Paul Krugman | Health Economics 101

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Mon, 14 Nov 2005 12:30:27 -0800

[Zepps_News] #t r u t h o u t - Paul Krugman | Health

Economics 101

 

 

 

 

http://www.truthout.org/docs_2005/111405M.shtml

 

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

 

*Health Economics 101*

By Paul Krugman

The New York Times

 

Monday 14 November 2005

 

Several readers have asked me a good question: we rely on free

markets to deliver most goods and services, so why shouldn't we do the

same thing for health care? Some correspondents were belligerent,

others honestly curious. Either way, they deserve an answer.

 

It comes down to three things: risk, selection and social justice.

 

First, about risk: in any given year, a small fraction of the

population accounts for the bulk of medical expenses. 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 a severe case of the economic problem

known as " adverse selection, " in which bad risks drive out good.

 

To understand adverse selection, imagine what would happen if

there were only one health insurance company, and 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 to anyone who wanted it would lose money hand over fist.

Healthy people, who don't expect to face high medical bills, would go

elsewhere, or go without insurance. Meanwhile, those 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 don't offer a standard health

insurance policy, available to anyone willing to buy it. Instead, they

devote a lot of effort and money to screening applicants, selling

insurance only to those considered unlikely to have high costs, while

rejecting those with pre-existing conditions or other indicators of

high future expenses.

 

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. That is, private 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 - 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.

 

At this point some readers may object that I'm painting too dark a

picture. After all, most Americans too young to receive Medicare do

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.

 

Private health insurance in America comes almost entirely in the

form of employment-based coverage: insurance provided by corporations

as part of their pay packages. The key to this coverage is the fact

that compensation in the form of health benefits, as opposed to wages,

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. On the contrary, 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.

 

 

 

 

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