What finally broke the grip of the hospitals (and later the doctors) on the methods of Medicare payment was the acute fiscal crisis that developed after Reagan cut taxes and increased military spending in 1981 and the economy then plunged into the worst recession in decades.

The dual recessions of the early 80s are largely thought to be the result of the necessary tightening of monetary policy at the time which was the unfortunate policy prescription (necessary) from the Keynesian unicorn period of the 1970s (high inflation and high unemployment). Indeed, the early 80s recession is known as the Volcker Recession after the chairman of the Fed who sharply and quickly increased the federal funds rate to stave off the inflation.

Interestingly, the narrative above is a little out of touch with modern stimulus advocates, no? Wouldn’t both cutting taxes and raising spending (whether on bombs or bridges or battery powered cars or basement digging for that matter) be precisely what the Keynesian doctor ordered? But is the author going to argue that doing this, only when Reagan was president, plunged us into recession? Seems like the opposite of the austerity fairy to me.

To give the author a little leeway, he did just remind readers on the page prior that Reagan himself was responsible for instituting both an expansion of Medicaid and in imposition of Medicare price controls. Remind your friends of that when you are at a dinner party.

This is odd. And it is wrong.

Do critics of markets actually understand what axiomatic principles are? Do critics of markets actually understand what the term “institutions” means? For those of us who are classically liberally oriented and prefer a much more market oriented economy, THE very fundamental premise of our economic and political worldview is the non-aggression axiom. Individuals may contract with one another and otherwise behave in ways that pursue their own interests so long as in doing so the property of others is not violated. If individuals violate the property of others, there is just cause for the situation to be rectified (let’s ignore how). In other words, the default “anarchist” position on things like pollution is, “no pollution allowed.”  And that position derives from the axiom that the rest of the classical liberal framework evolves from. For our utilitarian friends, upon what such axiomatic foundation does “environmental externalities are bad” derive? Keep searching … keep searching … keep searching … there is, of course, no such foundational reason outside of expediency.

Seriously, go ask someone what they think the default position of “free-marketers” is on pollution and I guarantee they’ll argue that “people who support free-markets are enemies of the environment.” But the default position of true market proponents is that injunctions against and damages for all forms of contamination of land, water and air are required when actual nuisance and damage occurs. Sure, there are cases when relying on the body of common-law and tort to deal with these intrusions will be costly or impossible, but the basic market approach provides a framework for understanding when this is likely and also a way to think about when those barriers to such implementation are likely to fall.

The ignorance, the almost proud ignorance, of anti-capitalists on this matter would be laughable if they didn’t have guns. The Keystone issue would be a good application. Does the fact that a pipeline exists mean that pollution is inevitable (ignoring the fact that there are already dozens of pipelines across the same area, and that pipeline safety is far better than transporting fuel in other ways)? Does the current body of environmental law, and the record of torts on environmental issue suggest that builders of the pipeline are going to be more or less sensitive to potential damages today than in the past? In this case too, you might think the conditions upon which market transactions can occur effectively would be violated – but it is clear where the pipeline would be travelling, and it is not hard to imagine that with today’s computing and communication technology that the pipeline owners could negotiate with all potential damaged parties to make it clear what might happen should a leak or explosion occur. Where in the entire discussion was the public made aware of what typically happens if a pipeline has an issue? Where in the entire discussion was the public made aware of tools they might have to become involved in the negotiations? Where in the entire discussion was the fact that Ogallala aquifer is a common-pool resources that is as much the source of the problem as the pipeline itself? Do you think if Warren Buffet owned the entire aquifer we’d have the same issues?

Finally, the existence of pollution and so-called externalities presents an opportunity for profit-seeking entrepreneurs to solve the problem. And while I understand that we don’t really want the problems to emerge in the first place, it is usually because of our problems that we are able to advance. For example, without copper prices skyrocketing, maybe we never stumble upon fiber optics.

But beyond that, and really the reason I wanted to write this post, is to remember that there are people in the current intellectual environment who believe that smart regulation creates jobs. Let’s not dispute that. Then the same exact argument can be applied to the spurring of market solutions to externality problems. The same … exact … argument. Do anti-capitalists think that market forces harness greed only when it comes to doing damage and not preventing or cleaning damage? So we are only greedy when it wrecks the lives of others and wrecks the planet. Under what model are you operating if that is in fact your worldview?  So you may want to argue for regulation, but you really ought not do so on the premise that it creates jobs first because it obviously doesn’t, and second, if it does, it doesn’t appear that it would create ‘em any differently than would emerge otherwise particularly if the legal system works well.

Once you put it in those terms, you should be utterly astounded by how small this stock seems to be. For example, the total net worth of households and nonprofits in the US is roughly $60 trillion.

Julian Simon famously called people the ultimate resource. Can we crudely estimate the value of this “natural capital stock” (which happily does not get depleted with additional “use”)? Sure. The US GDP is about $15 trillion right now. Based on the national income and product accounts, it appears that about two-thirds of this value is generated by labor (i.e. labor’s share of income). So, workers generate and receive about $10 trillion per year of income in the United States alone. In other words, American workers produce a flow of income that is 2.5 times the stock of the entire world’s natural ones. If you want to consider people in the US a permanently long-lived amorphous blob of an asset, and assume long term interest rates of around 3%, then the value of this human capital stock is about one-third of a quadrillion dollars. That’s for the US alone.

Is there a deeper lesson in the data? Perhaps not. It illustrates to us the point economists make regularly. A pile of dirt (which is nothing more than tightly packed chemicals) is just a pile of dirt. It takes a human mind to figure out it can turn itself into a soda can, pottery, or even the beginning of a new, truly innovative and green car engine.

If the government leaves the health-insurance market to voluntary choice, the costs of administering coverage are sure to be higher for small groups and individuals than for big employers. Individual consumers and small businesses also lack the knowledge and purchasing leverage of a large firm. Not unreasonably, insurers worry that in individual and small-group markets, those who sign up for insurance are likely to be at risk of high health costs (a problem known as “adverse selection”). In a voluntary market, insurers have every incentive to avoid covering the sick and instead to cherry-pick the healthy from among the individuals and small groups that apply for coverage. But if they do so, millions of people will remain uninsured.

The bolded section is the origin of the offense. You might be thinking, “it sounds right.” And you’d be right. In that sentence, he partially summarizes what the adverse selection problem is – but it would have been nice to see more detail. In a situation when the individuals purchasing insurance know more about their own health status than the insurers, we have what is called an “asymmetric information” problem. In this case, we are likely to see insurers charging premiums to all comers that reflect the average health status of all customers – since they cannot determine which customers are healthy and which are sick. In this case, insurance is a bad deal for healthy individuals since their expected medical expenses over the course of their lifetimes will be lower than the present value of the premiums they will pay over their lives. Insurance would be a good deal for the sick. In this case the premiums they would be paying would be a fraction of the expected value of their lifetime medical expenses.

The problem, you see, arises not from the fact that we have markets per se, but from the fact that we have an information asymmetry. If health insurers knew as much about your health status as you did, then everyone would have insurance for things that are insurable (more on that below). In this case, insurers would charge different premiums to difference classes of customers – with the healthier patients paying lower premiums than sicker ones (I am simplifying). But our author above is claiming that health insurers know, at least closely enough, who is sick and who is healthy. In other words, the fundamental condition for adverse selection to be present has been violated – he says so. Now to be fair, he says, “has the incentive” he does not say “they can actually do this.” But read the rest of the book and you will see that I am being generous.

OK, so even being fair, our author is confused (to be fair) or outright disingenuous and misleading. Why would I say that? Well, I think that Starr would agree that private insurance companies want to make money. Let me ask a rhetorical question. Do you think before dropping people entirely they would try to figure out a way to make money from them? It is really bad policy that prevents insurers from charging different premiums to different people – and it was the Progressives who pushed for these policies. Remember what I said about situations like this? Only when premiums cannot be adjusted to account for the higher costs of actually covering people would dropping them become a desirable option.

Before continuing, let me interject a decent idea for a policy proposal that includes government. If folks are not willing to allow insurance companies to charge for the higher cost of insuring the unhealthy, a reasonable proposal would either be for the federal government to step in as a reinsurer, or to provide subsidies to the unhealthy to purchase insurance, or better yet for the government to fully insure the sick for their chronic conditions. Why? If the condition has been fully-insured, then when a “sick” customer approaches an insurance company, that pre-existing condition has already been “taken care of.”  I see objections from many angles here: first that we should just have a full-blown free market and if anything just provide cash grants to people who need them. I see them from also coming from the camp that says that when a person has one condition it probably correlates with other negative health outcomes, so that pre-existing conditions could never be fully insured away. Note that the ObamaCare law tries to get at some of this issue. OK, back to the post.

If health insurers are cherry-picking health customers, that is the opposite of adverse selection. Starr seems to know this, but he could have been clearer. But onto the main point of the post. I cannot tell you how many times I have had discussions with students, parents and acquaintances about insurance and have heard them comment something to the effect of, “insurance companies have no right to charge the sick more, or to drop coverage” and they defend things like Obamacare ostensibly because “everyone needs to pay into an insurance pool in order for it to work.” But that is not right. Insurance cannot work for things that are not insurable. More on that in a future post.

Typically when I emphasize this point people like at me like I am some kind of a moral beast and this would truly puzzle me, since there is no moral position in making this seemingly analytic point. But now I see what is going on. The rhetoric of redistribution has taken over. I sense that a good portion of people view health insurance (and medical treatment) not as insurance, but as another form of redistribution. How else would they reject my observation above? By their thinking, “everyone” should pay into insurance so that people who “need” more will have the funds while people who “need” less don’t need as much. But real insurance has nothing at all to do with redistribution. It is NOT meant to redistribute resources from low-risk people to high-risk people. That is a political question of redistribution. Insurance is a way to pool like risks and that is all. So how could people be so confused? Again I lay the blame at the feet of FDR and the New Deal legacy. “Social insurance” programs emanated in the second New Deal as part of a grand political strategy by FDR to win votes. It worked. But he was extremely anxious about giving Social Security the appearance of being redistributive (read Amity Shlaes’ great book to learn more about this episode). So what is clearly a program that redistributes income from current workers to older non-workers is repackaged as “insurance.” And I wholly believe that using the rhetoric of “social insurance” to characterize a set of clearly redistributive policies has changed the psychology of how Americans think of insurance. Hence the utter contempt with which I am held by people when I suggest that some people are uninsurable. According to the redistributive vision of the world, that concept simply cannot exist.

There’s much more to say, in particular on the implication of administrative costs and a few other doozies from his book. They’ll come in due time.

I’m not chiming in on the particulars. It is pretty clear to me that responding second to videos like this, like the Story of Stuff, like Capitalism a Love Story and the dozens and dozens of other hack jobs is not getting anyone anywhere. It is also pretty clear to me that had Art put this together first, it would still not have nearly the influence of Ms. Leonard’s pieces.

On a related note, does anyone know how these videos are made? If I had some reasonable knowledge of how to do it, I would seriously dedicate a lot a time to making them – if for the only reason that I think they could aid in my teaching.

Given my interest in health economics and graphic novels, I was initially hopeful about Jonathan Gruber‘s graphic novel, entitled Health Care Reform: What It Is, Why It’s Necessary, How It Works.  But in all honesty, the book is awful.  Gruber crafts his argument like a salesman, not an economic educator.  He’s careful to avoid outright mistakes, and makes a couple of awkward disclosures.  Yet he omits a long list of crucial, damaging points.

1. Gruber explains the basic facts about health care costs: they’re rising, and government picks up much of the tab.  But he almost totally neglects the connection between the two.  Medicare and Medicaid vastly increase demand for health care.  There’s no denying it.  Imagine how much more affordable health care would be if these programs had never been adopted – or if they were abolished.

2. Gruber doesn’t just ignore the indirect effects of Medicare and Medicaid on health costs.  He repeatedly panders to the populist view that near-total insurance is good.  He brags that Obamacare will close the “enormous gaps” in many private insurance policies.  He frowns on insurance policies that place any ceiling on annual or lifetime payouts.  He even reassures readers that, under Obamacare, the government’s “comparative effectiveness research” cannot legally be used by private insurance companies to restrict health insurance coverage.  Gruber’s happy to blame “Cadillac” health insurance policies for raising medical costs.  But private insurers’ many efforts to restrain spending earn nothing but criticism from him.

3. More generally, Gruber ignores almost everything government does to increasethe cost of health care.  There’s no discussion of medical licensing versus certification.  There’s no discussion of the regulatory barriers to low-cost, high-deductible policies.  There’s no discussion of medical liability.  He mentions the high cost of “free” emergency room care, but fails to mention that this is a side effect of long-standing populist policy: government forces emergency rooms to treat people even if they certainly won’t pay.

4. There’s zero discussion of moral hazard – the unhealthy lifestyles that many people choose despite the risks.  For Gruber, or at least Gruber the graphic novelist, bad health is something that “just happens to you.”  Sigh.  Insurance companies aren’t omniscient, but they could do a lot more to tailor rates to risks – if it were legal to do so.  And maybe people would respond to those incentives by living healthier lives.

5. Gruber fails to counter “You can’t put a price on safety” populist rhetoric with the basic economic logic of risk.  Namely: There’s a trade-off between risk and other goods – and no person or society can afford perfect safety.  Indeed, he panders to the populists.  Gruber mentions people who “think they don’t need insurance because they are healthy” – then condescendingly adds, “They don’t realize that if they do get sick, they won’t be able to afford the care they need.”  Yes, or maybe they’ve weighed the risks and reasonably decided to take their chances.

6. Gruber never mentions health economists’ consensus that health care is vastly overrated.  Differences in medical treatment explain at most a tiny fraction of (a) why we’re so much healthier than we used to be, and (b) why the rich are so much healthier than the poor.  Gruber does admit that a lot of health care spending is pure waste.  But he neglects one of the best explanations: We waste a lot of health care because patients overrate its effectiveness.

7. Gruber is quick to praise the wonders of Romneycare in Massachusetts.  But he doesn’t mention the fact that Massachusetts already had extremely high coverage: coverage increased from 94% to 96%.  (Gruber says 98%, but I’ll go with Wikipedia).  Achieving Massachusetts-level coverage at the national level, where coverage rates are markedly lower, will be far more expensive.

8. Gruber studiously avoids the most remarkable health care system on earth:Singapore’s.  While it’s far from laissez-faire, it’s amazingly cheap and effective, and relies very heavily on individual incentives.  Why should anyone “learn from Massachusetts” when they can learn from Singapore?

9. Gruber praises the CBO’s “evidence-based estimates of how legislation will impact our nation,” including its estimates of the budgetary effects of Obamacare.  But he never mentions the crucial caveat: the CBO takes politicians at their word.  If legislation says that it’s going to reduce Medicare reimbursements, CBO assumes those cuts will actually happen – even though Congress habitually reverses its cuts before the day of reckoning arrives.  CBO’s estimates are about as “evidence-based” as the statement “If my father was a king, I’d be a prince.”

10. To his credit, Gruber carefully explains (a) the indirect consequences of banning pre-existing conditions clauses, and (b) how the individual mandatemitigates these indirect consequences.  Unfortunately, he doesn’t take this chance to explain that, contrary to most economists and econ textbooks, insurance companies are quite good at solving adverse selection problems – unless regulations prevent insurers from charging riskier people higher rates.

11. Gruber ignores the disemployment effects of fining employers who fail to provide coverage for their employees.  He just panders to populist prejudice: Obamacare gives small firms a tax credit, and big corporations can easily afford to pay.  (“Companies of that size should be offering insurance, or contributing to their employees’ coverage.”)  Never mind the unemployment rate – or nominal wage rigidity.

12. Gruber’s book begins and ends with the high cost of medical care and what to do about it.  But what does Obamacare really do about costs?  Not much.  Right now the Medicare Payment Advisory Commission gives “nonbinding” recommendations to Congress.  Under Obamacare, the new IPAB gives recommendations that Congress legally has to “respond to.”  In my book, that’s still “nonbinding.”

13. Gruber emphasizes how “complicated” cost control is.  But we should support Obamacare anyway:

To not support this bill because it doesn’t “do enough” on cost control is like criticizing a baby for not going directly to long-distance running.

In reality, cost control is simple.  Everyone knows how to do it: Austerity and incentives.  Government needs to spend less, and stop using regulation to discourage frugality.  Alas, these realistic solutions are extremely unpopular.  Gruber is too technocratic to go full populist and say, “We should spend as much as it takes to give the best possible health care to every American.”  But in the end, that’s the philosophy behind Obamacare: Do whatever it takes to cover everyone, and hope the American public one day sees the wisdom of austerity and incentives.

I need to print this onto a notecard, along with a few other posts and just hand them out at dinner parties when I am about to get myself uninvited. Just grab my drink, hand out the card and then be on my merry way. It will save a lot of frustration.