Economics

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Health Care Oddities

The silliness associated with health care can be extraordinary at times. Paul Krugman today comments on the apparently common notion that government health care cannot work – it does in many countries; and that a private system can work anywhere – it cannot, as I tried to explain yesterday.

Plus as he points out: America doesn’t have a totally private system anyway. Quite the contrary of all the health care dollars spent here 47% are accounted for by the government through Medicare and Medicaid; while private insurers foot the bill for 35%.

These numbers put a different gloss on the discussion.

They highlight, for instance, that controlling costs in the health care system has to include reform of the government provided side as well as the private side. This is where the so-called ‘moderate Republicans’ and ‘Blue Dogs Democrats’ find themselves trapped: they mostly voted for the Bush extension and modification of the Medicare system that specifically prevented the government from enacting cost control measures. For instance they made sure that there could be no hardball negotiation of drug prices. Their actions demonstrate that they are focused on protecting the profits of their campaign donors and are not concerned about deficits or cost control at all.

So whenever they warble about the cost of Obama’s health care reforms they are simply trying to divert our attention away from their true objective: keep the profit stream alive.

I am continually amazed at the hysteria whipped up about the word ‘socialized’ when it comes to medicine. With almost half our health care already delivered that way getting the rest reformed should be easy. But as the Krugman post illustrates there are some consumers who are blissfully unaware of the sources of their care.

Speaking personally: I have family members who rant endlessly about the inefficiency and waste of Medicare yet who relied totally on it for care when private insurance was either too expensive or refused to pay for certain kinds of care. It is this ability to receive help yet criticize the source of it simultaneously that muddies any rational debate over getting the system cleaned up.

These anecdotes highlights a few things:

  • Just how pernicious the ‘market magic’ ideology has become. Average Americans have been systematically misled into believing that free market can solve all economic problems. I don’t think there is a single respectable economist, no matter what their political convictions are, who believes that. On the contrary, the study of so-called ‘market failures’ has burgeoned in recent decades. The delivery of many services is best done either through a government system or through a private system heavily conditioned and regulated by government. Health care is manifestly one of those services.
  • You had better be careful with your lobbying. One of the strongest blocs of opposition to reform through the years has been the American Medical Association – and why not doctors and hospitals in America extract a huge rent from the system – yet even they are now facing the inevitable crush of the market: as the insurers push back to preserve profits the doctors find their own profits under attack. Similarly big companies like GM who wanted to scupper a government system and use health care as a ‘worker benefit’ now want to bail out because the cost of that benefit makes them uncompetitive in a global economy. Self-interested groups like these ignored the economics for as long as they could extract extra rents from the system. Once the cost of the fragmented system they advocated impinged on their profits they started to switch sides.
  • The American political system is infested with so much money getting legislation that actually helps voters is well nigh impossible. The flood of money from health care companies into Congress can only distort the process. Were this a foreign country we would all be sniggering at the utter corruption of such a process. Here we defend the same thing as ‘freedom of speech’. It takes a ridiculous amount of energy to overcome the corrupt bulwark that lobbyist money builds to defend a vested interest’s ability to game the system: doctors and insurance companies have succeeded for years in preventing health care reform so as to keep the gravy train alive. [I won’t mention bankers here, but they are even worse]. Now they complain … tough!

Finally I read a letter in today’s Financial Times advocating the old free market argument: the correspondent was defending the level of spending on health care along the lines of freedom of choice. If consumers want to spend 20% of GDP on health care we should let them … it’s their choice.

That is, of course, a red herring and should be ignored. Reform is necessary because even though we are consuming almost that much of GDP in health care, we are not getting a good return on our money. The outcomes do not justify the expenditure. Let me give you a simple concrete example that defeats the ‘freedom of choice’ argument: our system consumes millions of dollars a year on insurance company administration, some of which is designed – sensibly and properly because of the profit motive – to prevent the consumption of health care dollars by willing consumers by denying payment for service. In other words our system deliberately defeats freedom of choice and actually diverts money into that negative activity. Are freedom of choice advocates willing to strip insurance companies of that ability to protect their profits by forcing them to pay for all and any claims? If they are, then they have to advocate a non-free market solution. But to them only a free market can deliver ‘freedom of choice’ – their whole argument against reform rests on the potential ‘rationing’ represented by government intervention in the market. They want the market to ration via a price system. But that price system includes processes to limit choice! They are logically defeated. Their argument fails.

Meanwhile the ‘debate’ rumbles on, and we still sped too much on health care.

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More on Health Care

There seems to be a misconception that there is a viable purely market driven option for the provision of health care. There isn’t. The never was. Surprisingly there isn’t too much argument about this in the world of economics. The ability of a ‘free market’ to provide a satisfactory health care system was totally debunked a very long time ago by Kenneth Arrow, who is one of the post-war era’s most respected economists, and the co-author of something called the Arrow-Debreu model of general equilibrium that forms the backbone of modern textbook economics. He is hardly a left wing ideologue. His paper on health care insurance provides the definitive technical counter-argument to anyone suggesting that a market left to its own devices will allocate health care resources in a socially acceptable manner. It can’t because of some now well established and well studied aspects of market functioning.

The basic argument resolves itself down to the problem of uncertainty. A consumer of health care services cannot be presumed to know when those services will be required. Nor can they be presumed to be able to meet the cost of those services at the moment they are consumed since our experience shows that the cost will be very significant with respect to average wages. As a result the provision of health care becomes a problem of insurance. For the vast majority of the population the costs and uncertainties associated with them can only be managed in the context of an insurance like scheme.

But this immediately undermines some of the central theoretical concepts of a free market and introduces other, well known, problems that markets cannot cope with.

One example of such a problem is the selection process that is naturally associated with insurance. Markets operate on the assumption that business firms will maximize their profits. For an insurance company to meet this goal it must eliminate, as far as it can, known risks from the pool of consumers it is insuring. It does this by establishing all sorts of selection criteria: it tries to weed out anyone who is definitely going to make a claim. This is absolutely acceptable and expected in a free market. Anyone with a ‘prior’ condition; anyone with a family history of an inheritable condition; anyone with a high risk lifestyle; and anyone who even hints of being sure to make a claim must be eliminated from the insurance pool for the company to maximize its profits. In short: a ‘free market’ will avoid providing care to the sick.

That’s why the average insurance application form enquires about the things that it does. The application form is an indicator of what the real interest of an insurance company is: not paying money to claimants.

The normal insurance company rarely investigates the veracity of the information it receives on those application forms until it is forced to confront a claim. Again this is simply prudent free market practice. Only when the prospect of having to make a payment – which represents a loss to the insurance company – is it truly economical to check whether the claimant was telling the truth at the time of application. Good solid free market practice then dictates that the insurance company does everything it can to delay or avoid making a payment. In other words the dynamics of insurance is to avoid payments. Particularly if those payments were predictable. The whole theory of insurance is that it provides coverage for unpredictable things. Where predictability enters the equation, as in life insurance – we all die sometime – then the premiums are established to generate certain profit given actuarial experience. Since illness does not conform to actuarial experience ex ante – it does ex post – health care insurers go to great lengths to limit their losses by reducing the likelihood or having to make payments. So they offer insurance only to those who need it least.

Let me clarify that a bit.

Illness is an ‘uncertainty’. We use the word ‘risk’ too loosely. There is a huge difference between a ‘risk’ and an ‘uncertainty’.

Something that is ‘uncertain’ is unknown. It cannot be analyzed. We have no way of putting proper analytical boundaries around the problem so it remains a matter of conjecture or guesswork.

In contrast a ‘risk’ is something that we have information about – analytically we are able to assign probabilities to outcomes because we are aware of the likelihood of those outcomes, both in terms of their nature and frequency.

So there is great ‘uncertainty’ attaching to the question of someone having a form of cancer – we simply don’t know who will get it. But once we know who has cancer, we can talk of the ‘risks’ associated with survival and cure etc. The uncertainty is resolved into a risk.

Health insurance wants to pay only for uncertainties. They want to eliminate risks.

Hence the selection process to weed out ‘known risks’ like existing conditions etc.

There is no way within a free market to prevent this behavior. It is both expected and acceptable. It is what a free market should do.

But as you can easily see it is exactly the opposite of what we expect from health insurance from a social perspective. From a social perspective we want the sick to be covered, not just the healthy!

Not only this but it opens the system up to ‘gaming’ by consumers, which is the converse of an insurance company’s priority. People who ‘know’ they are healthy – the young adult population for instance – will avoid getting insurance which means the remaining pool of insured consumers is skewed towards the unhealthy. This skew produces a higher-than-need-be claim rate which, in turn drives the cost of coverage up for those in the pool.

So: a free market will inevitably run into difficulties. More to the point: within a free market there is no known way to avoid these difficulties.

Which is why there is no free market.

Since all societies want at least some of the sick to be covered they have devised alternatives to a free market: they ration via other means or they limit the freedom of the insurance companies to pursue maximum profits. Similarly the natural tendency towards gaming means that a free market will tend to produce an expensive solution.

So a purely privately and unrestricted insurance style system will, inevitably, be both more incomplete in coverage and more expensive, than a restricted or publicly funded one.

That this eludes those who still advocate private insurance is baffling since Arrow wrote about it in 1963.

However given the hegemony of ‘free market’ thinking over the past few decades I suppose it isn’t surprising to find that most people are not aware of the well known limitations on the ‘power’ of a market to solve all problems. The truth is that these limitations have been known for a long time within economics, but our ability to recall them was swamped by the ideologically driven wave of thought during the Reagan/Bush era. The fact is that markets do not always self correct – we have just learned that in the banking crisis – and that do not solve all problems more efficiently than other forms of rationing – this is the lesson of health care.

A free market system would most likely produce results that even the most ardent advocate of free markets would abhor. They simply haven’t though through the mechanics of a market system unfettered by regulatory limits. So to be pragmatic we need to limit the market in order to help it function acceptably by:

  1. Preventing gaming: all people should be forced to carry insurance. This will deepen the cash flow of the pool of insured and will drive down costs.
  2. Prevent socially unacceptable selection by insurance companies. This will widen coverage and increase costs.

Both of these steps are part of Obama’s reform project. Which is why it makes sense.

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Housing Perks Up

There’s no doubting that today’s release of the data for new home sales during June represents a marked improvement: we may be reaching the bottom of the real estate slump after all. This is obviously good news, so enjoy it.

The actual numbers are still nowhere near those of the heady peak bubble days, but they do show a decided firming. Especially in the lower price ranges where the combination of lower mortgage interest rates, lower prices, and the first time buyer tax credit have sparked a turn about in activity.

Sales rebounded to 384,000 in June, up 11% from the revised figure of 346,000 for May. Bear in mind, though, that last June sales were 488,000, or 21.3% higher than this year.

Another good sign was that sales improved in most regions, with only the South declining further.

Before we all get too euphoric, however, we should keep in mind that this turn about was strongly assisted by administration’s stimulus – specifically that tax credit for first time buyers. Once the effect of the tax credit wears off, as the number of people taking advantage of it dwindles, we will start to get a better indicator of just how resilient the turn around is.

Also, as I have argued before, there appears to be some ‘bottom feeding’ in the existing home sales numbers that have also shown some life: foreclosed homes constitute a very high percentage of sales, and therefore distort the figures somewhat. I think it quite possible that a similar effect is at work in the new homes data as well – in this case in the form of ‘distressed sales’ by builders who want to clear inventory. In fact the inventory of new homes awaiting sale dropped by about 4% last month, so the backlog is being cleared – at current sales levels there are a little under nine months worth of houses waiting to be sold, which is a marked improvement from the twelve months worth of inventory as recently as January. This elimination of unsold inventory will ultimately help put a floor under the fall in prices which have now fallen a further 12% in the last year.

What do we look for going forward?

  1. Will there be a continued reduction in inventories. I think so. This will help firm prices.
  2. Then what happens when the tax credit is no longer a driver of sales: in other words, just how robust is the market without a government subsidy?
  3. When will the South stop its free-fall: the Southern region constitutes the bulk of all home sales, until there is a turn around there the national figures will remain weak.
  4. How will a continuing rise in unemployment affect the immediate future? This slight recovery in the market may turn out to be a temporary ‘blip’ if the underlying economy doesn’t perk up.
  5. How much lower will prices have to go? There is no doubt that part of the recovery in recent months has been driven by the abundance of price cutting. I expect the prices in the housing market in general to continue to drift down throughout the year before hitting bottom next spring. Don’t forget that the price adjustment has shown a marked regional effect: some regions have dropped like a stone while others are only now on the way down, so the national figures may continue to fall even though some areas show a much firmer trend.
  6. The ‘time unsold’ is still drifting upwards – this is the measure of how long it takes to sell a new home. It is now up to almost a year, and has been steadily creeping up all year. As long as this continues all the activity will center around clearing out old inventory: the number of new homes under construction is now down to 113,000, compared with 201,000 in June last year.

All this implies that the market for new homes is settling in at a much lower level of activity. The bottom of the market is in sight, but there is no sign yet of growth. This is important because during most of the last business cycle construction provided one of the mainstays of job growth. So, by implication, a steady but low level of activity removes a very important job source from the economy.

Still it’s fun to report good news for a change.

Addendum:

A really interesting point made by Calculated Risk. There are most likely going to be ‘two bottoms’ in this real estate cycle: one for real estate investment and one for prices. This chart throws some historic perspective on the discussion. First it is clear that investment has now dropped to a very low level: as a percentage of GDP it is lower than at any time during the past forty years. And second, the cycle of price movements and investment movements are decoupled: the bottom for one is not necessarily the bottom for the other. In fact in the early 1990’s the bottom for real prices was a full five years after that of investment. The possible implication for us? That even though the housing industry might see some form of rebound in the near term, that does not mean prices will rebound. The price adjustment still appears to have more to go. Something worth thinking about.

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Weekend Round-Up

What did we learn this week?

  • That unemployment is going to be an intractable and long term problem. The free-fall phase of job losses seems to be ending, but the outlook for re-creating the lost jobs is very bleak. Frankly the sources of new jobs are still shrouded in mystery: the two strongest employers of recent years were construction and finance, neither of which appear likely to be generating huge demand for employees over the next few years. As long as employment lingers in the doldrums there is no way a recovery could be sustained. A ‘jobless’ recovery would be a very difficult problem to resolve because the political will to stimulate growth may be absent, yet the discontent amongst voters would be high.
  • Banking profits were generally stronger, but the details revealed near term difficulties. The administration has taken a very passive approach towards dealing with our banking problems. Yes they has spent a fortune on bailouts, but they have done very little to prevent a recurrence of the problems – just look at the Goldman Sachs bonus pool and you can see the source of our next bubble: the traders are on the loose again stacking up private gain knowing that the taxpayer will bail them out. Worse: buried in those bank earnings reports were the first signs of the commercial real estate debacle about to unfold. Our banks are not fixed yet by any means.
  • Ben Bernanke went to Congress to report on his ‘exit strategy’ from the extraordinary monetary stimulus the Fed has been providing. The bond market appears to have been soothed by his words. But he promptly ran into a political ambush: the Republicans all wanted to question him about the fiscal stimulus. They obviously were trying to get him to say it wasn’t working, and he was forced to be obscure in his responses, which, of course satisfied no one. As if that wasn’t bad enough his own position comes up for renewal next year so the rumor mongers are hard at it talking up possible replacements. Which has the effect of undermining his credibility right when we need him to be viewed as safe for the long term – those bond markets like continuity. He also managed to get into an open spat with Tim Geithner over financial reform: Geithner wants to be a little more aggressive and wants a new regulator to oversee consumer finance. Since such a new regulator would imply the Fed screwed up on mortgage oversight, Bernanke pushed back saying we didn’t need such a thing. Hey guys: there’s an economy to fix, just stop the bureaucratic infighting. Oh, and by the way: Geithner is right on this one.
  • Real estate perked up slightly. But it was a very ‘iffy’ report that suggested there was an improvement. The weight of foreclosures still hangs over home prices and will exert downward pressure for a while. The upward blip in sales reported this week can be explained by first time buyers exploiting one-off tax credits and ‘bottom feeders’ snapping up foreclosed houses at bargain prices. The vast middle and upper prices market is still in the tank and will remain there while sellers refuse to adjust to the new reality of lower prices. Plus, as I have mentioned, unemployment will keep many buyers off the market while they wait for more secure times to return.
  • To reinforce this point: consumer confidence slipped last month after having shown improvement in both of the prior two months. Clearly the notion that this is a long slog is beginning to settle in. Consumers are, at last, getting the message that there is no ‘silver bullet’ to resolve our crisis. The media reporting of ‘green shoots’ may have created an illusion that we were about to burst back sprinting: the bank crisis had faded from the front pages and the stimulus had been passed, so there was an expectation that a recovery and thus the ‘good times’ were just around the corner. No one viewing the data with a sobriety would have thought that, but the media has a short term focus. My fear is that the wrongheaded upbeat tone of May and June is not supplanted by an equally unnecessarily gloomy tone in July and August. This was always going to be a long fight. And its only just started.
  • Finally: it was a very bad week for economists. The internal fighting over the future of economic theory has burst onto the front pages. Several influential articles were printed this week, e.g. in the Economist and the Financial Times, over the collapse of consensus in economic theory. Some of us have been saying for years that there was no consensus, but now the ‘free marketeers’ have taken it on the chin even their friends in the media are chiming in and saying that free market theory sucks. From my point of view this is a welcome turn of events. But from a policy makers point of view the timing couldn’t be worse: with the ‘free market’ extremists of neo-classical economics now exposed as ideologically motivated and theoretically flawed the source of sound economic policy advice seems to be Keynesian. That incites the neo-classicists into apoplectic fits and forces them to write ridiculous op-ed pieces as a form of rebuttal. All of which causes even more confusion for both the public and politicians. But it’s great fun for those of us in the discussion.

Meanwhile the health care debate chugs on. I will leave you with a reference to today’s Financial Times, hardly a bastion of left wing or socialist thought, which argues that reform is not just necessary but vital. I couldn’t agree more. There are two issues that could cause the collapse of the economy in the medium term:

  1. The financial industry’s power and lack of control; and
  2. The huge cost and massive inefficiency of health care.

Ultimately we will be forced to reform both, because the status quo is simply unaffordable. Neither sector is serving us well. Both are making excessive profits and therefore extracting economic ‘rents’ which burden us all. Neither is remotely efficient. And either could destroy us.

To me health care is both a moral problem to be solved: I find it an abomination that the world’s richest country blithely ignores the health care issues of its poor; and a practical problem to be solved: we simply cannot afford the current system.

Either way reform is an imperative.

From where I sit any opposition to reform has to be based on a self-interest that is willing to jeopardize the economic welfare of the country. Those who oppose on the grounds of cost have yet to justify their support of the Bush tax cuts which cost us a lot more. Or they have to explain why every other country can afford something we cannot – are those foreigners simply better managers than we are? Or they have to justify why society should bear the costs of an immense and duplicative bureaucracy, one which offers, apparently, no offsetting advantage in terms of output.

It is a simple fact that our system is in the process of failing – wages are much lower, and the cost is out of control as a result of it.

It is also a simple fact that the free market cannot fix this problem. For the ‘market’ to work the incentive structure has to be transparent and obvious to all. This is not the case with our health care system: consumers of services do not bear the cost, so they have no incentive to demand better or cheaper service. So the producers of the service have no incentive to improve. On the contrary producers have every incentive to extract excessive profits by over-charging and over-prescribing, safe in the knowledge that their customers are not bearing the true costs of the service. Nor is there any pressure to improve outcomes or incentive to link costs with those outcomes.

In short health care in this country is a textbook example of the failure of a market.

For those of you who are aghast at the notion of a government run system, look at it this way: if you truly believe in free markets then pay the full cost of your care. All of it. Not a tax affected rate. Nor a subsidized rate. Pay the full cost. Right now that’s in the range of $15,000 per person per year. That’s before any service of course. Buy the insurance the way you buy car insurance: directly, not through an employer who masks the cost from you because they get a tax deduction [ By the way that tax deduction costs the taxpayers about $1.3 trillion a year or more than the cost of public health care for all]. Plus: accept the full consequences of a free market style insurance regime that will necessarily, for purely and sensible, profit motivated reasons, exclude anyone with a known illness or the aging since both those groups are loss makers for the profit system. Plus: accept that a free market system rations the sale of goods via a price mechanism, so there will always be some people who are too poor to afford coverage. Plus ask yourselves why it is that we as a nation do not ‘care’ about those who could not access a free market system.

Ultimately we have to learn that health care, like fresh air and clean water, are a ‘public’ good not a ‘private’ good. We all need to know that our fellow citizens are healthy so that we are not exposed to risk of disease from the uninsured. A sick person can impose a cost on you, so you may be forced to bear the cost of that fact that sick person had no health care. That disconnect between cause and effect is what makes health care a public good. The economic theories of the free market cannot deal with such public goods: they call things where the cost of something is borne by someone other than those consuming the goods or services ‘externalities’. The free market system is known to fail for externalities. Which is why the government has to step in.

But that’s enough for one week!

Enjoy the weekend everyone.

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Unemployment and Housing

Today’s news is generally slightly better. Not good. Very slightly better. Let’s take a look:

The weekly release of initial claims for unemployment showed a jump back up by 30,000 last week to 554,000. On the surface that’s obviously a move in the wrong direction. But, as I have cautioned before, one week is not a trend. The summer figures this year are being thrown out of whack by the seasonal adjustment factor the government applies to smooth out the temporary ups and downs associated with summer jobs, and summer furloughs etc. They do this so as to reveal the underlying ‘non-seasonal’ data. This year, however, and as I have reported before, the normal temporary blip up in unemployment associated with the auto industry’s traditional summer re-tooling is not happening – the carmakers have all gone through massive cost cutting or restructuring already so their summer furloughs are practically non-existent. Which means the government’s seasonal adjustment is skewing the data – there is no need to make the adjustment other than to be consistent with prior years.

So we should take the uptick in initial claims with a grain of salt. The four week moving average, which is more reliable anyway, fell by 19,000 to 566,000.

Meanwhile two other unemployment indicators were released today: the continuing claims data, which showed a marked decline of 88,000 to 6.22 million; and the ‘mass layoffs’ report – an indicator of how many instances there were of large scale layoffs [technically described as a layoff of at least 50 people at a single employer]- which fell by 170 to 2,763.

What to make of all this?

The job market remains grim. With there being no evidence of a return to hiring by business, the best explanation for the fall in ongoing unemployment aid claims is that people are exhausting there eligibility for aid and are simply dropping out of the workforce. The initial claims and mass layoffs seem to indicate a very gradual slowing of the rate of decline, but no strong improvement.

The job market is still very bad.

In contrast, housing is starting to show a little more life: the National Association of Realtors monthly release of existing home sales shoed a 3.6% improvement last month, the third straight month of gains. This is notable because it is the first time in five years that existing home sales have grown in three consecutive months. How important this trend is remains debatable. The inventory of unsold homes declined to about 9.4 months in June from May’s 9.8 months, but we don’t know if this decline was due to sales or due to discouraged sellers withdrawing from the market – the realtors don’t like to reveal that information. All of the gain came at the lower end of the market where the recent tax incentives have drawn plenty of new buyers onto the market. More expensive properties are not being sold at anywhere the same rate. Plus: the collapse of the housing market has created a flood of foreclosed properties that are being dumped by the banks: nearly a third of all sales last month were of foreclosed homes, which is not a sign of great strength.

So, while the realtors claim that the bottom of the market has been reached, I doubt that is true. There are significant regional markets where the price adjustment is only now taking place – New York City being an obvious example – while others have been devastated and are showing improvements from a disastrously low level.

Adding the unemployment and housing data together what do we get?

Not much!

We are still waiting for definitive signs of recovery. These indicators have some positive elements to them – the slight decline in the four week trend line of initial claims being one – but we would be grasping at very weak straws to argue that a recovery is just around the corner on the basis of this evidence. Plus the lingering rot throughout the job market has all the potential to kill off a housing recovery unless it reverses course soon: which it shows no signs of doing.

All in all: keep buckled up! We are nowhere near done with the recession.

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