Paul Krugman: Health Economics 101

It's nice to have Paul Krugman discuss a question that has been addressed repeatedly at this site, market failure in the provision of health and social insurance due to moral hazard and adverse selection:

Health Economics 101, by Paul Krugman, NY Times: ...[W]e rely on free markets to deliver most goods and services, so why shouldn't we do the same thing for health care? .... It comes down to three things: risk, selection and social justice. First, about risk: ... In 2002 a mere 5 percent of Americans incurred almost half of U.S. medical costs. If you find yourself one of the unlucky 5 percent, your medical expenses will be crushing, unless you're very wealthy - or you have good insurance. But good insurance is hard to come by, because private markets for health insurance suffer from ... the economic problem known as "adverse selection," in which bad risks drive out good. To understand adverse selection, imagine what would happen if ... everyone was required to buy the same insurance policy. In that case, the insurance company could charge a price reflecting the medical costs of the average American, plus a small extra charge for administrative expenses. But in the real insurance market, a company that offered such a policy ... would lose money hand over fist. Healthy people, who don't expect ... high medical bills, would go elsewhere, or go without insurance. ... [T]hose who bought the policy would be a self-selected group of people likely to have high medical costs. And if the company responded to this selection bias by charging a higher price for insurance, it would drive away even more healthy people.

That's why insurance companies ... devote a lot of effort and money to screening applicants... This screening process is the main reason private health insurers spend a much higher share of their revenue on administrative costs than do government insurance programs like Medicare, which doesn't try to screen anyone out. ... [P]rivate insurance companies spend large sums not on providing medical care, but on denying insurance to those who need it most. What happens to those denied coverage? Citizens of advanced countries ... don't believe that their fellow citizens should be denied essential health care because they can't afford it. And this belief in social justice gets translated into action... Some ... are covered by Medicaid. Others receive "uncompensated" treatment, ... paid for either by the government or by higher medical bills for the insured. ...

At this point some readers may object that I'm painting too dark a picture. After all, most Americans ... have private health insurance. So does the free market work better than I've suggested? No: to the extent that we do have a working system of private health insurance, it's the result of huge though hidden subsidies. ... [C]ompensation in the form of health benefits... isn't taxed. One recent study suggests that this tax subsidy may be as large as $190 billion per year. And even with this subsidy, employment-based coverage is in rapid decline.

I'm not an opponent of markets. ...  I've spent a lot of my career defending their virtues. But the fact is that the free market doesn't work for health insurance, and never did. All we ever had was a patchwork, semiprivate system supported by large government subsidies. That system is now failing.  And a rigid belief that markets are always superior to government programs - a belief that ignores basic economics as well as experience - stands in the way of rational thinking about what should replace it.

For similar comments on Social Security insurance, see  Social Security is about insurance, not savings, The Need for Social Insurance, and Optimizing Social Security through Poverty Insurance and Retirement Saving. And from Paul Krugman, see Passing the Buck.

Update: Tyler Cowen at Marginal Revolution notes:

Marginal Revolution: Paul Krugman, circa India: Here is yesterday's column on health care; I am not sure if the The Hindu will be carrying them all on-line.  Arnold Kling offers excellent commentary.  Thanks to Eswaran for the pointer.

Previous (11/11) column: Paul Krugman: The Deadly Doughnut
Next (11/18) column: Paul Krugman: A Private Obsession

Comments

[Bruce Webb]

Professor Krugman kind of whizzed by a key point. Certain reactionaries like to point out that people ultimately get treated even if they can't pay. That you can walk into an emergency room and they can and do treat you.

True enough but that doesn't mean they don't bill you, and when you don't pay report you to credit agencies and send the bill to collections. One trip to the emergency room can mean a lifetime of destroyed credit. Sure you can go back to the hospital time and again, but you will never be able to buy a house. That is the cruel reality for the uninsured poor. You can get food from the food bank, and you can get emergency medical from the emergency room, but financially you may never get over that hump. Which may keep you from taking your kid to the hospital in the first place.

[anne]

http://select.nytimes.com/2005/1.../ 14krugman.html

What happens to those denied coverage? Citizens of advanced countries - the United States included - don't believe that their fellow citizens should be denied essential health care because they can't afford it. And this belief in social justice gets translated into action, however imperfectly. Some of those unable to get private health insurance are covered by Medicaid. Others receive "uncompensated" treatment, which ends up being paid for either by the government or by higher medical bills for the insured. So we have a huge private health care bureaucracy whose main purpose is, in effect, to pass the buck to taxpayers....

[anne]

Here we go again.... The gist of an article about the President's adviser on health care technology, and about how better computer record keeping will surely save us all, is that what the Administration wishes are cuts in private and public health care benefits and less choice in care. No matter what this Administration goes after, there is always to be a tragic resolution.

[anne]

Though I do not believe Medicare will be soon threatened, for there will be a Congressional election in a year, there is a concerted Republican push that I had ignored, till an article was tossed at me today, to encourage cut health care benefits through the private sector. Medicaid benefits are already being cut. Later, the push will be to cut Medicare benefits by further or more rapidly raising premiums which already take up much of the cost of living increase in Social Security each year. I am not amused.

[anne]

http://select.nytimes.com/2005/11/14/opinion/14krugman.html

Paul Krugman:

What happens to those denied coverage? Citizens of advanced countries - the United States included - don't believe that their fellow citizens should be denied essential health care because they can't afford it. And this belief in social justice gets translated into action, however imperfectly. Some of those unable to get private health insurance are covered by Medicaid. Others receive "uncompensated" treatment, which ends up being paid for either by the government or by higher medical bills for the insured. So we have a huge private health care bureaucracy whose main purpose is, in effect, to pass the buck to taxpayers....

[California Health Insurance]

I agree medicare will be soon threatened. It is unfortunate to hear so many lack health insurance. We really need to improve our health care system. Health insurance is a major aspect to many and we should help everyone get covered.

[Blue Cross of California]

Krugman proves many good points on health care in this article. It really shows how important health insurance can be to many.