Editor’s Note: In an effort to center New Economic Thinking in the discussion of the COVID-19 crisis, we’ve curated a list of Evonomics articles relevant to this moment—including this one. Check out the full list here.

2018 April 6

Jag Bhalla interview with Economist Robert H. Frank

Fans of “let-the-market-decide” thinking face a trillion-dollar puzzle that’s deadly as well as costly. To diagnose this unhealthy situation, we’re fortunate to have Robert Frank (RF), an economist who writes regularly for The New York Times (he’s also written books I regularly quote).

JB: I’ve long felt that core economic ideas (~creeds) are ailing and failing to meet clearly desirable collective goals. Your latest NYT piece provides a great and glaring example, as you say America “spends far more on health care than any other nation, yet gets worse outcomes.” What are the numbers (per capita)?

RF: American per capita health care expenditures are more than twice the average of those in the 35 advanced countries that make up the Organization for Economic Cooperation and Development. That was a spending difference of more than $5,000 per person in 2016. But although we spend 18 percent of our national income on health care (or $1.65 trillion more annually than if we spent at the average OECD level), our system delivers significantly less favorable outcomes on the measures we care most about. Among developed countries, for example, we have the lowest life expectancy, the greatest incidence of chronic illnesses, and the highest infant, child, and maternal mortality rates.

JB: Why does America’s more market-oriented system (unique among rich nations) do so badly? How does the persistence and worsening of inefficiencies square with the markets-deliver-efficiency creed (the deep faith that markets self-organize to everyone’s benefit and incentives ensure efficient resource usage)?

RF: No developed country other than the United States relies on largely unregulated insurance companies for the provision of health care. As I explained in the column you mentioned, we almost certainly would have adopted the single-payer systems common in other countries except for a regulatory loophole during World War II.

The problem with private insurance is that it tends to break down when potential policy holders have much better information about their individual risks than insurers do. That information asymmetry is clearly present for individual risks of illness. People who know themselves to be most at risk of needing costly care are more likely than others to buy insurance, which drives premiums up, making insurance less attractive to the healthiest people. As those people drop out of the insured pool, rates rise further, which makes insurance still less attractive to the healthiest policy holders who remain, and so on. Economists call this an adverse-selection problem.

The American health insurance system was in the throes of the resulting death spiral when the Affordable Care Act was adopted. That legislation reversed the decline in the insured population and made tentative first steps at cost control. But it was not enough to eliminate our system’s glaring inefficiencies.

JB: Can you say a bit more about why the US spends so much more?

RF: Administrative costs under private insurance plans, for example, are about six times as high as under single-payer plans like Medicare. And unlike private insurance plans, single-payer plans spend virtually nothing on advertising and marketing. But by far the most important reason for higher health care costs in the US is that service providers charge so much more here than elsewhere. The average cost of coronary bypass surgery, for example, is more than three times higher in the United States than in France, and a day in an American hospital costs twelve times as much as one in The Netherlands.

JB: When Republicans were campaigning to repeal the Affordable Care Act, market enthusiasts like Paul Ryan insisted that competition among private insurers would lead to both lower prices and higher quality health care. Competition seems to have delivered high-quality goods at reasonable prices in many markets. Why shouldn’t we expect the same with health care?

RF: Economic theory tells us that this would be a reasonable expectation if certain conditions were met. Many of these conditions concern whether buyers and sellers can assess the attractiveness of transactions they are considering. Because insurance companies find it difficult to measure the risks posed by potential policy holders, we get the adverse selection problem described earlier. A related problem arises on the buyer’s side. In practice, people have little knowledge of the treatment options for the various maladies they might suffer, and policy language describing insurance coverage is notoriously complex and technical. Although consumers can easily compare the prices charged by competing insurance companies, they simply cannot make informed quality comparisons in this industry.

Because of the latter asymmetry, companies are under pressure to compete by highlighting the lower prices they’re able to offer if they cut costs by degrading the quality of their offerings. For example, it’s common for insurance companies to deny payment for procedures that their policies ostensibly cover. If policy holders complain loudly enough, they may eventually get reimbursed, but the money companies save by not paying others enables them to offer price cuts, which are a decisive competitive advantage over rivals that don’t employ this tactic. Such tactics are essentially absent under single-payer systems like Medicare.

In short, market competition often does deliver the benign results that its proponents claim, but only when important conditions are satisfied. In markets for the delivery of health care, many of those conditions just aren’t met.

JB: So the very same “self-interest” that drives markets, in practice often becomes collectively pathological. Your NYT piece ends on an optimistic note by saying, “there are attractive paths forward” to fix this deadly “national embarrassment without requiring painful sacrifices.” How can we overcome the “self interest” of those gaining from the current $ trillion overspend?

RF: Steps that would permit an orderly transition to Medicare-for-All are described in a recent American Prospect article by the Yale political scientist Jacob Hacker. A similar transition proposal has been suggested by policy analysts at the Center for American Progress.

My remark about no painful sacrifices being required for this transition was about the citizens whose tax dollars would support a single-payer system. Since the overall cost of single-payer would be so much lower than under the current system, the switch would actually save money for most of those taxpayers. But because the tax increases required to pay for the switch are far more visible that many of the hidden levies that pay for our current system, we’d want to explain carefully why people’s net outlays for health care would actually be going down.

Because the biggest savings associated with single-payer come from reduced payments to service providers, the switch would require American doctors and administrators to work for significantly less than they currently earn. But how painful would those sacrifices be? We know that highly qualified people are eager to become health-care professionals in countries where providers earn nothing like the premium salaries we see here. If you saw Michael Moore’s interviews with British NHS doctors in Sicko, you probably were struck, as I was, by how content they seemed with their standard of living.

A consistent message from the happiness literature is that once a certain absolute material standard is achieved, satisfaction from pay is heavily reference dependent. For doctors to be happy with their pay, they must earn as much as other doctors in the same environment earn. Another consistent message from this literature is that the comparisons that really matter are highly local. That helps explain why American doctors who work for non-profit clinics like Mayo, Cleveland, and Kaiser, who earn substantially less than their fee-for-service counterparts while delivering measurably better health outcomes for their patients, nonetheless seem quite content with their terms of employment. My own view is that asking fee-for-service physicians to work under such contracts here would not qualify as demanding painful sacrifices from them.

Doctors like the ones Atul Gawande profiled in this New Yorker piece would no doubt scream bloody murder if forced to live on only what they could garner under Medicare reimbursement rates. For some of them, the switch really would constitute a painful sacrifice. I probably should have written the last sentence in my column as “Avoiding this national embarrassment would actually require few painful sacrifices.”

JB: It’s critical that we inject more realism into economic creeds (“just so” stories). Without more market realism (“realonomics”?) we won’t be able to detect and diagnose when markets get stuck in counterproductive conditions (where chronic inflammation or cancerous growth imposes a “private tax” burden on individuals and businesses (~$19k per employee).

Originally published at Jag Bhalla’s Big Think blog