In Which I Take on a Nobel Laureate
Paul Krugman goes after arguments that the public option is not an important part of health care reform this morning. A central point of Krugman’s is that the public option will significantly reduce costs, which is an argument that I have had a hard time understanding. Considering that Krugman knows about 10,000 times more than I about this subject, I was hoping to see something that gave a convincing explanation as to the mechanism by which a public option would significantly reduce costs, thereby making its impact on the ever-increasing federal deficit acceptable.
Krugman left me sorely disappointed, though. He gives three reasons why the public option is important, although the third reason is by Krugman’s admission purely political and also dependent on the correctness of the first two reasons. Krugman also engages in some straw manning by claiming that “the argument against the public option boils down to the fact that it’s bad because it is, horrors, a government program.” While this may be true of the Palinites and a lot of the town hall protesters, it is hardly the only reason to have problems with the public option – one can be opposed to the public option on the grounds that its likely benefits do not justify the costs.
Anyhow, the two non-political reasons Krugman thinks the public option is important are: “the huge overhead of the private insurers, much of which involves marketing and attempts to cherry-pick clients,” and “a public plan would probably provide the only real competition in many markets.” These two reasons are pretty much the same reasons I’ve seen given by other public option advocates for months, and Krugman doesn’t put much effort into elaborating on the mechanism by which the public option is supposed to have much effect beyond a blanket statement of “less overhead, more competition.”
I’m willing to be convinced otherwise, but without some kind of elaboration, these two claims about the public option seem quite exagerrated.
First, in terms of the overhead issue, Krugman is ignoring that any public option is going to wind up investing pretty heavily in advertising itself if it’s going to be successful. It has to provide the public with information by which it can let the public know that it’s out there and how to sign up, and how it’s so well-worth signing up for, pretty much like the Post Office, Amtrak, and public universities do. So it’s difficult to see how the public option would meaningfully result in a reduction of marketing overhead costs. Meanwhile, although I have no illusions about the bureaucracy that is the health insurance industry, it’s difficult to see how the federal government would be significantly less of a bureaucracy. The only way I can see this happening is if the public option is set up in a way where it will deny fewer claims; the problem with this is that paying more claims has its own costs associated with it. This makes it highly likely that any reduction in bureacracy (and I’m skeptical that there would be any reduction) would only have the effect of shifting costs, not reducing them. To be sure, there may be a strong normative argument for such a cost shift, but I don’t see how it would actually reduce costs overall.
On the second issue – competition, the argument appears to miss some realities about the health insurance industry. Specifically, the health insurance industry’s relative profitability is surprisingly low – only about 2.2%. So introducing more competition would seem to have an overall price reduction ceiling of only 2.2% unless you really believe that the government can do exactly what existing insurance companies do in a less bureacratic, more streamlined fashion.
To be sure, increased competition may incentivize innovations that lead insurance companies to find ways of decreasing bureaucratic costs. But it’s difficult to see how one public entrant into the marketplace would create enough competition to make this significant, particularly if that entrant has to comply with existing state health insurance regulations, which are themselves a significant reason for sky-high health care costs and are one of the primary reasons state health insurance markets are so uncompetitive in the first place. On the other hand, if that entrant need not comply with local health care regulations, then it’s difficult to see how the existing market participants can compete on price when they have to comply with additional regulatory requirements – in other words, the public option and the existing local monopoly aren’t directly competing with each other, so the incentives for innovation are greatly reduced.
That said, there may be one way in which a public option could create the type of competition that would cut insurance industry bureaucracies. Specifically, if you have an appropriately-subsidized public option that had to comply with existing state regulations, maybe you could incentivize innovations in insurance industry bureaucracy. The thing is, this subsidy has to be just the right size – if it’s too large, it will quickly kill the existing insurance industry. The types of cost-saving innovations that the public option is supposed to create are going to take time to develop, and there is ultimately going to be a limit to how far private industry can realistically make cuts and still remain profitable. The problem is that we have no way of knowing how far the insurance industry will ultimately be able to cut bureaucratic costs in either the short or long-term since it relies on innovations that by definition have not yet happened.
Meanwhile, if we make the subsidy too small, the effect on innovation is going to be negligible, particularly if the government proves worse at efficiently running an insurance business than the private sector. This incrementalism would be fine, though, if we weren’t combining the public option with an individual mandate. An insufficiently subsidized public option combined with the individual mandate will impose potentially unbearable costs on the currently uninsured while failing to reduce the systemic costs by any significant amount. Indeed, you may actually wind up increasing systemic costs if the reduction in premiums due to the public option’s competition is less than the amount of the fines paid by people who refuse to obey the mandate.
Finally, although Krugman does not directly make this argument in today’s post, one common argument I’ve seen for the public option is that it will lower costs because of the strength of the government’s negotiating power with doctors and pharmaceutical companies. Although it is arguable at least that the increased economies of scale of the public option would give it a particularly powerful negotiating hand, it is difficult to see how this would result in significant cost savings. First, this would obviously have no effect on the private insurance companies’ ability to reduce costs. But second, it ignores that existing private insurers are already behemoths, and as anyone who has ever worked in a purchasing department knows, economies of scale tend to level off beyond a certain point. So Wal-Mart may well be able to get a better price for something than Target, but Target is still large enough that the difference in that price is going to be pretty small. Meanwhile, there aren’t likely to be any significant economies of scale with respect to the negotiation of doctors’ fees since the doctor has to do pretty much the same amount of work whether he has 100 patients with 1 insurer or 100 patients with 20 insurers. True, different insurers will require different amounts of paperwork, but paperwork is necessary to weed out improper claims. An insurer that doesn’t require a lot of paperwork is going to wind up paying out claims that it should not pay out, which means we wind up with an excess of treatments and more systemic costs.
In the end, I recognize that I am not an economist and definitely not a Nobel Laureate. So I assume there is some mechanism I’m missing here. But I would appreciate if someone could explain that mechanism beyond simple handwaving at the principles of competition and overhead. Indeed, if competition is our primary concern, it seems there are plenty of better ways of doing it without an expensive public option. We could remove restrictions on interstate insurance; while I think the effects of the resulting “race to the bottom” are overblown, it seems like the obvious way of avoiding a “race to the bottom” is just to federalize the regulations. In such an instance, we would wind up with dozens of insurers competing directly against each other instead of one public option competing with the existing insurance monopoly in each state. And don’t get me started on the ways in which eliminating the tie between employment and health insurance would increase competition.