Tag Archives: markets

Health Insurance vs Health Welfare

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The question of universal health coverage is one well worth discussing at the national level; the goal of universal coverage is to make health care services ubiquitously available, for rich and poor alike.  It’s a laudable goal.  However, in order to have a coherent discussion, it’s necessary to review the terms of the subject.

Too often, though, the discussion assumes that health care and health insurance are so much a part of each other that they cannot be had separately.  This is wrong.  Health care is what you get from your doctor or hospital.  You’re getting treatment for a medical condition, advice about how to treat a medical condition, advice about how to avoid getting a medical condition.  In return for these health care services, someone pays the doctor or hospital money.

Many people pay for these services with cash out of their own pocket, and many more would prefer to do so, were they given the choice.

Others—the vast majority of Americans (I’m eliding the free riders in the market)—pay for these services by buying something we call insurance: they pay a periodic premium to a health insurance provider for a policy that obligates the insurance provider to pay (most of) the costs of a medical condition should that condition actually arise at some time in the future.  The insurance company makes its money by selling lots of such policies on the bet that few enough people actually will incur the covered condition within a given time frame that the aggregated premiums over that time frame will more than cover the actually required medical payouts.  That’s what insurance is, including health insurance: it’s one person transferring part, or all, of a risk of something untoward happening to him to another—an insurance company, for instance—in return for an agreed upon fee.  For that fee, the entity accepting the risk, or the agreed part of it, agrees to cover the cost of that untoward event should it actually occur, with the aggregated fees over lots of such agreements, being enough to cover the required cost payouts.

Health care and health insurance, thus, are entirely separate industries: one is the actual provision of services, and the other is simply a means of paying for those services.

But for the risk transfer, or insurance, industry to work, though, two things must occur: the first is that the fees charged for the risk assumptions must be voluntarily agreed to between the two parties to the risk transfer.  If the fees are dictated to one or the other side, without any market flexibility, they run a very strong risk of being too high for the one party to afford, or too low for the other party to be able to cover the agreed costs.

The other thing that must occur is that the fees must be consistent with the risk assumed.  To take an over-simplified example, if a man has a risk of a medical condition that costs $1,000 to treat, and the likelihood of his incurring that condition within the next year is very high, and he wishes to transfer 80% of that risk to an insurance company (i.e., get the company to pay $800 should the condition arise), then the insurance company must be able to charge a premium that, over the course of a year, sums to $800 in order to break even.  Of course, if the insurance company were to sell that same policy to lots of folks subject to that medical condition, actuarially it’s highly unlikely that all of them—even with the same risk—will incur that condition in the same year.  This would allow the insurer to sell the policy for a lower premium than it could if the customer population were limited to that original single person.

With lots of companies in the market selling policies for a given coverage, competition ensures that a single company does not abuse single-company monopoly power and overcharge.  Nation-wide marketability of that policy both enhances the competition and expands the customer base with the insured-against condition, thus increasing downward pressure on the policy’s premium—the risk transfer fee.  This downward pressure makes insurance more accessible to more people.

The actual situation facing us, though, is a market structure of government limits on the policies offered, government limits on the premiums allowed to be charged, and two critical government mandates: every individual must buy health insurance—must buy those government-limited policies—and every insurer must accept all customers.  There is little to no market flexibility—or pressure—to structure coverages to match the risks being transferred, nor is there much flexibility to match the fees charged to the risks being transferred.  This combination of government limits and mandates is a health welfare program of universal coverage.

My own view is that universal coverage is unnecessary, never minding its laudability, and that health welfare (or welfare generally) is actively suboptimal when it’s the first resort, rather than the last resort after market forces have taken their effect on prices and availability.

Because the welfare program’s risks and fees do not match, and because competition among health insurance purveyors is limited, inefficiencies will rapidly develop in the form of coverage payouts being too great for the premium income in some areas and too little for the premium income in others, with a strong bias toward too little premium income.  While companies’ desires to charge more, including “too much,” would be heavily constrained by competitive pressure, the government’s bias is to hold down costs to its voters, without regard in the short term to the market consequences, and the bias is unchecked.

This drives the welfare program to one or more of three outcomes: the insurance companies must prevail on the regulatory authorities to raise premiums, they must get tax dollar help from the government to make up the shortfall, or they must stop providing that insurance coverage.  All of these represent stark cost increases to the insurees: either they pay higher premiums today (even for conditions for which they do not want coverage or whose risks are very low, because those conditions are included in the required coverage allowed to be sold), their taxes go up tomorrow, or next week they lose their insurance coverage altogether until they move to another company—if one is left in business.  Indeed, this is the rationale for the Individual Mandate requiring everyone to buy insurance: all those extra premiums, hopefully from young, healthy Americans who aren’t likely to need a payout (and who also aren’t likely to want to buy the coverage) are intended to provide those extra monies and so avoid any of the three outcomes.

A Short History Lesson

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Much ado has been made about the Great Depression and of the Panic of 2008, whose effects we’re still feeling.  Here is a brief history of another economic depression, one that could have had devastating impact, the depression that occurred in the US in 1920-1921.

In the 18 months between January 1920 and August 1921, our unemployment rate jumped to 14% or so from about 2%, as estimated from the times’ inexact records; wholesale prices fell more than 40%; and industrial production fell 23%.  From peak to trough, the total of checking accounts and currency fell by nearly 11%.  Some today might have considered the survival of the banking system as a whole to be in the wind.  The farm economy also was hard hit, and there were waves of business failures.  What interventions did the government effect to rescue the nation from this devastation?  The most effective intervention a government can execute with a free economy: it sat on its collective hands and let the economy right itself.

The Harding administration very deliberately ran a budgetary surplus. The Fed, with less than a decade’s worth of bad habits to influence it, raised interest rates, increasing the cost of money (and increasing the value of savings).   In response, the economy in 1922, the first full year of recovery, increased industrial production more than 27%, and by 1923, unemployment was back down to 3%.

What happened?  Market forces, unfettered by Know Betters in the government, happened.  The US and our goods and services were dirt cheap, and bargain-hunting investors from overseas jumped on the opportunity with both feet.  No central banker had to instruct investors in what to do with bargains.  Money flowed into the US, and this inflow delivered a powerful monetary stimulus.

Moreover, that 40% drop in prices meant that Americans’ dollars were able to buy more.  This increase in the value of our money—wonks call it the “real balances effect”—enabled Americans in our aggregate to begin again to buy goods and services.  Which stimulated demand for new production, which stimulated job creation.

And those banks that a Hank Paulson might have panicked over?  The biggest casualty was the little First National Bank of Cleburne, Texas, with its deposits of $2.8 million. That certainly hurt those Cleburne depositors, but the damage was that limited.  No bank was “too big to fail” in those days, and no big bank did.

That depression lasted all of 18 months, and over its course—one more little tidbit—the nation’s debt was reduced by nearly 6%, to a shade under $23 billion.  The Great Depression lasted 10-17 years (depending on who you read) and added billions to our debt—even before WWII, and the Panic of 2008 is still being felt four today, years later, and our national debt still is exploding by trillions of dollars per year.

Yet the Obama administration has cynically ignored the lessons the Harding administration could teach about not intervening in a free economy.  Rather, Obama and his “advisors” have chosen to listen to a fellow Progressive, Franklin Roosevelt, and so to ignore the manifest failures of government intervention into that more publicized depression.  Obama has chosen to double down on those failures with his own interventionist policies, which are exacerbating the Panic of 2008, and the ongoing recession still ensuing (never mind the “official” end of the recession in 2009—ask the millions of Americans who are out of work, and the millions more who have given up and abandoned the labor force altogether, how their recovery is going).

Worse (if that’s possible), the supposedly independent Federal Reserve System has been entirely complicit in these interventionist policies, what with its freely running dollar printing press, its QE2 (preceded by a QE1—why do these sound like failed luxury cruise liners?), its Twist, its artificially depressed interest rates (so much for the widows and orphans who need their savings for living), and so on.

Stocks and the Economy

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It’s good to see that American stock analysts/prognosticators aren’t the only ones who are no good at the task.  This is no knock on the Spiegel Online journalist, because no one is.  Nevertheless, it’s instructive to see his remarks.

In the last 10 days, the DAX, Germany’s blue-chip stock index, has fallen by 16 percent.  On Monday it fell below the 6,000 point benchmark for the first time since January and has continued its plunge on Tuesday.  Has the crisis, which for so long seemed to leave Germany untouched, finally reached Europe’s largest economy?

…last summer, when the DAX lost 30 percent within just a few weeks, sparking a wave of politicking. The widespread belief in Germany was that only the financial markets were acting up.

That is probably the biggest problem the Germans have in the now two-year-old euro crisis.  In a sea of misery, Germany was an island of bliss.

But now, though, even its most stubborn adherents have begun realizing that this concept cannot work.

Here’s a chart similar to what this writer is looking at for the DAX, courtesy of Yahoo!Finance.  It looks at the DAX over the five days ending 5 Jun 12 (not the ten that the writer describes; however, if you follow the link, select the one month view, and look back those ten days, you’ll see the preceding five days are generally flat, so little is lost to the point).

Pretty damning, isn’t it?  Nobody likes the German government’s euro, euro zone, or EU moves, and they’re trashing the German stock market over them.  Chancellor Merkel and Finance Minister Schaeuble must change their policies.

But here’s that same chart put into some sort of perspective, also courtesy of Yahoo!Finance.  This one looks at the DAX over the last five years.

That five day period is the tiny, little down-tick on the far right end, where you almost can’t see it against the five-year backdrop.  Indeed, the whole period from the Aug-Sep 2011 period to the end is little different from the period from October-ish 2010 and that Aug-Sep 2011 other than speed of occurrence.  And both periods are trivial compared to the period surrounding the onset of the Unpleasantness of late 1999-early 2000, which had a wholly different set of “causes.”

This time it’s different, though.  Yeah.  Sure it is.

The Long and Short of Fiscal Policy

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Sorry, I couldn’t resist.  That’s the title of another missive by Alan Blinder in a recent Wall Street Journal issue.

He begins with this Keynesian fiction:

In the short run—let’s say within a year or so—a larger deficit…boosts economic growth by increasing aggregate demand.  It’s pretty simple.  If the government spends more money without raising anyone’s taxes to pay the bills, that adds to total demand directly.

Umm, well, no, it doesn’t.  That increased government spending (accepting, arguendo, no associated increase in taxes) only comes at the expense of future taxes or current borrowing—which is more future taxes.  People aren’t as dumb as Keynes thought they were, or as Blinder thinks they are.  In the present case, Americans see this trap, and they reduce spending (and investing) today in favor of saving and/or paying down their own current debt, thus offsetting that spike (again assuming, arguendo, that a government actually can reduce spending after its spike up).

Moreover, that government spending crowds out a significant fraction of remaining private spending.  After all, why should we buy something that the government is going to buy and give to us?

On top of this, Swedish economists Andreas Bergh and Magnus Henrekson have a 2011 piece (login required; sorry), that surely Blinder has read, in the Journal of Economic Surveys that shows the deleterious effects of increases in government spending.  They conclude that a 10% increase in government size (relative to GDP) is associated with a 0.5%-1.0% lower annual growth rate in the economy.  This is no spike, but then governments don’t spike spending.

It really is pretty simple.  Just not as oversimplified as Blinder suggests, and not in the same direction.

In short, money that folks, and businesses, are paying in higher taxes is money that folks, and businesses, no longer have available for current spending.  Or investing, or saving.

It is true, though, that spending is increased relative to taxes.  But the only result of this “increase” is in the deleterious effects of deficit spending.

On this matter, Romer and Romer have a 2010 piece (login required here, too; sorry), that surely Blinder also has read, in American Economic Review, that shows the powerful effect of increasing tax rates on economic growth: an increase in taxes of 1% of GDP lowers GDP by nearly 3%.

Blinder has more in his piece, but with his underlying assumptions shown to be false, the rest has no more value than that.  For instance, he writes in all seriousness

But don’t we need to reduce the deficit—and by large amounts? Yes, we do, but that’s in the long run, where the effects of larger deficits are mostly harmful to economic growth.

Of course, as Blinder’s own Keynes noted so long ago, in the long run, we’re all dead.  More empirically, over the long run, governments do not unroll spending increases that they’ve foisted off on us for that good cause of the time.  As long as Blinder is satisfied that our present enormous debt can be safely reduced in that far-off fantastical long run, he’s satisfied that our present enormous debt never will be reduced.

Update: Deleted a section where I’d simply–and carelessly–misread Blinder’s statement, and so my argument became irrelevant.

Sound Currency Policy

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A Sound Dollar Act was introduced in the House of Representatives last month by the Vice Chairman of the House Joint Economic Committee, Congressman Kevin Brady (R, TX), and a companion bill was offered in the Senate by Senator Mike Lee (R, UT), who sits on, among other committees, the Senate Joint Economic Committee.

This bill has a couple of interesting aspects.  For one thing, it would limit the Federal Reserve Bank system  to a single mandate—to maintain price stability, i.e., control inflation.  It would eliminate the Fed’s current other mandate, that of maintaining full employment.

This simplified requirement would both eliminate the conflict inherent between those two requirements and reduce the government’s involvement in what is essentially a private economy imperative—the decision to expand a business, or not, and to employ more or fewer personnel (with a free market economy’s inherent bias toward more employment stemming from a prior inherent bias in favor of growth).

The bill also would reduce the Executive Branch’s political dominance of the Fed.  Currently, the Federal Open Market Committee, the instrument of the Fed that sets monetary policy, has as voting members seven men and women who are appointed by the President, the president of the New York Federal Reserve Bank (these eight are permanent voting members), and four presidents of the Fed system’s remaining eleven regional Federal Reserve Banks (the four rotate among the remaining eleven).  Thus, monetary policy is set by Presidential appointees.  Certainly, those appointees are nearly as independent as a President-appointed Supreme Court Justice, but still.  Under the bill, all 12 presidents of the individual Fed banks would become permanent FOMC voting members, so the regions collectively would outnumber the President’s appointees.  The advantage here is that the individual bank presidents are appointed by boards of directors made up of bankers and business leaders local to each of the Federal Reserve System’s regions.  In this way, the regions, which better understand their situations than can a remote government, would gain significant influence over FOMC decisions that impact those regions.

The Sound Dollar Act also would limit the Fed to purchases of Treasury securities.  This would reduce the ability of the Fed to make credit allocation decisions—to pick and choose which banks, for instance, it will “save” by buying from them the toxic asset du jour.  Bailout or bankruptcy is a free market decision; no government instrumentality, other than a bankruptcy court, has any legitimate role in the matter.

I’m not sure allowing the Fed even to buy Treasuries is a good idea, though, unless it’s done after the free market has bought what it wants, and then only at that just demonstrated set of prices.  If the Federal government is such a poor credit risk that it has trouble peddling its debt to private investors, or other governments, why should the American taxpayer be Dragooned into taking on that risk?

With some tweaks, this is a bill that would serve well.  We just need to get the Big Government types out of government and so out of the way.

Incidentally, the WSJ‘s op-ed also has some words on the Fed’s success rate with that other mandate, maintaining “full employment,” and why it’s useful to take that DOC away from the Fed.  RTWT.