[Mb-civic] Krugman

[Mike Blaxill]

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

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.