John Cochrane on Health Care

A reader asked me to comment on Cochrane’s essay from October 18. The title of the essay was “After the ACA,” which might indicate that Cochrane mis-forecast the election. To make a long story short, I agree with his economic prescription but disagree with his political diagnosis for why we have what I call insulation instead of real health insurance. Cochrane’s explanation for the absence of the latter is:

Because law and regulation prevent it from emerging. Before ACA, the elephant in the room was the tax deduction and regulatory pressure for employer‐based group plans. This distortion killed the long‐term individual market and thus directly caused the pre‐existing conditions mess. Anyone who might get a job in the future will not buy long‐term insurance. Mandated coverage, tax deductibility of regular expenses if cloaked as “insurance,” prohibition of full rating, barriers to insurance across state lines – why buy long term insurance if you might move? – and a string of other regulations did the rest. Now, the ACA is the whale in the room: The kind of private health insurance I described is simply and explicitly illegal.

My thoughts:

1. Nowhere do we observe the Cochrane (or Kling) health insurance system, or anything close to it. This suggests that something other than anomalous U.S. regulations are at work.

2. Health care is something that people love to have others pay for. Insert obligatory Robin Hanson reference.

3. Very few people understand insurance in general. Most people seem to be more loss averse than risk averse. They will buy extended warranties on cheap goods but ignore risks of catastrophic events, such as floods.

4. All around the developed world, third-party payment dominates direct consumer payment for health care. Perhaps consumers feel that if they are spared the need to take out their credit cards then it is easier sustain the belief (illusion?) that their doctors really care about them.

5. All else equal, doctors prefer being paid by someone other than the patient. They prefer to be thought of as offering the “gift of healing.” Of course they do want to get paid.

It turns out, much to doctors’ dismay, that all else is not equal. Third party payers impose all sorts of unpleasant paperwork and regulation. But you won’t see many doctors lobby for consumer-paid health care as the solution. They seem to view paperwork and regulation as an evil plot foisted on them for no apparent reason, without recognizing that it as an intrinsic result of introducing a third party into the payment process.

Cochrane goes on to discuss health care supply. Again, I agree with his prescription, which is to allow for vigorous competition. But he seems to regard health care regulation as an evil plot foisted on society, without recognizing that it may emerge naturally.

Competition is a trial-and-error process. In health care, we equate consumer protection with prevention of error, creating a trade-off between consumer protection and competition. Our choice along this trade-off is affected by the problem of “the seen and the unseen.” Health care errors have concentrated, direct impact on identifiable patients. Competition has diffuse benefits that show up indirectly in an ill-defined broader population. I think it is very difficult to convince people to trade off consumer protection for competition. And, of course, incumbents in the health care industry will do their best to persuade people not to make that trade-off.

While I think Cochrane’s essay will appeal to those who are already inclined to agree with him, others are unlikely to be persuaded. Incidentally, I had the same reaction to John Goodman’s book, Priceless.

Neither Cochrane nor Goodman addresses the arguments for intervention that derive from Arrow and Stiglitz. Arrow focuses on asymmetric information between consumers and doctors, which appears to justify consumer protection. Stiglitz focuses on asymmetric information between consumers and insurance companies, which appears to justify mandated health insurance.

Both the Arrow argument and the Stiglitz argument have merit in theory. My own view is that other forms of “market failure” are more important in practice. The “seen and the unseen” problem that I alluded to earlier means that, contra Arrow, we have too much consumer protection in medicine, not too little.

As I suggested earlier, the health insurance market suffers from the fact that consumers choose on the basis of loss aversion rather than risk aversion. Moreover, contra Stiglitz, there is that evidence relatively healthy people, rather than opting out of health insurance, are more likely to pay for it. This reflects the fact that the personality characteristic of conscientiousness drives both health and the propensity to obtain insurance. As a result, health insurance companies are treated to favorable selection, not adverse selection.

Having said that, I do not think it is Arrow and Stiglitz that libertarians need to overcome. I think we need to understand the deep-seated cultural beliefs that pertain to health care and either adapt our recommendations to those beliefs or try to change them.

6 thoughts on “John Cochrane on Health Care

  1. My initial reaction to this post is that I think the self-interested role of doctors, medical schools, and unions to prevent competition has been a far greater factor than deep-seated cultural beliefs in preventing an efficient healthcare system. I’ll need to checkout the links to see if I’m missing the point (likely!).

    • Kling’s post acknowledges something that I think libertarians in particular (and I have been one of them in the past) find very difficult to understand–people value certainty of quality as exemplified by guilds and strong consumer protections extremely highly and are often implicitly willing to pay the higher costs that result (and from a behavioral economics point of view, this is justified).

      Given the extremely costly damage that a single incompetent physician can do, the premium that one pays for ensuring minimum standards by cartelizing medicine is considered common sense. Ken Hirsch’s point (and to be fair, Friedman’s) is frankly irrelevant, even if it were true. Fortunately for us, most research into the area has shown physician costs have been stagnant over the last couple decades unlike every other component of the health care system and so we dont need to fight against changing physician selection, compensation, etc to slow cost growth…

      • I think many people are not aware of the extent of the historic role of special interest groups in creating the rules and regulations that govern our healthcare system. I found “The Social Transformation of American Medicine” by Paul Starr to be quite informative(http://goo.gl/ClQRG). (Starr helped to architect Hillary Clinton’s healthcare plan under Bill — he is not a libertarian.) All of the major anti-competitive regulations in healthcare have been the result of doctors, medical schools, and hospitals wanting to limit competition.

        In general, who do you think exerts the most influence in creating these rules and regulations — special interest groups or concerned citizens? Generally speaking, special interest groups have been the major force behind these movements. Perhaps though, a cultural bias in favor of certain regulations allows these special interests to accomplish their goals with limited resistance.

  2. Your Robin Hanson link is broken — you probably forgot the “http://” at the head of the link.

  3. If you have $10,000 in an HSA account, then deciding where to have your operation and who will perform it would indeed be a constructive exercise, both for you and for the health care system.

    The daunting amount of regulation in health care is largely intended to protect the millions of people who do not have $10,000 liquid anywhere.

    The informed consumer is indeed a worthy ideal. But only if the consumer has funding.

    If the advocates of competition were willing to fund HSA’s for low wage workers, I would start listening to them more closely. And actually, John Goodman has drifted toward supporting this step at times.

    But it would take serious income taxes to do this.

  4. “Neither Cochrane nor Goodman addresses the arguments for intervention that derive from Arrow and Stiglitz. Arrow focuses on asymmetric information between consumers and doctors, which appears to justify consumer protection. Stiglitz focuses on asymmetric information between consumers and insurance companies, which appears to justify mandated health insurance.”

    Cochrane doesn’t address the Arrow/Stiglitz argument in the essay, but he does in his EconLog podcast with Russ Roberts. Or at least he addresses the Stiglitz argument. As I recall, he mentions risk-rating, and also that arguably the asymmetric information runs in the opposite direction: the insurance companies probably have a better sense of a given patient’s expected cost than the patient himself does.