TCS Daily

Krugman vs. Munkhammar, Round One

By Tim Worstall - March 10, 2006 12:00 AM

Editor's Note: This is part one of a two part series. Round Two will be published soon...

Why is the American health care system so expensive? Why that huge 16 percent of GDP that the New York Times columnist Paul Krugman keeps telling us about? The rather surprising answer, according to Johnny Munkhammar in his new book European Dawn, is that Americans want it to be that expensive. Yes, I know, jaws drop, mouths are agape, but it isn't, once explained, all that counter-intuitive an idea.

The U.S. health care system is not perfect. Nothing, much to our collective disgust, designed by human beings ever is such. Our question should be, rather, as in so many things, whether the tradeoffs we are making are the best that we of those fundamental points of economics.

Where Munkhammar starts from is the idea of revealed preferences. If, as and when individuals are allowed to spend their own money as they wish, what do they spend it on? The answer changes at different levels of said income, those changes often described as the hierarchy of wants. At its most basic the man dying for lack of water will spend all he has on a drink to survive. As income rises things like water, food, shelter, all become well catered for and we spend increasing proportions of our extra income on other things. Education was a very small component of the medieval peasant's outgoings, a large part of the contemporary middle class families'.

It shouldn't surprise us that as more basic needs are catered to, our desire to spend more on health care rises (perhaps "changes" is better). That not just the amount we spend rises along with our incomes, but that it takes an ever greater portion of out incomes as well. Part of this could be, as Paul Krugman says in the "New York Review of Books":

[N]ew medical technology is the major factor in rising spending: we spend more on medicine because there's more that medicine can do...So far, this sounds like a happy story. We've found new ways to help people, and are spending more to take advantage of the opportunity. Why not view rising medical spending, like rising spending on, say, home entertainment systems, simply as a rational response to expanded choice?

Munkhammar's point is that the U.S. gets closest to allowing the expression of such preferences of any rich country. He quotes one paper (Fogel, 1999):

One study has shown that Americans are so anxious to improve their medical care that, given a $10 dollar rise in income, they want to spend the entire increase and a little more besides — $16 dollars in all — on better medical care.

In the European press, just before every election, there's a plethora of studies and opinion polls put out by the leftist parties stating that people are willing to pay higher taxes in return for better health service. This is exactly the same point, that as income rises people wish to spend more on health care.

However, as Munkhammar goes on to point out, the very fact that they are financed by taxes means that those true preferences don't actually get put into practice. It's not just that the tax guzzlers themselves can always find something else they'd rather spend the money on (and the associated cynicism about their promises) there's also a limit to how much we're prepared to hand over to the taxman.

It might be that we Europeans are willing to spend 16 percent of GDP on health care, as in the U.S. and unlike the eight or nine percent that we currently do, but we'll never be able to find out because we won't put up with handing over another seven percent of GDP in taxes while we might well have paid the extra if we'd been able to do it ourselves.

So Munkhammar's basic point is that Americans spend more on heath care than those in other countries simply because they are the only people who are able to do so outside the tax system. A controversial idea to be sure. But to my mind rather preferable to Krugman's expressed idea:

Imagine, for a moment, that some future U.S. administration were to push through a fundamental reform of health care that covered all the uninsured, replaced private insurance with a single-payer system, and took heed of the VA's lessons about the advantages of integrated health care. Would our health care problems be solved?

No. Although real reform would bring great improvement in our situation, continuing technological progress in health care still poses a deep dilemma: How much of what we can do should we do?

He goes on to point out that one of the very purposes of his desired changes to the U.S. health care system is that expenditure on it should decline. Which could be expressed as you should get as much health care as Professor Krugman says you should have, not how much you wish to purchase yourself. Not a great advance in human liberty as far as I can see.

There's a second point to be made as well about higher health care costs in the US. Krugman:

So why does U.S. health care cost so much? Part of the answer is that doctors, like other highly skilled workers, are paid much more in the United States than in other advanced countries.

Munkhammar expands on this and introduces us to the Baumol Effect. Just to prove that this isn't an invention of frothy-mouthed libertarians, here's the impeccably social democratic economist, John Quiggin on the subject:

To simplify drastically, the Baumol effect arises when productivity growth is more rapid in the goods-producing sector than in the service sector, and particularly in the provision of 'human services', including health, education, culture and recreational services [...] Since labour and capital are mobile between sectors in the long run, wages grow at much the same rate in both sectors, so the price of services has to rise relative to the price of goods.


Given all this, we can expect to see an increasing share of income being spent on services like health and education, even though the real supply of these services is increasing only modestly...

We almost always expect productivity in goods production to increase faster than in services so we almost always expect to see the latter becoming more expensive relative to the former. As we also know from an earlier Krugman essay (back in the good old days of sound economics) and I paraphrase, average wages are determined by average productivity in the economy. If we have one of the economies with the highest labor productivity (the U.S.), why would we be surprised that services are relatively more expensive than goods in that economy?

There's more to be said about Baumol and Krugman's desire to solve US health care by having (as I said I thought he would way back when) both a single payer and single provider system along with some comments from Munkhammar but that's for next time.

I'll leave you with just this thought. Krugman says:

Employer-based insurance is a peculiarly American institution. As Julius Richmond and Rashi Fein tell us in The Health Care Mess, the dominant role of such insurance is the result of historical accident rather than deliberate policy. World War II caused a labor shortage, but employers were subject to controls that prevented them from attracting workers by offering higher wages. Health benefits, however, weren't controlled, and so became a way for employers to compete for workers.

This is, from the liberal side, identified as one of the great problems of the American system, that very reliance upon employer based insurance. So what I want to know is why aren't all the liberals screaming at this guy (from Wikipedia)?

During World War II, Galbraith was America's "price czar", charged with keeping inflation from crippling the war effort.

Yes, that's JK Galbraith, John Kenneth himself. A wonderful example of government intervention storing up trouble for the future don't you think? Or at least you ought to acknowledge it as such if you really do think that insurance is really what's wrong with the American health care system.

Anyone able to tell me why he's a liberal icon instead?



The only problem
If you got what you paid for then maybe you'd be on something but you guys don't. The large amount you spend doesn't turn into better outcomes ie longer life. hte public private mix we have here in OZ produces a much better over all outcome.

An egregious example
The most serious contributor to needlessly expensive medical care is the inability of the various governments (state and federal) to properly regulate the industry.

By way of example, in North Carolina, Blue Cross Blue Shield found itself charging such excessive premiums they filed to quit their nonprofit status and become a for-profit company. Howls of outrage were heard across the state and the request was narrowly turned back. But that didn't stop them. They raised their premiums and soon had more profit than ever.

This term, "profit", means they had spent every penny they could on their mission, which was to provide effective health care for their customers, and still had many millions left over.

So they found ways to spend this money outside their mission, funding this and that around the state that didn't help their customers one bit. They started a chain of free clinics for uninsured residents, which is very noble. Only it takes people's money under false pretenses and spends it on something they, as a nonprofit, are not allowed to spend it on.

Much of the spending goes for self-advertisement and for underwriting programs unrelated to healthcare. Still, they have unspent profit, and their cash reserves are bursting.

As a result they have had to increase their premiums again this year-- a double digit increase.

The quality of the care, good to begin with, has gotten no better during this time.

What you don't know speaks volumes
Now before I really chime in.. me: MBA, CPA, 4 (FOUR) professional insurance designations and former government healthcare auditor.

"The most serious contributor to needlessly expensive medical care is the inability of the various governments (state and federal) to properly regulate the industry."

I'll agree with that. Of course you consider improper (which sure you really mean insufficient)regulation to be easily remediable, when the vast majority of us know stupid regulation to be the norm. To enforce one program in my state's medical assistance apparatus required thousands of people (auditors, lawyers-lots of lawyers, medical folks doing administrative work, not patient care) to implement,analyze and litigate-lots of litigation. Oh lets not forget those "advocacy" groups looking over everybody's shoulder-they draw really nice incomes working for NONPROFITS.

"found itself charging such excessive premiums they filed to quit their nonprofit status"

Now repeat after me: There is no rule (state or within the Internal Revenue Code Sec 501(c)(3)) that prevents a non-profit (the real term is tax-exempt) organization from making a profit-THE LIMITATION IS THAT THEY MAY NOT DISTRIBUTE THAT profit to individuals. The IRS code and regs are online-check it for yourself. 26 U.S.C, Sec 501(c)(3), Treasury Regulation 1.501(c)(3)-profits of the organization may not INURE TO AN INDIVIDUAL.

As for premiums-those premiums are determined by actuaries-but the regulators insist on reviewing an insurers financial condition, using a peculiar set of accounting rules unlike anything else in the world and SEND PEOPLE TO JAIL if they don't keep "adequate" capital on hand.

Now here's the rub, changing from a 501(c)(3) to a for profit is a real pain in the ass- but I guarantee that they changed not because of "EXCESS" premiums but because of the intransigence ignorance of dolts who don't know squat about healthcare, insurance or tax law.

How can I put this nicely? You don't know anything. You are an ideologue, incapable of rendering informed judgment.

roy_bean what percent of the money they brought in was "profit"? eom

The large amount you spend doesn't turn into better outcomes ie longer life.
Better outcomes are only one way to judge healthcare. For example in my area we have a great teaching hospital that has great outcomes but it is like a hospital inside. We have another hospital that looks like a nice hotel inside and I would much rather take my chances at the latter and be comfortable.

Longer life is not just a function of healthcare. I there are much bigger factors.

The biggest problems with healthcare in the USA are:

1. Employers most buy the insurance.
2. Excessive licensing constricts supply.
3. Excessive regulation.
4. Excessive mal practice – looser pays would help.

Additionally if you want government action you could force insurers to not discriminate and force all people to buy insurance at least for major medical. You could also make a minimum deductible that insurers can offer say $3,000/year.

An Alternative to Single Payor and Employer Based Plans: The MARKET
There are three general ways to fund healthcare:

SINGLE PAYOR…this approach exists outside of the US today. Costs are held down by restricting services and relying on the subsidized prescription drugs financed by US tax payers. This approach will never be optimal for health care or any other product/service.

EMPLOYER BASED…this has been the primary US system for more than 50 years. It is fundamentally flawed. Even the largest employers do not have enough size to negotiate both minimal costs and flexible product offerings. In addition, this model offers even worse choices for independent contractors and small businesses. And of course for the poor and unemployed, it offers nothing.

MARKET HEALTH CARE…Optimal health care can only be provided by a mature market infrastructure. There are many comparables, but I will use automobile industry. If I wish to buy a car, I have many choices. If I wish to choose a health care policy, I can choose only what my employer offers. It is very unlikely that Americans would accept their employers limiting their automobile choices, why do they accept it with health care?
The solution is health care Co-ops. These organizations could represent millions or tens of millions of health care consumers. They could offer multiple types of coverage in every state. They could even negotiate directly with health care providers to secure the most favorable prices and conditions. Employers only role would be administrative…facilitate membership in the Co-op their employees choose, and provide funding assistance in accordance with company compensation policies. Not an employee or your employer does not provide assistance…not a problem. Anyone could join a Co-op. The poor could join and their costs be subsidized by Medicaid. The elderly could join and their costs subsidized by Medicare. Co-op’s would compete against each other for consumer business, and providers (hospitals, clinics, doctors, testing facilities, pharmacies, etc…) would compete to be included in as many Co-op plans as possible. The end result is that competition and choice would lead to the optimal mix of minimal costs and maximum service.

Under a MARKET based health care system, it is likely that the percentage of health care expended will increase in the early part of this century. Only cost effective breakthroughs in regenerative and life extension treatments will stabilize the upward demand for better health care. But at least a MARKET approach will assure the health care consumer that they are getting the best value possible for their health care expenditure.

To answer your question...
Re: Galbraith--"Anyone able to tell me why he's a liberal icon instead?"

Widespread, all pervasive ignorance of economics reflects in a lack of critical thinking and plain economic common sense. JK was a big government economist and so appeals to the ignorant---even the "well educated" ignorant---who think that there is such a thing lunch (substitute your pet agenda, health care for example).

"The most serious contributor to needlessly expensive medical care is the inability of the various governments (state and federal) to properly regulate the industry."

This comment lacks foundation and common sense. A quick look at the market for goods and services will demonstrate that wherever government interferes there are problems. Healthcare, education, and landuse are just a few. One can easily see that these sectors are fraught with problems, yet they are either heavily regulated(healthcare and landuse) or outrightly government owned (education). Certainly one can further see that the regulated ones are a bit better off than the one owned by the government--state run/owned education in America is in dire straits. But, the truth is that absent the regulation or ownership these sectors would become more efficient and prices would fall as a result of competition encouraged by rising profits. If you doubt this look at the industries that are more subject to market forces---personal computers and chip makers for example.

The solution is less government not more.

let's see
The solution to bad govt regulation, is more bad govt regulation?

At least five general ways to fund healthcare:
At least five general ways to fund healthcare you forgot:

Mutual aid societies and charities.

Dear name withheld...
Yes, I am aware that a health insuror nees to keep adequate capital reserves on hand. But over the past several years, EVERY expert looking at the BCBSNC books has found that their cash reserve is excessive, in comparison with industry standards. Yet every year it grows greater and greater.

Add to this the advent of non-healthcare-related expenditures, which are not in accordance with the original mission statement.

Then add to that the fact that the cash reserve grows ever larger despite all these new ways in which a runaway public servant spends moneys earmarked for the health of its customers, and on top of that the latest double-digit premium increase, PLUS a deductible increase.

It's very clearly a runaway train, and state politics preclude someone who is actually a very dedicated insurance commissioner from stopping it. This is a prime example of an instance where the marketplace DOES NOT serve the public as adequately as a true nonprofit would-- one that dedicated itself to not going beyond the mission of providing the best bang for the healthcare buck for its customers.

Oh by the way-- the top officers just voted themselves handsome pay increases. Bob Greczyn, for instance, got an extra $275,000 in his stocking, on top of his $2.15 million base pay. These guys are thieves.

Certainly you must realize that such naked greed gives laissez faire capitalism a reputation for ugliness. Parse your terms as you will, every year we pay more and get less.

By the way, if you respond please forget the cheap shots. As you can see, my entire comment comes from the evidence of this specific firm's activities, not ideology.

Not the most important question
Since they are a nonprofit, and dividends may not be distrubuted, your question is not appropriate. It's not like profit should be considered a return on investment.

Instead, we should compare the size of the readily growing cash reserves on a mutli-year basis. When we do we find them constantly (and sharply) going up. This indicates that unspent moneys are a major factor in the system, and that prudent cash reserves have been exceeded.The following is not a profile of a company in need of premium increases:


The solution is neither "less government" nor "more government"
Yet here is an instance where the state government has held back, and not regulated. And the result has been price gouging. I think in general that ideology based solutions in which one size fits all are not worthy of consideration.

Obviously one can find instances where government regulation has made a problem worse. Equally prevalent are those cases where it makes a problem better. This is one case (BCBSNC) where more intervention is needed, to save us from a company that has squeezed out the competition in the state and is now having its way with its customers. Less regulation would make them even worse public servants.

That's a really dumb comment
Explain which bad government regulations led to BCBSNC's accruing excessive amounts in their unspent cash reserves, then reducing services and increasing premiums, and then paying the officers inordinate compensation for doing so.

You're getting to be a regular Johnny One-Note. What's next? Global warming is due to excessive regulation?

"Yet here is an instance where the state government has held back, and not regulated. And the result has been price gouging...

Obviously one can find instances where government regulation has made a problem worse. Equally prevalent are those cases where it makes a problem better..."

First of all there is no such thing as price gouging. Prices are a reflection of how individuals value a good or service. For instance you could make a great gadget, one that cost you $1000 to produce and you price at $1200. But your costs cannot determine what the final price will be. Only if consumers value your gadget more than they value $1200 will you sell anything. The short of it is that a producer can ask any price he wants...whether or not he survives is another question. So if your "price gouger" is selling and doing well then obviously his customers value his service more than the $ it costs them...period. No price gouging just voluntary buying and selling.

Government intervention can do nothing here accept make it harder for all producers to survive and forcing out smaller competitors, driving up prices. The producers faced with higher costs that cannot be extracted from consumers will drop out of the market. The remaining producers will face smaller markets as they can only afford to sell to those customers who value their produce more than those that were able to afford it at free market prices.

You will be hardpressed to find examples of where regulation and interference have NOT harmed and even more so when looking for examples where the situation was actually improved. Your thesis rests on economic nonsense.

The only thing dumb around here is your belief that govt can solve all problems
A better question would be, which govt regulations don't cause those problems.

Almost every aspect of such organizations are covered by overlapping federal regulations.

Ignore Mark
He knows nothing, can back up nothing, and makes everything up as he goes along according to the rule governent is always wrong. He's an obese loser failure sitting in front of a keyboard hoping someone will recognize his existence.

No such thing as price gouging
Unadulterated BS. What BCBSNC has done is to obtain a lock on the market, so that other healthcare providers no longer have a foothold in the state. Therefore they are in a position to charge any amount. Their customers have only the option of doing without health care. This is directly a result of poor regulatory policies.

Further, it has mirrored the conduct of this company in a number of other states, where the same thing has happened. At the beginning there is a level playing field, then the smaller companies are forced out. Once a monopoly is gained, premiums skyrocket and spending becomes unrestrained. It's a classic example of a company in need of intervention.

You're arguing dogma. I'm arguing events on the ground.

RSW: Thanks for the answer. It was, as you know, rather a rhetorical question. In one of the Krugman pieces linked to (Ricardo’s Difficult Idea) there’s actually a very good demolition of Galbraith. Beautifully written stuff (he really is an excellent prose stylist) but no modelling is Krugman’s complaint.
Fairly devastating when modelling is what economics is all about.

Social engineering and health care rationing
"So Munkhammar's basic point is that Americans spend more on heath care than those in other countries simply because they are the only people who are able to do so outside the tax system."

Exactly right! Americans can afford more health care, which enables them to pay the piper in money instead of life for gluttony (overeating) and sloth (not exercising). Since 70% of all Americans' ailments are at least partially self-induced by bad habits, Americans ought to be spending at least as much as they do on their health care, given their size and immobility.

Now just think what tricks liberal social engineers might get up to if the feds socialize health care, which would eventually require rationing. Imagine, oncology procedures only for cancers which a medical board believes were only 50% or less self-induced. Mandatory stomach stapling before authorizing the performance of other, non-related health procedures. Health care priviledges revoked for those whose heart rate/body fat percentage exceeds a certain limit. Etc.

The left favors big government because it believes wholeheartedly that people can be forced to do the right thing, and that such force can provide a certain outcome superior to any that free people can generate by cooperating voluntarily with one another. But history shows that people resist force, such that the outcomes force generates (like Galbraith & wage controls) are typically worse than those otherwise possible. In sum then, the left seeks certainty in force because it has no faith that people can otherwise do the right thing. On the other hand, when one has faith in people to do the right thing, one also believes that freedom produces outcomes superior to force.

Blindfolded ideologues
It amazes me to see how atrophied the sense of irony has become in all these people who hold the banner of capitalism aloft, and espouse the same old rote dogma in explanation of all things under the sun.

Have you never thought even for a moment how similar your approach to reducing life to a single all-encompassing explanation is to the philosophy of the dreaded Communists? Don't they also (or didn't they) have a single, logically consistent explanation for all economic activity? And whenever it clashed with readily observable evidence, didn't their evidence have to defer to a simple authoritarian philosophy just as yours does?

Oh, how much better the world might be if more people had had the benefit of a decent liberal arts education. You'd have been shown that it makes more sense to refuse to be fooled by some glib world view, but instead to question everything. You'd have come to realize that no box is so vast that everything under the sun can be put inside it.

Whose world view did you learn?
One of the best classes I ever took at Wazzu from one of the best professors at Wazzu (Prof. Cook) was Socialism. Dr. Cook expertly led his small class of students from proto-socialism to Marx, Lenin, and Mao. Great class with a fantastic professor!

Getting the skinny on socialist ideology first-hand was invaluable to me because the knowledge pointed me in the opposite direction of the political spectrum. I admit, I signed up for the class out of sympathy for the ideology, but completed it disgusted with every socialist ever to set pen to paper. Since then, I've become enamoured of writers such as Adam Smith, Frédéric Bastiat, Benjamin Franklin, Alexis de Toqueville, Mark Twain, H.L. Mencken, F.A. Hayek, Milton Friedman, and P.J. O'Rourke. These men write truth while the proto-socialists and socialist wrote only fantastic garbage.

So, knowledge determined my worldview. What determined yours? And what role did your liberal arts education play in it? Don't you see that a liberal arts education can impel one along both directions of the political spectrum?

It's a pretty big box, friend
In 230 years the freedom-capitalist box has revealed every other organizing social principle to be quite inferior. The less pure the capitalism the worse the results -- and when you get really far off on the left end of the spectrum the bodies start to pile up quickly.

While in theory competition wastes resources in production of the same goods and services, no system of central planning has ever been able to swim upstream for long against the current of self-interested human nature. By now it should be obvious to all that it is not simply a correlation between difficulties and government involvement in an industry: it is a causal relationship. Education, airlines, health care, etc., are all critically hampered by the ineffective steering mechanisms of government. This is not a glib world view but a painful reality.

Come on out to Karlifornia if you want to see the tragicomedy of insane regulatory governance up close and personal.

My own
Having an interest in anthropology, I left school and went around the world for a a few years to see what other kinds of people lived like, and what they thought about.

When I came back I needed work, so I got into the real estate business. Investment analysis, sales (which I was never good at) property management, maintenance and repairs. So my knowledge of the world is more a practical one.

The worthies you mention all have something in common. They're all writers. They get paid for passing along seeming profundities that don't much help in getting one through the real world. I do admit I enjoy Mark Twain. And Adam Smith is well worth reading, no matter how he is misinterpreted today.

My comments here went to the fact that the rigidly ideological right seems in my view as ridiculous as the rigidly ideological left. Although the fossilized left is something of a vanished species nowadays, while the ironbound right is rampant.

I think my success when I was working stemmed from the fact I never had to ask a man to do something I couldn't, or wouldn't, do myself. A plumbing shop I used to patronize had a sign in the window that said

"Distrust a society that values its philosophers above its plumbers; neither its great ideas nor its pipes will hold water."

The purest of capitalism
I notice that the Dutch once practised the purest of capitalism. Where is their empire now?

The British Empire also was founded and run on the purest of capitalism. How long did that last?

State Communism technically lasted seventy years. But it was moribund long before that. By the Brezhnev Era it was dead but still standing.

In order to build a lasting relationship between all individuals and their government I think we'll need to do a little better than we're doing. Otherwise as the American Century fades away we'll find we have made more enemies than friends.

If you think either the Dutch or British empires practiced pure capitalism that only proves that you have no idea what capitaism is. Try looking up mercantalism.

Funding healthcare
Interesting options you present. it's apparent you're not one of those knee jerk anti-socialists if you endorse mutual aid societies. These are communal groups, normally based on ethnicity. No one beats the Koreans for floating small business loans in the community. But when such societies form health care units they just become another health insuror. I used to belong to a group of independent business people, having no formal employment. We got good rates and the system worked fine.

Charity we already have. Who do you think pays the bills for the indigent, who hospitals can't readily turn away but must treat at a loss? Providers make up for this loss by charging their best customers, their cash customers, double and triple what they charge everyone else. Definitely not the best system.

rb says "What BCBSNC has done is to obtain a lock on the market"

Yet in other posts he has claimed that the problem is too little govt regulation.

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