Payment Reform,” New England Journal of Medicine 359, 1197-1200 (September 18, 2008) http://www.nejm.org/doi/full/10.1056/NEJMp0804658 ^↩
15 For example, http://www.personalinjurylawupdate.com/damorelaw/2012/04/what-is-outsourced-radiology.html, complete with a link, “Read the tragic story of a now brain-damaged young woman who had 2 sets of x-rays - yet no one diagnosed her brain abscess,” and “Outsourcing radiology abdicates 3 of 4 of the core responsibilities of radiologists.^↩
16 http://online.wsj.com/article/SB10000872396390444017504577645193107383610.html^↩
17 Kristof, Nicholas D. “A Possibly Fatal Mistake,” New York Times October 12 2012, Sunday Review, http://www.nytimes.com/2012/10/14/opinion/sunday/kristof-a-possibly-fatal-mistake.html?ref=healthcare^↩
18 One reference: Founding of the Misericordia charitable hospital in Florence, 1244. http://www.misericordia.firenze.it/Home/ChiSiamo^↩
19 These quotes are from commenters on my blog, not a very authoritative source, but they put the view so clearly I couldn’t resist. http://johnhcochrane.blogspot.com/search/label/Health%20economics ^↩
20 http://www.washingtonpost.com/blogs/ezra-klein/post/why-an-mri-costs-1080-in-america-and-280-in-france/2011/08/25/gIQAVHztoR_blog.html^↩
21 http://www.nytimes.com/2012/07/16/opinion/keller-five-obamacare-myths.html, July 15 2012^↩