More on Different Prices in Health Care

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

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

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...

Different Prices for Different Folks

"Reefnetter" asked a question about the justice/injustice of charging different people different prices for an important service like health care, or even basic products like food.

This does raise some interesting questions. Right now in health care, there are at least four levels of price, in order of high to low: The "rack" or "list" price; the negotiated price for insurance plans; the government/Medicare rate; and a price of zero. Who pays the rack price? Not too many people, would be my guess, but I am not sure. If you are self employed and buy health insurance in the marketplace, that policy could still have a negotiated rate with suppliers. Some people who pay the full price are actually the rich uninsured; others would be medical tourists. Who pays the "zero" price -- well, that would be the destitute who get care and cannot pay. This might also end up being a negotiated rate, greater than zero but less than maybe even the Medicare rate.

Do these price differences concern me, especially given that the well-to-do will generally receive the negotiated rates rather than the list prices? Not, not really.

One of the benefits of these price differences is that they serve to put pressure on the service providers. Suppose we had a law saying that health care providers had to charge everyone the same price. Do we think that would result in higher or lower prices overall? I am sure it would result in higher prices, because it would prevent any one insurance plan from being able to ask for and receive a lower price. It is that process of insurance plans going to service providers (e.g., large hospitals, doctors' clinics) and negotiating lower prices that gives us some relief from unmitigated price escalation. Does this process of competition mean that some plans will negotiate lower prices than other plans? Yes -- and that is exactly what we need to give the plans incentives to put pressure on the service providers. In the new world of health care about to emerge, this will be one of the main ways for different insurance plans to get a competitive advantage. We should celebrate it -- how else will we get the health care providers to put a lid on their prices?

Note also that generally the larger plans will be able to negotiate the best prices. Why? Because they will be able to promise (or withhold) large amounts of business from the providers. Bulk purchases generally do get better prices. This is true for electricity, food, cars, ....you name it. Reefnetter, I bet you give your largest customers some kind of volume discount, right? In health care, it is valuable for a hospital to be able to count on business from a large pool of insured people. This gives the hospital enough confidence in its volume to expand facilities, invest, etc.

Another side benefit of the high list prices is that it induces people into the ranks of the insured. There is a real problem in health insurance caused by people "gaming" the system: being uninsured when healthy, then getting into insurance just when you need it. This is one of the problems that the health care reform is dealing with, this time with penalties for not being insured. If the uninsured can get the same low rates as the insured, then there is even more incentive to game the system.

Interestingly, I have always thought that the lack of price differences for some goods and services has created some distortions in our society. For instance, the postal service charges the same rate for rural service as for urban service, even though the cost of rural service must be higher. Similarly, AT&T always charged the same rate for home service, no matter how few people were in an area. These prices entailed low-cost, urban customers subsidizing high-cost, rural customers -- was that fair, or good?

Health Care Question

I recently moderated a panel on health care for the Dartmouth Minneapolis Club. It was very good. Minnesota companies are doing some interesting things, including some vertically integrated health care delivery models that are very intriguing.

But a point came up about end of life expenses, with a president of a hospital lamenting on how much can be spent to maintain a few extra months of someone's life -- we all know the stories on this. And yes, the question arose from someone who was concerned about death panels. The hospital president was pitching living wills to deal with this problem.

I responded with this question: If I create a living will for myself that will limit the medical options to be used for me in certain end-of-life situations, should I get a lower price for my health insurance?

Note that the Senate Finance Committee bill will allow health insurance policies offered through their exchanges to differentiate prices based only on age, family size, and tobacco use -- and with maximum increases that can be applied for any of these situations.

Someone else on the panel wanted policy prices to be lower for folks who use seat belts.

If we recognize lower cost of health maintenance for people who don't smoke or use seatbelts, why not for people who voluntarily limit their access to some of the most costly medical technology?

I have always thought that the free market solution to the health insurance problem would give people choice in their coverage to a much greater extent than the policies available today. Such choices would have to limit a person's ability to access certain kinds of care in certain situations, such as my end-of-life example. Other ways to do this would be to accept a process for determining what procedures, devices, drugs are deemed to be cost effective. That sounds like death panels -- let a panel decide whether a procedure will be authorized -- but the difference is that individuals would be making the choices themselves and getting the benefit of lower prices.

Europe tilts right while US spins left?

Angela Merkel is celebrating --sort of -- in Germany. Her party, the CDU, did not do all that well, but the Free Democrats upped their percentage to 15% from 10% in 2005. The Free Democrats are more pro-market even than the CDU. See the NYT's coverage.

The left-leaning Social Democrats (SPD), with whom Merkel had to have a grand coalition with over the past four years, reached its post-War low in election percentage.

Merkel can now govern with a partner that is more in line with her own more conservative philosophy.

Interesting. After the biggest economic disaster since the Depression, with all the press blaming markets, Germany of all countries doubles down and bets even more on a free (r) market economy? Or am I misinterpreting this?

AIDS Vaccine Success (Funded by NIH)

Good news this week on the AIDS front, with mild success reported from a vaccine trial. See David Brown's reporting on it in the Washington Post.

The trial involved more than 16,000 men and women in Thailand, and it cost $105 million. Most of that came from the United States' National Institutes of Health, through the National Institute of Allergy and Infectious Disease.

Just for the record, the entire NIH budget is counted as health care spending by US residents when those tabulations are made of the percent of GDP that we spend on health care.

The Baucus/Senate Health Plan

Senator Max Baucus released the Senate version of a health care proposal today, and the New York Times said it "meets many of the requirements that President Obama laid out in his address to Congress last week."

What shocks me about the Baucus bill is the 35% tax on health coverage over certain amounts -- $21,000 for a family. The Times reports this, misleadingly of course, as follows:

"...the proposal would impose a new, 35 percent excise tax on the most expensive group insurance plans, those costing more than $8,000 for individuals and $21,000 for families."

Actually, the language of the proposal makes it abundantly clear that the total amount to be considered as the "limit" includes the total cost of health insurance provided to employees, whether they pay for it directly or the employer does, PLUS any dental, vision or other health coverage, PLUS the amount that an employee or the employer deposits into a Flexible Spending Account.

This year at Dartmouth the most expensive family health coverage costs $18,300. Add to that $1850 for dental coverage and the maximum $5,000 flexible spending employee contribution and you get $25,154. With a 35% surtax on the excess over $21,000, that means someone (look in the mirror) will end up paying about $1450 in additional tax (or change their health coverage). So now we know what the folks in DC consider to be a "gold-plated" insurance plan -- look no further than your own.

The President and others have been very vocal on how their proposals will not require those with insurance to change anything. In the President's words to Congress the other night: "Let me repeat this: nothing in our plan requires you to change what you have."

OK, so if someone holds a gun to my head and says, give me $1500 -- does that mean they aren't requiring me to change anything I do?

One might think that since health care benefits are provided taxfree right now, that starting to tax them is perfectly fine. In principle, yes. But not in this piecemeal, add-on, excise tax fashion!! If you want to really improve the health care insurance situation, sever the cord binding employees to get their insurance from their employer by giving the employee a tax credit for insurance no matter who they get it from. In the process, if we limit the tax deduction to a certain amount, I could live with that.

And I have just begun to read the Baucus plan. No doubt new gems lie to be discovered.

The Trifecta of Health Care Fallacies

I have already written about some of the fallacies involving health care outcomes across countries and the alleged negative role of insurance companies and their pursuit of profit.

The third big area of fallacy and outright misinformation involves the measurement of health care expenditures in the US and as compared to other countries.

This trifecta of fallacies, pushed onto the American people by the alliance of proponents of health care change and the liberal media, have convinced most people that health care in the US is of low quality, that we pay too much for it, and that insurance companies are greatly to blame. Yet if you ask most people, they are actually quite satisfied with their own coverage. You know that the media have been successful when most people think their situation is fine but think that everyone else is really suffering.

As to the measurement of health care expenditures, there are myriad problems in just measuring how much one country (the US) spends, much less comparing that to other countries. The situation of cross-country comparison is compounded for health care relative to other goods and services because in many countries health care prices are controlled or the entire sector is nationalized. How can we use prices or wages in a country like the UK to measure how much of that nation's resources are being used in health care, when that sector is nationalized but other sectors are not?

But let's ignore that elephant in the corner for a little while and focus on some other interesting issues involving the US expenditures on health care.

If you look around for US expenditure data, you will quickly land at either the OECD site or the Research, Statistics, Data and Systems: National Health Expenditure Data site of the Centers for Medicare and Medicaid Services. The OECD has the cross-country data, but it takes a while to download the whole thing and learn how to use it. (Also, interestingly, as soon as you try to pull out data from more than one country at once, you are presented with a window saying: "Please be careful regarding cross-country comparisons. We advise you to consult the Sources and Methods concerning the data you have selected." I wonder how many people then check the box with "Do not display this window anymore."!)

The number for the US that is typically reported is that we spend $2.2 trillion, or 16.2% of our GDP, on health care. I have often heard that number, and always wondered if I should trust it. The answer of course is no, and I proved that to myself with just a bit of checking. Where should I start -- so many fish to catch, and so little time! The source of much of my discussion is from the Sources and Definitions document from the Health and Human Services site noted above. As we go through this, have in mind that to a great extent what that total expenditure number represents is a summation of what we spend as a nation when we buy health care: so when you go to the hospital and your insurance company (or employer if they are self-insured!) pays the bill, that gets counted as health care expenditure.

Now in all of this, I will note how important it is, when interpreting these data, to have a model of the health care industry in mind. A colleague of mine pointed this out, and it is really true. Without some theory to guide one on how, for instance, prices are set in the industry, the data by themselves really say very little.

1. Start with the fact that in that 16.2% number we have included $101 billion of capital expenditures on structures and equipment. The problem here is one of possible doublecounting, or at least inaccurate comparisons across countries based on how different countries account for capital spending and depreciation. Since our health care industry is either for-profit or not-for-profit (with essentially a break-even constraint) we have to assume that the prices of the health care services cover the capital costs. Think of a competitive equilibrium: prices must equal average total cost of providing the service, including the cost of capital. Since the government uses prices to measure how much we spend on health care, by adding capital expenditures again, there is some doublecounting. Interestingly, the OECD recognizes that capex is a different creature and recommends it be reported "below the line." This does not solve the problem in cross-country comparisons however. For a nationalized system like the UK, prices are unlikely to include a capital cost. Thus, if you don't add capex in a country like the UK, you don't even count cost of capital once. So leaving it out of the UK, and comparing that expenditure data to the US is still biasing the US as too high. This is not an insignificant amount of money.

So when a hospital buys an MRI machine, that total amount gets counted that year in expenditure data. Then I go to get an MRI, pay the hospital for that and in that price is an implicit payment for the machine, and that gets counted again!

(Note: In calculating GDP, capital goods do get added in, even though the cost of those will get reflected in prices. Depreciation gets subtracted when we move from GDP to net national product and national income. So in a sense, GDP has this same doublecounting problem, in that capital goods get counted once when they are bought and then again as they are reflected in prices of goods and services. The problem in health care is really then not so much with intracountry calculations but inter-country, when countries treat capital expenditures and prices differently.)

2. The data for the US includes the entire NIH budget and a good chunk of the NSF budget as well. For those of my colleagues in the life sciences who are getting all their research funded through grants, perhaps you will be surprised to learn that you are part of the problem. Of course, with "overhead" rates on grants from places like the NIH running close to 50%, there is also a lot of funding of general university overhead in the NIH budget. Cross country comparisons are rendered problematic when we realize that other countries fund their universities through direct payment rather than through the US' s reliance on "indirects."

3. Now here is a subtle one. But note again that the basic calculation for the US number is to add up how much we spend on health care. So when you go to the hospital and pay for a service, you pay for all costs incurred in the provision of that service -- wages, benefits, taxes, capital costs. Ah, to the extent that we have for-profit entities providing health care, those prices include corporate income taxes. Is that a cost of health care? Well, in the UK health services are exempt from the VAT, which is about 20% on the rest of UK GDP. Oops! Yet another not-insignificant incomparable.

4. And now another more subtle doublecounting. Again, those prices we pay for health care have to cover all the costs of the health care provider. Part of that cost is the cost of the health care benefits to the provider's own employees -- think of the staff of the hospital. So when a staff member of the hospital goes to the hospital herself, that gets counted once as a health care expenditure. But -- and I agree this is subtle -- that (expected) expenditure is already represented in the prices that are being paid by everyone else. Presto -- another very significant doublecounting.

Well, that should be enough to make anyone start wondering how much of GDP we really spend on health care, and if our spending rate is really that much higher than other countries. And again, the elephant in the room is that many other countries, if not all, have significant wage and price controls on the health sector, if not having that sector entirely nationalized. I have no doubt that the US could dramatically reduce its measured share of GDP spent on health care if we, say, reduced all doctors' fees and all drug prices by 25%. Is this the way we really want to go -- a system where our very imperfect political mechanism determines prices and profits for the people and companies that are protecting our health?

More Inconvenient Health Care Facts: The Role of Self Insured Employers

I have previously mentioned that Dartmouth College was self-insured in regard to health care costs of its employees, and that this creates a situation wherein the College not only has the incentive to manage its employees' health costs but also has tremendous ability to do so.

In discussing this with people, I am struck by how many did not realize the extent of self insuring employers. So here is a document that gives the facts: Health Plan Differences: Fully-Insured vs. Self-Insured, from the Employee Benefit Research Institute.

As I suspected (ah, theory does help one predict accurately!) the extent of self insurance among employers is quite great. Overall, 55% of workers "with health insurance" were covered by a self-insuring employer in 2008. Even more telling, 89% of workers in firms with more than 5000 employees were covered through a self-insurance plan.

Most companies that self insure will still use a Third Party Administrator (TPA) -- Dartmouth uses Anthem BC/BS -- to handle the administration of the health plan. Besides processing all the paper, this also includes the important role of negotiating rates with medical service providers. Self insurance simply means that the company will pay all of its employees' health care bills -- they just get passed on by the TPA. (Most employees, however, probably think that they are being insured by the TPA, and when there are issues with nonpayment, etc., they will blame the TPA.)

How does the great extent of self insurance fit into everyone's perception of the greedy, rapacious role of insurance companies? They are not even insuring most workers!! And, the Third Party Administrator market is a very competitive one. A company can request bids from many TPAs and take the best one. And the employer can design its health care plans as best fit its employees, and then just tell the TPA to administer it. That is, as I have repeatedly argued, the employers have all the incentive and ability to manage their health care cost. The problem is NOT with insurance companies. This is one of the myths being consistently pushed by those who want reform at any cost.

More Health Care Facts

The columnist Steve Chapman at the Chicago Tribune has written a couple great columns on dispelling some health care myths. The latest is here. This column visits some of the infant mortality data that I discussed below. One good quote is:

Nicholas Eberstadt, a scholar at the American Enterprise Institute in Washington, also attributes the gap largely to conduct. Comparing white Americans to Norwegians in his 1995 book, "The Tyranny of Numbers," Eberstadt concluded that "white America's higher rates of infant mortality are explained not by poverty (as conventionally construed) or by medical care but rather by the habits, actions and indeed lifestyles of a critical portion of its parents."

When I was discussing infant mortality the other day, some folks were all too ready to say that the US health care system is also to blame for the tendency in the US to have low birth weight babies. If only those teen-age moms had seen a primary care physician, they said, they would have stopped smoking and using coke, and -- voila! -- we would have had a nice strapping 8 lb. baby. Ah, one has to marvel at the optimistic trusting innocence of the liberal mind.

I guess also that Steve Chapman is likely to get branded as one of these right-wing maniacs who are spreading misinformation and disrailing the high speed locomotive known as health care reform.

Health Insurance Fallacies

The proponents of health care reform like to argue that opponents are spreading misinformation to push their views.

I need to point out the one fallacy that I consistently hear from reform proponents, and that has sunk in due to its relentless repetition. I have had colleagues fall into the trap and many students as well, even those who have had several econ courses.

The fallacy is illustrated well by this quote from an AP story written by Ricardo Alonso-Zaldivar:

Proponents of a government plan say it could restore a competitive balance and lead to lower costs. For one thing, it wouldn't have to turn a profit.

Wouldn't have to turn a profit!! There is almost no economic nonsense that upsets me more than this kind of thinking -- that when we buy something from a company, we are paying an unnecessary "profit". In this make-believe world, profit is a "cost" that has to be paid, but only if we are buying from a private company. If only that private company were substituted for by a nonprofit organization or a government agency, then we could get the same service but at lower total cost. Magic!

Maybe it is the language of "for-profit" and "not-for-profit" that leads to this mistaken conclusion.

If only it were so simple to avoid an unnecessary cost! If it were, every single company in the world would fully vertically integrate, making all of its inputs itself -- why buy anything from another company and pay them an unnecessary profit? (Of course, this flies in the face of another trend that upsets many, that of outsourcing.)

And closer to home, nobody would lease a car -- why pay a profit to the owner, a bank -- and nobody would ever rent a house -- why pay a profit to the landlord?

The correct lesson from the most important part of any economics course, that on the organization and performance of competitive markets, has tragically failed to sink in. In a competitive market, any excess profit will get competed away. The only profit is a normal -- that is, the minimum acceptable -- return on invested capital. For example, if an insurance business requires $1 billion of invested capital, then at a 10% normal return, the level of profit will be $100 million. You should think of that $100 million not as a profit, but as a cost -- the cost of having that $1 billion invested in the insurance business. If the insurance business yields a profit of $125 million, then more capital and resources will enter that business, driving the return back down to normal levels. That is, there would have been in this case $25 million of "economic profit" and competition will drive that away.

A not for profit firm, or a government agency, cannot avoid incurring this cost of a normal return on invested capital. There is absolutely no sensible argument that a not for profit would not need the same amount of invested capital (buildings, equipment, cash on hand to pay employees and claims, etc.). And with the same amount of invested capital comes the same cost associated with its deployment. (In fact, with the public option being discussed in health care, the US government would give the new public organization an infusion of capital to get started. Do we think that capital comes free?)

One simply cannot argue that a not-for-profit or government agency can produce at lower cost because they can avoid paying a profit. The only way to argue that a not-for-profit or government agency can do something for less cost than a private entity has to rely on an ability to actually run the business more efficiently (fat chance!) or truly avoid some real cost (I will give you one idea here -- WHO DOES NOT PAY TAXES!)

This argument does of course rely on competition driving the return on capital to normal levels so it does not apply to an industry with significant monopoly power (if a company faces a monopolistic supplier of an input, then vertical integration can make sense). I am in no way prepared to accept that the insurance business is now or would be in the future characterized by enough market power to prevent the inexorable forces of economic competition from driving expected profit to normal levels, the arguments of folks such as Alonso-Zaldivar notwithstanding. My next post is going to revisit the issue of self insurance, which will raise even more questions about excess insurance company profit and the claimed lack of competition.

Google Voice, Apple and ATT

There is an increasing buzz around Apple's "rejection" of the Google Voice application for the iPhone. Andy Kessler, writing in the Wall Street Journal, lays out the usual case against Apple. Apple meanwhile has denied that it even rejected the app -- claiming it is just studying the issue -- and denies talking to its partner AT&T about it. See this article by Saul Hansell in the NYT, for instance.

There are many interesting aspects to this case, all worthy of careful thought.

One of my first reactions is: history does repeat itself. Many years ago, a startup long distance company called MCI forced AT&T, then the sole long distance carrier in the US, to allow MCI access to its trunk lines. MCI had a business model of leasing lines from AT&T and selling long distance service to business customers at a significantly lower price than AT&T. At least initially, AT&T did not want to lease lines to entrants like MCI, for obvious reasons.

This case also smells a bit like the big antitrust case against Microsoft, particularly in regard to the claim that Microsoft forced computer sellers to put only Internet Explorer on their desktops.

So the claim against Apple/AT&T is essentially one of creating barriers to entry through exclusion. (Besides the antitrust issues here, there are the usual "free internet" folks who hate to see any kind of proprietary/exclusionary activity on the internet.)

There are of course some serious differences in these situations, and I certainly don't agree with all of the antitrust claims against Microsoft anyway.

Both Apple and AT&T potentially have something to lose from the Google Voice app. (The app is pretty neat, one has to admit. It consolidates all one's phone numbers in one Google phone number, allows free domestic calls and text messages, cheap international calls, and some other very nice service features. It is available as a standalone service; the current controversy concerns only the offering of Google Voice via an iPhone application.) Apple may have a concern about Google gaining a foothold in the mobile phone market -- similar to claims that Microsoft by excluding Netscape was trying to protect its operating system market. AT&T's concerns are more direct: if its customers use Google Voice for texts and calls, it loses revenues immediately.

Apple/AT&T have several defenses that are very credible. Foremost would be the simple argument that Google is freeriding. Apple and AT&T have invested to build the iPhone business, and are continuing to invest to make it better (such as -- listen up, AT&T -- getting 3G service in places like Hanover). In order to recoup those costs, AT&T has to charge somehow. Demand elasticities make the pricing of things like international calls, and maybe text messaging, the best place to extract revenues. Along comes Google, essentially saying, "thank you very much for building this platform and discovering all these customers; now I will simply go in-between you and the customer and offer them a better deal." Google of course does not need to recover the costs of that big national wireless network of AT&T's, which is one of the major factors giving such a large customer base to the iPhone.

Imagine Coca Cola building up a customer base who love the taste of its product, and acquiring a fully owned/integrated bottler network to distribute its product. How would we feel in forcing Coke to let a coke imitator use the Coke bottling network to distribute its free-riding product to Coke's customers?

Apple and AT&T also do not have the kind of market power that one might have ascribed to AT&T of old and even Microsoft. There are numerous competitors to the iPhone, and there are good competitors for the AT&T network as well. Just look at RIM and Verizon. What we have going on is really a very healthy competition between different mobile phone platforms. Apple, true to form, is going with a fully integrated model (well, AT&T is not owned by Apple but it is a pretty tight partnership). RIM/Blackberry and others are more like the Microsoft/Windows model: don't worry so much about a fully integrated system, instead let competition at each stage determine the best parts and "hope" that they work together well. Why would we want the government to get involved in this battle that should be determined by the consumer? If consumers don't like the Apple/AT&T exclusionary model, then let them eat cake...oops, sorry, I mean let them buy a Blackberry and sign up with Verizon.

I do think though that AT&T in particular needs to be careful about its pricing of some services. It's international roaming rates are horrendously high, for example. One of the beauties of the iPhone/AT&T deal is unlimited internet access and virtually unlimited domestic calls and text messages (with the right plan). For some customers, however, I suspect the global charges are going to be the margin where purchase decisions are made.

Health Care Thoughts

It is most entertaining to talk about health care with intelligent people. The differences in beliefs, and in philosophical orientation, are just amazing. Some of the difference in belief can be eliminated with data. The philosophical differences are harder to get rid of.

A starting point is that many many people think that our current health care system is a disaster and delivers terrible quality at very high cost.

I would suggest looking at a couple of these items:

1. The book, The Business of Health, by Ohsfeldt and Schneider. Among other things, these two economists show that if you take out the impact of high rates of murder and accidental (especially highway) deaths from the US life expectancy, the US ends up number one in life expectancy. Now how can you possibly say that our high rates of murder are due to failings of the health care system?

2. Read the paper by June and David O'Neill, "Health Status, Health Care and Inequality: Canada vs the US," NBER Working paper13429. They document the failings of comparing health care systems by metrics such as infant mortality and, similar to point number one above, life expectancy. On infant mortality, they show how much of a role low birth weight plays in infant mortality -- and how low birth weight is greatest for teenage mothers. Of course, the US has many more teenage mothers than Canada. Shall we blame teenage pregnancy on the health care system?

3. And the paper by Hall and Jones, "The Value of Life and the Rise in Health Spending," Quarterly Journal of Economics, Feb 2007. These economists argue that optimal health care spending in the US is not inconsistent with utility maximization and that as we grow richer we should expect the percentage of GDP spent on health to rise much higher. This is a great point, and they back it up with great theory. In fact a colleague of mine was recently lamenting how he could not spend as much as he would like on health care, because he cannot hire a doctor on a consulting basis as easily as he would like. This is true: the practices and institutional rules in place do restrict us from buying some health care that many of us would purchase if we could.

4. The paper by my Dartmouth colleague Jon Skinner, and Alan Garber, "Is American Health Care Uniquely Inefficient?," Journal of Economic Perspectives, American Economic Association, vol. 22(4), pages 27-50, Fall. In particular, note the very neat argument how heterogeneity in demand for health care in different regions of a country might make it look like that country is inefficient in producing health care.

And here are some interesting questions to ask folks and ponder their responses:

-- should insurance pay for routine expenses like eye exams, and teeth cleanings?
-- should insurance pay for annual doctor checkups?
-- Why do we assume that people can take their cars in for oil changes, understanding that regular oil changes increase the life of the car, but we cannot trust people to go see the doctor?

Health Care Incentives

One of my main worries about the health care proposals is that I don't see them doing anything significant to reduce costs -- and even that the whole mindset is misguided on the cost issue. (On this latter point, the correct measure of welfare is clearly not cost, but overall surplus. Even more spending on health care may well be welfare enhancing.)

But if we want to assume that there is spending beyond the point where marginal cost equals marginal benefit, and we want to reduce the total spending, the question is how to do it.

To that end, I would present the case of Dartmouth College. Like many reasonably sized institutions and businesses, the College self-insures in regard to the health expenses of its employees. So while we all think we have Blue Cross Blue Shield insurance, in fact that organization simply manages the administration of the College's health benefits to its employees. The College actually ends up paying all the bills. Of course this would be true even if we did buy true insurance, as over time the premium we would pay would have to equal costs.

My point here is simply that the College, since it bears all of its employees' health costs, has tremendous incentive to reduce those costs through whatever means it can. It can find the most efficient administrative entity to handle all the paperwork -- and it can find this administrator through a competitive process. I have to assume that Anthem BC/BS must offer the best overall package of service and cost. The College can also tell this administrator how to structure the different policies offered to employees, including deductibles, coninsurance, incentives for good behavior, etc. In fact we have a relatively active committee consisting of faculty, staff and administrators who work together to determine the policy options that will be offered each year. I think the overall incentives and ability to manage health care costs are quite high.

Even with these incentives and ability for an institution like Dartmouth to manage health care costs, we still see cost increases very similar to those of the rest of the nation. And I think our overall costs, in an absolute sense, are close to average as well. As a very rough calculation, the cost for a single person to buy health insurance from the College is around $6500. If I take that and multiply by the 300 million population of the US, and divide by US GDP of about 13.8 trillion dollars, I get around 14%, roughly our national expenditures on health care.

So I don't think that the College does any better in reducing costs than the rest of the country.

And this is even with the incentives and ability noted above -- and even with the Dartmouth Institute on campus, the folks who the Obama administration seem to think have the magic wand to show where waste is and how to eliminate it!

So here is the question: to the extent that the health care proposals shift the center of cost controls and incentives away from institutions like Dartmouth and towards the US government, why should we assume there will be better management of health care spending?

Review of the Health Care Proposals: Predation by Government Enterprises?

It is costly to stay up-to-date on the status of the health care bill specifics, but the broad picture seems pretty well agreed. The Kaiser Foundation provides good summaries, see here. As I read the proposals, I see these as the key features:

1. A mandate for all citizens to have health insurance (punishable with fines).
2. A mandate for all employers (except "small" businesses) to provide health insurance to employees.
3. Provide individuals with subsidies to buy insurance.
4. Provide "small" businesses with subsidies to provide insurance to employees.
5. Create "gateways" or "exchanges" through which individuals and certain employers would buy insurance.

Here are my issues, with the last one being the most serious.

First, if a key objective is to provide health care insurance to the currently uninsured and needy, the proposal will likely fail. The system is too complex. The people that I want to be covered by health insurance are likely to be excluded by this proposal simply because they will still not know what to do or how to get coverage.

Second, the proposal does not cut the tie between health insurance and the employer, in fact it increases the strength of that tie. If you want to increase portability of insurance, get rid of the employer-based nature of our current coverage. That would be a great move in the right direction. Do our employers buy car insurance for us? No. Not even life insurance, at least not most of it. Then why health insurance?

Third, the proposal is economic/social engineering at its worst. The proposal has a bunch of subsidies, the most insidious being those for "small" businesses. Now, I like small business as much as everyone, but I like big business too. Why should our health policy have built into it an advantage for some kind of businesses? Can you imagine how this will be manipulated in years to come? (As an aside, the proposals should be viewed in that light -- as living documents. Don't just take the current policy as the end of the road, but anticipate how it will change with political winds in the future.)

Fourth, and most serious I think, are the "gateways" or "exchanges" that will be created. Think of this gateway idea as a government-overseen consortium of insurers, all of who can offer different health policies to the individuals and employers who qualify to buy insurance through the gateway (a set that even in the current bill is set to expand over time, letting more and more employers and individuals opt into the gateway if they desire). At least in the House bill, there is a provision to ensure that there is a "public" or "community health insurance" option in the gateway. This public option will compete with private insurers. The problem is that the public option is likely to have a huge cost advantage over the private insurers, with the cost advantage arising from the likelihood that the public option will pay service providers (doctors, hospitals, pharma companies) a much lower rate than private insurers can. The version of the House bill that I just read clearly specifies that the public option will pay suppliers prices based off Medicare rates (that are very low compared to what private insurers pay). More on this issue below.

To the extent that the public option has a cost advantage, it is the stealth bomb of the health care proposal. We should expect the public option to be increasingly chosen. As that happens, suppliers will raise prices to the private insurers even more, making their cost disadvantage even worse, and the market share of the public option will increase even more. Sounds to me like a vicious cycle leading to a public monopoly -- hence my reference to predation by government enterprise. Give a government entity a cost advantage, and it will drive private business out.

I recognize there is a vigorous debate over this issue of the public option, and I do have some questions about the theory above. Why can the public option just piggyback on Medicare prices, while private insurers cannot? This is an interesting question. How can Medicare get such low rates today, while private insurers pay more? I suspect there are two factors, one being the sheer size of Medicare and the second being that health providers do not want to turn down Medicare patients for political reasons. These effects will apply just as strongly to the public option described above. Steven Pearlstein, whose editorials I normally find enormously enlightening, has one in the Washington Post today that seems to me to rather shrill and downright wrong. He says that Republicans are "propagating falsehoods" about the proposal, with his main point illustrated with this quote:

But there is no credible way to look at what has been proposed by the president or any congressional committee and conclude that these will result in a government takeover of the health-care system. That is a flat-out lie whose only purpose is to scare the public and stop political conversation.

Now my analysis above might be wrong, and maybe Pearlstein's assurances about House leaders ruling out "piggybacking off Medicare" might turn out correct, but to say that I am being disengenous or being a "political terrorist" by making the argument, well, that is just the kind of discussion around this major policy proposal that we do not need. Lighten up, Pearlstein. You just lost a bunch of credibility from this reader.

I can support a health care proposal that would provide base insurance for the currently uninsured. I suspect many would support that. Why not just create something that did that, and leave the rest alone? And, be honest about what the effect will be: the more people we provide with free health care (free to them), the bigger will be the national bill for health care. This is NOT going to reduce costs.

Health Care Cost Savings from Less Paperwork

Much has been written about the waste in the US health care system from excess paperwork. One estimate -- here, from Physicians for a National Health Program, puts the total cost of "administrative expenses" at 31% of total health care expenditures. That is more, it appears, than in countries with a single payer system. The idea is that if we cut out all the paperwork -- tracking of expenses by patient -- for doctors, hospitals, and insurance companies, we could save a bundle.

As I was working at school the other day, I heard some of our hourly employees talking about getting their timesheets in, so that they would get paid on time. It made me remember when I worked at Wahlstrom's restaurant in Harvey, MI and had to punch the time clock.

Think of all that time spent filling out timesheets, I thought. Not just at Tuck, but across the entire country. There must be tens of millions of hourly workers filling out timesheets, then a bookkeeper needs to record those hours, and paychecks need to be cut. I bet we could save millions of dollars by cutting that out.

And why stop there? In the Wall Street Journal was an article about the THOUSANDS of patents that Toyota has filed for the Prius hybrid. My gosh, think of all the paperwork and administrative cost associated with our patent system! Not just the filling out of forms and the government Patent Office, but all the lawyers involved! Cut that out and we would be talking real money.

But we can go even further. Just think, if everyone was just paid the same yearly salary -- kind of like if everyone had the same health plan -- then we could get rid of all kinds of things, in particular the entire income tax code. Since everyone would owe the same tax, we could just take it out of their pay up front. Think of the savings if we abolished the IRS! All those hours spent filling out forms, and dealing with audits, etc.

Maybe we need to just think for a minute: Why do we have folks fill out timesheets?

Apple iPhone Price Elasticity

The market intelligence firm iSuppli has estimated the cost of the new iPhone 3G S to be $178.96 -- $172.46 of components and manufacturing expense of $6.50. I am not sure how accurate these are, but let's take them to be an estimate of Apple's marginal cost of production. They are probably pretty close.

From price theory, we know that optimal pricing implies the following markup relationship:

(price - MC)/price = 1/elasticity

or in words, the markup of price over marginal cost should be inversely related to elasticity.

Estimates of price are in the vicinity of $600: this is not what consumers pay, but what ATT likely pays for the phone. Using the $600 price and the above formula implies an elasticity of demand of 1.43. Probably not a bad estimate.

There are some interesting questions to think about in regard to what price one should actually use and how the impact of ATT's service revenues affect things. But I think that the above formula has to be based on the price Apple actually receives, and that would be the $600 figure.

A Dangerous Profession?

News reports this morning are of 70 university professors in Iran being arrested, whereabouts unknown, after meeting with former prime minister and opposition leader Mousavi.

Events in Iran could be some of the more significant in the Middle East since the Iraq War, maybe even more so.

It is striking to see these kind of crackdowns in 2009. Imagine what would be the case in any Western country if text messaging and cell phones were cut off, the internet restricted, and professors were arrested for meeting someone.

Can the current leaders of Iran pull this off? Can a government in this day and age be so intolerant, restrictive and oppressive and get away with it? The bulk of evidence leans toward "no" but China/Tiananmen Square shows it can happen.

My guess is that the current regime will get through the current crisis but that the genie is indeed out of the bottle and things will not be the same. How significant will be the changes and how long they will take are the questions.

The Market for Human Organs

So Steve Jobs, CEO of Apple, had a liver transplant -- see story here.

Interestingly, he had it in Tennessee, not the state that first comes to mind when speaking of the forefront of medicine.

But if your criteria is length of time to wait on the liver transplant list, Tennessee comes up with the shortest wait.

Interesting. Someone with enough money can relocate to a different area, get on the local list, and get a needed transplant before someone with less wealth.

Is that wrong? Should Steve Jobs be on the same timetable as everyone else?

Why do we accept wealth as enabling people to get an advantage in so many things, even many that are life-preserving (a new Mercedes is certainly safer than a used Chevy), but when it comes to things like organ transplants we balk?

Would it be OK if Mr. Jobs could offer cash to a live donor to spare half of their liver (all that is generally needed for a "live" liver transplant)? Is that OK if that person would never have considered donating part of their liver if not for the money? Is it not obvious that offering cash for livers would dramatically increase the supply? Aren't we really interested in saving lives, after all?