Health Care

Obama ran for office on a reform platform with 3 major themes: health care, energy/climate-change, and education.  The recent cap-and trade-legislation that passed in the House, and will be considered by the Senate later this year, addresses the energy/climate-change theme.  The issue currently dominating the headlines is health care.  (No doubt education will be next in the public spotlight.)

All 3 reform efforts involve addressing problems that at their root are caused by well known and long-studied economic problems.  Health care is no exception.  Perverse incentives, information asymmetry, moral hazard,  special interests, externalities… the whole gamut of market-destroying forces seem to be at work in distorting the modern health-care system from its ideal form.

Furthermore, the push for health-care reform is revealing in classic fashion the failings of the political system itself that I discussed in my previous post.  The “town hall meetings” that were supposed to add to the debate have instead devolved into circus acts.  Active misinformation campaigns about supposed “death panels” and a media complicit in giving airtime and weight to totally illegitimate claims have made a reasoned national debate on the very pressing issues facing us nearly impossible.

Without understanding in detail the economic principles in play, there is no hope for any kind of sensible solution.  Everyone knows and admits that health-care costs are gobbling up an ever-increasing share of our resources, with nearly 20% of GDP currently going to medical expenses.  But in today’s climate,  it is difficult to see how we will collectively be able to engage in a rational, subtle, and detailed discussion on the issues at hand, much less implement rational reform.

A recent article in The Atlantic by David Goldhill covers many of the problems underlying the health-care system from an economic and business perspective; an excerpt follows:

Indeed, I suspect that our collective search for villains—for someone to blame—has distracted us and our political leaders from addressing the fundamental causes of our nation’s health-care crisis. All of the actors in health care—from doctors to insurers to pharmaceutical companies—work in a heavily regulated, massively subsidized industry full of structural distortions. They all want to serve patients well. But they also all behave rationally in response to the economic incentives those distortions create. Accidentally, but relentlessly, America has built a health-care system with incentives that inexorably generate terrible and perverse results. Incentives that emphasize health care over any other aspect of health and well-being. That emphasize treatment over prevention. That disguise true costs. That favor complexity, and discourage transparent competition based on price or quality. That result in a generational pyramid scheme rather than sustainable financing. And that—most important—remove consumers from our irreplaceable role as the ultimate ensurer of value.

via How American Health Care Killed My Father – The Atlantic September 2009.

The article highlights a number of issues plaguing health care today, and traces most of them back to market failures caused by the current setup in which medical providers cater to insurers and Medicare, rather than to the patient.  Most of the participants in the system are genuinely trying to fulfill their role in providing us with quality care.  But the system itself in this case is horrendously flawed.  A few of the points raised in the article follow (along with some of my own thoughts):

• Health care is emphasized over health: The incentives in the current system reward treatments and care, not promotion of health itself.  Your doctor might suggest you exercise or you lose weight, but at the end of the day, the financial incentives at least don’t promote overall health.
• The concept of insurance has been misappropriated: Insurance is not the proper vehicle for delivering routine, expected care.  The author makes an analogy with car insurance: would it be sensible to have a system where car insurance is expected to pay for our gas?  What would happen to gas prices in that scenario?
• The patient is not the customer: Market forces drive industries to cater to the customer.  That is why Walmart is cheap, why everyone is nice to you at Disney World, and why your car has a cupholder.  But in the modern health care system, the patient is not the customer, and keeping the patient happy (or healthy) is not what helps the industry’s bottom line.  There is virtually no transparency in the health-care system with respect to quality and costs, so there is no in-built mechanism nudging the system towards a state of greater efficiency.
• The cost of the uninsured is hidden by bookkeeping tricks: What people often forget is that we already have a universal health care system, albeit highly inefficient.  Ever seen anyone critical get turned away at the ER?  Of course by the time someone makes it to the ER with a preventable condition, the cost of care becomes much higher.  Many other distortions take place in the health-care system because of the constant need to hide and shuffle around costs to keep the whole system politically palatable.  For instance, many hospitals are subsidized in a highly inefficient manner (through anti-competitive regulations and other means) because they are the only place it is politically expedient to provide health care to the uninsured (via the ER).  Hospitals get regulatory favors, and in turn they treat everyone who walks through the ER door.  If we were simply explicit about providing universal coverage, instead of burying it into ER costs with bookkeeping tricks (ever wonder why a Tylenol should cost $10 on a hospital bill?), the health-care system could be be greatly streamlined, increasing quality and decreasing costs.

Goldhill discusses several other problems underlying health care in a way that avoids the simple-minded, purely emotional reasoning so many in the debate are engaging in. “Intuitive,” feel-good proposals will help no one.  A hard look at the facts and figures, and the incentives at work, are necessary to make headway. I don’t necessarily agree with all of Goldhill’s specific proposals for reforming health care, but I do agree with his approach to thinking about the issue.

Health care reform is a vexing problem, and it remains to be seen whether the modern political system is capable of solving it.  But unlike ignoring climate-change (where we are shortchanging our unborn great-grandchildren), in ignoring the problems underlying health care, we are shortchanging ourselves.  Perhaps our instinctive need to act in our own self-interest will finally kick in and we can all get the health care we could so easily afford.

 

If more politicians would call out lies for what they are, maybe there’s hope.

The Banker Who Said No – Forbes.com

A recent article in Forbes talks about a banker, Andrew Beal, who played it safe while the rest of the financial industry was taking on billions of risky loans that at the time, seemed wildly profitable:

For three long years, from 2004 to 2007, he virtually stopped making or buying loans. While the credit markets were roaring and lenders were raking in billions, Beal shrank his bank’s assets because he thought the loans were going to blow up. He cut his staff in half and killed time playing backgammon or racing cars. He took long lunches with friends, carping to them about “stupid loans.” His odd behavior puzzled regulators, credit agencies and even his own board. [...]

But he wants to exploit their recklessness to amass his own fortune. Not much next to the trillion-dollar balance sheets of the nation’s troubled banks, but the lesson here might be revealed in the fact that this billionaire is not playing with other people’s money–he owns 100% of the bank and is acting accordingly.

via The Banker Who Said No – Forbes.com.

The key here is that Beal owns 100% of his bank — the principal-agent problem we discussed in a previous post does not apply. Because he wasn’t subject to the same kind of perverse incentives as other bankers, he made significantly different decisions than his peers.  His decisions were based on long term profits, not short term gain that relied on passing the buck to some future chump.  Not to downplay Beal, but it was the incentives of his situation more than anything else that led to his seemingly prophetic decisions.

Politics

Watching the way politicians have been behaving recently, during the economic crisis and during all of the ensuing bailouts and bonuses, and related controversies and dramas, one wonders how exactly anything positive can come out of Washington politics.  Of course a lot of boring things that keep the country chugging along do happen on a regular basis (just keep watching CSPAN).  But for anything that hits the public eye (from one off issues such as bailouts and bonuses, to ongoing themes such as taxes and health care), the disingenuous politicking becomes so extreme that any sort of parody is superfluous. But are “politicians” really to blame?

In a previous post on incentives, I described how compensation structures at financial (and other) firms can create perverse incentives that lead to unsurprising outcomes — firms seek short term profit and take excessive risks at the expensive of long term profits and sustainability.  A recent New York Times article, in discussing this principle, cites a 16-year-old academic paper, “Looting”, that describes how the implicit belief that the government would bail out any sufficiently critical financial firm from going under, led to excessive risk taking by investors at those firms.  They kept the gain, sticking the government with the pain.  In the case of financial firms and other public companies, the deleterious decision-making can generally be traced to perverse financial incentives.  In the case of politics, however, the problem is even worse: perverse incentives tightly coupled with adverse selection.

Consider for a moment the incentives driving a politician.  They are numerous, but certainly include:

• Civic duty – the politician wants to do what is best for his constituency and the country
• Money – the politician wants more money (or it’s equivalent in the form of perks)
• Power – the politician wants power (to secure money/perks for his friends and family)
• Desire to get reelected – the politician wants to do what it takes to ensure he gets reelected, so that he can continue to benefit from the other incentives above

That last incentive — the strong desire to get reelected — is often times the worst offender in terms of distorting a politician’s decision-making process. Ideally, we want politicians to only be driven by the first incentive above — we (the principals) want our politicians (our agents) to be aligned with our collective interests.  The desire for money and power for personal gain are unavoidable, and as long as they are kept in check (through transparency), perhaps not too unwieldy.  But the desire to get reelected is extremely powerful, since it is effectively basic survival as a politician, and causes the politician  to seek large contributions from special interests and wealthy companies and industries, thus becoming at least partly beholden to them. Although this effect is obvious to everyone, and leads to completely undesirable (from the perspective of the public good) policies at times, it is very hard to fix.  We have no way of knowing for sure which incentives are driving a particular politician’s decision making.

A politician with strong “moral” convictions may draw boundaries as to what they are willing to say and do to get reelected, and may continue to have their decision making dominated by their sense of civic duty.  They might seek and accept large campaign contributions, but remain steadfast in voting based on what they think is best for their constituents.  But any “moral” restriction a politician places on his behavior with respect to getting reelected disadvantages him.  (Consider that the truly amoral politician has more tools at his disposal to get reelected — even mimicking a moral politician is a tool open to him).  And now we see the perfect storm underpinning the subtle yet pernicious corruption that results in the dysfunctional political system: the very people most affected by the perverse incentive caused by the desire to get reelected are the ones who actually do get reelected.  The high-minded politicians with strong ethics and morals are the ones weeded out of the system, because they can not raise enough money, or make enough friends, or manipulate public opinion with enough half-truths and misdirection.  If the only problem with politics in Washington was the existence of perverse incentives, we might still expect to reach some workable equilibrium, where politicians got their fixed cut of money and power, in return for (mostly) working for the public interest.  If the selection were decoupled from perverse incentives, then we would still hope to see common sense rather than demagoguery permeate the halls of political power.  But with perverse incentives coupled with adverse selection, we end up with a one-way street to the bizarre state of affairs we see in Washington today.

In the interest of brevity, I’ve glossed over a number of subtle, yet significant points.  I hope to revisit them in future posts, but they include:

• What exactly is civic duty?  In an ideal world, whose interests should the politicians’ interests be aligned with?  His local constituency?  The country as a whole?  What are the tradeoffs between the two?  (Game theory can shed some light here on the pitfalls and solutions for aligning incentives)
• Although we only touched on the negative aspect of the wanting to get reelected, the desire for reelection is supposed to be a positive incentive.  It is supposed to keep politicians in check and is supposed to be the tool to actually align their interests with our interests.  (That’s the whole point of democracy.)  How can we achieve the positive aspect of this incentive, and avoid the perverse effects? (Is transparency the key?)
• How do term-limits factor in?  Is a lame-duck president for instance more able or less able to advance the public’s interests?