Robert Hansen's Blog

Various European Central Bank Topics

2011-12-29T14:27:00.005-05:00

Interesting things in Europe, where threats of various economic crises seem to have abated but not disappeared.

While Mario Draghi, the relatively new head of the European Central Bank, has been strident in saying that the ECB cannot be the lender of last resort to European governments, it seems that his actions are different from his words. Last week, the ECB opened up low interest (1%) three year loans to European banks in a "liquidity-providing operation" and banks promptly borrowed €489 billion. And this week, it was reported that the ECB's balance sheet had grown to €2.73 trillion, €553 billion higher than three months ago.

And as background, we have French President Sarkozy encouraging banks to run a "Sarkozy carry trade," that is, borrow from the ECB at 1% and invest it in sovereign government bonds that yield close to 7% (Italy). In fact, the ECB will even take those bonds as collateral on the loans! Not a bad deal if you can get it!

The expansion of the ECB balance sheet is of course from its lending program, among other things, and it represents an injection of high powered reserves into the European banking system. It seems to me to be quantitative easing, the new terminology for what we used to just call expansion of the money supply through open market operations.

By itself, this is not a bad thing, and in times of a liquidity crunch, such expansion is called for. However, there are some worries in the European situation. Are the loans to the European banks to help them with liquidity problems, or are the loans to the banks just a back-door way for the ECB to buy European government bonds? There certainly seems to have been an impact, as yields on Italian and Spanish bonds have fallen.

John Cochrane has a great editorial on many of these matters. Cochrane emphasizes how European banks have huge risks, as they have loaded up on sovereign bonds, and now they have even more incentive and ability to do so. And all this sovereign debt gets a zero weighting in the regulatory bank capital schema, meaning that it is considered risk-free!

To the extent that European banks run the Sarkozy carry trade, there is an interesting divergence between the US central bank policy and what the ECB is effectively doing. During the US credit crisis (post-Lehman) the Fed pumped up its balance sheet, partly through a policy of buying mortgage bonds issued by FannieMae and FreddieMac. This sounds similar to the ECB buying up bonds of Italy, Portugal and Spain. However, with the Fed and in the US, the bad practices that got us into the mess had ended -- the subprime market was shut, and even Freddie and Fannie tightened significantly their lending practices (so much so that it is too hard now for people to get a mortgage). In Europe, it is not yet clear that the government policies that got them into trouble have really been fixed. And the bonds sold by those governments are now on the balance sheet of the ECB.

Of Competition in Health Care, and Law Schools Too

2011-12-18T10:46:00.004-05:00

Yesterday I wrote that not much had been said about the new Wyden/Ryan “defined contribution” plan for Medicare. I guess I had not searched enough, for later I came across this piece by Krugman, Ron Wyden, Useful Idiot and in it he references a posting by Ezra Klein, Competition Hasn't Worked in Health Care.

Krugman's title is certainly choice, but besides that, we have these additional tidbits:

... Sen. Ron Wyden did indeed do a bad, bad thing in his joint proposal with Paul Ryan...So why would anyone who isn’t a right-wing ideologue propose that kind of degradation?

Also, Krugman states that

Looking both within the United States and across countries, if you ask which systems are best at cost control, the ranking looks like this:

Government provision as well as financing (socialized medicine) > single payer > market competition

The problem here is that Krugman is very careful to do his ranking only in regard to cost. The problem of Medicare is not just one of cost, although the public debate is focused on that. Everyone knows that there are consequences of holding down costs in the wrong way, for example, if the "doc fix" did not go into effect and doctors' reimbursements were to fall by 30%, there would be quality/access consequences. Even I have said that in the UK, with health care providers being employees of the government and all prices set by the government, you should be able to keep prices low. The problem of Medicare is one of providing high quality care at a cost that is politically acceptable. By framing the debate only around cost, Krugman simplifies things too much.

Krugman also states as his first reason for why competition can't work in health care: "Patients by and large don’t have the information to evaluate medical treatments... and he attributes this, rightly, to Kenneth Arrow some time ago. I will return to this "lack of information" idea below.

Ezra Klein is a little less vitriolic, but his thesis is that competition has never worked in health care and he asks for examples. Klein suffers from the same limitation of Krugman, which is that he focuses on the role of competition in helping to hold costs down, rather than the more relevant question of whether competition helps produce a (cost, quality) package that is more preferred. Klein crosses the border sometimes, however, and is less careful than Krugman to say that he is only talking about the ability of competition to hold cost down.

But let me take a shot at some that have worked even just on the cost side: Any self-insured employer with any sense puts its third party administrator contract up for bid occasionally, and lets health plans compete on price and quality. Health plans actually worry a lot about trying to control cost and improve care. Take a look at some of the cost control plans by BC/BS in Massachusetts. Or look at the number of instances in the past several years where a health plan has cut a hospital out of its network because that hospital's costs were too high. In my neighborhood, a company spun out of work from researchers at The Dartmouth Institute, Health Dialog, was sold to Bupa, a private for-profit British company with health insurance interests, for $775 million. One of the goals of Health Dialog is to help patients make more-informed decisions, which will result in better quality of care and often in lower cost. Folks might not look at something like Health Dialog as part of competition, but it is: It was a for-profit startup, funded by venture capital, and sold in a competitive marketplace to a larger company. The number of for-profit health care startups in our economy is large, and many of them are focused on cost control as well as better quality. In Hanover, we just had Iora Health, a for-profit startup, announce that it will be opening a new kind of primary care facility. I know that the intent here is to not only improve the coordination of care, but also to reduce cost. This is competition! In a government-financed and government-provided system, would we get such innovation?

Klein tries to negate the idea that the competitive bidding process for Medicare Part D is not responsible for its good performance, but there is no way he is going to succeed at that...just as I cannot succeed at saying the bidding process is mostly responsible for the good performance. However, there is a competitive bidding process, it works in establishing prices and giving choice, and I do know that companies think very seriously about how to bid in these auctions (this from talking to people who have advised companies in the bidding process). Note that I am NOT saying there are not issues with Medicare Part D, especially in regard to its complexity and some specific faults of its bidding process.

Consumer choice and competition "works" not just in Medicare Part D but also in the Federal employees health plan (competing plans with consumer choice) and in many countries, particularly Switzerland, where citizens (under an individual mandate) choose privately offered health insurance plans. Does "works" necessarily mean lower costs? No, of course not -- in what marketplace or for what product or service do we care only about cost (some, sure, but none with the complexity and importance of health).

Other areas where competition has worked in health care, to produce lower costs and/or higher quality? Production and marketing of generic drugs? Drug competition generally...is it really from the good will of the pharma companies that we get less costly ways to produce drugs? How about even much of the competition between hospitals? Yes, there are stories about how competition between hospitals results in an arms race for advanced medical equipment, but even in my local area there is some competition (smaller hospitals) for certain services in the hospital market, and it gives local consumers a cheaper and different alternative to the big medical complex known as Dartmouth Hitchcock. Local private practice doctors also provide a competitive -- yes, competitive -- alternative to doctors employed by DH. In the Boston market, it is at least legitimate to raise the question of whether the merger of major hospitals into the Partners group caused a significant decline in competition and increased medical prices -- see here, for reference to the MA Attorney General report on prices in Boston.

I could actually go on for some time showing where competition works in health care. Even given the unfair tilt towards focusing only on cost reductions, it is easier to answer than I thought it might be.

The better question is what things would look like if we did not have competition at all, say with a single government financed, government provided health care system.

At the heart of Krugman's dislke for a defined contribution Medicare plan (and Klein's too, I think) is this idea that consumers are just not informed and rational enough to make good decisions.

Instead of arguing about that one directly, let me note this other story from the NYT this morning, on how the American Bar Association puts all kinds of accreditation standards onto law schools. The thrust of the article's thesis is that the ABA makes all law schools meet very high quality standards (such as the number of full time vs. parttime faculty) so that there are no cheap law school alternatives.

Ah, but what would happen if we loosed different kinds of lawyers onto the ill-informed, irrational citizens that inhabit Krugman's and Klein's world? Obviously, the public needs to be protected from competition:

Members of the A.B.A. Section say the point of the standards is not to raise the cost of law school, or to limit competition. The point is to ensure that lawyers are well trained and that the public gets quality legal services.

”It’s pretty basic, and more or less the accreditation function that you’ll see for any profession,” says John O’Brien, chairman of the Section and dean of the New England School of Law. “You want to make certain that a school that is nationally approved is providing students with what they have a right to receive in terms of education. And at the other end you want to protect the public and make certain that graduates who offer themselves as qualified lawyers know what they’re doing.”

The Wyden/Ryan Medicare Plan

2011-12-17T16:30:00.002-05:00

Sen. Ron Wyden and Rep. Paul Ryan have a new plan for Medicare. It has gotten a surprisingly low amount of attention -- maybe the Republican primary is taking media precedence.

The proposal can be read here.

The main components of the plan are, in my order of interest/importance:

1. Seniors would choose their health coverage from competing plans on an exchange (the Medicare Exchange), similar to the way Medicare Part D works now. (Medicare Part D is prescription drug coverage. Companies wanting to offer drug coverage under the plan bid in regional markets and enrollees select their coverage from the offers made.) Plans would have to be approved, meaning that they would have to meet certain minimum standards of coverage.

2. The amount to be given to each enrollee as a subsidy for buying insurance would be determined by the auction. This subsidy would be either the second-lowest bid in the auction or the standard Medicare fee for service plan. See point 3 next.

3. One of the options would remain the standard Medicare fee for service option. This is not clear to me, but I guess the meaning is that the Federal government would have to put in a bid just like a private company. I am not sure what would prevent the government from always winning the auction, since they play with OPM (other people's money).

4. Exchanges would be on a regional basis, as for Medicare Part D.

5. If costs rose faster than 1% above nominal GDP growth, unspecified cost controls would kick in.

The idea deserves serious consideration. Moving Medicare toward a voucher/defined contribution plan makes a lot of sense to me. Such a change would get the government out of specifying how much providers are paid, leaving that to private insurers as is currently done (private insurers negotiate with hospitals and doctors to determine contract prices). Using a competitive bidding process to both select plans and to determine the subsidy amount seems to work well for Medicare Part D, so let's extend the model.

One of the interesting things will be if the subsidy is determined regionally or nationally. If done nationally, there will be some pain as enrollees in the high cost regions (see the Dartmouth Atlas) discover that their subsidy is not enough to buy any plan in that region. That would probably put more effective pressure on the high cost regions than anything the Center for Medicare and Medicaid seems able to do.

Al Gore's Manifesto for Sustainable Capitalism

2011-12-14T18:22:00.004-05:00

Al Gore and David Blood wrote an editorial in the WSJ titled a "Manifesto for Sustainable Capitalism."

A fair amount of this is actually fine -- essentially an argument for including what are now externalities into the economic calculus of firms and consumers. That is sound economics and policy. Of course, what the level of the externality is, in dollar terms, for any specific environmental problem is always a key question. I like to ask what I view as a telling question: What do you think the carbon tax should be, on the basis of a barrel of oil or gallon of gas?

But of course I could not read an article by Al Gore without having some arguments. This quote:

Before the crisis and since, we and others have called for a more responsible form of capitalism, what we call sustainable capitalism: a framework that seeks to maximize long-term economic value by reforming markets to address real needs while integrating environmental, social and governance (ESG) metrics throughout the decision-making process.

does worry me. Two things: first, what exactly is a "real" need? Who determines that? Is my desire for a fast car a real need? How about my desire for imported Scottish salmon?

The other thing that is a bit odd is the focus on long term value (I do like the metric of economic value, though). Yes, I do agree that there is at times too much focus on the short term. Examples abound. But to have one of the major actions proposed being an end to quarterly earnings reporting? That seems a stretch. Have they really thought out the unintended consequences of letting managers report only once or twice a year? I suppose my students might want grades to be issued only at the end of each year, yet I continue to push for grading at the end of each course.

So Laws do Work!

2011-12-14T18:08:00.002-05:00

Amazing. The new health care act requires employers who offer health insurance to employees to cover children up to the age of 26...no matter whether those "children" live at home, work elsewhere, are in college or not...

And with this mandate in place for almost a year, the Administration reports that almost 2.5 million additional young adults have received coverage.

We should not be surprised that this part of the health care law works.

I am a little ambivalent about it. Hopefully nobody thinks it comes for free, as any employer who falls under this mandate will experience additional costs. Those costs are generally going to be borne by employees, through higher health care premia, lower wages, and fewer jobs. Any self-insured employer could have offered such coverage on their own in the past; the fact that they did not might reveal that employees were not willing to bear the cost.

I also don't really like the principle and economics of making an employer responsible for the health care of a 25 year old who has nothing to do with that employer other than being the child of an employee. There is really nothing the employer is going to be able to do to influence the health of that individual (for actual employees, the employer might be able to do some things in the workplace to improve health). The law also really makes parents continue supporting their children well past the usual age where the youngsters are pushed out of the nest. Heck, why don't we mandate college tuition to be covered too?

The nice aspect of the law is that it does get young adults into the health insurance market during a time when they might choose to go without coverage. It seems to me that this law coupled with a "continuous coverage" provision would go a long way to making an individual mandate less necessary. So kids get covered through 26 with employer coverage; if they want health insurance at any other point in their life, let insurers put in a continuous coverage clause: an insurer must issue coverage so long as the individual has had continuous coverage. If someone has not had continuous coverage, have a high risk pool available, but make there be a cost to not maintaining continuous coverage.

Leverage Limits vs. the Euro Discipline Rules

2011-11-20T17:31:00.002-05:00

Much blame has been put on the 2004 regulatory change in the US that let investment banks increase their leverage and also changed the general regulatory regime to one of more self-regulation. See my post here and the related posts.

It is interesting to compare the attention that rule change received to the amount of recent coverage I have seen (almost none) on the rule changes in the Eurozone that let member countries run higher deficits and higher debt levels than the original pact allowed.

IN 2002, France and Germany ran deficits in excess of 3% of GDP, which the original Stability and Growth Pact allowed. By 2004, Greece, the Netherlands, Portugal and Italy were also beyond the limit. See Feldstein, "The Euro and the Stability Pact.

Nothing was done to the violators.

In March of 2005, the Pact was changed to make the limits even less meaningful: see the summary summary available here.

Also see the comment at the time by the European Central Bank:

PRESS RELEASE

21 March 2005 - Statement of the Governing Council on the ECOFIN Council’s report on Improving the implementation of the Stability and Growth Pact

The Governing Council of the ECB is seriously concerned about the proposed changes to the Stability and Growth Pact. It must be avoided that changes in the corrective arm undermine confidence in the fiscal framework of the European Union and the sustainability of public finances in the euro area Member States. As regards the preventive arm of the Pact, the Governing Council also takes note of some proposed changes which are in line with its possible strengthening.

Sound fiscal policies and a monetary policy geared to price stability are fundamental for the success of Economic and Monetary Union. They are prerequisites for macroeconomic stability, growth and cohesion in the euro area. It is imperative that Member States, the European Commission and the Council of the European Union implement the revised framework in a rigorous and consistent manner conducive to prudent fiscal policies.

More than ever, in the present circumstances, it is essential that all parties concerned fulfil their respective responsibilities. The public and the markets can trust that the Governing Council remains firmly committed to deliver on its mandate of maintaining price stability.

The Health Care/Jobs Bill

2011-11-16T09:37:00.002-05:00

It appears that the Patient Protection and Affordable Care Act has morphed into the jobs bill -- see this Reuters story.

The essence of the new initiative is that up to $1 billion (of the $10 billion set aside for "innovation" at the Center for Medicare and Medicaid Services (CMS)) will be used as grants for people who come up with good ideas to save money and improve care.

Ah, but the wrinkle is this:

"To get a grant, projects must start within six months and the program will concentrate on those ideas that spur the most hiring and workforce training, the Department of Health and Human Services said."

Here we have a perfect example of economic engineering. Give grants/subsidies/impose taxes, with a variety of specific constraints, all meant to achieve what some policymakers think is the current objective.

But what if the projects that save the most money are the ones that lay off a bunch of health care workers? Funny, but at our local hospital, layoffs are proceeding at a rapid rate. So we will have one set of incentives to lay people off and another set of incentives to hire new ones...but only in certain areas..."shovel ready health care projects."

The health care bill is starting to look like our tax code, and it hasn't even kicked in yet.

Interesting Issues on Greek Debt: Non-Participation in Exchange, and Non-Trigger of CDS

2011-11-06T06:18:00.008-05:00

It is interesting that the 50% writedown on Greek debt applies only to privately held debt (held by banks and I guess any other private individuals or institutions) NOT to the bonds held by the European Central Bank. (I believe that any bonds held by the European Financial Stability Facility will be excluded as well). The Economist notes the matter; also see this Bloomberg story.

How this discrimination actually works is interesting. The writedown is voluntary, and will be effected by an exchange of old bonds for new ones at some time in December. It seems that anyone is free to forego the exchange, and that will include the ECB. Holding on to your old bonds, however, will put you at some risk that the terms of those bonds will be changed down the road, along the lines of squeezing minority shareholders.

Why is the deal is struck this way, to allow the ECB and other public entities to avoid a loss? There is a cost: if the public sector holders also took part in the exchange, then the Greek solvency problem could be solved with a smaller writedown. That is, if the private sector only holds 60% of outstanding Greek debt, then a 50% writedown on that is equivalent to a 30% writedown on 100% of the outstanding debt.

What would happen if the ECB had to write down the value of its Greek debt? Would that be a problem for its balance sheet? Maybe.

Another possible explanation for the discriminatory treatment is that the purchases of Greek debt by the ECB were to help the banks in the first place, and those purchases might have been at close to face value. So letting the ECB avoid the writedown and putting more of it on the banks is just ex post recognition that the banks owned all this debt in the first place.

This situation also creates the potential for some private holders to not do the exchange, essentially casting their lot in with the ECB. How that strategy will play out is anyone's guess.

The second interesting thing is that the voluntary exchange will not, it appears, qualify as a credit event that would trigger credit default swap payments. CDS would normally be triggered if timely interest and/or principal payments are not received, and I guess an exchange does not meet that test. I have often had students question the idea of "voluntary" exchange in situations where one party is under duress. In this case of a voluntary bond exchange, I must admit to thinking that the definition of "voluntary" is sounding pretty Clinton-esque. I imagine there are some European banks who bought CDs to hedge the default risk of their Greek bonds and are pretty unhappy now to see that the insurance will not pay out.

Of course, none of this is written in stone yet...the last installment of bailout money to Greece has been held up by the political turmoil in Greece after Papandreou said he would put the deal to a vote.

Long Term Care Insurance, RIP

2011-10-14T17:54:00.002-05:00

The Obama Administration made a late Friday announcement to finally pull the plug on the long term care part of the health care bill. This long term care plan was known as CLASS, for Community Living Assistance Services and Support. It was designed as a supplemental insurance plan, with people paying premiums during their younger years in return for support when disabled later.

The plan had fundamental economic flaws, deriving from adverse selection effects: the program to be financially sustainable had to have a lot of healthy premium payers and relatively few payees. Analysis suggested that would not happen, with the program instead attracting initially unhealthy patients who would receive benefits for too short a period to cover their costs. If premiums were increased, the adverse selection would only grow worse.

A good description of CLASS is given by the Kaiser Family Foundation here.

Most interesting is that the Congressional Budget Office (CBO) credited CLASS with reducing the Federal deficit by $70 billion over the 10 year period that was used to measure the financial effect of the health plan. How does that fit with a plan that is now recognized as financially unsustainable? Well, there is a 5 year vesting requirement, so over the first 10 years of the plan, more money comes in than goes out...but it all falls apart in the later years. The savings projected from CLASS helped the bill to gain votes and be passed. (Interesting that adverse selection would work so strongly even with the 5 year vesting. I would like to see some of the models that have been used to analyze the program.)

How many other parts of the health care bill were designed as poorly as CLASS? And how much were "savings" from such ideas relied on to get the bill passed? What would happen if CBO were to re-score the bill now?

Health Confusion -- or Consistency?

2011-10-12T17:52:00.002-05:00

Two contrasting and interesting issues in health care arose in the last week.

First, we have the US Preventive Services Task Force recommending that men not get routine PSA tests to screen for prostate cancer. See here for one of the thousands of articles reporting the recommendation. Without going into too much detail, I would summarize the recommendation as being based on the test being relatively uninformative, especially in regard to distinguishing between cancers that will progress dangerously versus those that will remain contained. Further tests beyond the PSA -- biopsy -- run risks themselves, and are also unable to finely distinguish cancer types.

The recommendation runs afoul of a core principle in information economics, which is that more information is at worst valueless (and the recommendation is not based on cost of the test).

There are subsidiary assumptions that can make a test be of negative value, but I would like to see them laid out (for example, reliance on an expert for further actions, with that expert biased by an agency problem).

I continue to be bothered by this idea of not having a test. As one of my colleagues put it: Suppose a doctor did a PSA test on you and emailed you the results. You are saying that you would pay for a spam filter to keep from knowing the result? I think it is possible to set up an optimal decision rule based on test results, which given a noisy test, will often lead to no action. But in some extreme cases, it will lead to a biopsy, identification of a severe grade tumor, and surgery that is valuable. The key is to not taking action for many outcomes.

Second, we have a bill in California, passed by the CA legislature, that would REQUIRE doctors to inform women that their mammogram revealed they have "dense" breast tissue. Now I am really venturing outside of my area of even limited expertise, but the idea here seems to be that dense breast tissue can prevent a mammogram from revealing small tumors. So if women have dense breast tissue, their mammogram might not be as accurate, and they might want to have a different screening test.

Governor Jerry Brown vetoed this bill by the way.

So on the one hand, we have a recommendation that men NOT be given a test for cancer, partly on the grounds that it would lead to more testing, while on the other hand we have a law saying that women MUST be given information that will cause those women to have more tests.

While there might be some inconsistency here, the consistent theme is that consumer/patients are not good at making health care decisions.

Medical Marijuana Confusion and Irony

2011-10-10T09:25:00.003-05:00

Another story that hit while I was in San Francisco concerns a new crackdown by the US Department of Justice over medical marijuana dispensaries -- see, for instance, "Feds' confusing crackdown on medical marijuana."

Based on my anecdotal evidence, the medical marijuana road is indeed a slippery one. Getting a prescription seems relatively easy, with prescribing doctors and dispensaries sometimes vertically integrated. And allowing medical card holders to grow their own probably allows a reasonable amount of pot to get into the general marketplace.

Irony abounds in the politics around marijuana. The Republicans, who generally favor individual liberty in the economic sphere, want to restrict our ability to do what we want with our bodies and brains. The Democrats, and the liberals, while favoring liberty in the social sphere (to their credit, I would editorialize) generally like to restrict our economic freedom. I trust the Libertarians are the only philosophically consistent ones.

And now we have the Obama administration, that up to now was averting its eye from medical marijuana, getting quite aggressive about policing the dispensaries.

One of the more interesting policing actions is that the Feds have sent letters to LANDLORDS of medical dispensaries, threatening them with alleged violations and pointing out that the penalty could be confiscation of the property.

Maybe this is why there are actually delivery services for medical marijuana in California -- the cost of renting physical property has been pushed up by the threat of confiscation??

Fleet Week in San Francisco!

2011-10-07T18:28:00.003-05:00

I have been in San Francisco for the last two days,with one of the true highlights being a very impressive demonstration of US military might -- right over the City! I guess it is Fleet Week, and the Navy's Blue Angels have been flying over the city, showing off really nicely. The jets scream -- literally -- right over the tops of the buildings. Amazing and pretty frightening at times.

The irony of this display going on over liberal San Francisco makes it all the better. I understand that Senator Diane Feinstein actually came up with the idea for Fleet Week.

Shut Out

2011-09-02T18:39:00.002-05:00

The August 2011 employment report shows that nonfarm employment in August was exactly what it was in July, for a net increase of zero jobs: "Nonfarm payroll employment was unchanged (0) in August, and the unemployment rate held at 9.1 percent, the U.S. Bureau of Labor Statistics reported today."

That is tough, especially with Obama giving a jobs talk next Thursday. There is something about that number zero that stands out.

Why is employment growth so slow? Nobody really knows of course. Animal spirits, as Keynes might have said, are not very aggressive right now.

I would point out some of the regulatory issues, however. The health reform act, whatever we think of its merits, was passed right when we were emerging from the recession. I wonder how many people actually know its major taxes and penalties? A few colleagues of mine just the other day discovered that the Medicare tax will be increasing for them. And for employers, do they really understand what the employer mandate does? If they don't provide insurance, there is a $2,000 fine for every employee they have, if even one employee buys subsidized insurance on an exchange. And if an employer provides insurance but it is not "affordable" then there is also a fine. The details are excruciatingly difficult to understand.

Obama's reversal today on ozone rules reflects at least a recognition of the political aspects of new regulations.

In my own world of academia, there is a new set of conflict of interest rules issued by National Institute of Health. Whereas before, researchers had to report their investments only when they believed a conflict existed, the new rules require researchers to report investments that are related to any of their institutional responsibilities, instead of only ones that are related to research activity. It will be up to the university to figure out if the investment is related to the research and if a conflict exits. This will require significant work. Again, whatever we think of the merits, let's be sure to understand the costs. (And let's not think of this as employment-increasing!)

Update on the Calm Before Storm

2011-08-27T17:57:00.002-05:00

Two more pictures, looking east over Goose Pond, New Hampshire. Definitely the calm before the storm. Even the loons are acting strange...scooting across the water chasing each other.

The Calm Before the Storm

2011-08-27T15:16:00.002-05:00

Above are two pictures of the Connecticut River in the Upper Valley of NH/VT -- just a few miles upstream of Hanover, NH.

As you can see, the water level is very low. Someone is looking ahead, and opened all the dams downstream to pull as much water out of the watershed as possible. With several inches due from Irene starting tonight, I greatly appreciate that.

Should be an interesting 24 hours. I do believe that the MSM has exaggerated the risk from this one and are not adjusting to Irene's weakening. But there will still be a lot of wind and water in areas that are already waterlogged.

Federal Spending Update

2011-08-25T18:15:00.002-05:00

The WSJ has a fine editorial today on the growth of Federal spending (see my related post below).

They report, on the basis of a Congressional Budget Office update, that the Federal government will spend an all-time record this fiscal year (which ends Sept. 30) -- $3.6 trillion dollars. That will be almost 24% of GDP.

The Journal article includes this chart, which shows the tremendous increase from 2008, and how the new level of Federal spending is looking more like a permanent new track rather than a temporary increase due to stimulus. All of this is consistent with my post below.

Also, it is interesting to note that the Select Committee on Deficit Reduction is charged with coming up with deficit reductions of $1.5 trillion over the next ten years -- that is, $150 billion per year.

Note well: $150 billion is 4% of fiscal year 2011 spending. 4%!!!???? All of this to get a 4% reduction in spending. Amazing.

Wisconsin Speaks

2011-08-10T08:02:00.003-05:00

Recall how Republicans in Wisconsin dealt public unions a body blow, and the liberal world erupted in agony? Remember that the Wisconsin Democrats decamped to a neighboring state to try and avoid a vote on the union issue? Remember how in almost all press reporting of the changes to unions' collective bargaining powers the word "stripped" was always used, as here

Tuesday's recalls were largely seen as a test of Republican Gov. Scott Walker, who has drawn national attention since unveiling his controversial plan to strip nearly all collective bargaining rights from most public workers.

Well, yesterday six recall elections were held, with six Republican senators up for recall. The Dems had to win 3 of these to take back the Wisconsin senate. The Dems only won two of the six.

It cannot be said better than this, from the same Wisconsin State Journal article as above:

"The revolution has not occurred," said UW-Milwaukee political science professor Mordecai Lee, a former Democratic lawmaker. "The proletariat did not take over the streets."

Take notice, world.

And Whither Europe?

2011-08-06T21:04:00.003-05:00

Here is a very good article laying out the tough choice facing European policy makers: Dan O'Brien's article in the Irish Times, see here.

What are the choices? One, Europe could become more integrated, which would allow a central finance authority to backstop the debt of the close-to-default nations -- Greece, Ireland, Portugal -- as well as the larger countries of Italy and Spain which are also showing fault lines.

Or Europe could disintegrate. Another interesting idea, see here, is that Germany and a few related countries would be the ones to leave the Euro. Interesting -- leave Greece and others to wallow in the Euro, but at least they don't have to rewrite all contracts. It probably is true that it would be easier for the stronger set of countries to leave the Euro (back to the DM?!) than for the weaker.

The problem with increased integration, as I see it, is that increased economic integration requires more political integration. Look at what the Greeks and others did when they could borrow in euros, even when they ostensibly had to pay back the debt themselves. What would happen if they could borrow in euros and have the debt be every European country's responsibility? Talk about a major free-rider problem. But how can all the countries of Europe give up their rights to determine their own levels of spending and taxation? And to the Germans?

I guess the third choice is to try and ride out the storm. Batten down the hatches, tie the rudder, furl the sails and hope that the boat doesn't founder.

Federal Government Spending, 2008-2011

2011-08-06T15:36:00.010-05:00

In light of S&P's downgrade of the US, it is interesting to take a look at Federal Government spending in the last three years 2008-2010 and this current year, 2011. Strictly speaking, the 2010 budget was the first one submitted by Obama; it was released in February 2009 after he took office. However, the American Recovery and Reinvestment Act was also passed in February 2009 and provided for economic stimulus spending of $800 billion over the next several years. It definitely impacted spending in 2009. Note also that while Obama has submitted a budget for every year of his presidency, Congress failed to pass a budget resolution for 2011 and will not do so for 2012 either.

Data are from GPO Access, see here.

Total outlays are as follows. Figures are in billions, so 2008 is $2.983 trillion.

2008 $2,983 billion
2009 $3,518
2010 $3,456
2011 (est.) $3,819

From 2008-2009, spending increased by 18%. Spending in 2011 will be, based on the estimate above, 28% above the level just three years earlier in 2008. The compound annual growth rate 2008-2011 is 8.5%. Over this same period, the general price level as measured by the CPI increased around 2% per year.

The broad based nature of the spending increase is striking. See the table I created showing expenditures by function. Figures here are in millions, not billions. The defense function in 2011 will account for $768 billion, or 20% of total Federal spending.

The figures for Energy are strange; in 2008 there was actually a $416 million surplus in a sub-energy account, Energy Supply, but by 2011 that account is negative $13.732 billion. But this is not the whole story in the energy area: energy conservation also goes from $409 million to $13.161 billion (I guess that was my metal roof that I got a tax credit for?)

I suppose that some of these increases are related to stimulus spending, but my fear and expectation is that any stimulus spending will end up being a permanent increase. In fact, projections for total spending in 2012 and 2103 from the same source above are $3,729 and $3,771 billion, hardly a significant decrease.

Is Federal government spending out of control? Indeed it has been. Is it any surprise that the voters sent Tea Party representatives to Congress to try and get some restraint? And are we surprised that our credit score took a hit?

The same source gives total tax revenues as well. In 2008, Federal receipts were $2,524 billion and in 2011 are estimated to be $2,174 billion, for a 14% reduction.

It was the sprouts!

2011-06-10T19:23:00.001-05:00

Or was it? Does this statement make any sense?

“It was the sprouts,” Mr. Burger said.

He said investigators had examined 112 people, 19 of whom had been infected with E. coli during a group visit to a single restaurant, and had examined recipes for the food they had eaten, spoken to the chefs and even examined photographs they had taken of one another with their choices of food on the table.

The aim was “to discover exactly how each meal was prepared, which ingredients went into it,” Mr. Burger said. Customers who ate sprouts were found to be almost nine times as likely to be infected as other diners. It was this trail that led health inspectors to the organic farm where the sprouts originated.

See the NY Times for full story.

Of Nukes and Cucumbers

2011-06-01T19:32:00.002-05:00

Germany has been impressing me lately with its lamentable public policy.

First, it announces the closure of several nuclear power plants and the future closure of all its nukes -- see here. This was on the basis of the Fukushima nuclear accident in Japan, caused by an earthquake and tsunami.

How many people were killed by the Fukushima accident? None. How many earthquakes and tsunamis has Germany recorded in the last century?

Meanwhile, Germany has 16 deaths from an e. Coli outbreak, with the deaths being violent and quick. Some officials in Germany quickly blamed cucumbers from Spain -- see here-- which was most likely a mistake. Spanish agriculture is naturally devastated, which is the last thing that country needs.

I wonder if Germany will now phase out cucumbers and raw vegetables generally. Was, kein mehr Gurken??

A Finnish Tea Party

2011-04-18T12:49:00.004-05:00

Being half Finn, I have to chuckle at the success of the True Finns party. Timo Soini is the head of the True Finns, and he was the individual getting the most votes in last Sunday's election. The True Finns won 39 seats in the 200 member parliament, up from six prior to that. The Finnish cabinet had to resign due to the upheaval and it is not clear what a new government will look like.

The True Finns are opposed to Eurozone bailouts of member countries, and any bailout requires unanimity among member countries including Finland.

Mr. Soini had this to say:

“We won’t be dictating conditions for the rest of Europe but we will maintain the right for Finland to decide for itself on money matters,” he said. “Finnish cows must be milked in Finland and we shouldn’t send their milk for charity outside the borders of this country.”

Seems to me that the Tea Party movement has spread beyond the US!

US Debt on Negative Outlook!

2011-04-18T11:16:00.002-05:00

The rating agency S&P today put out a negative outlook for the US debt rating, citing a deficit of 11% and no clear political consensus to do anything about it.

The White House had some interesting responses, according to CNBC. Among other things, the White House thought they should be given more time to get things in order before any ratings agencies take action.

Is this the same set of people who complained about slow ratings adjustments as Bear Stearns, AIG and Lehman were going down?

Ah, hypocrisy.

Thank you, Wisconsin!

2011-04-08T07:10:00.002-05:00

What a nice boost to optimism on a Friday morning!

Late Thursday afternoon, a county clerk in a Republican district in Wisconsin discovered that a bunch of votes had not been recorded in the recent Wisconsin Supreme Court race, and the net effect gave the incumbent Republican David Prosser a big lead -- big enough even to avoid a state-funded recount. This story has not reached much of the new services yet; read about it here.

The counting is not over yet, so let's not break out the champagne, but this is certainly a nice reversal.

To recap events, Gov. Scott Walker's attempt to shift power away from public employee unions and help Wisconsin cut its government spending had spread to the election for Supreme Court justice. The WI Court had a 4-3 Republican majority and was in line to review the bill that the WI legislature just passed. If the Republican incumbent Prosser lost, the philosophical majority of the Court would not be sympathetic to the legislation. What should have been a noneventful, low turnout, low budget election in a liberal midwestern state turned out to be a national referendum on Republican attempts to cut government spending.

Initial results showed an extremely close race, but with the challenger Kloppenburg in the lead by a couple hundred votes.

I tried hard to rationalize the results, arguing that given the amount of liberal money and media attention, the fact that the race was even close in liberal Wisconsin should be a victory. But it was disappointing, and consistent with my bigger fear: that the public, even in the face of clearly unsustainable Federal and State deficit spending, would lose its backbone and not support drastic cuts in spending.

Now everything looks different. If Prosser wins, the conclusion is thus: Even in a liberal stronghold, after the left's best shots, including weeks of protests in the Madison capital that was covered nonstop in the media, and even given that what the Republicans were doing could easilly be cast in bad light ("stripping away" the right to negotiate by unions in the state that invented public unions) -- the public in the end continues to support the Republicans!

I think the Democrats in Washington who believe that the public will support them in their battle to keep the status quo in Federal government spending better reconsider their assumptions.

Hospital and Ramsey Pricing: The Cost Shifting Issue

2011-03-05T09:55:00.004-05:00

A discussion I had the other evening with a hospital executive centered around issues of hospital pricing, costs, Medicaid, and market power. My comments along the lines of, "Hospitals face inelastic demands and little effective competition, and they price accordingly" got the executive justifiably agitated. It was a lively evening.

Let me present a violently simplified picture of hospital pricing. I will assume we are dealing with a nonprofit hospital, which essentially faces a "balanced budget" constraint.

Suppose that the state government cuts its Medicaid reimbursements to this hospital in response to state budgetary problems. So instead of getting the list price of $10,000 for a gall bladder surgery, and for which the hospital used to receive $2500 from Medicaid, the hospital will now receive only $2,000. All reimbursements are cut in this fashion.

Faced with a balanced budget constraint, what is our hospital to do? Well, about 60% of the hospital's patients use private insurance, typically through an employer. This is a very inelastic demand. As a hospital increases its prices to private insurers, about the worst that can happen is that one or more of those insurers will cut the hospital out of their preferred supplier network. This is a relatively unlikely occurrence, but of course it depends on the current level of prices, the amount of the increase, and the competition among insurers.

In fact, what provoked my evening discussion was my work on this case in New Hampshire between Anthem BCBS and Exeter Hospital. Anthem threatened to cut Exeter Hospital out of its supplier network, claiming that Exeter had higher prices than other suppliers.

Such events do happen, but they do not present enough of a reason to reject my assumption of inelastic demand for private insurers' patients.

So what is our budget-constrained hospital to do, faced with cuts in government reimbursements. Raise prices to the private insurance market, of course! This is the infamous "cost-shifting" phenomenon in health care.

However, this turns out to be exactly what a central planner concerned with welfare maximization would do -- or, shall we say, it is exactly what the doctor would order!

There is a well-known idea in economics, Ramsey pricing. The classic problem is exactly our setup from above: How should an organization price its products or services, if it has to balance its budget (zero profit) and it wants to maximize welfare of society? The answer is to price in inverse relation to demand elasticity: the most elastic products get the lowest prices and the least elastic products get the highest prices (prices are actually relative to marginal cost of production). The sense of this is as follows. For maximum welfare, you want to create the least distortion in consumer behavior from what is optimal. What would be optimal would be for consumers to buy the product right up to where their value equalled marginal cost of production. That would take a price equal to marginal cost, and will not be feasible with the budget constraint. So we price higher to the inelastic demands, knowing that consumers will not cut back much on their purchases -- hence we will get a lot of revenue.
for the elastic demands, we keep prices closer to marginal cost, for if we raised prices there, we would get a large cutback in consumption which is inefficient.

So cost shifting to the private insurance market is just Ramsey pricing.

And in fact, take an even broader view of what is going on. We have something that the public has deemed to be good -- provision of medical care to the poor. But how to pay for this? We could use broad income taxes, but those are hard to raise, and in fact, cause inefficient distortion for production throughout the economy. So let's just force hospitals to take really low prices for services provided to the poor, knowing very well that the impact will be to raise health care prices to the privately insured. Turns out to be an efficient implicit tax scheme.

There is another angle I could pursue as well, which is a bit of what I was doing with the health care exec. This one paints nonprofit hospitals in not such a benign fashion. Faced with an inelastic demand curve, what else might we expect hospitals to do? Since they are nonprofit, they cannot make money for shareholders. But, they can certainly make life nice for anyone who works there. They can make sure that docs have all the resources they want, far beyond what a pure cost/benefit analysis would justify. They can, if faced with rising costs for whatever reason, take the easy road and raise prices rather than take the hard road of pushing back on the cost increases. If a typical for-profit business in a competitive marketplace faces rising costs, it cannot just raise prices to make it up. Hospitals often do not face that kind of competition, for a variety of reasons.

Broccoli, Schmoccoli: A Mandate for Education

2011-02-26T21:31:00.006-05:00

As an argument against the individual mandate to buy health insurance, one often hears something like this: "If the government can force us to buy health insurance, they could also force us to buy GM cars or even broccoli!"

Those are rather lame analogies -- unrealistic and not truly parallel to health insurance. While forcing us to buy cars has probably already crossed some civil servant's mind, the auto market just does not have the features of health insurance to make it even a remote candidate for an individual mandate-type rule. And broccoli...come on.

Here is a better one. Let's look forward to the year 2025, and read an editorial in the New York Times supporting the College Responsibility and Accountability Program.

What is more important than education, as a means for upward mobility in society? What better than education to break the generational cycle of ignorance, poverty, and dependence? The statistical evidence confirms that there is no better investment than investment in oneself, through a great post-secondary, college education. Education is truly a "special" economic commodity. It deserves special social and legal consideration.

Yet the United States is failing in providing a reasonably priced college education for all those who could benefit from it. In fact, the United States spends considerably more of its GDP on education, but its citizens consistently perform worse than other countries on any measures of intellectual ability, be it verbal or quantitative. The rate of increase in tuition at American universities exceeds by a large margin the general rate of inflation, and it has done so for decades.

The reasons for this high-cost, low-quality education market are numerous, and the forces of change work at glacial speed in the education industry. We still teach in the same way that Socrates did thousands of years ago. Some professors still use a blackboard! Technology advances abound, yet their rate of adoption is tortoise-like. Variations in costs and outcomes across colleges are huge: the total cost of an MBA at a private university exceeds $140,000, yet the graduates of elite schools can calculate an NPV no better than graduates of state universities with costs significantly less.

High costs force high prices, and many students and their parents are deep in educational loan debt.

And of course, the main problem is that we have a huge uneducated portion of the population -- those who are essentially closed out of the educational market. Without a college education, the chances of these young people making it into the middle class are very low. Their children will be in an even worse situation. While luck sometimes will lift a family out of ignorance and poverty, we cannot rely on hope alone. Something has to be done.

Exacerbating the situation is ruinous, death-spiral inducing competition in the education market. The best private and public colleges, rich with donations from wealthy alumni and blessed with grand reputations and brand names, attract only the very brightest students with the most potential. The less qualified (at least as measured by test scores and high school records) end up at colleges with...less qualified professors, fewer resources, and worse opportunities. The best companies go to the best colleges to recruit those students, leaving graduates of lesser schools in the ranks of the unemployed. As opportunities at lower tier schools deteriorate, prospective students wisely choose to not attend. This is the lemons market of education.

The College Responsibility and Accountability Program promises a remedy. In today's world, we have to recognize that a college education is a right. We must provide all young Americans an excellent college education. To do so, an individual mandate for everyone to purchase a four-year college education is both necessary and proper. Without an individual mandate, too many young people will choose to not attend college, and many universities will be unable to adequately provide the necessary resources for those foresighted students who do attend.

There are those who say that the US Constitution does not give Congress the power to regulate the education market, or to regulate an inaction on the part of its citizens. Yet the education market is clearly an interstate market, with students freely flowing across state lines, making application of the interstate commerce clause a trivial exercise. And as for the argument that Congress lacks the power to regulate an inaction: What more significant action can there be than the failure to attend college? To characterize the decision to not attend college as the lack of a decision or the lack of an action is to fail to see the other side of a coin. Deciding to not attend college is a decision to free ride off the rest of society; it is a decision to save one's own money now with the guarantee that the rest of society will protect one later on. The aggregate effect of a large portion of our young population to not attend college will prevent efficient functioning of an interstate higher education market; the regulation of these decisions is therefore a necessary and proper exercise of Congress' enumerated Constitutional power to regulate interstate commerce.

The College Responsibility and Accountability Program has many other provisions besides the individual mandate. There are provisions for employer-based tuition credits; enhanced subsidies and tax credits for lower income students; and the establishment of pilot programs to bend the value curve in education. There is an innovative new system of state-level educational exchanges to permit students to pick the college education that best fits their needs -- with choices of bronze, silver, gold and platinum packages. Pricing of the options is tightly regulated, with pricing differentials allowed only for the length of the program and the degree offered.

But the individual mandate to buy post-secondary education from a Federally-accredited institution is an absolutely necessary part of the overall package. If the pool of students remains at only 60% of the potential, as it is now, this country will never achieve the high quality educational industry that we need to be competitive. Requiring the purchase of a college education, with generous subsidies for those in need, is not only constitutionally permitted but absolutely necessary.

More on Wisconsin

2011-02-19T09:36:00.003-05:00

An excellent article by Tim Carney gets, I think, to the heart of the issue about "stripping away" collective bargaining rights over non-wage aspects of government union workers.

Carney cites these statistics:

Four of the top six Wisconsin contributors to the 2010 elections were labor unions, with the state's teachers union giving $119,342 and the Wisconsin chapter of the American Federation of State, County, and Municipal Employees spending $83,888. The teachers union gave 96 percent of its money to Democrats, while Wisconsin AFSCME gave Democrats every penny.

Government unions spent $573,868 on Wisconsin's 2010 elections -- almost all of it going to Democrats -- while government employees spent another half million, with most going to Democrats.

I trust the broad thrust of these numbers -- the public unions whose collective bargaining rights are being stripped overwhelmingly support the Democratic Party.

Now put yourself in a taxpayer's situation. Public officials bargain with the unions. The unions support them, financially. Taxpayers have to monitor the relationship to make sure it does not get too cozy. The more complicated the bargaining -- the more dimensions for politicians to reward a focused group of supporters -- the more difficult it is for taxpayers to monitor the relationship.

If we are concerned about the classic problem of politics - the ability of politicians to focus benefits on a small group while imposing a small cost on a large diffuse set of taxpayers - I think we could make a strong case for making any bargaining between politicians and public unions (or any other group that fits the above description) as clear and transparent as possible. Having multiple dimensions of a contract up for grabs makes the task of monitoring difficult. In principle, if the union were truly bargaining with the principal (rather than the agent of the principal) then it could extract all that is possible via just one instrument, the cash compensation.

A downside to the Wisconsin solution might be that politicians can set the benefits at any level they want. So if a new regime comes in, it would seem that they would have even more ability to give out largesse to the public employees.

One also does have to admit the view that this is simply reneging on an earlier contract. I am not overly sympathetic to that view, as even in the private sector the contributions to health care and pensions are constantly changing. The idea that the nonwage components of compensation are sacrosanct certainly went out the window, even in academia, with the last financial crisis.

Antitrust Inquiry for Apple?

2011-02-18T19:47:00.002-05:00

Numerous reports on a potential FTC inquiry over Apple's policies on media subscriptions sold through its AppStore and billed through iTunes: see here for example.

What law is being violated here?

I have been waiting for Apple and publishers to get their collective act together and start offering some decent content, at a reasonable price, that I can access on my phone (preferred for now) or my iPad (birthday present coming up).

The complaint seems to be that Apple's 30% take is too large.

I ask again: What law is being broken here?

Fascinating Events in Wisconsin!

2011-02-18T19:31:00.003-05:00

How many people really understand just what "collective bargaining rights" the Wisconsin governor's (Republican Scott Walker) proposal "strips away?" ("Strips away" seems to be the favorite media phrase for it.)

If you want to design a health care plan for public sector employees that makes economic sense (as measured by maximizing the total net value) might it be the case that you don't want to bargain over deductibles, copays, and network coverage while you are also bargaining over wages?

And doesn't bargaining over wages give sufficient leverage for the union? If other parameters of the job are set, the residual falls onto the wage, and that is what can be collectively bargained over.

Two final thoughts. In regard to the Democrat legislators leaving the State to prevent a vote from being taken, I find this pretty humorous:

The Wisconsin Constitution prohibits police from arresting legislators while they're in session.

What, are you kidding -- the WI constitution has that kind of detail? Quote is from this MSNBC story.

Second, this will be I think a watershed event. Let's see who blinks.

UPDATE: A reader has pointed out my naivety. His explanation of the constitutional prohibition against arresting legislators is sensible -- supposedly arresting your opponents was common practice in olden times. And I thought it was just another perk of elected office. Even our NH constitution provides for this: "No member of the house of representatives, or senate shall be arrested, or held to bail, on mesne process, during his going to, returning from, or attendance upon, the court."

The Individual Mandate, The Coase Theorem, and the Takings Clause

2011-02-12T18:01:00.007-05:00

There is nothing improper in the means that Obamacare deploys. Laws may properly regulate both actions and inactions...

If Congress can tax me, and can use my tax dollars to buy a health insurance policy for me, why can't it tell me to get a policy myself (or pay extra taxes)?

These are two quotes from Prof. Akhil Amar's opinion piece in the LA Times, "Constitutional Showdown."

Is there really no substantive, principle-based distinction between regulating action vs. inaction? Or similarly, is it really the same to tax me and use the proceeds to buy insurance for me vs. telling me to buy a policy or pay a tax (penalty)?

I think there are very large differences, substantive differences based on very important principles, that would seem to have constitutional implications as well.

The differences relate to a famous theorem in economics, the Coase Theorem, and they also relate to the Takings Clause of the Constitution ("nor shall private property be taken for public use, without just compensation").

The Coase Theorem states that the final allocation of property rights is independent of the initial allocation, in the absence of transaction costs and income effects. It is a remarkable yet simple theorem (the best kind). I like to illustrate it with pollution. If firms have the legal right to pollute the air, one might think that we will get a lot of pollution. Yet in such a world, those affected by pollution could pay the firms to stop. Whether the bargain works will depend on the cost of stopping the pollution versus the costs of the pollution. Another legal regime would give the citizens the right to clean air. In that case, we might think that we would get perfectly clean air, but of course that is wrong: firms may buy the right to pollute from the ciitzens. Indeed, they will do so if the cost of not polluting exceeds the cost of the pollution to the citizens, hence the Coase Theorem: pollution levels will be the same, no matter the initial allocation of legal/property rights.

Of course, in a world with transaction costs and income effects, the initial allocation of rights does matter. If citizens have to buy the right to clean air, they will likely buy less than the amount they would keep in a regime where they had the right to clean air to begin with -- the main reason being an income effect. Having to buy the right to clean air reduces citizens' wealth, and that in turn affects how much clean air they want. Transaction costs reinforce this: such costs make trading of rights difficult, so the initial allocation of rights is sticky.

If polluters have the initial right to pollute, it is reasonable to believe that we will have more pollution than if citizens initially have the right to clean air.

Of course, the Coase Theorem does not deny that the allocation of wealth is (strongly) affected by the initial allocation of rights. Citizens are better off if they start with the rights.

The individual mandate can be seen as an initial allocation of rights in favor of the government -- I don't have the right to decide whether to buy or not, the government can mandate it. The transaction costs of buying that right back are low, however, as all I need to do to buy my freedom of choice back is pay the penalty.

Without a mandate, citizens have the legal right to choose insurance or not, and if the government wanted them to buy insurance, they would have to pay them to do so (subsidize the insurance). This means that the government will have to raise tax revenue, and the transaction costs of that are large.

Following Coasian logic, I conclude that there will be less insurance purchased in a regime without the individual mandate. My main rationale is that the government will find it hard to raise sufficient tax revenue to get to the same outcome they would achieve with the individual mandate. This is indeed the heart of the mandate: it is a cheap (to the government) way to get everyone insured.

Now let's think about the takings clause in the Constitution. I have not seen anyone raise it in light of the individual mandate, yet it seems to me to hold some relevance. What is more "private property" than one's own wealth/money? Isn't the government essentially "taking" our money and using it for public purpose when they say that we must buy insurance?

The takings clause is very important in our society. It restricts how much public policy the government can implement, by giving citizens the initial right to their property. In Coasian terms, the takings clause forces the government to buy our property if they want to use it for public purpose. The takings clause forces government to go to taxpayers to finance policy, and that is a difficult task. Following my Coasian arguments above, the takings clause results in less public policy. Think of how much environmental policy could be implemented if only government could appropriate any private land, without just compensation, to hold in its natural state for conservation reasons!

Many commentators are arguing that the individual mandate is constitutional because it is a "necessary and proper" way to implement a constitutionally acceptable regulation of interstate (health care) commerce.

"Proper" in this sense has always been interpreted to mean not inconsistent with any part of the Constitution. In the words of Justice Marshall, "let it be within the scope of the constitution, and all means which are appropriate, which are plainly adapted to that end, which are not prohibited, but consistent with the letter and spirit of the constitution, are constitutional."

The individual mandate seems to me to be inconsistent with the takings clause, at least in spirit. The takings clause makes the government bear the cost of its good intentions, in the sense that it must raise taxes on the citizenry. Doing good by taking private property is not allowed. I ask again: what is more private than my own wealth? Isn't it a "taking" for the government to tell me what I have to spend my money on? Doesn't the individual mandate represent the clearest taking of all?

PS. I could entertain the idea that just compensation is given, in that the individual receives insurance. But this is a hard story to tell, given the main reason for the mandate: to force a whole class of individuals into a transaction that a rational individual would not undertake.

The Stubborn Charade of the Individual Mandate

2011-02-02T08:52:00.002-05:00

Why the stubborn insistence that the individual mandate is absolutely necessary to effective reform of our health care system? I am somewhat baffled.

The individual mandate is combined with a penalty for not buying government approved insurance, and with subsidies for buying such insurance, where the subsidy depends on your income level. By 2016 the penalty will be the greater of 2.5% of income or $695. Coupled with the penalty will be a subsidized insurance policy available. Let's say just for argument that the subsidized price of insurance for such a person would be $3,000. Thus, the purely economic calculus is that the net cost of insurance is $2,305 -- the difference between the cost of insurance and the penalty. Presumably if the insurance is worth more than $2,305, such a person would buy it and avoid the penalty.

Of course it is extremely simple to achieve the same outcome purely with a larger subsidy. Just make the cost of the insurance $2,305. The economics of the situation are virtually identical (virtually in that the person's situation is improved by $695 in the second scenario, whether they buy insurance or not). The key point is that the difference in wealth between having insurance vs. not having insurance is $2305 in both scenarios, i.e., the real price of insurance is the same.

So why do folks insist on the mandate/penalty combination instead of the free choice/subsidy combination?

Well, the larger subsidy costs more tax revenues. That probably would not have passed even the 2010 Congress. Essentially the mandate is a way to shift the cost of the program from general tax revenues to individuals who are forced to buy a product they don't want to.

There are other ways to achieve larger participation in the health insurance market as well, such as open enrollment periods at certain times only, and imposing a real cost for noncontinuous coverage.

Strike Two Against the Individual Mandate

2011-02-01T19:03:00.003-05:00

A US District Court in Florida (R. Vinson, judge) issued summary judgment in support of 26 states who had brought suit against the Patient Protection and Affordable Care Act. The judge in the case considers two routes to a constitutional basis, flowing directly from the Commerce Clause and secondarily, resting on the Necessary and Proper Clause. As to the Commerce Clause, the telling summary is as follows:

Because I find both the “uniqueness” and “economic decision” arguments unpersuasive, I conclude that the individual mandate seeks to regulate economic inactivity, which is the very opposite of economic activity. And because activity is required under the Commerce Clause, the individual mandate exceeds Congress’ commerce power, as it is understood, defined, and applied in the existing Supreme Court case law.

As expected, the key point is that the Act requires action from an otherwise passive citizen, and this is not what the Commerce Clause permits, as defined in all previous Supreme Court decisions or by the Founders.

The Court secondarily turns to justifying the individual mandate on the basis of the Necessary and Proper Clause:

To make all Laws which shall be necessary and proper for carrying into Execution the foregoing Powers, and all other Powers vested by this Constitution in the Government of the United States, or in any Department or Officer thereof.

The argument here is a bit more convoluted in my humble opinion, but the judge's decision is clear:

The Necessary and Proper Clause cannot be utilized to “pass laws for the accomplishment of objects” that are not within Congress’ enumerated powers. As the previous analysis of the defendants’ Commerce Clause argument reveals, the individual mandate is neither within the letter nor the spirit of the Constitution. To uphold that provision via application of the Necessary and Proper Clause would authorize Congress to reach and regulate far beyond the currently established “outer limits” of the Commerce Clause and effectively remove all limits on federal power.

Again in my humble opinion, the Necessary and Proper Clause issue is an important one, and I do not find Judge Vinson convincing. It is a hard one -- if regulation of the insurance industry is the desired and constitutional end (justified via Commerce Clause) then isn't the individual mandate a necessary and proper means to that end?
It seems to me that one line of argument raised by Judge Vinson but not adequately argued is the difference between means and ends. I don't quite view the individual mandate as a means, but more of an end in itself. The language of the Clause is what I point to -- authorizing laws necessary for "carrying into execution." I can see the Constitutional basis of requirements for keeping records, or for creating criminal statutes for enforcing laws based on Constitutional powers. But is the individual mandate really a law necessary for "carrying into execution" the rest of the PPAC Act? Or is it an integral part of the Act itself, part of the ends that are being desired?

Another possible line of inquiry is that the individual mandate steps into territory that is normally reserved by the States -- a sure limiting factor to application of the Necessary and Proper Clause. The fact that Massachusetts already instituted a state level individual mandate would support this line of thinking.

Certain of Judge Vinson's words are being picked up by liberals, especially this part:

It is difficult to imagine that a nation which began, at least in part, as the result of opposition to a British mandate giving the East India Company a monopoly and imposing a nominal tax on all tea sold in America would have set out to create a government with the power to force people to buy tea in the first place. If Congress can penalize a passive individual for failing to engage in commerce, the enumeration of powers in the Constitution would have been in vain for it would be “difficult to perceive any limitation on federal power” [Lopez, supra, 514 U.S. at 564], and we would have a Constitution in name only. Surely this is not what the Founding Fathers could have intended.

Do you see Tea Party written all over that? Time for a Rorschach Test!

Beware Comma-Shaped Low Pressure Systems

2011-02-01T16:54:00.004-05:00

One picture says it all; this will be a fun storm.

ps. that little bit of blue in the Northeast dumped 4-6 inches today, as the opening act.

Dueling Financial Crisis Commission Reports

2011-01-29T19:43:00.002-05:00

The Financial Crisis Inquiry Commission released its massive report today, with a majority group taking the bulk of the report and then two dissents (by Republican members).

Lots of interesting facts, conjectures, and conclusions.

One of the main issues argued between the majority and the dissent is the role of the GSEs, Fannie Mae and Freddie Mac.

The majority downplays their role, accepting that they played a part but not being a primary cause. I guess I would tend to agree with that, but not to the extent of the majority. The majority report notes that

Importantly, GSE mortgage securities essentially maintained their value
throughout the crisis and did not contribute to the significant financial firm losses
that were central to the financial crisis. (page xxvi)

Peter Wallison, in his dissent, argues that the GSEs played a larger role. His Table 1 on page 456 is definitely of interest, showing that the two main GSEs held 39% of the total subprime mortgage principal as of 2008 (definitions of the Table are not precise, but the Pinto document referenced does help).

In thinking about the role of the GSEs, who bought a lot of subprime originations and held them, I thought of mortgage backed securities as a big set of joint products. The GSEs wanted the AAA tranches, and sure enough, as the majority points out, those securities and the similar whole loans the GSEs bought did not have significant actual losses. None of the AAA securities did. But: suppose a set of consumers has a large increase in demand for beef. That will result in an increase supply of cow hides, pushing down the price of hides -- and someone is going to buy the hides. So the GSEs wanted a lot of AAA securities, with the byproduct being a lot of mezzanine B rated paper. That paper had to go somewhere, even at lower prices/higher yields. At high enough yields, it was bought, and it seemed quite profitable to the investment banks who held it (maybe after it was repackaged in CDOs).

Another analogy would be the war on drugs. Isn't it the buyer of drugs who are the real problem? They create the demand, and the suppliers just respond.

So without the GSEs we might not have had so much supply of lower rated MBSs.

I don't want to go so far as to make the GSEs a primary cause of the crisis, but they played a pretty significant part.

And Now For This Commercial Message

2010-12-22T20:51:00.003-05:00

Check out this great new website -- www.newsle.com. The newsle service allows you to track news, the best news, about people. It works on both Facebook friends and on public figures.

This is my son's brainchild, along with his Harvard roommate, hence the full disclosure in this posting's title.

As Axel says, "The goal of Newsle is to make sure you never miss an important story about a friend, professional contact, or public figure you care about."

Go ahead, plug your favorite academic, businessperson, investor, or politician into it and see what news they are making or what is being said about them. Or maybe an ex-boyfriend or girlfriend, or the person who is threatening to sue you. I thought the CEO of BAA (operator of Heathrow airport) would make for an interesting search, which it does.

Key thing is newsle's ability to follow lots of people, with a very wide source of news, automatically for you.

Anyone have any commercialization ideas for this? Applications?

Chaos at Heathrow

2010-12-19T17:50:00.002-05:00

Due to "heavy" snow -- about 7 inches, as far as I can tell -- and freezing conditions (15 degrees F tonight) -- the situation at Heathrow airport is chaotic at best. Some poor folks will be spending their their second or even third night at the terminal, with flights having been cancelled since Friday on. No flights left Saturday, and very few today.

What a mess.

Perhaps the chaps who run Heathrow should take a visit to Logan or even better O'Hare. Six to seven inches of snow will not shut them for two days! But, there is the question of optimal investment in snow plows. If these events are rare at Heathrow, they should have less capability. Offsetting this, however, is the very large cost imposed in those rare circumstances. The concept of insurance comes to mind.

And the rarity of the circumstances seems to be changing! Last December Heathrow got belted with snow as well. Some government official was quoted as saying they were consulting with their chief science officer. I would love to hear that discussion.

It does make one wonder how well the climate models do in regard to regional effects.

Where's the Outrage Over the Tax Bill?

2010-12-15T18:39:00.003-05:00

When the Democratic Congress was loading the health care bill with sweeteners such as the Nebraska Medicaid exception (the Cornhusker Kickback) and other beauties like money for a new hospital in Connecticut, in order to buy votes, there was a nationwide outrage. Much of the pork, of course, remained, and one of the things I really don't like about the ACA is the amount of pork it spreads around. But there was outrage, especially from Republicans, and it did have some effect.

Now we have a Republican goal, extension of the Bush tax cuts, and the bill that emerges....surprise, surprise, it has a bunch of pork in order to buy support. Not only extension of unemployment benefits, but ethanol subsidies, investment credit, extension of child and marriage benefits....and the huge surprise of a one year reduction in the FICA payroll tax!! Where did that one come from? That I have to say makes no sense to me at all. We do not need more Keynesian stimulus financed by debt, and there is certainly no significant supply-side incentives created by a one year tax break that does not lower the marginal rate for anyone earning above the social security maximum earnings, a bit over $100,000. This one is truly a giveaway.

It really does seem that the Democrats and Republicans together are just trying to one up each other in how much money they can pretend to throw back to the taxpayers. Shameless.

But where is the outrage that we saw with the pork-laden health care bill?

Ah, hypocrisy. If one worries too much about all the hypocrisy in the world, one could work up to a real artery-buster.

If Obama wants to, I think the opportunity is there to show some real leadership by re-shaping the tax system.

Social Security vs. Individual Mandate: Constitutionality?

2010-12-14T11:58:00.002-05:00

It is interesting to ask the question of constitutionality about the Social Security system in the United States: Social Security seems on the surface to be a requirement that everyone purchase retirement and survivors' insurance, so how did that pass muster with the Supreme Court?

Well, a little study of history shows that this was a big controversy back in 1937, when the Supreme Court took the case Helvering v. Davis. The Court ruled that Social Security was constitutional under the Tax and Spending Clause, Article I Section 8 of the US Constitution.

The US government, in that case, went to great lengths to argue that Social Security was not an insurance plan. It was just public policy to provide for the general welfare of the country, and it was supported by a tax system not directly related to the specific policy. The Court agreed.

Note the difference with health care insurance today, and the individual mandate. It seems pretty clear that the individual mandate is to buy insurance -- a real contract with a private company, not a "maybe we will give you something when you retire" sort of scheme with the Federal government (again, the government argued that social security was NOT an insurance contract in the general meaning of that phrase). And you could avoid social security by not working and not paying the tax. The penalty of the individual mandate is a funny kind of tax for sure, which you avoid by engaging in the activity.

Remember that the individual mandate exists to avoid folks gaming the system, waiting until they get sick to buy insurance. Such behavior results in pre-exisiting conditions clauses, something most of us find very disturbing. But there are other ways around this problem, as in requiring insurance companies to issue to anyone who has continuous coverage (see my earlier posts). To save the folks who still game the system and end up sick and at our doors begging for mercy, there could be a high risk pool (as there now is) funded by general tax revenues...or even a tax on the insurance that the rest of us buy. Such a plan would seem to be on safer constitutional ground as it does not mandate that anyone do anything.

Such a plan is not without its problems, and would still be subject to gaming unless the high risk pool carried a significant cost, as in substandard coverage. Such a plan also would have would have made the price tag of dealing with those who try to avoid buying insurance real obvious, with the cost to everyone clear in the taxes they paid.

So in order to get the Bill passed (and I think to be able to say that the US has mandatory coverage) the Administration opted for the tactic of making everyone buy insurance, thereby avoiding the price coming to the government and having to be funded by taxes. And we are in the midst of a long protracted legal battle -- with declining support in the public and in Congress for the bill. Again, go back to the Social Security court fight -- there we had increasing public and Congressional support for the legislation.

Individual Mandate Ruled Unconstitutional

2010-12-13T13:22:00.005-05:00

Here is but one choice quote from the judge in Virginia (see here for the whole decision: "The use of the term "tax" appears to be a tactic to achieve enlarged regulatory license."

There were a couple main parts of the decision; this quote was a summary of why the penalty for not buying insurance cannot now be construed as a tax, and therefore constitutional under the taxing power.

The main part of the decision lays out the arguments for why inactivity cannot be regulated under the Commerce Clause, and why regulation of inactivity cannot be construed as constitutional under the Necessary and Proper Clause.

All in all, a very intriguing development. It concerns me that so little thought was put into this issue during the legislative process -- recall Nancy Pelosi's comments almost questioning someone's intelligence for even thinking that the law might be unconstitutional. "When CNSNews.com asked House Speaker Nancy Pelosi (D-Calif.) on Thursday where the Constitution authorized Congress to order Americans to buy health insurance--a mandate included in both the House and Senate versions of the health care bill--Pelosi dismissed the question by saying: “Are you serious? Are you serious?”"

Was so little thought also put into other elements of the health care bill, as in the employer mandates?

I think our country, through employers primarily, are in for a major regulatory burden because of this law. And it did not need to be that way.

See posts below on thoughts of avoiding the individual mandate. There are ways to get much of what we need to do in health insurance reform without an individual mandate. We will have to, however, be willing to face the consequence that someone who willingly goes without health insurance will be put into a high risk pool with limited coverage.

Admirers of European socialist-leaning democracies and health care reform zealots will bemoan the lack of Federal power in prescribing behavior of US citizens. I view this decision as a firm reminder that some principles stand above even health care -- as in, our system of a constitutional democracy whereby the Federal government has limited and enumerated powers. As much as we might like the ends here, the means are simply not justified, and that is a more important principle than getting health care for all through an individual mandate.

Thorny Issues of Insurance Availability and Renewability

2010-11-11T15:01:00.002-05:00

If the individual mandate gets struck down, as I argue could well happen in my post below, then other mechanisms will be needed to avoid the more egregious problems that tend to occur in health insurance markets.

I highly recommend two articles that address some of the issues in thought-provoking fashion: Cochrane, "Time Consistent Health Insurance," Journal of Political Economy 1995; and Patel and Pauly, "Guaranteed Renewability and the Problem of Risk Variation in Individual Health Insurance Markets," Health Affairs, Aug 28, 2002.

The Cochrane piece casts health insurance as having two components: the insurance of health expenses in a period, and then the insurance against premium increases in the future. His basic argument is for time consistent insurance contracts that get "marked to market" each year. If an insured has gotten sicker during the year, so that their risk-based premium increases for the future, then the "second" insurance contract pays an amount equal to the present value of those premium increases. Presto -- the consumer has the money to pay the increased premiums. The problem of having insurance companies raise premiums when you get sick has disappeared, through the magic of mark to market contracts! (As I note below, symmetry requires the consumer to pay money to the insurer if the consumer's health improves over time, but Cochrane shows that the cash flow implications of this can be easily dealt with.)

The Patel and Pauly article argues for a similar in spirit but practically different arrangement to prevent the problems of premium increases upon illness -- the idea of guaranteed renewability, and at a price that does not reflect any changes in health. So long as you stick with your existing insurer, they must renew you each year, and at prices that do not reflect your benefits history. In fact, as Patel and Pauly show, most states regulatory schemes already required this, and historically much insurance had this long term feature (see below my point on term life insurance).

Both of these papers show that one thorny issue, the prevention of having health insurance premiums skyrocket in price upon becoming sick, can be relatively easily solved, with a minimum of regulation. But in reading these papers, many ideas and concerns come to mind.

Think of your own term life insurance, if you have such insurance. I do, and it is guaranteed renewable for a term of 20 years. The price each year goes up only with my age -- an event that nobody can insure against! So I am protected against my insurer raising my price if they were to discover that I had a heart attack. Am I in some sense "stuck" with my company? Yes, at least if I am no longer healthy, because it would be hard for me to switch insurers at that point. But at least I still have my existing insurance. Is there the possibility that another company will try to induce healthy people away from their existing carriers with policies that reflect their lower risk? One would think so, but I am hardly inundated with such offers. One suspects that perhaps those kind of selection problems are not as serious as the textbooks make them sound.

A concern I have with the Cochrane idea is the ability for consumers and insurers to reap the benefits of specific investments in health. Suppose I do all I can to improve my health -- exercise, diet, all risk factors. Cochrane dismisses the role of behavior on health, but the thinking on that has evolved. Just look at obesity and diabetes. Much of my investments in health will be unobservable to others. As my insurance policy only gets marked to market on the basis of observable risk factors, I am left with no reason to improve my health. In fact, since the contract requires the consumer to pay money to the insurer if they get healthier (remember the consumer gets money from the insurer if they get sicker) I can envision negative incentives to invest in one's health. Of course, existing insurance policies also fail to give me much incentive to increase my health. And if an insurer were to spend money on consumers to improve their health (think employer-based insurance) there is no way for the insurer to recoup those investments if the consumer switches carriers. One yearns for a mechanism to make the new insurance carrier pay the old one for consumer-specific investments in health.

Neither the Cochrane or Patel/Pauly ideas covers the problem of people gaming an insurance system by not buying any insurance until they are sick. Cochrane might respond with, "well, they pay their risk-adjusted price at that time". The problem with that is that society will not tolerate the outcome of sick people facing prohibitively expensive insurance.

If the individual mandate is struck down, and the problem of gaming the system is quantitatively important to the overall insurance market, then there has to be some significant cost to people who wait until they are sick to buy insurance, enough to make such behavior unlikely in the aggregate. And this needs to be done without a mandate to buy insurance enforced via a penalty for not buying it. A reasonable approach might be a low quality Medicaid type insurance policy priced at a significant portion of income for those who have not maintained health insurance, public or private, over their lifetime. Since children are now on their parents' policies until 26, most children will automatically have continuous coverage through that age. All they would need to do at 26 is buy a longterm policy a la Cochrane or Patel/Pauly and maintain it until they hit Medicare age.

The Individual Mandate and Insurance Markets

2010-11-11T08:47:00.003-05:00

I believe there is at least an even chance that the Supreme Court will strike down the individual mandate in the new health care bill. Here is a paragraph from the Court's decision in US v. Lopez, the first case in decades that did limit the powers of Congress under the commerce clause of the Constitution:

We pause to consider the implications of the Government's arguments. The Government admits, under its "costs of crime" reasoning, that Congress could regulate not only all violent crime, but all activities that might lead to violent crime, regardless of how tenuously they relate to interstate commerce. See Tr. of Oral Arg. 8-9. Similarly, under the Government's "national productivity" reasoning, Congress could regulate any activity that it found was related to the economic productivity of individual citizens: family law (including marriage, divorce, and child custody), for example. Under the theories that the Government presents in support of § 922(q), it is difficult to perceive any limitation on federal power, even in areas such as criminal law enforcement or education where States historically have been sovereign. Thus, if we were to accept the Government's arguments, we are hard-pressed to posit any activity by an individual that Congress is without power to regulate.

This was the case on the Gun Free School Zones Act, and the Government argued that it had the power to regulate guns in school zones under the commerce clause because: a) guns increase the cost of crime, which affects commerce among the states; and b) guns and crime affect national productivity, which also affects commerce. The Court states quite clearly that these arguments would justify any police power at the Federal level and therefore cannot be right.

In terms of the individual mandate, the parallel argument would be that if inaction -- failure to buy a product -- is considered to be reachable under the commerce clause, then the regulatory power of the Congress would be expanded into a region that would further make the commerce clause infinitely powerful. In Lopez, the Court was willing to draw a line in front of an activity that was not sufficiently related to interstate commerce. I can certainly see another line being drawn, a very bright one it would seem, at the distinction between inactivity and activity.

If the mandate is struck down, then some creativity will be required in insurance markets in order to maintain some of the accomplishments of the health care bill, in particular the avoidance of universally-hated insurance policies such as restrictions on pre-existing conditions and indiscriminate premium increases. My next post will get into some of these issues.

Some Economics of the Employer Mandate

2010-10-29T09:23:00.007-05:00

It is exceedingly difficult to figure out from the text of the health bill itself just what are the employer responsibilities under the new health bill. First, which bill does one actually look to? The original House bill, the Senate bill, or the reconciliation bill? I have yet to sort that out...which gives you an idea why people can be justifiably upset about this legislation.

But I trust some lawyers and accountants to sort it out for me. See here for a nice summary piece from the law firm Mintz Levin. I have seen other descriptions that are the same, so I think this is correct.

The basic employer responsibility is two-fold: one, provide "minimum essential coverage" to your employees; and two, make sure it is affordable. Affordable is obviously a key definition. From the Mintz article: "...coverage is deemed "unaffordable" if the premium required to be paid by the employee exceeds 9.5% of the employee's household income." Also, a plan is unaffordable if it covers less than 60% of the total cost of benefits. That 60% rule is actually quite complex, as it involves the actuarial value of the plan with a standard pool of participants. Take a standard pool of participants, simulate them through your health plan -- if the participants pay more than 40% of total costs (through deuctibles and copays) on average, then you do not have an affordable plan.

If the employer does not offer coverage or affordable coverage, it will pay a penalty. The calculation of such penalty -- or is it a tax? -- is itself complicated, depending on the number of employees not being offered coverage and who get a subsidy on insurance they buy on their own (remember there is an individual mandate too). Let us say that it is $3000 per year per employee who does not get offered affordable, minimum essential coverage.

As I write this, I realize just how complex all of this is, and think that perhaps the biggest burden on business is going to be paying the accountants, lawyers and consultants to figure all this out. If the rate of business formation takes a hit, I for one won't be surprised.

But my main focus in this posting are the economic effects of the employer mandate on the labor market.

The basic economics would seem to be the following. Employers must offer employees subsidized insurance in additon to any wage paid. This lowers the demand curve for labor by the cost of the insurance to the employer. Employees get a subsidy, therefore the supply of labor also shifts down by the value of the insurance to the employee. The supply/demand figure shown here illustrates the shifts in the demand and supply for labor.

The key issues are these: (1), Is the cost of the insurance to the employer equal to the value of the insurance to the employee? (2), Can wages freely adjust?

As to point (1), if we took the position that $X of insurance provided by the employer must be valued at $X by the employee, then the way I have the curves depicted would be correct. The demand curve shifts down by $X and the supply curve also shifts down by $X (think of the wage and the insurance all being in annual amounts). Then the new equilibrium is at the same quantity, but at a wage that is reduced by $X. Think of it like this: The government says that employees must be paid 90% in cash and 10% in a dollar-based voucher that can be purchased on a dollar for dollar basis and can be spent on anything. Then the cost of a $1 voucher is $1 and the value to the employee is $1. Clearly this does not affect the equilibrium except that some of the wage is paid in vouchers instead of cold hard dollar bills.

In this case of health care, however, employees do not get vouchers for anything but they get a specific good, health insurance. Economic theory shows that payments in kind are generally worth less than payment in cash. That many employees do not now spend their money on insurance supports this idea. So in this case, the supply curve would shift down less than the demand curve shifts down, and employment will fall.

There is a counterargument, based on the market failure in insurance markets. Suppose that adverse selection is making insurance either unavailable or priced such that some individuals choose not to buy the policies available. Then $X of insurance offered by an employer could not only be valued at $X but even by more than that. In this case, the supply curve of labor would shift down by at least as much as the demand curve falls, and employment could even increase.

Point number (2) from above, can wages freely adjust, is also important to consider. First, wages are notoriously sticky downwards. This is the main reason why labor markets do not clear and we get unemployment. With sticky wages, the adjustments pictured in the graph will not happen, or at least not quickly. Labor demand will drop and labor supply might increase, but the money wage will not fall by the value of the insurance. In this case, labor demand will determine employment, which will be lower than before -- at the point where the old wage intersects the new and lower demand curve. Since more people are willing to work than before, there is observed unemployment.

Another reason for sticky downward wages is the minimum wage. To the extent that the current wage is already above market clearing levels because of government mandate, employment is already being determined by the labor demand curve alone. As that shifts down because of the insurance mandate, employment falls and measured unemployment increases.

The summary of all this? Using my prior beliefs on the differential value of insurance between employer and employed (reasonably higher to the employee) and the very significant downward inflexibility of wages, I predict less employment.

The Democrats' Closing Arguments

2010-10-29T07:48:00.002-05:00

Paul Krugman: "So if the elections go as expected next week, here’s my advice: Be afraid. Be very afraid."

Robert Reich:
"Why Business Should Fear the Tea Party"

President Obama: "We're gonna punish our enemies and we're gonna reward our friends who stand with us on issues that are important to us."

The comforting thought of Robert Reich looking out for business interests will keep me smiling all day long.

A Parking Proposal

2010-10-13T18:30:00.004-05:00

It always strikes me how unwilling many people are to use prices to solve problems of scarce resources. Parking on college campuses is a prime example, and Dartmouth serves well as a case in point.

The parking lot close to the Tuck School fills up by 8:15am; if you arrive after that, you will have to hike a distance of at least 10-15 minutes. Now I know that may not sound like a catastrophe, and even be good for one's health, but the value of people's time is significant. When it is raining or snowing, or just plain cold (as in below zero) a 15 minute walk across campus is quite unappealing. And of course it is on such days that the parking lot fills up by 8:05 am.

The major cost of not having adequate parking is that faculty will simply choose to not come in to work. On days when not teaching, a professor can just as effectively work from home. Unfortunately, they are then not mingling with others on campus and the lifeblood of the university -- collegial, intellectual interaction -- drains away. For junior faculty, if senior folks are not around, this is a very serious problem. This is not a visible effect, but it is there, and college administrators who ignore it are ill-advised.

This effect also occurs during the day, if an employee has to leave for an off-campus meeting. Not knowing if there will be a spot when they return, many will go home and finish the day there.

Other less important effects are the waste of time spent circling for a free spot (and the gas and carbon) and the time spent trying to be the early bird. I really hate seeing people idling their cars in the parking lot waiting for someone to show up and leave, yet that happens regularly. Where are the green police when you need them?

So what is the answer? Raise the price of parking in the lots closest to campus. Raise the prices until the market clears and the excess demand disappears. "The beatings will continue until the whining stops."

Why the vehement objection to something like this? The usual culprit is that lower-paid employees will not be able to afford the increases, or just that such price increases are a larger part of lower-paid employees' income, so they hurt them more. Yes, that is true, and it is a valid complaint. But the complaint is confusing the incentive effects of higher marginal prices with income effects.

The way to get around this objection is as follows. The rate for on-campus parking right now is $30 per month and $22.50 per month in remote lots. First point: these prices are way too low to have any meaningful incentive effects, and the discrepancy between lots is a joke -- $7.50 per month, $90 per year. Ha!

So the rates should be something like $100 per month for on-campus lots and $20 for remote. Now we are starting to get into an incentive-relevant region. I suspect many people would opt for a remote lot if it meant $960 per year in their pocket.

But here is the real kicker. To put just the price effect into play, without the negative aspects of an income effect, the College can give everyone a cash bonus in their paycheck equal to the increase in rates: $70 per month, or $840 per year. So everyone can keep their current parking and their overall financial situation is unchanged.

But! Anyone can also switch to a remote lot and save $80 per month! Note how this is more of a carrot approach than a stick. Instead of just saying, "parking is more expensive" we are saying, "Parking is more expensive, but we are going to give you additional money to spend how you like. For many of you, spending it on parking is probably not the best use."

Yes, to the extent that people switch to the lower cost lot, the College loses some money. I confidently conjecture that the gains from increased presence on campus and time and fuel savings will far outweigh the loss of revenue. But if that is such a big problem, then I propose this: have the cash bonus paid only to lower-income employees, accomplished through a sliding reduction of the payment. Something like this: the payment is the full $840 per year for anyone earning less than $50,000, and then it phases out linearly between $50K and $100K. This will make the proposal revenue neutral or even revenue positive for the College.

There are a few minor complications that would have to be dealt with, such as the fact that lower income employees actually only pay $12 and $9 for on-campus vs. remote parking right now. See how fairness and equity issues get resolved through pricing of resources -- exactly the last thing you want to do!! For crying out loud, a parking spot is a parking spot; its price has to be the same to everyone so that we all face the same cost of using it! Prices of parking will have to be raised significantly to these lower income folks, but again, they can be given a cash bonus to offset the impact. They will in the end be better off -- as evidenced by their willingness to forego expensive parking for more cash but more walking.

I am going to be pushing this one.

Patient-Based Cost Saving Incentives

2010-10-07T18:43:00.002-05:00

There is a lot of talk about new payment schemes for health care providers as possible ways to control health care cost and improve quality. The general principle behind the plans is to create incentives for providers to save cost while maintaining or even increasing quality. Payment systems have to put some risk onto the provider, as through a fixed payment for the care of a population, with residual risk borne by the provider. The theme of "accountable care organizations" includes some form of risk-sharing or savings-sharing, as do payment schemes such as "global payments" or "bundled payments." Of course, Medicare does this to some extent already, by paying providers a fixed fee for a DRG -- diagnostic related group.

What I don't see in any of these discussions is extension of the risk- or savings-sharing to the patient/consumer.

Without bringing the patient to bear on the equation, I fear that we will be trying to make the proverbial horse drink from the stream. We will encounter the problems that HMOs (health management organizations) encountered some years back, when consumers paying good money for health insurance ran up against providers who had incentives to reduce care. Yes, I understand that quality is in the forefront today, but I still think there is a basic conflict with consumers who face a marginal price of zero and a provider who wants to do less. That is a recipe for trouble. We have to somehow reduce the moral hazard problem of consumers demanding care to the point where marginal value is zero (which is typically the marginal price they pay).

One idea one of my colleagues has is for insurance companies to give consumers a lump sum when they are sick -- like your car insurer does when you have a crash. Broken leg? OK, that usually costs $10,00, so here is a check for that amount, do what you want.

The big problem with this is it puts all the risk onto the patient, who is even less able to bear financial risk from cost uncertainty than the provider. There is also the problem that some folks won't get the leg fixed -- we will be a nation of limpers.

But there is another way to do it. How about the insurer says: OK, broken leg, that usually costs $10,000 in our pool. If you can get your leg fixed for less than that, you get to keep 33% of the difference.

Voila!! No risk to the consumer, just upside potential. The insurer will have to price policies a bit higher on average, since they bear all the downside risk and share the upside. But that could be priced easily. As consumers started shopping around and asking providers to cut costs, the whole distribution of cost would shift down. This would unleash tremendous forces to cut cost while keeping quality high. And consumers would not be complaining, for they would be getting paid to save!

I like this idea a lot. It creates tremendously powerful incentives on the patient side, without the problems that other incentive mechanisms have. For example, high deductible policies have the (possible) risk of inducing patients to not take enough preventive care, and both deductibles and copays have to run out at some point if the consumer is not going to bear a tremendous amount of risk. In fact, this is such a good idea that it must be out there somewhere already.

More Fuel for the "Administration is Anti-Business" Fire

2010-10-05T18:29:00.005-05:00

The Obama Administration's Justice Department announced an antitrust suit against American Express, after Amex failed to agree to changes to its contracts with retailers. See here.

I have three thoughts on this case. First, I see it as an example of the "economic engineering" philosophy of the Obama administration economics policy. If they see something that they don't think is right, like credit card fees to retailers that seem too high (or health insurance prices), they look for some regulatory scheme to fix it. In this case, the regulatory scheme of choice is antitrust law (which is meant to prevent inefficient exercise of market power, not to simply push down prices that seem too high).

We had a seminar by Ed Leamer of UCLA last week, and in his paper he quoted Frederic Bastiat (1848) as follows: "There is only one difference between a bad economist and a good one: The bad economist confines himself to the visible effect; the good economist takes into account both the effect that can be seen and those effects that must be foreseen."

Economic engineering of the sort we are seeing is bad economics. It tries to regulate the visible and ignores the unpleasant fact that economic forces will cause adjustments and outcomes that are even worse. Regulating credit card fees sounds great for consumers, but what if it causes less competition in the credit market, or causes companies like American Express to change their very successful and consumer-friendly business model as a result? Or what if threatening insurance companies causes them to stop issuing policies?

My second thought is on why this is essentially an anti-business policy. At best, this policy is a misguided attempt to help "consumers" without consideration of the impact on companies and their owners (also consumers, but in the form of shareholders). That is antibusiness. Even worse, the policy smacks of pitting large business -- banks and payment networks -- against "small" business -- the retailers (is Gap really a small business though)? Even scarier is the hint that just like Secretary Sebelius in threatening insurers, this case is the follow-through of a threat by Justice against Amex: either change your behavior or we will bring you to court. While such threats are OK in many instances, I get the feeling that this Administration likes to flex its muscles a bit too much, and the flexing is usually aimed at getting prices to change from free market levels.

Third thought is on the antitrust case per se. Amex has about a 25% share of the card payments business, a level that is reasonably high but, I believe, below thresholds normally used in such cases. The overall market is somewhat concentrated, at least on some measures (not at the issuing bank level, but on the network level). These facts I agree make the case interesting. However, Amex has a very good efficiency argument for its policy of not permitting retailers to offer consumers discounts for using non-Amex cards: such behavior is free-riding off the investment that Amex has made in its brand name and what "American Express Accepted Here" means. Consumers are attracted to stores that display the Amex logo, but once in the store, the retailer has incentive to induce them to use other payment means. But Amex only collects revenue if the consumer who was brought into the store by the Amex logo then uses the Amex card. Go back and read the classic article, Howard P. Marvel, Exclusive Dealing, 25 J. L. & Econ. 1 (1982).

If the retailer does not think that the Amex logo on its door is worth the restriction, it is perfectly free to drop Amex as a card and no longer display the logo.

That is a pro-business attitude: freedom of contract.

Does the UK need a tea party?

2010-09-21T15:52:00.002-05:00

I would love to see the reaction of the tea partiers if this were proposed in the US!

The UK's tax collection agency is putting forth a proposal that all employers send employee paychecks to the government, after which the government would deduct what it deems as the appropriate tax and pay the employees by bank transfer.

See here for more on the proposal, from CNBC.

I grant that it is not all that different from the withholding that we endure, but something about the cosmetics of "your check got sent to the IRS before you" doesn't seem quite right.

Good for a laugh.

On The Road to Price Controls

2010-09-13T17:29:00.004-05:00

A while back I was angry with Kathleen Sebelius, the Secretary for Health and Human Services, for her shameful ranting against insurance companies that raised prices -- see this earlier post, for instance: http://robertghansen.blogspot.com/2010/02/price-increases-on-individual-health.html.

But it now gets even worse. After some insurance companies announced future rate increases for individual plans, the Secretary of HHS wrote a letter to the insurance industry. As reported in the WSJ:

The Health and Human Services secretary wrote that some insurers have been attributing part of their 2011 premium increases to ObamaCare and warned that "there will be zero tolerance for this type of misinformation and unjustified rate increases."

The whole Sebelius letter can be read here.

What would the government do to companies that passed out "misinformation" and had "unjustified" (gasp!) rate increases? One action would be to ban such companies from participating in the insurance exchanges that were mandated in the new health care bill. From the Sebelius letter:

We will also keep track of insurers with a record of unjustified rate increases: those plans may be excluded from health insurance Exchanges in 2014.

And this is even scarier:

Later this fall, we will issue a regulation that will require state or federal review of all potentially unreasonable rate increases filed by health insurers, with the justification for increases posted publicly for consumers and employers.

Potentially unreasonable? Definition, please?? In anything close to a market economy, would one expect to have to justify to the Federal government every price increase? Does the Obama Administration wonder any longer why it is being painted as anti-business?

Guest Post on Net Neutrality

2010-09-13T17:12:00.002-05:00

A recent student of mine, Brent Mattis, wrote the following on net neutrality. It makes some good points, especially the one on the heterogeneity of consumers, with some willing to accept lower tiers of service quality for a lower price.

"My friend posted a funny image showing the price structure of a
future ISP if proposed network neutrality regulation fails to pass:

http://i.imgur.com/5RrWm.png

It basically resembles the worst parts of your cellphone and cable
subscriptions. The services are expensive, the offerings are limited,
in short it's awful.

If that truly was the future of high-speed internet access without the
proposed legislation I'd have to debate setting aside my libertarian
sympathies on the issue. Fortunately, for the reasons I'll ellucidate
below I think that is NOT what the future of internet access will be
without network neutrality regulation.

First let's take a trip down memory lane. Back in 1999, my house had
two options for high-speed internet access, ADSL for $60/mo or ISDN
for $150/mo, both provided by the local phone monopoly.

In that a situation I could imagine a company like Bellsouth tampering
with access as envisioned by the artist above. Now however, customers
have significantly more options. To enforce mediocre, high-price,
non-neutral service, ISP's would have to form a cartel.

Fortunately, cartels are only stable in two situations:
1) the resource being offered has very limited natural supply (imagine
there are only two iron ore mines in the world)
2) the government grants cartel-like privileges to the firms (for
example, airlines prior to deregulation).

Because of the relentless march of technology, the former seems pretty
impotent. Between DSL, Cable, Microwave, WiMax, 3G, LTE, 4G, Muni
WiFi, Satellite, Powerline, FiOS, 802.20, WiFi Mesh networking, I
think it would be nigh impossible for BellSouth to provide both bad
services and high prices. If Bellsouth told me they would charge me
$80 dollars/mo for service without access to Usenet or Bittorrent, I'd
tell them, thanks but no thanks. In a competitive market place,
customers are king. Take one example, when Comcast started to throttle
Bittorrent traffic, hellfire and brimstone rained down upon them...
other ISP's certainly took note.

This isn't to say that in a competitive scenario, such as the one I
feel is likely, some ISP's might provide 'content-constrained'
internet service, for a very cheap rate. Many gamers might love to pay
$10/mo for a low latency connection that blocked access to Usenet and
Bittorrent. Other folks might opt for a free service that used a
gatekeeper that set Bing as their permanent homepage. These are
options that benefit the company and the consumer. These are options
that wouldn't exist in a world with government mandated network
neutrality.

We can't say in advance what the market structure will evolve to, but
I would caution that putting the FCC in charge of the ISP industry
will likely have unintended consequences. If the FCC holds the power
to license ISP's, we will be one step closer to the cartelization that
would all but guarantee high prices and shitty service."

The (Difficult) Route to No Tax Rate Increases

2010-09-13T14:49:00.004-05:00

How do Republicans arrange for maintaining the Bush tax cuts for everyone when the Democrats want to raise rates for those earning more than $250,000? Impossible feat? Maybe not.

The key is to present the Democrats and the President with only two alternatives: either the Bush cuts are maintained across the board, or everyone sees their taxes go up. No in-between option of "cuts only for the middle class."

I suspect that Democrats would rather take cuts for everyone than the alternative of no cuts at all. Sure, their base of liberals would be furious that the "rich" are getting a tax cut, but the liberals are going to vote Democrat anyway. How many votes will they lose if November comes, the economy is still moribund, and there has been no action on preventing the largest tax increase on record to take effect come 2011?

So how do we get to the point where the Dems have only those two choices? The Republicans have to make Democrats think that they are willing to accept a stalemate -- no tax cuts for anyone. The rational fear of an impasse, given my assumption above that the cost of no tax cut is really high for the Democrats, will make them accept the less desirable alternative of cuts for everyone.

How do Republicans credibly signal to Democrats their willingness to accept a stalemate?

Ironically, I think John Boehner might be off to a good start with these words:

In a pre-taped interview to appear on CBS' "Face the Nation" Sunday, Republican House Minority Leader John Boehner said that, if approving a bill to extend breaks for middle class income Americans were "the only option," he would support it.

To make the threat of opposing "cuts only for the middle class" credible, the Republicans need to establish a public record that they could point to in their defense, if the end result is a logjam and all tax rates go up. This is what Boehner said -- he will not oppose a middle class-only cut. And the White House jumped on his statement, giving it even more publicity and authenticity. So now the Republicans are on record for not opposing a cut only for the middle class. Clearly if we don't get that, it will be the Democrats' fault!

Of course, now the Republicans do have to work for the whole package, cuts for everyone. They need to play chicken, holding off any vote for as long as possible, making the Dems more and more nervous that there will be too little support for cuts only for the middle class. Tell them that there would be enough votes for an across the board maintenance of the Bush cuts, but that the middle class only option looks like it will fail...

Still a long shot, but I can see the road-- well, a small path -- to victory on this one.

The Amazing Keynesian Resurrection

2010-08-17T18:10:00.003-05:00

I am dumbfounded at how talk of taxes and spending is focused almost exclusively on the demand-side stimulus effects rather than supply-side incentives.

This is certainly true for the question of maintaining the Bush tax cuts. Almost to a person, the question hinges on whether the "rich" will spend their tax cuts or save it. Funny how saving is seen as a negative! But even worse is the lack of serious argument on the effects of higher marginal rates at higher income levels on labor supply, entrepreneurial effort, and investment. I had to chuckle when one liberal outlet noted that while some of the highest income tax returns are due to small business income, those returns only represent a minor percentage of all small business. How is that relevant? And maybe we should actually be concerned with those small businesses that are actually profitable?

But the frosting on the Keynesian birthday cake came today with Bill Gross' (head of PIMCO, Pacific Investment Management) propoal for Fannie Mae and Freddie Mac to somehow reduce mortgage rates on millions of mortgages. The rationale? Here it is:

"That [action] would obviously benefit the homeowner to the extent of one-third of its future payments,” he said.

“In terms of real dollars, it’s a $50 billion to $60 billion push or stimulus going forward. In my estimation it would lift housing prices by 2 to 5 percent, which is an important policy objective of the administration.”

So let me get this straight. Since the Federal Government has tapped out the public's appetite for borrowing and spending, let's do it by subterfuge: take from bondholders and give to homeowners. Voila! Redistribution and Keynesian stimulus all at once.

Bondholders should be furious at such ideas. If homeowners want to refinance, let them do so on their own. And if they cannot, well, that is the deal that they entered into.

Information Economics and Medical Testing

2010-08-13T21:39:00.010-05:00

I have been talking to some colleagues about the issues around medical tests, in particular whether some tests provide such low quality information as to be of negative value. The PSA test for prostate cancer is a case in point, especially for men of my age. Should men around the age of 50 get the PSA test? My understanding of this test is that it reports a number from 0 to infinity, with higher numbers and a positive rate of change being thought to signal the presence of prostate cancer. Critics of the test note a high rate of false positives.

There are many other situations where medical tests are possible, from full body scans to mammograms. None of these tests are perfect. They will fail to detect cancers (false negatives) and they will signal cancer when none is present (false positive).

There is definitely a community of health professionals who advise many patients to not get the tests – and this is not because the tests fail to provide value in excess of their cost, but because the tests are actually thought to be of negative value even without considering their direct cost.

Note that this idea conflicts quite extremely with an idea that many economists would hold, which is that any information is good. As one of my colleagues puts it: The test has been done, and your doctor has emailed it to you. Would you actually pay for an email filter that would prevent you from seeing that message? If the test has negative value, you would pay for a filter. If the test is of even small value, you would open that email!

This is an important question, of both personal and social value. It deserves adequate consideration. I am going to give some initial analysis, using a framework from Bayesian statistical and decision theory, which I think is the optimal approach.

I am going to begin with what I call a Robinson Crusoe world, where the decision maker acts individually and only in consideration of his situation. So third party effects, such as influence by doctors, will be ignored.

The information setup is as follows. Bear with me if you have not done Bayesian analysis for a while, but it is pretty straightforward. This is all standard stuff; if you want to read more I highly recommend an old survey by two of my UCLA professors: Hirshleifer, J & Riley, John G, 1979. "The Analytics of Uncertainty and Information-An Expository Survey," Journal of Economic Literature, American Economic Association, vol. 17(4), pages 1375-1421, December.

In a Bayesian decision setup, we have three kinds of variables: states of the world; messages, and actions. Here, we will have only two states of the world: cancer, or no cancer. Messages are what the test provides. Now the PSA test is a continuous variable, and later I will return to that characteristic. For now, think of the test as returning one of two messages, m1 or m2. Message m1 can be thought of as a low PSA, below a critical value, while message m2 can be thought of as a high PSA, above the critical value.

There are four possible (message, state) outcomes, illustrated by the two-by-two matrix at the top of this post: Two of these have the message being consistent with the state, (m1,s1) and (m2,s2). Then we have two outcomes where the message is in error: a false negative of (m1,s2) and a false positive of (m2,s1). Note in this I am assuming that m1 is the message that we will think of as being the “no cancer” message, i.e., a low PSA.

The key probabilities for decisionmaking will be the posterior probabilities, which are derived from priors and the joint message/state probability density. More precisely:

(1) Pr (s1|m1) = {Pr(m1|s1)Pr(s1)} / Pr (m1)

(2) Pr (s2|m1) = {Pr(m1|s2)Pr(s2)} / Pr (m1)

(3) Pr (s1|m2) = {Pr(m2|s1)Pr(s1)} / Pr (m2)

(4) Pr (s2|m2) = {Pr(m2|s2)Pr(s2)} / Pr (m2)

Note that the message likelihoods – Pr(m2|s2) for example – are a function of the test’s characteristics and quality. For better information quality, we want large differences in the probabilities of a message conditional on different states.

The last two posterior probabilities are the important ones as they are our posteriors after getting the bad message: the probability of not having cancer dependent on getting m2, and the probability of having cancer dependent on getting m2. Note that these two posterior probabilities will differ from their respective prior probabilities, depending on how far the ratios of Pr(m2|s1)/Pr(m2) and Pr(m2|s2)Pr(m2) are from 1. If Pr(m2|s2)/Pr(m2), for example, is much greater than 1, then the posterior probability of having cancer conditional on getting the bad message will be much higher than the decisionmaker’s prior probability. This means that m2 is a highly informative message.

Now we can consider taking actions conditional on a message. I will presume the action to be “treatment,” with the implicit understanding that that might just mean further testing. The decisionmaker wants to take actions that increase their utility, or well-being.

Suppose we take the action of treatment if we get the bad message, m2. Then we can write our expected utility conditional on m2 to be:

(5) E(utility|action,m2) = GAIN*Pr(s2|m2) + LOSS*Pr(s1|m2) - c

where GAIN is our health improvement from treating a real cancer, and LOSS is our health decrement from taking treatment when we do not have cancer (since we got a false positive test). Note that I do include the cost of the test, c, even though I am most interested in whether the before-cost, gross value, of the information can be negative.

Our expected utility conditional on message 1,

(6) E(utility|no action, m1) = -c

since all we do is pay the cost of the test when we get message m1. I could put an additional cost in here, if there were “angst” caused by the test, but I will pass on that idea for now.

The crux of the issue is illustrated by Equation (5), the expected utility conditional on message m2. The value of the test is going to be greater, the greater is the GAIN from treating a detected cancer and the greater is Pr(s2|m2). The value of the test is going to be lower, the greater is the LOSS from undergoing treatment when we do not have cancer, and the greater is Pr(s1|m2) – the probability of a false positive. (Note that false negatives do not enter our analysis directly, but they do indirectly since the probability of a false negative, Pr(m1|s2) equals 1-Pr(m2|s2), so the lower is the probability of a false negative, the higher is the probability of a correct positive.)

One might jump on the fact that the expected utility conditional on message m2 can be negative, even without considering the cost of the test. This is true, if the LOSS and/or the probability of a false positive are large.

However, we need to take a rational decisionmaking viewpoint. If the expected utility conditional on m2 is negative, then we should just never take the treatment! Granted, we will pay the cost of the test, but as I said at the beginning, some people seem to think that tests can be of negative value even without considering the direct cost of the test. From our point of view here, that cannot be true. Of zero value, that is possible, but not negative.

And there is yet another level to the analysis, which will show even more strongly the likelihood of a strictly positive value to any medical test that reports a continuous variable and that has the property that the test becomes more precise as we increase the cutoff. See this report from Johns Hopkins for some discussion, in particular the following:

"In general, a PSA value of 4 ng/mL is considered the cut-off for suspected cancer (although it may vary slightly by age), and levels above 10 ng/mL indicate very high risk. It is values between 4 and 10 ng/mL that are the most ambiguous; men in this range may benefit most from refinements in the PSA test. The risk of cancer based on PSA levels follows:

PSA levels under 4 ng/mL: "normal"
4 to 10 ng/mL: 20 to 30% risk
10 to 20 ng/mL: 50 to 75% risk
Above 20 ng/mL: 90%."

If the expected utility conditional on m2 is negative, then we should increase our cutoff to reduce the probability of false positives and increase the probability of a correct diagnosis (conditional on getting m2). For instance, if a PSA of 8 was our cutoff in the above analysis, then let’s use a cutoff of PSA=50.

In equation 5, increasing the cutoff will clearly increase our expected utility conditional on m2, for Pr(s2|m2) will increase and Pr(s1|m2) will decrease.

Now it is of course true that by increasing our cutoff, we are decreasing the chance of getting a bad message, that is, of getting m2. So we will be less likely to take action, but when we do, we can be pretty sure that we are doing the right thing.

With a low probability of m2, the overall value of the test may be negative, for we are always paying for the test and very rarely taking action. However, my point again is that the test must have value in the gross, before-cost, sense. Or to use the email analogy, if someone already emailed me the results of the test, I definitely do not want to delete that message before seeing it!

I could bring in considerations of angst of getting a test result that is not high enough to take action but enough to make one nervous, or issues of self-control -- an inability to commit oneself to not taking action (or not worrying) if the test result is not extremely high. But that will be for another discussion.

Can Someone Explain Why Net Neutrality Makes Sense?

2010-08-09T19:04:00.002-05:00

Google and Verizon have made a proposal to deal with access over the internet.

The proposal says Internet providers should treat all providers of Internet content the same, and should not be able to block them or offer them a paid “fast lane.” It says the Federal Communications Commission should have the authority to stop or fine those who break the rules.

Eric Schmidt, head of Google, justifies their position with this:

Freedom from such discrimination is crucial for consumers and for fostering innovation among Internet entrepreneurs, said Eric E. Schmidt, Google’s chief executive, in a conference call with reporters. “The next two people in a garage really do need an open Internet,” he said.

Yes, and the next two guys in a garage also need free access to a supercomputer, lots of talented college graduates, and venture capital funding at TBill rates.

I suspect strongly that some consumers and some providers of content value the speed of access more highly than others. Economic efficiency calls for them to get that, so long as they pay the cost. Perhaps CEO Schmidt and others assume that their proposal will somehow result in everyone getting the technologically fastest access possible, regardless of cost? More likely, we will all get a mediocre level of service.

The US Postal Service has always given equal service at the same rates for urban and rural customers, even though the costs obviously differ. And Ma Bell (AT&T for youngsters) gave basic access to the phone system at the same prices.

I note that Ma Bell no longer exists in its same form, and the US Postal Service is about to die (only a slight exaggeration).

So I remain unconvinced. If I want to go faster than someone else, or let my customers go faster, why can't I buy a Corvette?

Sound familiar? Mark my words -- the next crisis.

2010-08-09T17:17:00.002-05:00

President Obama today launched a call for more Americans to receive a college education:

"That's why I'm absolutely committed to making sure that here, in America, nobody is denied a college education, nobody is denied a chance to pursue their dreams, nobody is denied a chance to make the most in life just because they can't afford it," Obama said. "We are a better county than that, and we need to act like it."

Hmmm....So what were the critical elements of the subprime crisis? A push on the part of the US government to increase home ownership, especially among segments of the population that had traditionally not owned houses or held mortgages. A huge subsidy from the government to those who borrowed to buy a home (through FannieMae and Freddie Mac and through home mortgage interest tax deductibility). An industry of subprime mortgage brokers who, fed by large up-front fees paid for mortgage origination, found millions of willing borrowers -- even though the brokers often knew that the loans were not appropriate and had little chance of being repaid, unless home prices continued their seeming relentless climb.

What do we have with education and student loans? Well, certainly the push for more to attend college (do we remember the studies showing that home ownership leads to all kinds of social good?). We have a subsidy, in the form of student loans -- and with the recent changes in the student loan program (packaged as part of the health reform bill !!), those loans are made and owned by the US government. In the subprime mortgage industry, FannieMae and FreddieMac decided to dramatically increase their purchase and repackaging of subprime mortgages in response to the Federal government's wishes: if your boss wants more home ownership, you better not stand in the way. It is still unclear how the new Federally owned and managed student loan program will work out. In the old days, private banks made student loans. Now it will all go through the Feds, with the taxpayer on the hook through our general taxes. If the Federal government wants more Americans to attend college, how do you expect the political appointees in charge of student loan origination to behave?

Last, we have a growing industry of what I will call subprime educational institutions, or degree mills. These institutions, whether for profit or nonprofit, will benefit from enrolling students, helping them navigate the Federal student loan process, and collecting tuition. The increase in demand for degrees is palpable, and supply will increase to meet the demand. These degree mills will lack significant "skin in the game" just like subprime mortgage brokers -- they will enroll students who have little likelihood of benefitting from the program or even graduating. But tuition is collected up front, and then it will be up to the Feds to collect on the student loans. Even some of the better colleges and educational institutions will be tempted by the increase in demand, and new technology -- online education -- makes it even easier to provide the coursework (for subprime mortgages, the technological innovation was in software to process mortgage applications).

Hell, we even have the equivalent of the credit rating agencies -- let's call them Educational Testing Service and ACT, Inc. What -- there are only two main educational testing services? That is even less than the three main credit rating agencies!

Oh, and the new student loan reform also gives subsidies to those student borrowers who take work in public service, and it caps payments at 10% of income.

All of this reform is promised to save us, the US taxpayers, lots of money.

I have a bridge in Brooklyn you might be interested in.

Multiple Choice: An Airline Pricing Question

2010-07-20T14:30:00.002-05:00

It appears as a stylized fact that airlines are getting an increased portion of their revenue through pricing channels other than the "basic ticket." Examples: baggage fees; ticket change fees; food and drink charges; charges for pillows and blankets; optional and priced plans for early check-in; charges for extra leg room. Kevin O'Leary of discount carrier RyanAir has repeatedly suggested charging for the loo, but I don't think that has been implemented yet.

Why the increased reliance on these new revenue channels?

a) Behavioral economics: Consumers don't notice such charges as readily as ticket prices. (I try this with my cat -- hide the pill in her food, but she outsmarts me every time. But don't let me influence your choice; cats might be smarter than people. One of my favorite econ profs used to famously tell his graduate students: You all think you are smarter than dogs, but you aren't -- you're just quicker.)

b) All these things have positive marginal costs, so the airlines are simply learning to price services in line with their costs.

c) Price discrimination. People who travel with lots of bags, for e.g., are more likely to have an inelastic demand for travel, so use baggage charges as a price discrimination scheme. This is similar to IBM in the old days charging their mainframe computer users by the number of "cards" that they consumed. (For youngsters, in the old days, data and even programs were coded onto paper cards and fed into computers. Yes, it was a pain in the butt.)

d) That perennial issue of taxes, and avoidance thereof. According to an IRS ruling in January, the kinds of fees being discussed are not subject to the 7.5% airline transportation tax. See here for details on the ruling, including the IRS private letter.

e) Because they can.

And the answer is.....

On the Proper Role of Government

2010-07-15T18:16:00.001-05:00

As reported in CNET:

On Thursday, Sen. Charles Schumer (D-N.Y.), posted an open letter to Apple CEO Steve Jobs, expressing "concern" over the iPhone 4's reported reception problems.

Need we say anything more?

Goldman Coughs Up

2010-07-15T17:54:00.003-05:00

So Goldman Sachs wil pay the largest penalty ever assessed on a Wall Street investment bank, $550 million. By settling with the SEC, Goldman avoids going to court with the government. I imagine however that there will now be a slew of private suits, even though investors will get $250 million and the US Treasury the rest. Goldman states in the settlement document,

"It was a mistake for the Goldman marketing materials to state that the reference portfolio was 'selected by' ACA Management LLC without disclosing the role of Paulson & Co. Inc. in the portfolio selection process and that Paulson's economic interests were adverse to CDO investors. Goldman regrets that the marketing materials did not contain that disclosure."

This is exactly what I have said all along. Their marketing materials were clearly deceptive. Nobody with good conscience should have prepared those.

Now GS has to follow through with some employee discipline.

Subsidize the Media?

2010-07-15T17:39:00.003-05:00

Lee Bollinger, ex-Provost of Dartmouth College and current President of Columbia University, wrote in an editorial in the Wall Street Journal that we should consider public funding of the press.

You cannot be serious.

Sure, I can see the arguments -- we fund research in academia, and that is unbiased. Plus we fund NPR and hey, the British have the rock solid BBC. As an economist, can't I see all the positive externalities coming from the New York Times?

Bollinger states that in regard to public funding of academic research,

...there have been strikingly few instances of government abuse. Indeed, the most problematic funding issues in academic research come from alliances with the corporate sector.

Well, I wonder what evidence he has to support this claim. In my view, government funding of research is great at pushing forward the mainstream, generally accepted vision. Climate science is a great example.

Bollinger's argument shows why you cannot use the standard kind of economic efficiency arguments on everything. If we agree to subsidize everything that gives positive externalities at the margin, where will we stop? There are way too many activities that generate benefits that cannot be appropriated through market transactions. A free market is not going to be perfect in that regard. But holding it to the standard of optimality is not right. We have to compare it to the real alternative, which would be public funding of some activities. Can you imagine what it would look like if we were to start funding the media. (Hint: What would happen to Fox? Or Drudge?)

PS. There once was a time when I used to listen to the BBC on a shortwave radio, they were so good. That time is long past.

iPhone on June 24th

2010-06-07T13:42:00.003-05:00

The prices he gave were $199 for a 16gb model, $299 for 32 GB. Decent.

Looks like its new phone time. The FaceTime program is really neat.

And here is a picture that Jobs showed, I took it from macrumorslive.com, where I was following Jobs' address. Note that Tuck's Bridge program is all about the intersection of business and the liberal arts. Maybe Steve needs a third dimension: business, technology, and the liberal arts. Nice.

Video Calling -- How Cool is That?

2010-06-07T13:34:00.001-05:00

I'm watching a live blog of Steve Jobs' address to the WWDC in San Francisco.

He saved one of the coolest features of the new iPhone for last -- video calling.

Are we in the 21st century or what?

An Insurance Story

2010-06-02T13:35:00.002-05:00

I busted one of the panes in the rear window of my Toyota Tacoma yesterday. I was putting a piece of cedar decking into it, and just nicked the edge of the window -- shattered it.

Called a window replacement service and almost had a heart attack: $1200 for the Toyota OEM replacement window. $1200 for one stupid Finlander moment?

But...I could get a third-party replacement, installed, for $295. A call to a second service confirmed the OEM price but got the third party window down to $220.

Now isn't that amazing. The OEM window costs 5.5 times as much, and we are not talking small change here. There might be some, hopefully minor, quality difference -- on the fit, most likely. I will find out tomorrow when I see the window.

Why the huge price difference? Two things. One, a monopoly position in the OEM window, due to the brand of Toyota. Second, insurance. Most people with comprehensive insurance will just pay the deductible and will therefore go for the more expensive but brand name window. Me, I cannot justify sending that kind of money to Toyota no matter who is paying, so even though I have comprehensive, if that third party window is OK it is going in.

What a lesson in what insurance can do to demand and prices! Do we wonder why medical services cost so much?

One of my colleagues had a very interesting proposal for health insurance that I have not come across. There are proposals to pay health care providers a lump sum -- bundled payment -- for a patient with some diagnosis. Say you need a hip replacement; then your insurer would pay the provider a lump sum of like $12,000. My colleague takes this one step further: he would have the insurer pay the patient the $12,000 and let them get their hip replaced wherever they wish.

That would create some very neat incentives! The problems, and they are important, are several. Foremost is the risk that the lump sum won't be enough to cover some complications. That puts additional risk onto the patient. Second might be the issue that some folks would rather take the money than the new hip. So we would have a nation of limping, but wealthier, elderly.

More on Carried Interest

2010-05-30T07:02:00.003-05:00

I received the following comment on my initial post on carried interest:

One way of framing the carried interest question is to find the policy that preserves
the favored tax treatment in the aggregate. If I hold an index fund, my dividends
are taxed at a 15% rate and my realized long-term capital gains are taxed at a
20% rate. Now suppose I hire you to pick my stock for me. However we tax you,
there should be a consistency so that the aggregate dividends and capital gains
are still taxed in a favored manner.

My way of thinking of this would be the following: Suppose a set of friends get together to buy stock. There are five of them and they each put up 20% of the capital. They do well, and decide that one of them who has been bringing the best advice to the group should become the "general partner" and do most of the work. For that, the other four agree to reduce their share of any portfolio gains from 20% to 18%, so that the fifth partner will get 28%.

Since the aggregate capital gains are still the same, the argument above would imply that the manager/GP in my example should get capital gains taxation on his 28% just like the other four "limited partners."

This is a nice analogy, and analogies are nice for framing the issues and perhaps particularly for thinking about horizontal equity issues (are folks in this situation being treated similarly to folks elsewhere doing essentially the same thing?).

But this argument does not trump, for l return to the issue of economic efficiency -- what activities do we want to favor from an "activity level" point of view? By giving our newly minted General Partner the ability to get capital gains treatment on his larger share of the pie, we are enabling division of labor in investment activities. If we made the GP pay ordinary tax rates on any larger share he was given by his partners, we would reduce the incentives the partners would have to take advantage of comparative advantage and specialization.

Do we want to encourage such division of labor? Well, that is the question -- do we want to encourage the supply of specialized labor into management of private equity and venture capital? Perhaps. Capital gains rates are low after all because we want to encourage long term investments over short term.

The Carried Interest Dilemma

2010-05-28T19:24:00.002-05:00

A couple colleagues and I were discussing the "carried interest" issue today. In a nutshell, a private equity firm, and other investment vehicles as well, such as venture capital firms, are organized as a partnership, with limited partners (LPs) providing the cash to invest and the general partner (GP) providing the management (and maybe a little bit of cash). The GP is often compensated in two parts, as memorialized in the phrase "2 plus 20": the GP gets 2% of the assets as a management fee, but they also get 20% of any gains when the investment is closed out.

The controversy is over Federal taxation. Now, the 2% is taxed as ordinary income (high rates!) and the 20% is taxed at capital gains rates (lower). Many folks feel that is unfair, letting these rapacious private equity fellows pay such low taxes on huge capital gains.

Before going too far into this, the right question of course is: what will be the different economic outcomes of different tax policies, and what do we think of those outcomes? Fairness is not foremost in my mind -- incentives, behavior, and outcomes loom larger.

It is not hard to think of analogies where similar compensation is paid. The taxation of those situations is instructive. For analogies, how about employees' grants of stock or stock options? Suppose I give stock to an employee, to create incentives for her to increase value. At the time of the stock grant, my understanding is that the value of the shares at that time is income, taxed at ordinary rates. Any capital gain in the stock would be taxed at capital gains rates, assuming the holding period was long enough. If I give the employee options, there is generally no tax due with the option grant, but when exercised, the difference between strike price and market value is ordinary income, unless the stock obtained through exercise is held for a certain period of time.

Another interesting case to consider would be if I lent money to an employee with the requirement that they use it to buy stock. My guess is that what would be taxable at ordinary rates here would be any difference in the interest rate charged the employee versus market rates. If there was a capital gain on the stock, then those would be taxed at capital gains rates.

This latter situation is close to what is happening with private equity. The GPs are being given an interest free loan to buy 20% of the portfolio. They should certainly pay taxes on that interest free loan.

A paper that comes to this conclusion is: Cunningham and Engler, The Carried Interest Controversy: Let's Not Get Carried Away, 61 Tax L. Rev. 121 (2007-2008).

But there is more than just the interest free loan, as the GPS essentially get to buy the shares at a zero price as well.

The more appropriate analogy seems to be the options one. The GPs are being given a call option on 20% of the portfolio, with a strike price of zero. Following the employee stock option tax policy, the grant of the option is not a taxable event. But when the option is exercised, it would be taxed at ordinary income rates, unless the GP somehow maintained their investment position for a period of time after that.

The idea of not taxing the granting of the option but taxing the gain at ordinary rates seems a nice balancing of our desire to stimulate incentives for creating long term value against the creation of excess incentives to enter one specific industry or profession. The tax advantage is essentially one of deferment of taxes -- no tax liability upon grant of the option, but upon exercise.

I think this solution balances nicely the incentives we want to preserve for investments that create value against giving excess incentives for supplying talent to certain industries.

Apple the Second Largest Company by Equity Value

2010-05-26T20:21:00.002-05:00

Many stories have reported that Apple today overtook Microsoft in the market value of its equity.

What is more interesting is that Apple is the second-largest company in the US by market value of equity -- second to Exxon Mobil. See here.

Including debt to get total company, or enterprise value, would change the rankings as Apple has no debt and Microsoft has some. And of course other companies may have a lot more.

But it is still very impressive for a company that was almost dead a little over ten years ago.

I still remember the first Apple I bought...an LC 475. It had something like 4mb of ram -- I had to always play around, shutting off some of the built in system components, to get it to run certain programs. That was the first machine I bought for home use, and I have never bought anything other than an Apple since.

Nuke the BP oil leak?

2010-05-26T18:25:00.003-05:00

I think BP is in big trouble, as is the Gulf of Mexico. It is a real tragedy for sure -- the only surprising thing so far is the seemingly small amount of actual damage to wetlands, beaches etc. Perhaps I am not paying enough attention, but the internet is not exactly overwhelmed with pictures and evidence of oil everywhere.

But the stories starting to come out on how BP folks made ill-fated decisions that possibly led to the disaster are scary for the company. Larry Kudlow on CNBC has been railing against BP for days on end...he just referred to them as an enemy of the US. Now that is because of something the company is supposedly doing in Iran, but Kudlow mixes Iran and the Gulf in a pretty vitriolic diatribe against the company.

Then there are these stories about how Russia used tactical nukes to stop blowouts back in the USSR days...supposedly did it five times and it worked four out of the five. Hmmmm...what about that fifth time?

Here is the Russian newspaper story that I guess discusses the use of nukes in blowouts. If you cannot read Russian, try this. Where is Red Adair when we need him?

Cyanobacteria in lakes vs. bacteria in pools

2010-05-22T19:30:00.002-05:00

The local vigilantes on my beautiful New Hampshire lake have been spotting and reporting cyanobacteria blooms for two years now. Cyanobacteria are naturally occurring bacterial that do at times give off toxins that can cause harm to mammals. Dogs have been known to become sick, although I am unaware of any confirmed cases of human illness. Last summer I got very concerned when some local researchers reported -- in an unpublished paper that nonetheless got much local press-- a statistical correlation between living close to freshwater lakes and onset of ALS, or Lou Gehrig's disease. I don't know where that research now stands, but in my considered opinion it suffered from serious defects. One of these potential defects was the way cases of ALS were reported. I actually got an email from someone on my lake who said that anyone knowing of ALS cases around our lake should report them to the researchers. Hmmmmm....I wonder if a similar email went out to folks who don't live near a lake?

Anyway, the risk from cyanobacteria is incredibly small, especially if one doesn't swim directly in visible blooms (I like to cite a WHO report that said if you are standing in kneedeep water and cannot see your toes, you probably should not go swimming. Hell, even those of us from the UP would figure that one out!)

But finally, the CDC has come out with a report saying that 1 in 8 public swimming pools pose immediate infection risks.

I always told people who asked about cyanobacteria in my beautiful clean Goose Pond: maybe if you are worried you would prefer to go to the pool at Storrs Pond in Hanover and swim in chlorinated water that a bunch of little kid have....well you don't want to know.

Risks are everywhere.

Is Greece Facing a Liquidity Problem or it it Truly Insolvent?

2010-05-10T10:31:00.003-05:00

I imagine that the Jean-Claude Trichet has dealt with more pleasant situations than the one over the weekend.

Last week, Mr. Trichet was broadly quoted as saying that the European Central Bank had not even considered the option of buying European government bonds.

Today, the ECB announced that it would indeed be buying government bonds, but that the Bank did not bow to any pressure in coming to this decision -- see here for a sample of one of the hundreds of stories.

OK, no political pressure but certainly a lot of bond market vigilante pressure!

The issue for the US back in 2008-09 was whether banks were insolvent or illiquid. The line there is a gray one to be sure. I support the lender of last resort stepping in during liquidity crises, which in modern banking systems are inevitable, but not to rescue truly insolvent institutions.

The question then is: is Greece insolvent or just illiquid?

This looks to me like massive monetization of European debt, which will not be good for the Euro. And, unlike the US, much if not most of Europe has very little leeway for additional taxation. The US can solve its debt problems, in the worst case scenario, by increasing taxes, most favorably through a VAT. I am certainly not advocating that we do this; I would prefer to see the pressure kept on to cut spending. But if need be, I think the US could raise several percentage points of GDP through a VAT with very little cost to the economy. I don't think that Greece, or many other European countries, could do that.

Seems to me that insolvency is the more likely situation, and bailing out insolvents cannot be good policy. The only offsetting arguments are that the state of the markets do raise liquidity issues for other countries, if Greece were to be let go.

Tough decision for the ECB.

Are Apple's Actions Anticompetitive? Doubtful

2010-04-11T09:33:00.003-05:00

As has been widely discussed, it appears that Apple will be preventing iPhone applications developers from using anything other than Apple-approved development tools -- ruling out, among other tools, Adobe's Flash CS5. See here for more of the facts and here for more editorial comment.

Do these kind of restrictions rise to the level of being anticompetitive in the sense of antitrust? Let me sketch some possibilities, none of which I think make for a reasonable business strategy nor do they meet any kind of anticompetitive test. The most likely explanation is a very non-strategic one, simply that Apple wants to make sure that its iPhones and iPads meet the kind of quality test that its vertically integrated Mac platform does. Applications can impact the overall user experience in a variety of ways, and Apple has all the incentive in the world to make sure that they do not impair performance.

It pays to go back and re-study the Microsoft antitrust case. There, the government's claim was that Microsoft was excluding other internet browsers such as Netscape from the original equipment market, mostly by bundling its own browser (Internet Explorer) with its operating system, Windows. The alleged reason for this exclusion was Microsoft's desire to protect its market power in the operating system market. Interesting - the actions were not designed to gain market power in the browser market, but to protect a position in operating systems. Supposedly, Microsoft feared that as other browsers got traction, software developers could write applications that would interface directly with the browser (so called middle-ware) rather than having to interface with the operating system itself. Once applications could be written for browsers, Windows would potentially face more potential entry into the operating system market, since new operating systems would not face the chicken-and-egg problem of not having any applications that could interface with it. That is, the argument was that Windows had a nice network externality working for it, through software developers, and the middleware concept was seen as a threat to the market power that that network externality conveyed.

Now this is not the only possible angle to thinking about Apple and the exclusion of non-approved development tools, but it is an interesting one to consider. That is, could Apple be excluding some development tools to protect its position in a related market?

What market might Apple be trying to protect? Maybe its the Applications Store platform? This is what the post by John Gruber linked to above builds on. Can one build a coherent argument that Apple is restricting development tools so that the Apps Store becomes a standard, for purposes of exploiting market power? This is not unlike some of the earlier antitrust claims, more popular in Europe, that Apple put restrictions on iPods and iTunes so as to lock customers into both platforms.

I think there is one big weakness in any anticompetitive angle to this story, and that involves the inherent lack of power of a standard on an applications store platform. Recall the essential source of market power in the Microsoft story: the software development network externality, whereby the fixed costs of writing for different operating systems gave the operating system with the largest installed base an insurmountable advantage.

I cannot see anything working the same way in the mobile phone applications market. One possibility would be to get all developers writing for the iPhone platform, thereby giving the iPhone and iPad the chicken and egg externality benefit. But the mobile phone market is way too competitive for this story to hold water. The market share of iPhone is around 25%, with very strong competitors. Maybe for the iPad, but that is a whole new market that is too early to even assess for viability. I also do not know how much credence the "fixed cost of development" story should be given here. With Microsoft, I could see that writing something like a whole new spreadsheet package for a new operating system, and overcoming the advantage of installed base of existing products, would be a real challenge. But for mobile apps? Are the fixed development costs really going to prevent apps developers from writing more than one version of a product, if there were two platforms with different requirements? Isn't the gaming market a point against this argument, with popular games being written for the different platforms all the time?

Maybe the Apps Store market itself? Could Apple be trying to protect a dominant position in selling applications? Doubtful. For one, if that were the objective, I fail to see why restricting product would be beneficial -- does Amazon restrict products from its site? Second, it is way too easy for competing applications stores to launch and compete.

I am left with Occam's Razor, having to accept the simplest explanation: Apple wants to approach what it would have with a fully vertically integrated chain from hardware to operating system to applications. That means putting some restrictions on the applications.

There's an Ad for That!: Apple's Amazing Innovation Juggernaut

2010-04-10T06:59:00.002-05:00

Apple was on a tear this week. Last Saturday, they had a very successful launch of the iPad, opening up a whole new category for exploration and innovation. Our lives, in short, just got even more interesting and better. Then later in the week, they gave a preview of the new iPhone operating system, which powers not just the iPhones but the iPad as well.

Among the new features was an ability for application developers to include advertisements that run inside of applications. This takes the amazing evolving world of mobile applications to a new revenue-generating level.

The opportunities are going to be pretty incredible. Advertisements will be able to use the GPS capability of the iPhone. So, if you are using an app that looks for restaurants, and you are standing in Marquette, Michigan, well then I would hope that Jean Kays Pasties on Presque Isle Avenue would drop you a nice little note inviting you in to try one of the Upper Peninsula's true delicacies.

Think of how this is a change from Google's search-based advertising. With Google, ads are focused on the search terms that you type in. With Apple, the ads are tailored based on the app you are running (and there are thousands of those) and then the infinitely variable physical location. Plus who knows what else?

The other thing that Apple did was to take another step in the standards war going on over HTML and Adobe's flash. Apple will restrict developers to using programming languages approved by Apple, and that is presumably not going to include Adobe's package that converts Flash based apps to run on the iPhone. I am not quite sure what is going on here, but certainly Apple's control of the entire vertically integrated package of software and hardware has been key to its success so far. I can see obvious potential for some third party programs and languages to impinge on the overall value of a device, from the consumer's perspective. Whether Flash presents those problems, or if something else is going on, that I cannot say.

Stupak to Retire

2010-04-09T07:54:00.002-05:00

More fallout from the health care bill. This time, Representative Bart Stupak of Michigan has announced -- or will soon announce, I guess -- his retirement.

Stupak it turns out represents my home territory, the Upper Peninsula of Michigan. I thought I recognized a faint Yooper accent. I saw him on CNN yesterday while he was giving a speech in Bessemer, Michigan.

Well, well. Interesting times for sure. Stupak was the leader of the pro-life argument against the health care bill, and had been leading a bloc of pro-life Democrats against the bill. At the very end, he voted for the bill after getting the promise of an executive order from the President that promised to continue current Federal prohibition against financial support of abortions.

Folks will have different takes on what this means for, well, just about everything. The weekend papers will make for good reading.

An Important Referendum in CA

2010-03-28T17:59:00.002-05:00

Steve Chapman writes in the Chicago Tribune about the upcoming ballot initiative in California to legalize possession, growing and sale of small amounts of....marijuana!

Now I think there is the small problem of Federal laws against drugs like marijuana, but I am guessing the cooler heads in the Obama administration might decide that it would be better to let CA give it a shot.

What a noble experiment that would be. Question: what would happen to anyone in prison for possession or sale of amounts that would now be legal?

Lights Out!

2010-03-27T10:01:00.002-05:00

A while back I got an email from my neighborhood association that had the bright idea to get rid of our street lights. The thinking behind this brainstorm was twofold, one being to combat global warming and the other being to save money.

I replied with what I thought was a pretty witty piece about taking us back into the Dark Ages. While I would support preserving the night sky for stargazing, I could not see any evidence for significant cost or carbon savings, certainly not enough to offset the disadvantages of dark streets. The idea seems to have died, as the neighborhood is still lit at night.

But I must have been wrong, as now the whole world is turning out the lights. I can't wait for someone to estimate the additional crime and accidents that will occur during that hour.

The Health Care Bill

2010-03-24T07:49:00.002-05:00

It should not be all that surprising that we finally got a health care bill passed. Before the Scott Brown victory in Massachusetts, the House and Senate had already passed separate bills; all that remained was to combine the two. The House had the courage to pass the Senate bill with the hope that a reconciliation bill of some kind will remove the most egregious parts of the Senate bill.

The opposition of the populace, as measured by polls and other more informal means, ended up being set aside in favor of the hope that by November all will be forgotten, by a respectable belief on the part of some that the bill is really good for the country, and no doubt by a lot of armtwisting and dealmaking on the part of Pelosi, Reid and the President.

I do believe that the Anthem/Wellpoint increases in individual insurance rates in California, discussed by me in prior posts, played a not-insignificant role. Those increases pointed to the failure of the individual insurance market and defused some of the critics of the bill. The President and others hammered on those increases as evidence of what would happen if the bill did not pass -- and to extent they are correct; the individual markets are in a bit of a death spiral due to adverse selection and other issues.

I would really like to see a news reporter did into that Anthem decision to see if the Anthem folks understodd the gravity of their decisions at that time.

But this is now all water under the bridge.

On the positive side -- always an optimist -- the bill does some good. I have said for some time now that this country passed the point of not wanting to have all citizens have decent health insurance. This bill goes a long way to fixing that basic social safety net issue. Let's not deceive ourselves, however, there will still be a lot of uninsured people, just as there are a lot of folks who do not file their tax returns.

And there is no doubt, as I note above, that the individual and small group health insurance market was headed for disaster. That was making it extremely difficult for self-employed people and for small businesses (if you worked for an employer who did not offer insurance, you had to buy it on your own in a lemons market). That probably induced many people to work for large companies rather than striking out on their own. Removing that wedge between self-employment and working for large companies could be good for entrepreneurship and innovation. I have little doubt that access to health insurance was a large factor in many decisions as to what kind of career to pursue, at least at some point in one's life.

If the new exchanges function well, my hope is that the bill will be altered in the future to allow people in companies that offer plans to buy insurance from the exchanges as well. As the bill stands, that is not allowed (I am not sure why). If that would happen, then the link between place of employment and health insurance will indeed be broken. That in my mind is one of the better things that could happen. Sorry, but I just don't believe that an employer has the ability or incentives to offer me the best kind of insurance. I don't have Dartmouth offer me retirement investment services; they just give me a portion of my salary and let me invest it in my choice of independent, professional investment funds. Health insurance should be handled the same way.

It is too bad that the tax on plans was taken away because of union opposition (well, postponed until some time well in the future). To reduce demand to a more natural level, we need to remove the 25% - 40% subsidy given to purchasers of insurance through the exclusion of health benefits from taxation. I suspect that this tax will get moved up in time as the costs of the new bill become obvious. Get ready, but it actually is a good thing (maybe next they will remove the interest deduction for first and second homes as well?).

I have to look through the bill to see what provisions there are on the supply of doctors. I really worry what is going to happen with another 20 million or so people putting unlimited demands on an already-stretched health care system. This is not the time to be without a physician, for sure -- line one up now. And, I suspect that in the future, because there is going to be more nonprice rationing, WHERE you live will become almost as important as what company you work for, in regard to having access to medical care. I suspect that health care is going to become very similar to public schools, with location being very important and with a two tiered system emerging as well.

So, we are off to a brave new world. At least Americans can now walk through Europe without being thought of as monsters who don't provide health insurance to their neediest of citizens. And there will be some interesting possibilities for innovation and efficiency in this new system.

Is This How History Will View Bush?

2010-03-06T07:11:00.002-05:00

Interesting editorial by Richard Grenell in Al Jazeera on the current Iraqi elections.

On January 10, 2007, George W Bush, the then US president, defied critics and ignored popular opinion and political polls in the US by committing more than 20,000 additional American troops to the war in Iraq.

"The Surge," as it is commonly called, has since been credited with bringing the Iraqi people more security, less violence and greater freedoms. By July 2008, the surge was heralded as a success from Baghdad to Boston.

Grenell also has some choice quotes from Obama, Biden and H. Clinton on their view of The Surge.

There is no doubt that the war was costly and the planning and handling of the immediate post-war situation was pretty well botched. Also, the rhetoric for the war was unfortunately focused too much on WMD instead of the facts of S. Hussein's greater non-WMD threats to peace, security, and freedom.

Run the counterfactual for me, please. What if the US had not invaded Iraq back in 2003? Quick bottom line: would the Middle East and the rest of the world be more or less secure than we are now? Would the prospect for longterm peace, security and freedom in the Middle East be more or less than now?

Obama's Unrelenting Rhetoric Against Insurance Companies

2010-03-06T06:40:00.003-05:00

Obama today steps up again to rail against insurance companies "arbitrarily and massively raising premiums."

This is so deceitful, and the President and his advisers know it. Larry Summers ought to be ashamed to have this kind of rhetoric being used for purely political purposes.

Insurance companies are not the reason for the rising cost of health insurance any more than the local grocery store is the reason for the high price of orange juice after a freeze in Florida.

Folks might want to explore the situation in Massachusetts, a state that passed a mandatory health insurance law a few years back. The Boston Globe reports today about health insurance price increases in that state that range from 8 to 32 percent (in the text, one individual reports an increase of 40%). The Globe even notes that

Even as businesses and individuals feel the pinch of surging health costs, three of the four largest state health insurers last week posted financial reports showing operating losses for 2009.

It appears that consumers in Massachusetts got a gift last year from their rapacious insurance companies -- health insurance at below cost prices. That, of course, cannot continue.

Even more scary about all this is that the spectre of price controls has risen. The Administration added language to their insurance proposal that would allow the Federal government to review price increases by insurance companies. Massachusetts is reviewing all increases that exceed 4.8%. Real price controls are not far behind.

I suggest that if Obama cannot get a straight answer from the insurance company CEOs he listen a bit more carefully, with an open mind. Or maybe he can start by reading the several page letter that Wellpoint put out after the Californica fiasco (linked to in one of my earlier posts on the topic).

Even better, I suggest that Obama and his advisers go talk to some health care providers -- docs and hospitals -- and ask them what their price increases are. I guarantee you that they will be closer to the source of health care price inflation at the hospital than at the insurance company office.

And Another Person in Favor of Consumer Health Responsibility

2010-03-03T08:59:00.003-05:00

This article by Barbara Kiviat discusses the importance of knowing price when we buy things, including health services.

I am about to go on a rampage to get my local hospital and clinic to clearly post prices. As I know some folks on the Board of Trustees and other high places, it should be fun. I wonder how many of the Directors of the hospital know what things cost at the institution they are responsible for?

More on the Case for High Deductible Policies

2010-03-01T09:55:00.002-05:00

Two fresh editorials out today, suggesting a wave (!) of positive sentiment for high deductible health insurance policies.

One from the governor of Indiana, describing the Indiana experiment with Health Savings Accounts in combination with high deductible, high copay policies: "Hoosiers and Health Savings Accounts."

The second is titled "The Case for High Deductible Health Insurance."

If the Obama administration is reading these things, I hope they take them seriously. Such policies will be one critical part of a health care system that delivers care efficiently.

Designing a High Deductible Plan

2010-02-27T22:18:00.003-05:00

I am increasingly gratified to see more economists and politicians coming out in favor of high deductible health insurance. The positive effects of such plans would be both direct and indirect. I am actually more excited by some of the indirect, subtle effects that I think would happen as more people moved into high deductible plans, especially in regard to demanding more price information.

Here are my thoughts on how one would go about thinking about designing a high deductible plan for a self-insuring employer. There are lots of details that I won't get into, and most important, to make real progress I would need historical data on the distribution of health expenses in the employee base. But I think I can illustrate some of the key ideas.

The data that I would start with would be the percentage of employees with yearly expenses falling in different ranges, like this:

Health Care Expenses, % of Employees

0 - 2500, 10%

2500- 5000, 15%

5000 - 7500, 25%

7500 - 10000, 20%

10000 - 12500, 10%

Greater than 12500, 20%

If I had this data for an employer, I would start with it to get a feel for where a reasonable initial deductible might be. I want a deductible high enough so that I capture a reasonable number of employees with total expenses under that amount. At the same time, I don't want a deductible that is going to be unreasonably high. What's reasonable? Well, for the number of employees, I think we would want to catch something like 25%-50% of the base with total expenses under the deductible, at least. My thinking here is that the deductible is set to capture expenses for which true insurance makes sense, and if something is occurring more than 75% of the time, or even up to 50% of the time, it sounds too common to be reasonably covered by insurance. But on the other hand, I don't think a deductible that is too high is going to be acceptable to people who are used to "insurance" paying the bills.

Since I don't have that detailed of data at hand right now, let me proceed by assuming that what I do know is that 1/2 of the employees have total yearly expenses under $7500, and that the overall average expenses are $18,000 per year. For a family, that is a reasonable number. Given these two assumptions, we can infer that the other 1/2 of the people have expenses that are on average $32,250 per year (with some no doubt having very high expenses!)

With average expenses of $18,000 per year over all employees, we know that "fair" insurance would be priced at $18,000. (Apologies again to Sec. Sebelius for using such a blasphemous phrase as "fair insurance. What I mean by fair here is just that if the employer charged $18,000 for the insurance, with no deductible, it would come out, on average, just even.) I do recognize that the data we observe will be influenced by the deductible in place during the data collection period.

Now what would happen if we put a $7500 deductible in place? Well, everyone with expenses less than $7500 would pay all their health expenses themselves. That is 1/2 of the people. The other half would pay their deductible, and the employer would pick up the rest.

If expenses in the upper half of the distribution (greater than $7500) stayed the same -- I will return to this point -- then the employer's expected expenses look like this:

Employer's Expected Expense = .5(0) + .5($32,250 - $7500)
= $12,375

That would be the "fair" price of the insurance plan with a $7500 deductible. Note that the fair price of the plan with a deductible is not just the average expenses less the deductible -- that is, the fair price is not $18,000 less $7500 = $11,500.

So, there is our comparison: Insurance that covers everything for $18,000, or a $7500 deductible policy that would cost only $12,375.

Importantly, as a consumer, I could buy the cheaper policy and put the difference in prices, $18,000- $12,375 = $5625 into an account, which we might as well call a Medical Savings Account. On average, that amount of money will cover my out-of-pocket medical expenses (1/2 of the time my expenses will be less than $7500, or $3750 on average; and half of the time my expenses will be the deductible, $7500.) I am not dealing with taxes here, but if that MSA better be tax deductible if the cost of insurance is, or this will never work. Also, the MSA cannot be "use it or lose it."

That gives an idea of some of the thinking that would go into the design of high deductible plan. Next would come some more subtle, yet important, issues. One, what would happen to the expenses of those folks who used to have expenses greater than $7500. I would expect them to come down, for several reasons: One, the employees would simply not incur as many expenses, partly because they would decide to forego some expensive but optional services. Two, because they would be more careful about their health to begin with. Three, because they would put some pressure on health care providers to cut their prices. These effects would be the cost-control measures that we so desperately need, and they would allow for a DECREASE in the price of insurance as time went on. Can you imagine that??

Another subtle issue would be self-selection if we made two plans, the high deductible and the no deductible, both available. Then we would get folks taking the no deductible plan who expected to incur large expenses, and vice versa for the low deductible plan. That would allow the high deductible plan to be priced even lower, and would force a higher price on the no deductible plan. This is essentially what we see happening to individual insurance prices in the California market, and it should not be viewed as a bad thing.

Other Economists Supporting Reasonable Health Care Proposals

2010-02-25T10:03:00.003-05:00

Two editorials by some very smart people that are very similar to my proposals for health care changes -- a focus on incentives for individuals, and changes in the tax treatment of health care.

First, one by Cliff Asness: "Don't Ask" is No Way to Run Health Care" The basic message here is that we are "insuring" way too much -- small health care expenses instead of focusing on catastrophic expenses. Large events are what insurance was created for. I like to ask people if they have insurance for new tires on their car every couple years?

Second good editorial is by three economists, John Cogan, Glenn Hubbard and Daniel Kessler, "A Better Way to Reform Health Care." These guys also stress the need to make individuals bear the true cost of their health care. High deductible policies and elimination of tax deductions for health spending would effect that.

Nice to see a little press on these very common sense changes to our messed up system.

Price Increases on Individual Health Plans: Deductible Leveraging

2010-02-20T10:19:00.002-05:00

I was intrigued by the mention of "deductible leveraging" in Wellpoint's response to criticisms of their on-average 25% premium increases for individual customers in the California market.

How important an effect might this leveraging idea be? Well, pretty significant. The basic idea is that as underlying expenses increase, the company bears a larger portion of the total expense, so long as the deductible remains fixed. This increase in cost is going to be reflected in premiums. Here's the simple math.

Let x, a random variable, be an individual's actual health care expenses for a year. Let the deductible be D and we will call the premium P. All these will be annual amounts.

Then the expected value of the individual's insurance expenses are E(x) and the insurance company's portion of that would be:

I = insurance company's costs = E(x) - D

since the individual pays the deductible first. I am ignoring any coinsurance.

With fair insurance (I wonder if Sec. Sebelius can imagine such a concept!) the premium would be set at:

P = I = E(x) - D

Now let's just see what happens to P when we experience inflation at the rate of "i" in underlying insurance expenses.

Expenses will become (1+i)x, and therefore the insurance company's costs become (1+i)E(x) - D. This means that the premium increases to

P' = (1+i)E(x) - D

Then the percentage increase in the premium is

P'/P = {(1+i)E(x) - D}/{E(x) - D}

= {E(x)-D}/{E(x)-D} + {iE(x)/(E(x)-D)}

= 1 + i{E(x)/(E(x)-D)}

Note that the term multiplying the inflation rate is greater than 1, since the denominator is smaller than the numerator. There is the basic leveraging effect.

Let's use some numbers to see how it might work out. Suppose underlying inflation in health costs to be 10%, and let's take a policy with a $2500 deductible with a premium of $3600 per year. This implies, from the above equation, that total expected costs must be $6100.

Using that last equation up above, it follows that the rate of increase in the premium will not be 10% but instead 16.9%. Using the kind of rhetoric that Sec. Sebelius (fast becoming my least favorite person in Washington), the premium increases 1.69 times faster than the underlying rate of inflation.

As will be obvious from the last equation, this leveraging effect is greater for higher deductible policies.

Note that while the individual feels a 16.9% increase in their premium, their total expected cost still only increases by the rate of inflation, that is, 10%. This is a trivial point, but one that not a single reporter or story has made.

There are many problems in the individual health insurance market that need fixing and that can be fixed. I just wish that Obama, and the Republicans too, would hold true to their pledges to stop the rhetoric and focus on the real issues. Blaming the insurance companies and their "excess profits" as dear Sec. Sebelius has been doing, is shameful.

High Deductible Health Plans: Difficulties With

2010-02-13T11:06:00.005-05:00

Like at many other institutions, I expect to see significant increases in my health insurance costs purchased through my employer in 2011. I have often advocated for high deductible plans -- catastrophic coverage, essentially -- as a good direction to go in health insurance. Such plans would potentially:

-- Make consumers internalize the true cost of health care and make efficient decisions concerning purchases
-- Create conditions for more price transparency. I expect that more consumers would start asking their providers what procedures will cost.
-- Make consumers realize that much of the problem with health care cost is not with the insurance companies but with high prices from providers.

Unfortunately the path to high deductible plans that would lead to such effects is not easy. There are a lot of behavioral and institutional issues that need to be corrected, and at least one major tax issue. Let me elaborate a bit by using Dartmouth's prices for insurance as an example.

My choices in health insurance are three-fold: a "high" deductible indemnity plan, a "zero" deductible PPO (preferred provider organization) plan, and a "zero" deductible POS (point of service) plan. I put quotes around the deductible amounts since they are fuzzy -- depending on what kind of provider you use, the deductible might or might not apply.

But let's try to keep it easy and focus on the two plans I paid attention to. The indemnity plan has a $3000 per year family deductible, while the PPO plan has a $750 family deductible so long as I stay in the network of preferred providers, which I normally would do. The PPO deductible only applies to some things, like hospital stays, outpatient services, physician services. Routine exams and things like xrays are either covered in full or for a nominal amount ($15).

The high deductible indemnity plan would cost $19,800 per year while the low deductible PPO costs $18,635. Thanks to misguided tax policy, all of this is paid for with pre-tax dollars.

Already you can see how tough this choice is going to be. This is not like comparing what kind of beer to buy, for sure. Not even like auto or home insurance.

But let's try to cut to the chase. If I buy the high deductible plan, I save $1165 per year. For that, I risk paying an additional $2250 or even $3000 in my own health costs. If I can put money into a health savings account, then I can keep the comparison in pretax dollars, but the problem with our health savings account is that if I don't use all the money in a year, I lose it. So I have to estimate what I will spend, and put only that much in. If I underestimate, then I will end up paying the deductible with post-tax dollars, which really hurts.

So if I expect my health care costs to be less than $1165 for the year, I would be better off with the high deductible plan -- the savings in plan price exceeds what I will pay out of pocket for costs. (I am assuming here that the effective deductible on the PPO plan is zero, as most of my expenses are in the zero deductible category.) More than $1165, and I should take the low deductible plan. And in doing these calculations, I should anticipate that my pattern of health care consumption should be different depending on what plan I have (since in one plan I pay for each service and in the other plan I do not).

This is a tough call. The biggest problem for me is that there is simply not much to be gained one way or the other. The dollar amounts are just not that large. And then there are other differences that our dear benefits providers have thrown in to make the choice even more complicated: the plans differ in mental health services, eye care, drug coverage, and even reimbursement for health care membership.

Faced with the choice, most people, I believe, opt for the PPO plan. Yes, it costs a bit more, but it is easy to understand. I think the College probably feels this is good, that most people opt for the PPO, as it discriminates against out-of-network providers. So employees use the low-cost preferred providers.

The problem of course is that now I have a zero deductible on all kinds of services and a low deductible on a lot of other things. So many consumers get into a situation where the marginal price of health care for them is zero. That causes consumption of services to be too high, and creates a situation where consumers don't know what things cost. Not even doctors and hospitals know what things cost, because nobody has an incentive to ask. And, consumers, when they see increases each year in their health care plans, blame the only entity for which they see a meaningful price that they pay -- in this case, Anthem. (Interesting, the payment for a doctor visit under the PPO plan is $15, probably leading many consumers to think that doctor's can't be charging too much!)

In my opinion, the design and pricing of these plans is very poor. If they are designed to get folks into a PPO so they select in-network providers, that can be accomplished another way. What they plans are not doing is getting people to take high deductible plans and have proper incentives.

Could better plans be designed? Of course. In my next post, I will work out some more details. However, the key elements are going to be: First, there has to be a really high deductible plan, something in the $5,000 range. Otherwise there just won't be enough potential savings to play around with. Second, with such a high deductible, the medical reimbursement account will have to have a corresponding high limit, and, CRITICALLY, the "use it or lose it" aspect will have to disappear. If you put $5,000 into an account for medical costs, and use only $1,000, then next year you should be able to roll that entire amount forward. Essentially we should be able to self-insure our medical expenses with pretax dollars over time.

Next post will take some imaginary data and play around with a couple plans that could get a larger portion of employees into a high-deductible plan.

More on the Health Insurance Price Hikes in CA

2010-02-13T08:08:00.003-05:00

Both the facts and the reporting of the facts interest me in this story about Anthem/Wellpoint's price increases for individual health insurance in California.

After some searching I found the five-page response letter from Wellpoint -- why don't virtually any of the stories reporting on the increases link to Wellpoint's response, which is available here?

The letter gives some information, but it is not perfect. Brian Sassi, CEO of the Wellpoint Consumer Business Unit makes some good points. He notes that the 39% increase reported is one of the largest increases, not the average. He points out that many increases are related to insured consumers getting older and moving into higher priced tiers. He makes an interesting argument, which is that if insurance has a fixed deductible, and health care costs increase, then there is a phenomenon that he calls "deductible leveraging." This is true; with a fixed deductible and an x% increase in underlying health care costs, the premium will have to increase by more than x% to maintain fair insurance. Why deductibles are not indexed is an interesting question.

He also argues that adverse selection is working powerfully in the individual market. This is probably true.

He argues that many individuals can and do move into lower cost policies (with higher deductible) both before and after price increases. He cited one fact, that a 40 year old woman in LA can obtain a $1500 deductible policy for as low as $156 a month.

What he doesn't do, unfortunately, is give us data on the actual age-constant policy premium increases. Why beat around the bush so badly? Come on, 'fess up and spit it out for crying out loud!

So, a big question here is: Why would Anthem institute rather large price increases in the individual market at a time when such an announcement is sure to cause a huge ruckus?

Theories, with my probabilities:

1. A lower level manager made the moves without thinking about the effect and without alerting upper management. Now the company is in defensive mode. (10%)

2. Upper management made the decision on the basis of sound business analysis, understood the implications, and decided that business trumps politics and they would just deal with the outrage. (35%)

3. Upper management made the decision on the basis of sound business analysis, understood the implications, and decided that it would actually be good to stimulate some debate, since much of the increase follows from the bad state of current policy. (50%)

4. The price changes were not entirely based on sound business analysis, but upper management decided to announce them purposely to stimulate debate. (5%)

Note that the letter from Wellpoint does devote a fair amount to current policy problems, and why the proposals in Congress will not solve these problems:

Unfortunately, the proposed personal coverage requirements in the health care reform legislation passed by both houses of Congress failed all three requirements by (1) exempting tens of millions of Americans from the requirement, (2) using the tax filing process as the only checkpoint which misses tens of millions of Americans who do not file taxes, and (3) including penalties that are a small fraction of the cost of coverage. Under this framework, it is only logical that many individuals— primarily those who are healthy—would have not been captured by the mandate or would have made the logical choice to pay the penalty unless services were needed.

And Now for Some GOOD Republican Ideas

2010-02-12T08:22:00.002-05:00

George Will, in a column titled Charting a Simple Road to Government Solvency lays out the proposals of Paul Ryan, Congressman from Wisconsin (with help, it seems, from Republican representatives Devin Nunes of CA and Jeb Hensarling of TX). The full proposals are available here.

First, on health care: refundable tax credits for purchasing portable coverage in any state, with the link to employment clearly severed. Quoting from Ryan's proposal:

Yet health coverage is currently linked to employment by the individual income tax exclusion for employer-sponsored health care. This tax treatment effectively discriminates against workers and families who do not have employer-sponsored health insurance. Compounding the problem, the number of employers providing health insurance has dropped 69 percent since 2000; and this alarming trend is continuing.

Equalizing the tax treatment of health care and coverage will give workers and families much more freedom to acquire a plan that best suits their needs. Making health insurance portable means an individual no longer will live in fear of losing his or her health care along with a job. As the marketplace begins to respond to this new patient-centered control, the resulting increase in competition will improve the quality of services and provide more options to meet the diverse needs of Americans, while lowering costs.

In addition, Medical Savings Accounts would be strengthened. Medicare would be grandfathered in for older people but younger people would enter a new program that would give them vouchers to buy insurance.

These are significant changes. Intellectually exciting, with the potential to really change the system as we know it (which makes any scoring by the CBO virtually meaningless, as they cannot take account of behavioral changes.)

But Ryan doesn't stop at health care -- he has changes for the tax code and Social Security as well.

As for taxes, he opts for simplicity and incentives: a broad base (no deductions other than the health care credit) and two rates, 10% up to $100,000 and 25% beyond that. Beautiful. (It also solves a problem that a colleague was really harping on the other day to me: that the majority of Americans now pay NO income taxes. What kind of "skin in the game" is that?)

And Social Security, like Medicare, gets grandfathered in for older people but younger people get the option of Personal Retirement Accounts for up to 1/3 of their Social Security taxes.

Nobody can say that the Republicans do not have any ideas. This set of ideas is radical, but based on sound economics and conservative principles (as in, individual responsibility and small government). They could ensure that the US economy would be the most dynamic wealth-producing economy in the world for decades to come.

In fact, these ideas are enough to make me want to join Mr. Ryan and his colleagues.

Gingrich and Goodman's Semi-Lame Ideas

2010-02-12T08:05:00.003-05:00

The Republicans have some pressure now to show that they are skilled at more than just blocking the Democrats. They need to come up with some ideas of their own. In two posts, I give two examples: First, a set of ideas for health care reform that don't really excite me, from Newt Gingrich and John Goodman, as they wrote in an editorial in the WSJ.

Gingrich and Goodman start out with a couple OK ideas. Give consumers the choice of either a tax credit or a deduction for health insurance, and have it be a fixed dollar amount regardless of how much insurance one purchases. Make insurance portable they say. (But they don't say clearly if they mean to sever the link of tax credits/deductions to employment. Just saying that "Employers should be encouraged to provide employees with insurance that travels with them from job to job..." Why not take the big step and make the tax credit/deduction separate from employment?)

After the first couple points that could have some effect if they were made a little more powerful, the two Republicans end up with a list of rather minor and vague points: "Allow doctors and patients to control costs." "Don't cut Medicare." "Inform consumers."

I almost fell asleep reading it. Zero intellectual excitement.

On to a better version in the next post.

Individual Health Insurance Prices/Adverse Selection Spiral?

2010-02-11T08:15:00.003-05:00

Many are reporting on Anthem of California's large price increases in the individual health insurance market -- see here for instance.

Be careful, of course, because all we really know is that

Anthem Blue Cross has unveiled rate increases of up to 39 percent for its 800,000 individual policyholders in California.

And of course there are the stories of individuals reporting their own personal increases.

What we don't know from the stories is what the average increase for the entire pool is.

However, some of the explanations are reasonable -- that some insured people are dropping out of the pool, leaving only the most costly remaining. As prices go up, this will of course only get worse: those who think they are healthy will take their chances, and drop out. This is the adverse selection death spiral.

I am, however, skeptical -- as usual. Skeptical that the anecdotes don't represent the average. And, if indeed the average is going up anything close to 39%, skeptical on why Anthem would be stimulating the debate on health care in such an aggravated fashion.

I will be keeping my eyes open for more information on this important development.

Yale University Announces: We'll Eat our Seed Corn

2010-02-11T08:04:00.003-05:00

In a letter to the faculty and staff of Yale, President Richard Levin announced that he was seeking $150 million of savings in order to balance their budget. Among other cost reductions, he said that the number of new students admitted into the Graduate School will be reduced by 10-15%.

No detail was given on what schools would see the reductions, but this is depressing. In my world at least, great PhDs are in extremely short supply, and we should be increasing the numbers.

Levin attempts to temper the news by saying that the number of graduate students will be no lower than a decade ago.

So...a decade of no growth in Yale graduate students. Did the population of the world not grow in the last decade? Did the world's demands for doctorates stay level?

This cut in graduate school admissions needs to be put into the context of flat undergraduate admissions at the nation's top colleges, especially the Ivy League. When these schools were flush with cash, instead of admitting more students, they gave away more financial aid to the existing students and put up nice new buildings. The choke point at the top of the pyramid just got tighter and tighter: a larger US population, more global applicants, yet the same number of students being let through the doors of opportunity.

Trying to Understand the Pre-existing Conditions Issue

2010-01-31T09:31:00.002-05:00

One of the bigger talking points for health care reform was the idea that greedy insurance companies turn away people with pre-existing conditions.

The confusion over these kind of claims is amazing. As I dig into issues like this even a little bit, I get more and more worried that we were being sold a pig in a poke and/or that many legislators and advocates did not really understand what our current health care system really is like. If they don't understand the true nature of what we have, how can we trust them to design something new?

(I have already pointed out in this blog two other major areas of confusion, one being that most folks who get insurance through their employer are actually part of a self-insurance program; and the other being the large extent of miscounting in the percent-of-GDP calculations for health care.)

So a friend and I were wondering why Dartmouth College had dropped its pre-existing conditions clauses several years ago. I remember having to deal with such issues when hiring faculty, but we no longer have such clauses for new employees. The most likely explanation (I wish I could say enlightenment on the College's part but I don't think I can) was a new Federal law: HIPAA, or Health Insurance Portability and Accountability Act of 1996. I recommend this site to get an overview. Here is a brief description:

HIPAA is a federal law that:

Limits the ability of a new employer plan to exclude coverage for preexisting conditions;

Provides additional opportunities to enroll in a group health plan if you lose other coverage or experience certain life events;

Prohibits discrimination against employees and their dependent family members based on any health factors they may have, including prior medical conditions, previous claims experience, and genetic information;

and

Guarantees that certain individuals will have access to, and can renew, individual health insurance policies.

Now this law does not solve perfectly a key issue involving health insurance, that being the ability of individuals who have not had group-based health insurance to continue with individual insurance (at reasonable prices). But, I note that it did solve many problems that could have affected the vast majority of people with health insurance, that being the difficulty in even switching jobs if you have health issues. (I think that many people still think that they can be denied coverage by a new employer for pre-existing conditions. Probably many of those folks support health care reform on the basis of that faulty assumption!) I also think that HIPAA points the way to MODEST reforms that could be made to the individual insurance market that would help alleviate the issues that remain in that market (even short of the policy change that would really help that market, that being severing of the tie between one's employer and one's health insurance).

Lake Skating

2010-01-31T09:26:00.002-05:00

For anyone interested in a real new winter adventure, I highly recommend lake skating. Check out these pictures of Goose Pond in NH yesterday. The entire lake, all 550 acres, was like a hockey rink. Snap a pair of nordic skates onto your cross country ski boots, buck the North wind up to the head of the lake (avoiding frostbite), then turn around and scream down to the other end.

I was a little afraid yesterday to go across the wide part of the lake to get to the other side, but today I am going to do it. As they say, it's not a sport if you can't get killed doing it.

Getting Intimate with the iPad?

2010-01-31T09:14:00.002-05:00

It was well below zero yesterday morning, and the fire in my woodstove had burned down to only glowing coals. The temperature was probably about 45 degrees in the house. So, with a cup of coffee in one hand and my iPhone in the other, I stayed in bed and cruised the web and got all the Saturday morning news. All my favorite sites...Fox, Drudge, RealClear Politics, Roger Pielke Sr. ...

The interesting thing is that I had my laptop with me as well, and could have been using that. I would get a bigger image, but I would not really be as comfortable. With the iPhone, I could move around at will, and of course the image orientation followed me.

Two eureka thoughts. The first one was, hey, wouldn't a slightly larger version of the iPhone make this picture even sweeter? Yes indeed it would. A nice light device, with a large screen, and one that would allow me to multitask easily from a website to maybe a book that I had been reading? Thank you Steve Jobs -- I can see an iPad on my wishlist.

Second, I had jumped around to myriad news sites, including the WSJ, BBC News, Washington Post, Washington TImes -- :), New York Times, but I had not paid anyone a single dime for all that good reading. Sure, a few advertisements were somewhere in my screen occasionally, but on an iPhone one hardly notices them.

I am still waiting for Steve Jobs to figure out some way to package news content with the iPad, and charge me a monthly fee for it. Yes, that will be painful, but I am willing to do it. How much? Let's see...if you gave me the Economist, WSJ, New York Times, Shooting Illustrated, Washington Post and maybe one or two others...I already pay a hundred dollars per year each for the first two...how about $50 per month?

A Bad New Beginning

2010-01-20T18:29:00.003-05:00

Obama has conceded that goals for a health care reform package need to be revisited in light of the Massachusetts Surprise.

But he gets off to a very bad start with this line:

We know that we need insurance reform, that the health insurance companies are taking advantage of people.

How about stopping the blame game and the populist rhetoric for a better beginning? If we want to eliminate the pre-existing conditions clause, how about we start by honestly recognizing the basic and real problem faced by self insuring employers and insurance companies of individuals who stay uninsured but as soon as they get seriously sick opt into the insurance pool? Pre-existing conditions clauses prevent that.

I suggest a small commission of smart, unbiased, action-oriented individuals who would come up with a nice clean set of changes to our health care system that would meet a small number of clear objectives. And then have Congress vote up or down with no option for bribes and payoffs.

Hope Springs Eternal

2010-01-20T18:20:00.002-05:00

There is a ton of writing out there on the election of Scott Brown by the voters of Massachusetts, and much of it is very good.

I will just add a couple thoughts. One is that I derive a LOT of hope and optimism from this result. The electorate does matter, that is very clear. A seat that anyone would have thought was tenured to the Democrats long ago was taken away by a Republican in a blue, blue state. Wow.

Two, I think this puts the country back on its trend line of an electorate slightly more conservative on at least economic and defense issues. The election of Obama and the Democratic Congress was the bigger aberration. But how could that not have happened, with two wars, an unpopular Republican President, an economy on the brink of a second depression, and a lackluster Republican candidate and his somewhat problematic running mate? And Obama did not exactly win a landslide.

But three, I would be cautious in interpreting this as a massive turn to the Republican Party. This was an expression of outrage at government, ie., the incumbents broadly speaking and the Democrats in particular who are in charge and who are spewing out trash like the exemption of union workers from the cadillac health care tax. The Republicans can capitalize on this by actually coming up with some constructive ideas on, for instance, health care. And taxation -- and more than just "cut taxes." How about a serious review of the income tax code. I for one will volunteer a slight increase in my total tax payment if part of the deal was a broadening of the base, a lowering of marginal rates, and a general elimination of complexities like the AMT.

Venezuela Appropriates a French Chain of Stores

2010-01-17T23:11:00.002-05:00

Will the French invade in response?

More realistically, how long will this Chavez fiasco in a once-great country continue?

Story on the expropriation here and here.

Betting Markets Predict a Scott Brown Victory!

2010-01-16T18:01:00.002-05:00

One of my colleagues alerted me to the recent trading activity on InTrade. The runup in price for the Scott Brown contract, and the corresponding decline in the M. Coakley contract, is just amazing. Not a lot of volume in the market, and I still think it is too good to be true.

The AM radio station 1030 WBZ must be enjoying a tremendous revenue windfall, as is the NECN news channel. Ads for Brown and Coakley are running almost continuously. I do think that the Coakley ads, at least some of them that I have seen, are markedly negative -- dark, nasty images and pictures of (horrors!) George W. and Dick Cheney.

On NECN right now, a Coakley ad is running. It claims that Brown would deny rape victims immediate contraception. I heard Brown on the radio earlier denying that explicitly. In fact, here is news that Brown is claiming defamation against the Massachusetts Democratic Party for such a claim in a mailing it sent out.

The Stench of Health Care Deals

2010-01-15T21:01:00.002-05:00

I just cannot believe that the Democrats and Obama have stooped so low as to give the unions five years more than the rest of us, in regard to when a tax on "cadillac" health care plans kicks in. Is that sad or what? In order to get the support of the unions, Pelosi, Reid and Obama have to pay them off with petty cash. See here for a description of the story.

Why would any rational policy exempt workers who are identical in all ways except they are covered by a collective bargaining agreement, i.e., they belong to a union?

This comes on top of the buyout of Ben Nelson and Nebraska, and a few other groups as well. It's been a while since I read the Senate bill, and I suppose I should get out a bottle of wine and PeptoBismol and do it again. (Note that reports today had Nelson asking for removal of Nebraska's special status, but I will believe equal treatment of states when I see it.)

The other thing is that they are really gutting the cadillac tax, by raising the limit, excluding "high cost states" (what is the point of reform anyway?) and by now excluding vision and dental. I wonder when people will realize that the current version still includes reimbursement accounts. The cadillac tax is not such a bad idea, in a world of second-best, but if unions and longshoremen and others get breaks I drop my limited-to-begin-with support.

Too Good to Be True

2010-01-15T21:00:00.003-05:00

If Scott Brown were to win the Massachusetts US Senate seat held by the late Teddy Kennedy, what would that qualify as?

Definitely a political heads-up to any Democrat who wants to keep their job.

Tuesday night is going to be a late one. I hope I don't have any meetings Wednesday morning scheduled.

Would You Buy a Used Car from James Hansen?

2009-12-12T08:30:00.003-05:00

James Hansen recently had an editorial, "Cap and Fade," in the NYT.

In it, he argues against a cap and trade system in favor of a carbon fee (aka "tax").

I might actually agree with him on some matters of economics, but that is not the point.

This editorial is as full of errors in logic as almost anything I have seen. Even worse, it reveals the philosophical beliefs and political biases behind much of the climate change agenda.

As for some of the errors in logic: How about this one, early in the editorial:

Because cap and trade is enforced through the selling and trading of permits, it actually perpetuates the pollution it is supposed to eliminate. If every polluter’s emissions fell below the incrementally lowered cap, then the price of pollution credits would collapse and the economic rationale to keep reducing pollution would disappear.

To say that cap and trade "actually perpetuates the pollution it is supposed to eliminate" is either a naive attempt to influence complete idiots or a completely ignorant statement, take your pick. How putting a high price on something -- just as a carbon tax would, by the way -- helps perpetuate pollution rather than create incentives for its elimination is beyond me. (And also, with a cap and trade system, the beauty is that you will get in total whatever amount of pollution the political process decides upon. Contrast that with a tax based system, where the quantity of pollution reduction will be uncertain.) Hansen is correct that if for some other reason every polluters' emissions fell below the cap (well, almost correct -- it is the total of everyone's emissions that would have to fall below the total cap) then the price of credits would go to zero. But that should be celebrated, as the amount of pollution would now be under the level determined to be the socially optimal amount!! Hansen is showing his clear disdain for any kind of cost/benefit determined optimal pollution level and instead thinking that the socially optimal policy is to keep pushing to zero emissions -- while of course decreasing the demand for fossil fuels, lumber, minerals etc. The road to serfdom, in other words.

Here is another statement that just comes out of the blue and makes little sense:

Cap and trade (for sulfur dioxide emissions of power plants in the US) also did little to improve public health. Coal emissions are still significant contributing factors in four of the five leading causes of mortality in the United States — and mercury, arsenic and various coal pollutants also cause birth defects, asthma and other ailments.

Cap and trade did little to improve health...because coal emissions are still contributing factors?? This is the way we do science in the climate change community? Come on, now. What, the only improvement would have been if coal emissions were no longer a contributing factor to anything bad? Ah, right...the only test is if we get emissions down to zero...there we go again down the road to serfdom.

Here is an even better quote from Hansen, showing both a lack of economics understanding and his political biases:

The market for trading permits to emit carbon appears likely to be loosely regulated, to be open to speculators and to include derivatives. All the profits of this pollution trading system would be extracted from the public via increased energy prices.

Oh my god!! The market will be open to speculators and ....will include DERIVATIVES!!!! And of course the cost of all this high tech finance will be EXTRACTED from the public. Scary stuff. But if Hansen would think for a minute, he might not want the price of carbon credits to be $25 in one year and $250 the next...but eliminating those kind of price differences -- AND THEREBY CREATING SAVINGS -- will require trading and, most efficiently, derivatives contracts.

But the funniest quote from Hansen is this:

The fee would be uniform, a certain number of dollars per ton of carbon dioxide in the fuel. The public would not directly pay any fee, but the price of goods would rise in proportion to how much carbon-emitting fuel is used in their production.

All of the collected fees would then be distributed to the public. Prudent people would use their dividend wisely, adjusting their lifestyle, choice of vehicle and so on.

"All of the collected fees would then be distributed to the public. Prudent people..." Wow. Does anyone believe that if the US government collected hundreds of billions in new taxes, that these funds would then be distributed back to the public? And how would that redistribution occur, exactly? And prudent people would then use those dividends wisely? You have got to be kidding. It would be nice, if we got a carbon tax, that all such collected funds be used to reduce the deficit. But money, as we always say in economics, is fungible...our legislators and president could just say that the money they are spending is coming from somewhere else. Spending overall would increase, and the deficit would stay the same. The share of US GDP controlled by the government would increase.

Two conclusions are possible on the basis of Hansen's editorial. One, that he is incredibly ignorant and unwilling to learn when it comes to economics. Two, that he is willing to say almost anything in the pursuit of climate change goals. On the basis of other things he has written and said, and on the basis of many other writings of carbon control proponents, including the emails of ClimateGate, I put my weight on the second: Scarily, the ends justify the means.

In the Spirit of Famous Last Words

2009-12-02T19:49:00.002-05:00

Frank Fabozzi, page 115 of his edited volume The Handbook of Mortgage Backed Securities, 2006 edition:

"Based on historical experience with financial guarantees by monoline insurers, capital market participants have a high degree of confidence in bond insurance because no investor in any bond-insured security failed to receive a single timely payment of principal or interest. Moreover, downgrade risk is viewed as minimal because no US financial guarantee company has been downgraded. Investors realize another benefit from bond inusrance. While rating agencies face reputational risk when assigning a rating to a security, monoline insurers are placing their won capital and credit at risk. Hence investors can correctly expect that the transactions structure is inherently safe and will remain so over the life of the securities guaranteed."

Joseph Stiglitz, Jonathan Orszag and Peter Orszag, "Implications of the New Fannie Mae and Freddie Mac Risk-Based Capital Standard," Fannie Mae Papers Vol. 1, Issue 2 March 2002:

"These results regarding the risk-based capital standard are striking: They suggest that on the basis of historical experience, the risk to the government from a potential default on GSE debt is effectively zero. Given this striking result, it may be worthwhile exploring three potential shortcomings in the standard. None of the potential shortcomings appears to be significant enough to alter the basic conclusion that the risk-based capital standard provides substantial protection against insolvency."

Dr. Michael Schlesinger, as quoted on Roger Pielke Sr.'s climate blog:

"As documented in the IPCC AR 4, it is not possible to replicate the observed warming due to natural causes -- the sun and volcanoes -- alone. Such replication can be done only by including the effects of the human-generated increase in the concentrations of greenhouse gases.

Thus the case of the causes of the observed climate change is closed, period -- RSP or any other climate skeptic notwithstanding."

More on Different Prices in Health Care

2009-11-13T13:11:00.004-05:00

Some folks are still asking about the justification of different prices for health care services paid by different groups of people. The tone of the critiques is that the well-to-do are supporting a system that benefits them at the expense of the people who pay full prices for doctor and hospital services -- with those latter people being to a great extent the uninsured.

First, let's see if we can get some data to bear on the problem, rather than relying on my speculations and the media's love for heart-wrenching anecdotes. We can always find, for any system, some stories that make us want to cry, like the uninsured person who goes bankrupt because of a huge hospital bill based on full prices. I don't want to completely dismiss the exceptional cases, but I think when we are designing a social/economic policy we should focus on the total picture.

So I had speculated that not too many people pay full price at hospitals, and I claimed that many hospitals treat the destitute for free. In fact, most hospitals have formal sliding scales of prices, giving LOWER prices to lower income people. I found a good blog posting by Uwe Reinhardt at Princeton on this subject, and he referenced a paper, Melnick and Fonkych, "Hospital Pricing and the Uninsured: Do the Uninsured Pay Higher Prices?" in Health Affairs, Feb. 5 2008. The Reinhardt piece is very good; he actually argues for a law that would restrict pricing to the uninsured at more than 115% of Medicare rates -- although he also admits that for most hospitals this would be nonbinding, as they already do so.

But on to the main article and their findings. They looked at California hospitals in 2005-2007. Below is the chart of their main findings:

So what does this show? Well, the four solid lines show the percent of full price paid by four groups of patients: The commercially insured; the uninsured; Medicare; and MediCal (low income California Medicaid system). You can see a few things. First, who pays the most? The insured. Of course. Who pays the least? MediCal, followed closely by Medicare. Just for the record, Medicare patients in 2005 paid on average about 27% of full price!!! Even the insured, who pay the most, only pay about 38% of full price.

Point number one: my claim that not many people pay full price is correct. Given how low all of these percentages are, there is no statistical way that many people can be paying full price. Some in the sample will be, no doubt, but to get an average of 27% I am sure that the vast majority are paying closer to 27% than to 100%.

Point number two: Who pays on average the most? The insured population. Again, of course. If anything, the insured patients should be screaming about the lower prices being given to the Medicare, Medicaid, and uninsured populations. (But be careful here: it is probably profitable for the hospitals to charge lower prices to those groups -- that is what price discrimination is all about. Prices to the insured would be even higher if the hospitals had to cover all their costs just from the insured population.)

Point number three: Who pays the least? Those insured through government programs, that is, Medicare and Medicaid. So those of you out there who want "one price to all" better realize that the biggest effect of that will be to raise Medicare costs substantially. Essentially what we have here is a hidden tax: the government uses their negotiating clout with doctors and hospitals to get lower rates, which the rest of us then pay for. If you mandate one price, then Medicare will have to raise funds somehow else -- an increase in the income tax, most likely.

Point number four: This pricing is pretty crazy, with list prices being so high. Why not just cut them down across the board? I could go into that, but it is not crucial right here and now.

Beyond this paper, another main point of mine about price differences for health care is that they serve a very important purpose. If the government mandates one price for all, how is that one price ever going to be determined in anything that would approach a competitive fashion? It is the ability for one buyer to negotiate and get a better rate for themselves that benefits all of us by helping to set prices at a reasonable level and keep the escalation of health care costs to a lower level.

Also, people have this idea that pricing is kind of a zero sum game. If one group gets a lower price, someone else has to get a higher price. That logic is tempting but not correct. Hospitals have huge fixed costs they need to cover, from all groups. If you don't let the commercial insurance group get a lower price, you won't get their business. Then all of the fixed costs need to be covered by the remaining groups -- the self insured, for example. The price they will have to pay to cover the hospital's costs is likely to be much, much higher. The zero sum logic applies if we always have all the customers and we are just trying to spread costs around, but this is not the real situation we face.

No Generalized Villains, But Many Squandered Opportunities for Heroes

2009-11-10T18:58:00.002-05:00

The title of this post is my summary of the credit crisis.

News today that the managers of two Bear Stearns hedge funds were found not guilty of fraud and insider trading supports the "no villains" idea.

This was a trial by jury, with normal everyday people on the jury. That they found the two not guilty is significant.

These two Bear funds that went bankrupt heralded the beginning of our credit crisis, but not enough people saw the meaning of their downfall at the time. Why? Because it simply wasn't clear that the world as we knew it was about to end...

More on Different Prices for Different Folks

2009-11-10T18:47:00.003-05:00

Here is a good story from the Wall Street Journal that I found in my search for good information on who pays the "rack rate" or "list price" for health care.

I agree that it is bothersome that some of the most needy end up paying the highest prices for health care.

But at the same time, there are some good reasons for those price differences and some lessons to be learned.

How many of us ask when we go to the doctor what the price of the service will be (and how many doctors even know)? Why are we willing to accept such ignorance of prices from docs and hospitals when we will haggle to the final penny with a car dealer or a bank on a mortgage? This is just one example of the inconsistencies in people's behavior when it comes to health care vs. other products and services. Another one is that many people think regular exams and preventive maintenance should obviously be covered by insurance. I bet I could find people who would argue that, on their way to the car dealership to pay hundreds of dollars for their 50,000 mile checkup on their three year old Chevy. We accept that we have to maintain our cars, houses, and other property, but not our own bodies? Go figure.

At least larger insurance plans do some negotiating for us. It is too bad that not everybody gets the benefit of those negotiated rates -- if self employed people buy individual insurance plans and then have to pay full list prices. But again, if we take away the incentives for anyone to negotiate, what will that do to the pricing power of the suppliers and to the overall level of prices? I predict we would see even higher prices.

I believe it is also true that the great price differences we observe today in health care (list price vs. negotiated health plan rates) began when Medicare got into the market. Just an observation...