Monday, December 06, 2004

A Malpractice of Economists

[UPDATE: (12-6-04) Andrew Samwick puts some numbers on the frame]

As noted in an earlier post on the Blogging Newmarks, there are a number of odd collectives describing groups of animals, such as a kaleidoscope of butterflies, a convocation of eagles, or--and closer to the point this post is going to make--a battery of barracudas.

The title of this post introduces one for economists who can't pass their own tests, nor have the requisite self-awareness to refrain from criticizing those who seem to be able to do so:

For this assertion that Bush is trying to "adhere strictly to economic theory" is simply and totally false.

I can think of five principles of economic theory that apply to employer-sponsored health insurance:

1. Cost shifting: coverage for those who don't have health insurance is ultimately paid for by those who do, causing all kinds of financing and incentive problems. Thus there is very good reason to subsidize coverage to try to minimize the number of uninsured.

Ahem, Professor, there are already "all kinds of financing and incentive problems" inherent in using insurance to finance expenditures. The question should be "how much" and "compared to what", and that's exactly what Greg Mankiw, Glenn Hubbard, and Kevin Hassett (all quoted in the article being criticized) are getting at.


2. Adverse selection: markets in which one party knows much more about the value of the deal than the other are markets that work badly.

Again describes the current situation. The entity paying the bills doesn't have the specific knowledge that the patient does about pain or other symptoms (nor the individual's tolerance), nor the first hand knowledge of the proposed treatment.

Health insurance markets work much better when what is insured is a group with statistically-predictable risks than an individual with idiosyncratic risks difficult for the insurer to discover.

Which ignores the perverse incentives created when insurance pays for anything other than a catastrophe that we can safely assume the person suffering it would avoid if possible. As you recognize:

3. Moral hazard: when insurance companies rather than patients bear the marginal costs of treatments, there is an incentive to overtreat--except where treatment has public-health external benefits, and except where the insurer has written the contract to control utilization.

And that moral hazard increases when it's combined with a ridiculous legal regime where doctors have been closing their practices rather than be sitting ducks for the John Edwards of the world. As George W. Bush specifically stated during one of the debates.

4. Coase theorem: Whenever informed and knowledgeable parties have reached agreement on the terms of a contract (i.e., comprehensive health insurance), do not presume that the government is doing anybody any favors by reaching in and monkeying with the contract terms.

Except that isn't the Coase Theorem (try Hayek). The point of the article is that "informed and knowledgeable parties have reached agreement" in an environment with perverse incentives. The Bush advisers are seeking to improve the incentives.

5. Transaction costs: pointless churning of industry structure can be very expensive indeed.

And finally and again, as we've moved to more and more reliance on insurance paying the bills of our health care we've increased health care as a share of GDP. But at least you mentioned "transaction costs" in the same post as "Coase Theorem".

Let's let Kevin Hassett have the last word:

"...such grumbling reflects a liberal propensity to dismiss the intellectual merit of Bush's policies, especially his economic proposals.

"The economy's doing great, but all you hear is complaints about the Bush economic team,"

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