Is the Health Care System Too Expensive to Fix?
Tyler Cowen is not impressed with his best estimate of the cost per life saved of health reform.
If the Obama plan spends $90 billion extra a year on coverage and saves/extends 10,000 lives a year (a plausible estimate, in my view), that is $9 million a life, a rather underwhelming rate of return.
I agree that is an underwhelming return. But I don’t agree that 10,000 is necessarily the right number of lives saved. Roughly two to four times that value seems plausible. Nor do I agree that we should dismiss all the value of all the other returns. Those potentially include cost offsets due to better health, quality of life improvements, financial security from high health care expenses, reduction in the degree of job lock, among others.
However, even if considering all that one is still underwhelmed by the resulting net cost per life saved, whatever that may be, I still don’t accept that as an argument for not implementing reforms of the insurance market. (To be clear, I don’t think Cowen thinks so either.) Instead, I’d view that as an argument that we should reform the insurance market and work harder at efficient provision of care. Put another way, I don’t believe the uninsured should suffer the burden of high costs of our system. They should be insured and the high costs of our system should be addressed. Accepting defeat of the latter as an excuse for not addressing the former would be a double tragedy.
An Economy of One’s Own
Tyler Cowen’s latest book Create Your Own Economy is chock full of ideas, many you (or I) could not guess from the title. The simplest summary is the most deceptive. It is about the virtues and utility of characteristics of autistic cognition in today’s world. That’s deceptive for most of us because we likely don’t appreciate how autistic minds think. Nor do we necessarily understand today’s world, at least not in the way Tyler Cowen does.
Rather than attempt to review the book I want to focus on one element of the world that Cowen understands better than most. Though most of us understand that today, relative to the past, information is more accessible and comes in much smaller packages, it takes special insight to see how these facts signal a new type of personalized economy or narrative.
Think web pages, e-mail, text messages, tweets, blog posts, Facebook status updates, and so forth. Today, an information lover’s or a news junkie’s day looks very different than it did a decade or more ago. It’s clear that the cutting edge of news (very broadly defined) isn’t found in newspapers anymore, and that’s one reason they’re dying. But another reason, and one Cowen makes plain, is that they’re inflexible.
A newspaper has a fixed organization, style, and daily content that may suit some fraction of the population but cannot suit everybody. Not so with digital sources that deliver information in small packages. Those can be organized on the fly to suit an individual’s taste. Each of us is free to stitch together our own “newspaper” or world narrative. Those small bits of information are not indicative of shorter attention spans, as some have claimed, rather they’re indicative of the new desire for informational autonomy, our yearning to view the world through our own lens.
Doing so puts a premium on ordering, a task, Cowen tells us, to which the autistic mind gravitates and at which it excels relative to others. Cowen’s thesis is that this and other tendencies of the autistic mind are more valuable than most of us perceive. Harnessing ordering skills, among others, one can create one’s own narrative to find beauty and harmony in the otherwise disordered (or unordered) information economy. I think he’s right.
But one should be a little careful. The brave new world may not be a beautiful one to individuals who lack the skills to navigate it. Likely to many the world is becoming more disordered and chaotic, and the familiar institutions that used to organize it–newspapers, among others–are dying just as they are becoming more necessary (for some). How many are adrift in a cacophonous sea of information? How many succeed in charting a meaningful course? How many even feel a need to do so?
Cowen does, as do I. Two simple tools, Google Reader and the iPod, have dramatically changed the nature and volume of information I receive and process. In the course of a day information from over fifty sources is presented to me, organized as I like (within the limits of the tools). In less time than it would take me to fully read a newspaper I am able to grasp the day’s events I care to notice at a deeper level than provided by traditional sources and turn some of this information into new content of my own making (on this blog, on Facebook, Twitter, and so forth), augmented with my own perspective and unique mix of knowledge. My posts are then read by others, a few of whom integrate them into content of their own.
Through this process I’ve met people and made connections I would not have otherwise, some relevant and important to my professional work. In Cowen’s view, this whole process of extracting utility from organizing disparate bits of information using a few modern tools is the creation of my own economy.
This degree of participation in the ordering and reordering of information is something new. It is born in the information age but is not of it. Some are calling it the attention age. I’m not sure that’s the right name, but it is right in one respect. It is a call to wake up and pay attention. Do you know where your economy is?
Health Reform Debate 2.0
In a post today Tyler Cowen offers 14 creative suggestions for alternatives to the versions of health reform in current legislation. I like some of his ideas, such as federalizing Medicaid, making “all-out attempts” at improving procedures to limit hospital deaths (hand washing!), increasing access to care via walk-in clinics staffed with nurses, paramedics, and pharmacists, and introducing price transparency, among others (read the whole thing–it isn’t long).
A few of Cowen’s ideas may decrease the per-encounter cost of care. Some could reduce costs overall if widely adopted (e.g. greater reliance on health savings accounts and catastrophic coverage coupled with greater price transparency). Broadly speaking, these ideas fit within the framework of the current debate in that they focus on coverage but not on payment reform. I believe it is the latter that will be health reform’s next battleground.
Any health reform passed this year (or next) is unlikely to include Cowen’s cost-related suggestions or any other serious measures to reduce costs. That’s why the current debate over health reform is just the beginning–call it Health Reform Debate 1.0 (beta). Debate 2.0 will be about costs, specifically about payment reform. There is a little bit in today’s health reform legislation that suggests the promise of “bending the cost curve” via payment reform, but there is nothing that gives me or others tremendous confidence that it will be bent much, if at all.
Dealing with health care costs can’t be avoided or kicked down the road very far. Medicare is already in horrible financial shape. Before the Obama presidency is over or in the next president’s first term something substantial will need to be done to resolve Medicare’s insolvency. Meanwhile, the cost of care, and coverage for it, is becoming an increasingly heavy load stone for states, businesses, and families. Debate 2.0 is nearly upon us, even as we struggle to resolve 1.0 (beta).
Therefore, I’d like to add a 15th item to Cowen’s list: payment reform that compensates providers, at least in part, on the basis of quality and cost control. That’s very vague. One can conjure up some specifics and some have. Few are thoroughly tested and none have been anywhere near the center of political debate. But they will, and soon.
Pascal’s Wager? The Uncommon Relationship Between Drug Industry Profits and Research
Tyler Cowen has cautioned in the NY Times that cost containment measures as part of health care reform may impact the US lead in medical research and development. But how much do private sector profits contribute to the pace of medical innovation? This question is particularly salient to the US pharmaceutical industry, which is the largest private contributor to US medical R&D, and has agreed to provide up to $80 billion in cost savings over ten years in connection with comprehensive health reform. Will this modest hit to their profits detract from their investments in research and development?
The standard corporate finance answer is no. In a well established business with access to capital markets, the link between profits and investment in research development is weak. So long as a business’s expected profits from research and development exceed its cost of capital by some amount, its investment in research and development will chiefly be limited by the law of diminishing returns. An increase in profits will not spur additional R&D investment, because the business has already invested all it profitably can. A decrease in profits to some point still above its cost of capital will not decrease R&D investment, because foregoing profitable investment opportunities will not increase profits.
But it turns out this is not true for pharmaceutical companies. Pharmaceutical R&D investment does vary in close relation with profits (Scherer 2001, Health Affairs). Why? Pharmaceutical companies do not lack access to capital markets. Why do they choose to make investments in R&D out of free cash flow that they won’t make with funds from other sources?
I think the answer is this: Patent protection assures an enormous payoff to the inventor of a blockbuster drug. But the probability is remote and in any event difficult to estimate that any given research program is going to produce a blockbuster. Thus it is difficult to impossible to estimate the risk-adjusted return on investment of such a research program relative to cost of capital. So such research programs get funded cautiously if at all from the capital markets. Free cash flow, however, is close to cost-free money. Betting it on a blockbuster with free cash flow is a lot like Pascal’s wager: if you lose, you lose nothing; if you win, you win everything.
I had the discussion that led up to these thoughts with a Facebook friend of a certain free market bent whom I took to be making the generally incorrect assertion that R&D investment varies with profit. Though I took great pains to explain the text-book reasons why that is not generally the case, he remained incredulous that I could not appreciate the obvious relationship. And the thing is, it was completely intuitive to him, because he works for a company – Google – that is also a special case. Google also operates in an industry where a single success can create blockbuster returns through first mover advantages and network effects. Not surprisingly, Google plows a lot of its free cash flow back into R&D on projects whose odds of success are hard to quantify. It was completely obvious to my friend why it should do so.
The pharmaceutical R&D investment model that also applies to software has been called “virtuous rent seeking.” But the CBO, for example, has questioned whether the private incentives for such investments, in the pharmaceutical arena at least, are so strong that they produce overinvestment from the perspective of social utility. And of course, that is the tragedy of Pascal’s wager: whether or not he lost nothing on the bet, society as a whole perhaps lost a great deal when he turned his mind away from science to God. In the end, it is not clear that any diminution of investment in R&D by the pharmaceutical companies as a result of health care reform will actually be missed.
Sound Investing Advice in a Macro Textbook (Cowen/Tabarrok)
I’ve been reading a preliminary edition of the new macroeconomics textbook by Tyler Cowen and Alex Tabarrok (Modern Principles: Macroeconomics). It was sent to me for free, courtesy of the publisher. The textbook is now out and two more in their Modern Principles series are expected this fall. Cowen and Tabarrok also post on the very popular Marginal Revolution blog.
I have enjoyed their macro book. It presents undergraduate level material in a clear, accessible, and updated style, incorporating recent events and standard theory in a seamless way. The figures are beautiful and are used in novel ways (as far as I know) to illuminate central concepts (e.g. supply/demand, welfare calculations). All in all, it is a treatment of macro far superior to the one I received as an undergraduate or in more recent readings of other macro texts.
Among the other impressive characteristics of the book is the manner in which the authors motivate the material with and relate it to actual world events, policy, and institutions. Many texts try to do this but it ends up seeming like an afterthought to the drier theoretical and conceptual content. Often in other textbooks the applications are set aside in boxes apart from the main text, as if to suggest it is secondary. Not so with Modern Principles. It isn’t easy to achieve such a tight integration of concepts and application but Cowen/Tabarrok make it all flow. Bravo!
More relevant to one of the themes of this blog is that the Cowen/Tabarrok Modern Principles macro text has a chapter with Boglehead style investing advice (of course they don’t identify it as such, nor would I expect them to). Chapter 9 of Part 2 titled “Stock Markets and Personal Finance” makes the following points:
- Passive beats active investing in the vast majority of cases.
- For all practical purposes, for the personal investor, the stock market is efficient. It is not possible to systematically outperform the market over time.
- A sound personal investment plan is based on the concepts of diversification, minimization of fees, and a long-term commitment.
- There is no greater return without greater risk (no free lunch).
- Bubbles are part of market dynamics and are not a reason to avoid market participation. On the other hand, do not expect to spot and profit from a bubble.
It is uncommon (unheard of?) for an undergraduate macro text to provide such explicit, practical, and sensible advice on personal investing. Yet it is critical education that everyone should receive. I applaud Cowen and Tabarrok for including it in their macro book and look forward to reading the other books in their Modern Principles series. To learn more about the Modern Principles series and read sample chapters, visit the Modern Principles website.
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