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The Power of Monopsony

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I work at a public university. Like many such institutions, we have been dealing with reduced support from the state. In fact, the percentage of the school’s budget that is funded directly by the state has fallen from 50-60% in the 1970s to about 10% (I think it’s less than 10% currently). The school has had to increasingly rely on tuition hikes in order to fund itself. This, of course, is increasingly unpopular with students. No longer can they attend their home state public university at a reasonable cost. In-state tuition is about $12,500 before room and board, about three times more expensive in real terms than in the mid-1980s. Out-of-state tuition, on which the university relies heavily has also seen similar increases. So the only public university in the state receives about 2.4% of the state’s total expenditures.

This seems like a bad idea. In a world in which economic success increasingly relies on completing some level of higher education, the state is not investing in the human capital it will need to grow in the future. Parents and students are upset. Professors and administrators are upset. This doesn’t seem like a political equilibrium. And yet the trend continues. The question, then, is why?

I believe that the answer is the rising cost of health care and specifically the larger and larger percentage of the budget taken up by Medicaid. Medicaid expenditures, of which the state pays slightly less than half of the total (the Fed picking up the rest), now account for 30% of the state’s total budget. This, of course, is up from 0% in the mid-1960s. As Medicaid eats up a larger and larger piece of the budget pie, everything else has to shrink.

So what do we do? I suppose one solution would be to leave our poorest and most vulnerable citizens without access to health care. But I don’t believe that would be the best solution. Instead, we should look at the best way to control our health care costs. And this is where the power of monopsony comes in. A monopsony is like the opposite of a monopoly. In a monopoly, there is only one seller. That seller can maximize its profit by increasing its prices and reducing its output compared to what would exist if there was more competition. In a market with a monopsony, there is only one buyer. That buyer can reduce the sellers’ profits by paying less than they would have to in a more competitive market.

Now normally, I wouldn’t encourage either monopoly and monopsony in any market. But the health insurance and health care markets are not like any market. They are fraught with problems of adverse selection, moral hazard, and information asymmetries. These markets, left on their own, will fail to achieve efficiency 10 times out of 10. That’s where monopsony, in the form of a national, single-payer health plan comes in.

With single-payer health care, everyone is enrolled and pays for it through a tax (similar to Medicare). Out goes adverse selection and moral hazard. The government is in the position to provide information on the efficacy of treatments and only pay for those that work. And the single plan is in a position to bargain prices with doctors, hospitals, and pharmaceutical companies to keep costs low.

The United States spends more than twice as much per person on health care than the median OECD country. And it does so without getting better results. If we adopted a single-payer plan, the potential savings would be measured in the trillions of dollars. We could increase funding to public education (that’s where we started) and infrastructure and everything else that’s being starved. What’s not to like?

Always remember that one person’s spending is another person’s income. Spending $1 trillion less on health care each year means $1 trillion less in income for doctors, nurses, hospital staff, and pharmaceutical workers. This would have to be a gradual process just so we didn’t throw the economy into recession. But these groups will fight tooth and nail to protect their incomes. Bargains will have to be made. I would start with paying off education loans for health care workers. It may also be a good idea to throw more federal research money to the pharmaceutical companies.

But it doesn’t make sense to allow one industry, even one as important as health care, to eat up more and more of our resources if we don’t have to. The power of monopsony would allow the federal and state governments to spend less and less on Medicare, Medicaid, and other health programs, opening up money for investing in the areas that strengthen our economy for the future. What kind of suckers are we that we don’t do this?


Written by Liam C Malloy

June 1, 2012 at 11:13 am

Taxes Aren’t Bad

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Jonathan Cohn has a nice post about the benefits of taxes. He points out all of the nice things that taxes buy and that U.S. taxes are fairly low when compared to other OECD countries.

One of the bugaboos of the right is that higher taxes will lead to lower economic growth. There is no evidence of this, either in our own country’s history, or in the international data. In fact, a simple (quadratic) regression on U.S. post-WWII data suggests that a marginal income tax rate on the top 1% (those earning over $900k) of between 40-45% would maximize growth. If you look at the top 0.01% (those earning over $17 million) that growth-maximizing marginal tax rate is over 70%. In an earlier post I showed that we could eliminate the corporate income tax by raising top rates to only 50% (maybe a bit higher to actually balance the budget).

There may or may not be a causal relationship between higher taxes on the rich and higher GDP growth, but it is certainly possible. Higher taxes allow the government to spend more on infrastructure and education, both important for economic growth. Currently, higher taxes would allow the government to provide health insurance for all. This should increase the health, especially of the working lower middle class (who are the ones most often without insurance), and benefit economic growth.

The rich, very rich, and wannabe rich on the right have certainly stepped up their rhetoric over the last decade and seem to have convinced most politicians that higher taxes are evil things. But this is clearly not always the case. My total health insurance premium is about $19,000 a year for an excellent family coverage plan. That amounts to about 25% of my gross salary. If we put in a Medicare-for-all plan, I would bet those costs would fall fairly substantially (with only a small drop in coverage, after all, all providers would be in the network). I would gladly pay an extra 15-20% in taxes for such a plan, assuming that my salary is increased by the amount of my current coverage. The economic (and social) benefits of covering everybody, I would bet, would be significant.

Written by Liam C Malloy

April 18, 2011 at 3:19 pm

Why Don’t People Understand Health Insurance Markets?

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There’s been a minor debate in the blogs I read about the value of Medicare as opposed to a cash voucher. The basic idea is that if you’re 65 you could either sign up for Medicare or take the cash equivalent. Now, as someone who has received his fair share of stupid gifts from friends, family, and employers and has often thought, “Gee, could you just give me the cash instead?”, I understand the impetus to think that the cash might in fact be better.

So Ezra Klein points out the debate between Tyler Cowen and Matt Yglesias. He also points out that this is not the proposal in the Ryan plan which would simply cut benefits. The voucher in that plan could only be used to buy health insurance and would not, as far as I can see, be redeemable for cash. Klein says that the point is that we don’t want people to die in poverty on the street so we won’t deny them healthcare in their final days. He is, of course, right, and somebody will have to pay for that healthcare.

But Klein misses the larger point. Cowen points out that many people might in fact choose the cash as opposed to the health care. And that’s exactly the point! Healthy people will opt out of coverage, costs will increase, and pretty soon the market will fail to work. As Brad DeLong notes, we’ve known this since at least Arrow’s 1963 paper on health insurance markets.

I guess this is why it’s important to have a degree in economics. So you don’t make stupid mistakes. I suppose Klein and Yglesias can be forgiven since they lack such a distinction. I wonder what Cowen’s degree is in.

Written by Liam C Malloy

April 17, 2011 at 8:06 am

Posted in Healthcare, Policy