• Economics Arguments for a Public Option

    This post has been cited in the 17 September 2009 edition of the Health Wonk Review, hosted by Healthcare Technology News.

    Finally, a few more-than-incidental economists have said something sensible in defense of a public option in a remade health system. I’ve been looking for such arguments for some time. Last week, Alex Tabarrok made the reasonable (but by no means certain) assumption that health reform would strengthen the market power of health insurers. His premise is that individuals eventually will be required to purchase health insurance. He writes that major health reform proposals would

    require insurance companies to take all customers …, offer guaranteed renewability…, impose no annual or lifetime caps, and offer coverage of preventative care with no-cost share, among other requirements…

    In short, insurance reform will mean that everyone will be required to buy a product that will be tightly regulated and more homogeneous.  Both of these factors will increase the market power of insurance firms.  Since escape via non-purchase will no longer be a potential response to higher prices, mandatory purchase will reduce the elasticity of demand giving firms an incentive to increase prices.  Moreover, in oligopolistic markets, a more homogeneous product can increase the ability of firms to collude.

    Tabarrok goes on to conclude that the foregoing predictions are justification for a public option.

    Simon Johnson and James Kwak made a similar argument at the end of their Washington Post column Don’t Want a Public Plan? Well, What Do You Think of Medicare? but not before they correctly point out that the main features of a public option are precisely what we have now in traditional Medicare. If one is intellectually consistent, one cannot be simultaneously against a public option and in favor of traditional Medicare.

    Johnson and Kwak don’t point out that Medicare includes private plans. Relative to traditional Medicare (the analog of the public option), those private plans are far less popular, attracting something like 20% of beneficiaries (and only that high due to overpayment to private plans, which is likely to be corrected soon). On the other hand, the Medicare market is not like the non-elderly market. Many retirees have employer supplements. While it is possible to draw lessons from Medicare that are relevant to health reform, one has to be careful to make apples-to-apples comparisons.

    Nevertheless, good economics arguments for the public option have finally been made. Will they influence the debate? It may be too late.

    Later: See also my post The Economic Necessity of a Public Option.

    Comments closed
    • Austin
      Assuming better measurement and quality measures over the next decade, wont apples to apples measurement between plans increase. I know you are looking at this from a purely econometric perspective, but how would above effect elasticity if plan A had better outcomes than B, and charged the same price.

      How would they collude, and why would they collude, especially in view of potential for market dominance, A>B

      • @Brad F – It’s Alex Tabarrok’s argument, not mine. So you could ask him on his blog. However, like you, I assume firms would not collude unless it was in their interest to do so. If plan A could dominate the market on quality it would. But what could plan A do so well that plan B could not copy?

    • Ask American Airlines about Southwest? Ask Microsoft about Apple? Anyway, you get my point.

      Not so sure copying is feasible, trust me, I live it every day.


      • @Brad F – Ah, but the distinction one finds in health care but not in those industries you cite is that the insurers generally do not employ the providers (AA employs pilots and mechanics, MSFT employs coders, and so forth). With the exception of the VA and a few organizations, hospitals and doctors contract with insurers but are otherwise independent. The quality comes mainly from the providers. So an insurer with higher quality ratings is getting them because it is contracting with higher quality providers. Another insurer could also contract with those providers. Copying is trivial, especially when the quality data are public. Moreover, those high quality providers could raise their prices if in high demand. All these dynamics are consistent with Tabarrok’s argument that consumers will be at the mercy of escalating prices (without a public option or some other unspecified regulations).

    • You need to get inside the industry. Culture, culture, culture, trust me. Huge difference between Aetna vs Oxford. Ask the employees and providers. It all starts from within, just like any good company.

      If we differ on that, what can i say.

      Have a great holiday,and thanks for sticking with me

      • @Brad F – Perhaps I could stick with you if I understood you. Can you help me out? Companies have different cultures. Sure, I buy that. Do any companies have cultures that don’t exploit market power? I’m not disagreeing with you (yet) because I don’t believe I’ve understood you (yet).

    • Great to discuss the economics of healthcare! Normally in classical economics we would expect that when firms are making large profits in a particular industry (especially a large and somewhat homogeneous industry) then new firms will come and under cut them. In the healthcare insurance market it seems that it is possible to have an equilibrium with firms making large profits.

      One potential issue is that there is bargaining power for big insurers when negotiating with hospitals, small insurers don’t have this bargaining power, potential competitors need to raise capital to become big before they can compete and undercut the big names. But no one on wall street is going to back a firm whose strategy is to make low profits when they can instead back a high profit insurer!

      I think that the health care “exchanges” could make the negotiations between insurer and hospital more competitive and decrease the economies of scale, eliminating a barrier to entry and encouraging more competition.

      If this does not eventuate, then any reform would indeed be homogenizing and in such a case there should be specific proposals in any reform bill that would encourage “competition-like” innovation in the health care which would put the consumer first when prioritizing different specific areas of healthcare such as general practice, general well being, surgery, rehabilitation, consultation…