heath care reform

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Health Care Summit and Housing: Blather and Gloom

Not just a big snow storm provided gloom at the end of the week. The report on existing home sales was miserable, and even the revision upward to fourth quarter GDP failed to lift the mood; it simply confirmed that growth still depends on one time efforts and is not yet strongly sustainable.

The National association of realtors reported today that sales of existing homes dropped 7.2% in January to an annual rate of 5.05 million. this is the lowest level for seven months and means we have given up all the gains of last summer and fall. there is not too much to say with regard to this, other than we can take it as yet another supporting datapoint confirming the sideways drift we now find ourselves in. One by one, most of the major economic indicators are shifting from positive to neutral. The gains of late last year are evaporating and we are being exposed to the distinct possibility of a halt to our current growth path.

That growth path is best described by the fourth quarter GDP figures that were revised in a report issued today.

The first estimate of fourth quarter growth had GDP rising at a 5.7% annual rate. This second report, based on more detailed information, alters that slightly and has growth at 5.9%.

Be careful with is number. looking into the details reveals that most of this growth came from sources unlikely to be repeated any time soon. In particular, a big chunk of it came from the inventory adjustment we were all talking about late last year. From the looks of the orders data earlier this week that adjustment has run its course and will not provide as substantial a boost in the next few quarters. Other strong points were an increase in non-residential investment – that the durable goods orders report on monday suggests is now weakening – and a better trade position produced by both a decrease in imports and an increase in exports. The problem with that trade improvement is that if, and when, the economy kicks into a higher gear imports will increase sharply, if for no other reason than oil consumption is highly sensitive to economic activity. With the dollar picking up value against the Euro, it is tough to see exports gaining speed too. So the bright spots in the fourth quarter provide little comfort for 2010.

In particular the drop in personal consumption expenditure is a worrisome trend. If that decline is repeated we would be left relying on those other factors to keep GDP growing. Given this week’s drop in consumer confidence it is very hard to argue that consumption is going to gather sufficient strength to offset the flattening out I expect in inventory adjustments.

So we remain firmly attached to life support. The good news is that there is plenty of stimulus impact coming on stream this year – probably enough to offset declines elsewhere. That buys us time to get consumption going.

Nonetheless this has been a very gloomy week.

And that gloom was not exactly lifted by the health care summit yesterday.

There is not much to be said for a multi-hour ideological stand-off. Nothing happened to elicit hope that a grand coalition would emerge and push reform through to the finishing line. Of course there is no surprise in what happened. The lines have been drawn months ago and are not about to be crossed. The issue of health care reform is such a divisive one for the political parties that I doubt compromise was possible even had the GOP made an effort to come around and support it.

The plain fact is that the Republicans, in their current ideological frame of mind, are dead set against reform for two reasons: one, they see it as a major political points gainer to resist what they characterize as yet another unaffordable government program; and, two, they are still mired in their Reagan inspired de-regulatory mindset.

The first of these requires the GOP to frame all reform as an expensive and bureaucratic waste of taxpayer money. In this they appear to have succeeded in part. This is despite the fact that the CBO has clearly said that the reform as it now stands is a major cost saver to the Federal budget.

The second line of attack is more important to them since it springs from their belief system: government is bad, markets are good. This requires them to defend the insurance companies and stop the government pooling resources in order to use its bargaining power to lower costs.

By combining opportunistic political posturing with a strongly market driven ideological sentiment the GOP has defined itself very clearly. Its ongoing problem will be squaring this with the general attitude of the voting public who remain supportive of reform. Were the GOP to articulate their true value system, which inevitably has to include the abolition of the New Deal safety net, they would face huge voter resistance, and the loss of any chance of regaining power in the near future. So they have come up with a different approach: obfuscation and obstruction in order to create a war of attrition. This is intended to buy enough time and to create enough confusion that the populace gets tired of the bickering and lashes out against Congress for its inaction. Such a backlash would hurt the Democrats more and would, possibly, return Congress to Republican hands.

The virtue of yesterday’s farce was that it called the bluff and ended any opportunity for the GOP to claim it had been ignored. As it stands the Senate bill – which has been passed – includes Democrats are balking at voting for the combined bill. This erosion of support within the Democratic ranks makes a complete mockery of the Republican claims that they had no influence or that they were ignored.

So what happens next?

Reconciliation, and an ‘up and down’ vote. The Republicans hate this prospect because it means, inevitably, that reform will pass. Their objection, repeated in the media, that such an important piece of legislation should not be subject to a simple partisan vote is arrant nonsense. Nor is it without precedent. A reconciliation vote has occurred twenty-one times in the last three decades, and most of them have been for highly contentious legislation. The Bush tax cuts were passed on a 50 – 50 vote with Cheney breaking the deadlock. Those tax cuts had a far greater impact on our budget than the proposed health care reform will ever have, and they were just as ideologically divisive. As the White House has pointed out: every single GOP Senator attending the summit yesterday and objecting to the ‘unfairness’ of reconciliation, has voted more than once along partisan lines in previous GOP inspired reconciliation votes.

So the only bump remaining in the road is that Democratic unease with passing the watered down and Republican influenced legislation.

So as the week ends we seem to be back in familiar territory: all blather in Washington; and all gloom in the economy.

Let’s hope spring gets here quickly. We all need some fresh air.

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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.