A few days ago, Robert Reich had an op-ed in the Wall Street Journal entitled Why We Need a Public Health Care Plan. I had hoped to respond, but I’m a bit consumed with summer research right now. Fortunately, Friday’s Journal included an op-ed by John Calfee, The Dangers of Fannie Mae Health Care, that persuasively and eloquently responded to Reich’s arguments. If you’re at all interested in this topic (and you should be, as the matter will substantially affect your life and is proceeding through Congress with disarming speed), please read both pieces.

Reich sets forth all the standard arguments in favor of the public plan:

(1) It will enhance competition among insurers, leading to better insurance products. (”As a practical matter, the choice people make between private plans and a public one is likely to function as a check on both. Such competition will encourage private plans to do better — offering more value at less cost.”)

(2) It will have lower administrative costs than private insurers. (”[Insurance company critics say that] the public plan starts off with an unfair advantage because it’s likely to have lower administrative costs. That may be true — Medicare’s administrative costs per enrollee are a small fraction of typical private insurance costs — but here again, why exactly is this unfair? Isn’t one of the goals of health-care cost containment to lower administrative costs?”)

(3) It will not need to earn profits and can thus provide a cheaper offering. (”[I]f nonprofit plans can offer high-quality health care more cheaply than for-profit plans, why should for-profit plans be coddled? The public plan would merely force profit-making private plans to take whatever steps were necessary to become more competitive.”)

(4) It will have economies of scale that will permit it to negotiate favorable reimbursement rates from providers. (”Being the one public plan, it will have large economies of scale that will enable it to negotiate more favorable terms with pharmaceutical companies and other providers.”)

(5) Because it’s optional, it can’t really hurt anybody because people can always just choose a private insurer. (”It’s an option. No one has to choose it. Individuals and families will merely be invited to compare costs and outcomes. Presumably they will choose the public plan only if it offers them and their families the best deal — more and better health care for less.”)

Calfee takes on each of these points.

With regard to the “enhanced competition” argument, Calfee points out that there is already vigorous competition in the health insurance industry. Adding one more player won’t noticeably enhance competition. As he notes, “Hundreds of health insurance plans already exist, and employer benefit managers can choose among numerous alternatives. There is no lack of firms willing to compete to provide health insurance.”

In response to the “lower administrative costs” argument, Calfee observes that government-run enterprises, which need not earn a profit or even break even, are almost always less — not more — efficient than private businesses:

Would a public plan have lower administrative costs? Well, how often are public enterprises run more efficiently than private ones? Why did practically all economically advanced nations dismantle their public airlines, phone companies, and so on, invariably obtaining lower administrative costs and consumer prices?

As Stanford University health economist Victor Fuchs has pointed out, what “insurance” firms actually sell to large employers — which account for the single largest segment of the entire health-care market — is usually administrative services, not actual insurance. (Large companies are not insured; they pay benefits directly.) There is no reason to expect a Medicare-like public plan to match the administrative efficiency of Aetna, Blue Cross-Blue Shield, Cigna, UnitedHealth Group, and WellPoint. Medicare doesn’t even try. It outsources most administrative services to the private sector.

Turning to public plans like Medicare and Medicaid for more efficient administration is a fool’s errand.

[NOTE: Calfee could have gone further here. The argument that the public plan would have lower administrative costs than private insurance is based on the bogus claim -- parroted by Reich -- that Medicare has lower administrative costs than private insurance. As Robert Book has recently explained, Medicare's purported administrative cost advantage is based on fuzzy math. Public plan proponents measure administrative costs not as a dollar amount per beneficiary but as a percentage of an insurer's total outlays (i.e., administrative costs divided by the sum of health benefits paid plus all other costs). This measure gives Medicare an unfair advantage for two reasons. First, the total health benefits paid by Medicare (the bulk of the denominator in the measurement) are much higher than those of private insurers, making the fraction comprised of administrative costs much lower. Medicare patients are by definition elderly, disabled, or patients with end-stage renal failure. They have much higher average patient care costs than the folks covered by private insurance. When administrative costs are measured instead on a per beneficiary basis, Medicare's administrative costs are higher (12.3% higher in 2005, 22.7% higher in 2004, a whopping 48.4% higher in 2000). Second, public plan proponents improperly label some patient care costs incurred by private insurers as administrative costs. To get the numbers the proponents set forth, private insurers' administrative costs are measured by the difference between premiums collected and claims paid. Much of this sum, though, is not "administrative" cost. For example, many private insurers provide disease management services for chronically ill patients and/or on-call nurses that patients may consult by phone. These are patient care expenses, but they're labeled administrative costs under the public plan proponents' formula. In addition, "administrative costs" are taken to include state-imposed premium taxes that private insurers, but not Medicare, have to pay. Nonetheless, even if we include these various costs in private insurers' administrative costs, such insurers are still more efficient than Medicare on a per beneficiary basis. OK... Back to Calfee's rebuttal.]

With respect to the argument that the public plan would be non-profit and thus more efficient, Calfee notes that we’ve already had lots of (disappointing) experience with non-profit health plans:

Nonprofit health insurance firms are common, including many of the Blue Cross-Blue Shield plans. Nonprofit status has not proved to be a reliable source of efficiency and cost-saving. The addition of new nonprofit cooperatives and the like — as a bipartisan group of senators has proposed — would make little difference, unless the new plans are given the power to set prices and take on extra risk supported by government subsidies.

So what about the economies of scale argument? Given the massive size of many private insurers, all scale economies have likely been exploited already. As Calfee explains,

Aetna currently serves about 18 million subscribers, UnitedHealth Care serves between 25 million and 30 million, and WellPoint more than 35 million. That is more than is served by the health-care monopoly of Canada (population 33.6 million), and more than the entire health-care systems of most European nations. Once a plan reaches a few million subscribers, there may not be a lot of economies of scale left that can enable public plans to provide lower prices.

But what about the fact that the public plan is optional? Doesn’t that imply that no real harm can result from offering such a plan? Sadly, no. The major harm from a public option, Calfee explains, will stem from its one feature that will, in fact, permit it to cut health care costs. While a public option can’t cut costs by enhancing competition, reducing administrative costs, foregoing profits, or achieving economies of scale, it will have one cost-cutting advantage private insurers lack: monopsony power. If it exercises that power, though, it will hurt us.

A public option will likely become, very quickly, the nation’s dominant insurer. Having the backing of the federal government, which will certainly not permit it to fail (see, e.g., Fannie and Freddie), and the ability to use government carrots and sticks to negotiate deals with providers, it will immediately have both a lower cost of capital and some negotiating advantages. Taken together, these cost advantages will permit it to enroll most Americans. Indeed, the Lewin Group estimates that 70 percent of the 172 million privately insured Americans would convert to the public plan.

Once that mass conversion occurs, the public plan will have serious cost-cutting advantages that stem from its monopsonist status. Monopsony power is simply the flip-side of monopoly power. Whereas a monopolist (a dominant seller) has the power to drive prices above cost (by withholding its output), a monopsonist (a dominant buyer) has the power to drive prices beneath sellers’ costs (by withholding its purchases).

While an exercise of such power might benefit some consumers, at least in the short term, the long-term effects would be quite negative. Forced to price below their costs, health care providers would quickly begin to cut all expenses unrelated to the immediate provision of services. Most notably, they would cut research and development expenditures, leading to reduced health care innovation. Because the United States is the dominant source of the profits that fund health care R&D worldwide, this would be disastrous. As Calfee explains:

The U.S. is unique because it alone is the source of half of world-wide profits that provide the payoff for the complex, lengthy, and expensive process of developing new treatments. When other nations construct their health-care systems, they ignore the impact of their pricing policies on R&D incentives. As the dominant R&D funding wellhead, we do not have that option.

Competitive markets have generated the prices and the profits necessary to induce a steady flow of medical innovation in this country. A public plan option would tend to dismantle that system. The people in charge will not know how to set reimbursement levels to motivate reasonable R&D efforts, and there is no reason to expect them to try. In public plans, the tried-and-true method is to push the prices of suppliers down until something gives — too few doctors willing to take on Medicare patients, for example — and then to ease up. That is a destructive approach to medical technology R&D.

Who knows what drugs will not be developed if reimbursement levels for a new multiple-sclerosis treatment are too measly? In virtually every advanced economy but our own, pricing authorities simply make sure prices are high enough so that existing drugs continue to be made available. We can expect a public plan here to do the same. The inevitable result is to drastically under-incentivize R&D.

I obviously believe there is a clear victor in the Reich versus Calfee debate, but read both op-eds and decide for yourself. For a price competition-based (not monopsonization-based) approach to reducing health care costs, see here.

• My former FTC colleague David Wales joins Jones Day
  
• The CATO “New Course for Antitrust” video is now available for your viewing pleasure
• Microsoft on the release of Windows 7 in Europe without IE
• The FTC issues its interim report on authorized generics and Chairman Leibowitz claims that reverse payment settlements (based on a Bureau of Economics analysis)  cost consumers at least $35 billion over 10 years

I’m very pleased to announce that my first book editing project (along with my colleague Lloyd Cohen), Pioneers of Law and Economics, is available on-line from Edward Elgar Publishing.  The book includes a series of specially commissioned essays designed to honor the founders of the law and economics enterprise.  From the book:

The editors of the volume embrace a view of the field that is inclusive not only of a broad range of issues, but also of economic methods. Celebrated here are the founders of law and economics as well as economic theorists, public choice scholars, lawyers and judges who applied economic insights to the law and legal institutions. They include: Ronald Coase, Aaron Director, George Stigler, Armen Alchian, Harold Demsetz, Benjamin Klein, James Buchanan, Gordon Tullock, Henry Manne, Richard Posner, Gary Becker, William Landes, Richard Epstein, Guido Calabresi, Frank Easterbrook, Daniel Fischel, Steven Shavell and A. Mitchell Polinsky. Contributors to the volume include other pioneers, former students and clerks, colleagues, and influential scholars in the field.

Scholars and students working in the tradition of law and economics, as well as those in the fields of economics, law and public policy will find the book an essential reference for this important area of scholarship.

Many thanks to the excellent list of contributors who devoted their time and energy into this project!

1. Ronald H. Coase
Thomas W. Hazlett

2. Aaron Director Remembered
Stephen M. Stigler

3. Aaron Director’s Influence on Antitrust Policy
Sam Peltzman

4. George J. Stigler and his Contributions to Law and Economics
Harold Demsetz

5. The Enduring Contributions of Armen Alchian
Susan Woodward

6. Harold Demsetz
Mark F. Grady

7. Benjamin Klein’s Contributions to Law and Economics
Joshua D. Wright

8. Buchanan and Tullock on Law and Economics
Robert D. Tollison

9. Henry Manne
Larry E. Ribstein

10. Gary Becker’s Contributions to Law and Economics
John F. Pfaff

11. Pioneers of Law and Economics: William M. Landes and Richard A. Posner
Thomas S. Ulen

12. Putting Law First: Richard Epstein’s Contribution to Law and Economics
Andrew P. Morriss

13. Calabresi’s Influence of Law and Economics
Keith N. Hylton

14. Easterbrook and Fischel
Katherine V. Litvak

15. The Path Breaking Contributions of A. Mitchell Polinsky and Steven Shavell to Law and Economics
Nuno Garoupa and Fernando Gomez-Pomar

If you are a student, teacher, producer or consumer of law and economics scholarship this is a great volume for you.  With the exceptions of the Peltzman and Stigler essays on Aaron Director from the recent Journal of Law and Economics tribute Buy the book, these are all original essays written for the purposes of this collection.  You can buy the book here.

I’ve just returned from Sydney where I was at the ICANN meetings giving a presentation (with Steve Salop of Georgetown Law) and participating in a Q&A on the potential economic consequences of vertical integration between registries and registrars.  I had a great time on the panel, but the highlight for me was spending talking to the various industry and ICANN representatives.  This is a fascinating and dynamic space with more interesting legal and economic issues than one can imagine.  I’m thrilled that I was able to go and learned a lot.

Note to graduate students studying economics, industrial organization, regulation, public and law and economics: this is a field ripe for dissertation topics and in need of both theoretical and empirical contributions.

Tomorrow at Cato at noon, Carl Shapiro (Deputy Assistant Attorney General for Economics at the Antitrust Division) will be giving some remarks on the Obama administration’s antitrust agenda.  I’ll be giving some brief remarks in response and participating in a discussion including Shapiro and Edwin Rockefeller and moderated by Douglas Ginsburg.  Details are available here.

UPDATE: It was a great event and well attended (including plenty of representation from the agencies).  I want to thank Roger Pilon and the folks at Cato for putting on a wonderful program as well as Doug Ginsburg for moderating.  I really had a great time.  I’m told that you should be able to watch it in a day or two at this link.  My remarks focused on the ambitious monopolization enforcement agenda at the “new” DOJ and the withdraw of the Section 2 Report.  Carl Shapiro, who gave a very thoughtful and interesting opening talk, and I have a few fun exchanges about the DOJ’s views on the existence of false positives.

Economic theory is essential to antitrust law.  It is economic analysis that constrains antitrust law and harnesses it so that it is used to protect consumers rather than competitors.  And the relationship between economics and antitrust is responsible for the successful evolution of antitrust from its economically incoherent origins to its present state.  In my view, which I’ve expressed in greater detail elsewhere, the fundamental challenge for antitrust is one that is created by having “too many theories” without methodological commitments from regulators and courts on how to select between them.  The proliferation of economic models that came along with the rise of Post-Chicago economics and integration of game theory into industrial organization has led to a state of affairs where a regulator or court has a broad spectrum of models to choose from when analyzing an antitrust issue.

This may have been a positive development for economic science.  This is not the place to have that debate.  But for law and economics the proliferation of theoretical models without attention paid to empirical testing of models, combined with the above-mentioned “model selection” issue allow regulators and courts significant degrees of freedom to select any model they like — why not the one that matches their ideological prior beliefs or policy preferences?  Taken to the extreme, this model selection problem threatens to strip the disciplining force that economics has placed on antitrust law that was a key part of the successful evolution of that body of law over the last fifty years.   The stakes involved in appropriately specifying the link between economic theory and antitrust law, and understanding the role of empirical evidence in that relationship, are high.

The importance of the issue is why I have criticized both what I view to be a trend toward reducing the role of economics and economists in antitrust, as well as those who turn the issue of model selection into an ideological debate rather than one driven by economic theory and evidence.  Readers of TOTM will know that I have, on occasion, criticized Commissioner Rosch on these grounds.  Well — apparently he was reading (see n.3) and has devoted some time in a recent speech to “dispelling a misconception about how I view economics and economists, attributable I fear to not making my views clear.”

I applaud Commissioner Rosch for recognizing the confusion that some of his views on economics may have caused and further applaud him for attempting to set them straight in a public forum.  Transparency is useful in contexts such as these precisely because it allows these views to be strained and tested by those who disagree (and also because it puts the antitrust and business communities on notice).  Here is what the Commissioner had to say about his critics:

More specifically, critics – overwhelmingly Chicago School apologists – have suggested that I am anti-economics and anti-economist and, indeed, that I doubt that economics should play a role in antitrust law enforcement.  Those are not my views. My views are as follows….

If one follows n.3 in that speech, despite the use of the plural, the reference is apparently one that is exclusive to me and this series of posts on Commissioner Rosch’s treatment of economics, economists, and the role of economic theory in antitrust:

Commissioner Rosch on the Smaller Role of Economists in Antitrust Litigation

Inter-Agency Scuffling Over Section 2: What Role for Economists and Economics at the FTC and DOJ?

Commissioner Rosch v. Economics Again

And here are a few that the Commissioner didn’t cite for the sake of completeness:

No Ovation for the FTCs Latest Enforcement Theory

Is the Chicago School Really Dead?  How Do You Know?

“One Thing is Clear to Me: The orthodox and unvarnished Chicago School of economic theory is on life support, if not dead”

In a later speech on the “Redemption of a Republican,” in which the punchline is that the “confessions of sin” from Posner and George Osborne in the UK redeem Rosch’s views and might even save us from clinging to “bankrupt” economics, the Commissioner refers to his “orthodox Chicago School critics” without identification or citation, writing that:

The orthodox Chicago School economist community has been especially dumbfounded. Some economists have denounced my remarks questioning the use of economic formulae as reflecting a general bias against economists. With specific reference to my January remarks, they have both asserted, on the one hand, that the current economic crisis says nothing about microeconomics as opposed to macroeconomics and at the same time have denied that any Chicago School economist has ever asserted that markets are perfect or self-correcting or that businesspeople are rational. They have also asserted that most of the decent post-Chicago School economics thinking has come from orthodox Chicago School economists.  After all of this criticism, I was starting to question whether I really was a loyal Republican.

I suspect I’m also the dumbfounded denouncer  —  though I refer readers to this post to see what I actually said (see also here) because it differs substantially from Rosch’s characterization (if indeed it purports to summarize my positions).  Suffice it so say that one can read very closely and there is no claim there about what Chicago School economists have said or not said about businesspeople being rational.

As for the “assertion” that most of the decent post-Chicago thinking has come from orthodox Chicago School economists — again, this is simply untrue and misleading.  Instead, the claim is that folks like Aaron Director anticipated many of the economic insights of the raising rivals’ cost models, that Chicagoans such as Ben Klein and Tom Hazlett are responsible for some of the leading empirical examples of Post-Chicago phenomena, and that Dennis Carlton (Chicago GSB) extended some of the theoretical work (for more on this, see here).  Don’t, however, take it from a Chicago School apologist.  Instead, here it is straight from the leading thinker of the Post-Chicago economic movement: “it is important to recognize that [the Post-Chicago] approach has its root in the economic analysis of Chicago School commentators.” See Steven C. Salop, Economic Analysis of Exclusionary Vertical Conduct: Where Chicago Has Overshot the Mark, in OVERSHOT THE MARK, at 144. Similarly, try to talk about coordinated effects without invoking Stigler (1968).

This is why the prefix “orthodox” in front of Chicago School is misleading — though perhaps an effective rhetorical device.  Chicagoans have done important empirical work on market failures and helped to develop and test Post-Chicago models.  By what meaningful definition does this constitute “orthodoxy”?  Nevermind the persistent use of the term orthodox to imply a static, monolithic body of economic knowledge.  This term by colloquial implication glosses over important differences between the work and approaches of, for example, Alchian, Klein and Oliver Williamson and in understanding how asset specifity and opportunism influence firm behavior, or between Klein, Telser and Marvel on vertical restraints, or between Demsetz and Coase on the theory of the firm.  The label both misleads, errs as a matter of economic history, and favors ideology and shorthand labels over substance.  None of this, of course, is new to political rhetoric.  To some, to invoke the term Chicago School is not to reference a broad intellectual movement but to utilize a heuristic to describe a reflexively anti-interventionist position that typically involves (in the eyes of the evoker) irrational disdain for government regulation. While current financial times make it somewhat fashionable for journalists and casual observers to toss around without regard to accuracy or evidence caricatured versions of entire schools of economic thought (to which serious scholars have devoted decades of intellectual energy), antitrust experts have generally carefully avoided such style of commentary in favor of careful analysis of competing theories and evidence.

One more quick — but related — about misrepresenting views.  Rosch describes George Stigler’s work on oligopoly theory as follows:

Nobel Prize winning economist George Stigler’s 1964 article “A Theory of Oligopoly” in which he explained that it was improper to assume that firms in an oligopolistic market would find a way to agree to raise prices above competitive levels.

This is wrong.  Stigler said it was wrong to assume that firms would inevitably collude.  Rather, he proposed a framework for analyzing the factors that would affect their ability to do so.  That framework provides the basis for much of our modern antitrust understanding on collusion and coordinated effects.  It is simply wrong to insinuate that Stigler thought it was impossible for oligopolists to collude successfully.

Ultimately, I’m far more concerned with the misrepresentation of ideas, theories and evidence than Commissioner Rosch’s description of me as a “Chicago apologist.”  The label Commissioner Rosch assigns to me or others does not resolve the substantive merits of the “model selection” problem or the fundamental question here of whether Rosch’s ideas on the relationship between economics and antitrust are sensible.  It’s true that I’ve written as a positive matter that the Roberts Court’s antitrust jurisprudence is more Chicago than Harvard.  I’ve criticized those who have caricatured and Chicago School scholars and ideas and avoided taking on the substantive merits of those economic ideas in favor of ideological labels.  I’ve also argued that the appropriate way to settle intellectual battles in antitrust between competing models is with reference to the empirical evidence — and that attempts to explain the persistence of Chicago School economics in antitrust jurisprudence without rejecting the hypothesis that it is the body of economic theory that is most consistent with the available empirical evidence is unlikely to lead to good antitrust policy.

In short, an analysis of the existing theory and evidence that suggests that the Chicago School’s contributions to antitrust economics hold up quite well relative to competing theories when the contest is run with reference to empirical data rather than who shouts the loudest is not an apology as I understand the word.  I therefore conclude that I am no Chicago School apologist.  Commissioner Rosch obviously disagrees.   In this context, this is a rhetorical and political term not an economic one, so I don’t have much else to say about it — well, maybe one thing.  Apologist is not a neutral word. I point this out because the use of the term “apologist” contradicts the Commissioner’s anecdotal introduction to his speech wherein he analogizes the intellectual debates in antitrust to the scientific debates over quantum mechanics and general relativity in characterizing the relationship between atoms and sub-atomic particles.  The analogy appears to hint that the Commissioner endorses an approach grounded in the scientific method to settle these disputes.  But the use of rhetoric like “apologists” to describe critics that have taken on the substance of ideas and evaluated the evidence in a manner consistent with social science methodology dispels that notion and suggests mostly interest in superficial labels and t-shirt slogans rather than serious engagement with ideas and evidence.  Its use does not imply that Commissioner Rosch and I simply have different views on the relevant economics that we can debate on the substantive merits.  Rather, it implies that I know that the competing economic approaches he advocates are superior, but I am in a state of denial or perhaps that I am just being intellectually dishonest about the Chicagoans losing the war of ideas in antitrust economics.  I do not read the term as a neutral one.  It’s important, however, not to get too distracted by name calling.  As name calling is a tactic typically relied upon to avoid delving deeply into the substantive merits of an issue, its use signals that it is especially important to ignore it here.  But I will say that, given its use, I’ve granted myself permission in this post to treat the Commissioner as a hostile witness, as it were.

The relevant question is not whether Commissioner Rosch’s  views on economics and antitrust law and whether they do in fact, or do not, have those qualities that I’ve criticized in previous posts.  I’ll focus on that issue in this post, and will argue that Rosch’s attempt to clarify his views on the role of economics and economists on antitrust was unsuccessful in the sense that 1) those views remain unclear in many instances, 2) are a primary example of the “model selection” problem described above, 3) will lead to overly aggressive antitrust enforcement, and 4) thus I conclude are likely to result in significant potential to harm consumers if they express agency enforcement priorities or policies.

Read the rest of this entry »

As his Council of Economic Advisers made clear in its recent health care report, President Obama sees two primary goals for his health care reform efforts: to slow the growth of health care costs and to expand coverage of health insurance. It’s pretty clear, though, which of these goals is steering the ship. While the President’s proposals include a few modest measures ostensibly aimed at reducing costs (digitizing medical records, collecting and disseminating data on treatment-effectiveness, etc.), the primary focus is on increasing insurance coverage. That’s unfortunate, for relentless pursuit of coverage expansion is almost certain to undermine the goal of cost containment.

To see why this is so, consider two facts the Obama administration keeps emphasizing: (1) that prices for health care services are spiraling upward faster than the rate of inflation, and (2) that health care expenditures, but not health care outcomes, inexplicably differ greatly across regions. Both of these facts are bizarre, and both suggest that an expansion of insurance coverage may actually impede efforts to slow the growth of health care costs.

In an innovative and competitive economy like ours, the normal tendency — absent a large increase in demand relative to supply, which we haven’t witnessed — is for the quality- and inflation-adjusted prices of goods and services to fall. The real prices for most health care services, by contrast, seem to spiral upward. That’s odd. So are the CEA’s observations that “utilization of specific procedures and per capita health care spending vary enormously by geographic region,” that “in many cases these variations are not associated with any substantial differences in health outcomes,” and that “[l]arge variation remains even after adjusting for differences in the age, sex, and race of enrollees across states.” Why would residents of Texas and Massachusetts spend so much more than residents of New Mexico and Maine to achieve the same health outcome?

Both anomalies — upward spiraling health care costs and substantial regional variations in outcome-adjusted spending — can be explained by the lack of price competition in the health care industry. When most consumers buy health care, somebody else, a private or public insurer, makes the direct payment. Consumers therefore have little incentive to shop around for favorable prices. And health care providers, aware of consumers’ price insensitivity, have little incentive to compete on price and to streamline their operations in a manner that reduces their costs (and consequently their prices). Providers are also likely to over-sell high margin services, which price-insensitive consumers are likely to buy, and to coordinate with local competitors on both prices and norms of treatment — e.g., the degree to which non-essential services (tests, etc.) are routinely provided. Such coordination is easy in an environment in which there is little price competition.

To get a sense of health care consumers’ price insensitivity, consider the results of a 2005 Harris Interactive poll of 2,000 adults covered under employer-provided health plans. That poll found that “63 percent of respondents who themselves or a close family member received treatment for a serious health issue in the past two years[] did not know the cost until after the treatment was received and 10 percent revealed they never found out the cost.” The survey also found that while two-thirds of consumers spend more than eight hours researching the purchase of an automobile, fewer than four in ten spend that amount of time researching a doctor (38%) or a health insurance plan (34%). It should not be surprising, then, that the average survey participant could predict the price of a Honda Accord within $300 but was off by a whopping $8,100 when it came to estimating the price of a four-day hospital stay.

These survey results make perfect sense. If someone else is footing the bill (directly, at least) for your medical care and you aren’t rewarded for selecting a lower-priced provider or for foregoing unnecessary service, you won’t spend the time and effort required to select a cost-effective provider and you won’t decline services of marginal value. Health care providers, well-aware of insured customers’ shopping tendencies, have little incentive to compete on price and plenty of motivation to adopt input-intensive treatment norms.

Things change drastically when customers have to foot the direct bill for medical treatment. Consider, for example, the price of LASIK eye surgery, which insurance generally does not cover. When LASIK was approved by the FDA in 1999, the price for the procedure averaged about $2,100 per eye. By 2005, the average price had fallen 20 percent to $1,687. By contrast, overall annual health expenditures per person in the United States rose from $4,400 to nearly $6,300 (a 43 percent increase) from 1999 to 2004. What accounts for this difference in price trends? Most likely, the vigorous price competition resulting from the fact that LASIK consumers shop around because they must pay out-of-pocket.

The lesson for health care reformers is that if we want to stop the upward spiral of health care costs — the real source of America’s purported health care crisis — we need to find ways to motivate providers to compete on price. Expanding insurance coverage won’t help here; such expansion will instead result in even less price-comparison among consumers and will encourage providers to raise prices and over-sell unnecessary or marginally useful medical services.

A better policy would encourage a system in which consumers pay more directly for at least a portion of their health care consumption so that providers have an incentive to win customers by offering the most cost-effective services. Increasing deductibles and co-payments would help on this front. Current policy, though, discourages high deductible and high co-payment insurance policies. Right now, employer contributions to health insurance – but not individuals’ own expenditures on such insurance – are not taxed. This creates an incentive for employers to provide very generous health insurance benefits (i.e., low deductibles, low co-pays, lots of costly bells and whistles) as a tax-advantaged element of their employees’ compensation.

Legislation proposed by Sen. Tom Coburn and Rep. Paul Ryan confronts this unfortunate incentive head-on and would increase the ranks of the insured while creating strong incentives to control costs. The central feature of the Coburn/Ryan legislation is the elimination of the employer insurance deduction and the creation of a refundable tax credit for individual insurance purchases. As John Goodman explains:

Under the Coburn bill, no longer would employers be able to buy insurance with pretax dollars. These payments would be taxable to the employee, just like wages. However, every individual would get a $2,300 credit (and every family would get $5,700) to be applied dollar-for-dollar against taxes owed.

The Coburn bill does not raise taxes, nor does it lower them. Instead, it takes the existing system of tax subsidies and treats everyone alike, regardless of income or job status. All health insurance would be sold on a level playing field under the tax law, regardless of how it is purchased. The impact would be enormous. For the first time, low- and moderate-income families would get just as much tax relief as the very rich when they purchase health insurance.

The Coburn bill would also encourage all Americans to control costs. The tax credit would subsidize the core insurance that everyone should have. It would not subsidize bells and whistles (marriage counseling, acupuncture, etc.) as the current system does. Since employees and their employers will be paying for additional coverage with after-tax dollars, everyone will have an incentive to compare the value of extra health benefits to the value of other things money can buy. When patients eliminate health-care waste, they will get to keep every dollar they save.

This plan, or some version of it, would go a long way toward accomplishing President Obama’s twin goals of cost containment and coverage expansion. And unlike his own plan and the leading Democratic proposals, it won’t drive the deficit (further) into the stratosphere. Unfortunately, though, Mr. Obama would have a hard time embracing this sort of approach, given his barely true attacks on Sen. McCain’s health care proposals during the presidential campaign.

This is when we could really use a flip-flopper.

President Obama in yesterday’s speech on fiscal responsibility:

The reckless fiscal policies of the past have left us in a very deep hole. And digging our way out of it will take time, patience, and some tough choices.

George Priest has an excellent op-ed in the WSJ correctly calling out the Justice Department’s new Assistant Attorney General Christine Varney for attributing the financial crisis to a lack of antitrust enforcement:

Assistant Attorney General for Antitrust Christine Varney claims that the Justice Department can aid economic recovery by prosecuting businesses that have been successful in gaining large market shares. In her announcement last month she argued that “many observers agree” that our current recession reflects “a failure of antitrust” and “inadequate antitrust oversight.”

This is news to most economists. The cause of the recession is not easy money by the Fed, or the bursting of the housing bubble, or excessive risk-taking through complicated financial instruments? It’s insufficient antitrust prosecution? The claim is hardly plausible. Prosecuting successful businesses will help the recovery? Again, hard to believe.

Priest raises similar issues to those Keith Hylton, Geoff and I discussed in our Forbes piece.  One of those issues is that it is misleading to characterize the Section 2 Report as  a “right wing” political document, rather the product of hearings that consulted the views of hundreds of witnesses, including those enforcement agency officials, practitioners, academics and the business community over two years.  Professor Priest makes the point as follows:

It’s fair enough for a succeeding administration to reject policies of its predecessor. But the Justice Department report was not authored by John Yoo or Alberto Gonzales. It was the work of a year-long study that considered recommendations from 29 panels and 119 witnesses, most of them critical of the minimalist Chicago School approach to antitrust law. The report’s conclusions basically track Supreme Court law with modest extensions in areas where the Supreme Court has not ruled. Ms. Varney denounced the report in its entirety.

But the real punchline of Priest’s op-ed is the confident and interesting conclusion that despite the strong will of the DOJ to reinvigorate Section 2 enforcement, the “new” antitrust agenda will be thwarted by existing Section 2 law:

The saving grace here is that, unlike her European counterpart Neelie Kroes (who is antitrust prosecutor and judge at once), Ms. Varney is only the director of an administrative agency. She and her department can prosecute cases but they cannot convict. The positions put forth in the now-rejected 2008 Justice Department study derive largely from opinions of the Supreme Court. And in the last three monopolization cases considered by the Supreme Court (spanning over a decade) there were no dissenting opinions. Even if President Obama makes the court more liberal the court’s antitrust opinions are secure.  Ms. Varney’s proposed change in direction of antitrust policy may impose extraordinary litigation costs on the government and on her targets. It is unlikely to have a significant effect on U.S. antitrust law.

Professors Hylton, Manne and Wright make a related point about the prospects under existing Supreme Court monopolization doctrine:

The new strategy, so far as one can tell, seeks to pressure the courts to change the law in order to meet the desires of the new administration. In the end, either the Antitrust Division will fail, or the courts will bend in a way that unsettles the law. But either way, this week’s events in Europe and the U.S. portend a tough road ahead for the world’s most successful companies.

I do wonder how confident one can be that the new agenda will fail?  It is true that it will be tough for the DOJ to win Section 2 cases such as the ones favored by the EU, e.g. Intel and Microsoft.  Section 2 law certainly does place significant constraints on the ability to force convergence with the European approach.  But there are limits to these constraints.  One is that firms have to be willing to engage in high stakes and costly litigation to force the agencies into court and win.  Another is, at least at the FTC, the use of Section 5 to circumvent those constraints.  And of course, much of Section 2 law was borne out of private litigation rather than public enforcement.  At the end of the day, however, I do think it’s correct to say that the agencies are going to have a very tough time winning monopolization cases because the law is, as Priest says, essentially as the Section 2 Report describes it.

In his recent speech on the GM bankruptcy, President Obama reassured Americans that the government, which now holds 60% of GM’s stock, is not going to try to take over management of the company:

What we are not doing, what I have no interest in doing, is running GM. GM will be run by a private board of directors and management team with a track record in American manufacturing that reflects a commitment to innovation and quality. They, and not the government, will call the shots and make the decisions about how to turn this company around. The federal government will refrain from exercising its rights as a shareholder in all but the most fundamental corporate decisions. When a difficult decision has to be made on matters like where to open a new plant or what type of new car to make, the new GM, not the United States government, will make that decision.

It wasn’t true when he said it. President Obama had already intervened on the issue of where GM should be headquartered. The night before his speech, the President telephoned Detroit mayor Dave Bing to provide assurance that he opposed moving the company’s headquarters from Detroit’s Renaissance Center to the suburb of Warren. The President’s opposition pretty much put the kibosh on any business decision by GM to relocate its headquarters to take advantage of incredibly lucrative tax incentives.

Perhaps it’s not fair, though, to call the President’s statement false. The statement was primarily forward-looking, so it’s not really inconsistent with past meddling. Indeed, it seems the administration was simply announcing future intentions, for it simultaneously set forth “four core principles that will guide the government’s management of ownership interests in private firms.” One of those principles stated:

After any up-front conditions are in place, the government will protect the taxpayers’ investment by managing its ownership stake in a hands-off, commercial manner. The government will not interfere with or exert control over day-to-day company operations.

Unfortunately, this reassuring rhetoric must confront the reality that President Obama and those he controls do not by themselves constitute “the government.” The government consists of lots of folks, most notably 535 members of Congress whose careers depend on winning popularity contests and who cannot be counted on to manage GM in a “hands-off, commercial manner.” Thus, in the last few days:

* West Virginia Senator John Rockefeller convened a Senate Commerce Committee hearing in which Senators lambasted Chrysler and GM for closing dealerships. Sen. Rockefeller explained, “I honestly don’t believe that companies should be allowed to take taxpayer funds for a bailout and then leave it to local dealers and their customers to fend for themselves with no real plan, with no real notice, with no real help.”

* Texas Senator Kay Bailey Hutchison threatened to hold up a war-funding bill because of the dealer closings. “It’s a huge burden,” she said. “We’re talking about 40,000 families” of workers affected by the closings. “We’re talking about communities.”

* Michigan Senator Carl Levin said he and his office will do “everything we can” to persuade GM that a Michigan plant scheduled to be idled should be reopened later. Mr. Levin told reporters, “We’re going to do what every other representative and member of the Senate will do from these states and districts.” He added, “There’ll be plenty of jawboning, persuasion.”

* House Majority Leader Steny Hoyer insisted that at least five House committees may have jurisdiction over the GM and Chrysler bailouts, and he assured reporters that “[w]e will certainly be exercising oversight.”

(Articles detailing these events here and here.)

Is anybody surprised that Congress insists in having some say over GM’s business decisions? Will anybody be surprised when the Obama administration itself exerts control over a run-of-the-mill business decision that adversely affects one of the President’s favored groups (e.g., organized labor)? Does anybody really expect success from a company with so many popularity-seeking chiefs who are beholden to so many constituents and who have no real need to earn a profit on their “investment” of other people’s money? If so, shoot me an email — I’d like to talk to you about a real estate investment opportunity in suburban Phoenix.

***

UPDATE: More on this basic point in today’s (Friday’s) Wall Street Journal and from Professor Bainbridge.

Jeff Toobin has an interesting profile on John Roberts in the New Yorker (HT: Jonathan Adler who also takes issue with Toobin’s description of Leegin, but goes on to challenge Toobin’s general account of Roberts as a “stealth nominee”).   Toobin’s column has very little to do with antitrust.  with the exception of one sentence describing the Leegin decision where he writes:

That same day, the Justices overturned a ninety-six-year-old precedent in antitrust law and thus made it harder to prove collusion by corporations.

Mr. Toobin clearly did not get this memo.  Descriptions of resale price maintenance agreements between manufacturers and retailers are not collusion in the antitrust sense, a label that connotes horizontal price-fixing between competitors.   Toobin’s explanation implies that what the Roberts court did was make it more difficult to prove a price-fixing agreement that harms consumers.  In the United States where the difference is not only economic but also legal, there is simply no excuse to use the words “cartel” or “price-fixing” to describe RPM.  Yes, a vertical agreement “fixes prices” but this is a fairly transparent attempt to obfuscate the economic issues (empirically RPM generally increases consumer welfare and does not have cartel-like effects) by analogizing it to a cartel.  If one was not paying attention, or knew nothing about antitrust economics, they could take the wrong impression from Toobin’s description that the Court reached an anti-consumer and pro-business result.  That’s a silly way to think about RPM as discussed here.

UPDATE: A reader reminds me that the Antitrust Section at the American Bar Association, which I don’t believe can fairly be characterized as a “conservative” (if that’s a useful label at all in this context) antitrust group, has made an official statement in support of the Roberts Court’s analysis in Leegin:

The ABA supports the position that under the federal antitrust laws—and analogous state and territorial antitrust law—agreements between a buyer and seller setting the price at which the buyer may resell a product or service purchased from the seller should not be illegal per se. Instead, these agreements should be analyzed under a rule of reason analysis. The ABA also believes that the Supreme Court’s recent decision in Leegin is consistent with that position.

Several people, including Josh, have drawn my attention to John Hasnas’ excellent op-ed on the Sotomayor nomination in the WSJ last week.  Just in case you don’t read the same blogs I do, I thought I’d highlight it here.  It is brilliant.  Here’s a taste:

One can have compassion for workers who lose their jobs when a plant closes. They can be seen. One cannot have compassion for unknown persons in other industries who do not receive job offers when a compassionate government subsidizes an unprofitable plant. The potential employees not hired are unseen.

One can empathize with innocent children born with birth defects. Such children and the adversity they face can be seen. One cannot empathize with as-yet-unborn children in rural communities who may not have access to pediatricians if a judicial decision based on compassion raises the cost of medical malpractice insurance. These children are unseen.

One can feel for unfortunate homeowners about to lose their homes through foreclosure. One cannot feel for unknown individuals who may not be able to afford a home in the future if the compassionate and empathetic protection of current homeowners increases the cost of a mortgage.

In general, one can feel compassion for and empathize with individual plaintiffs in a lawsuit who are facing hardship. They are visible. One cannot feel compassion for or empathize with impersonal corporate defendants, who, should they incur liability, will pass the costs on to consumers, reduce their output, or cut employment. Those who must pay more for products, or are unable to obtain needed goods or services, or cannot find a job are invisible.

The point, derived from Bastiat, is extraordinarily powerful, and, as Hasnas notes, the lesson is as important for economists as it is for judges (and for everyone else).  Making decisions on the basis of only the most visible effects of behavior under scrutiny is always a recipe for bad decision-making.  I’d also add that taking advantage of the relative obscurity of broader effects is the essential root cause of the depredations of politics and politicians, who never miss an opportunity to demagogue about a favored interest or idea to the exclusion of the (usually far greater) broader and longer-term effects.

Someone should write a book about the importance of this one idea.

If you haven’t been living under a rock recently, you’ve seen an incredible amount of hand wringing–and proposed regulation–around “excessive compensation.”  I’m a little too lazy to amass all the relevant links here, but both the administration and the congress are introducing regulations/bills and talking about the issue extensively.

Commentators, too, have gotten in on the act, and one of the most respected, Alan Blinder, has recently penned a much-lauded WSJ op-ed on the topic, titled, “Crazy Compensation and the Crisis.”  The op-ed is well-written, and even makes some good points.  Here’s an excerpt I can get behind:

What to do? It is tempting to conclude that the U.S. (and other) governments should regulate compensation practices to eliminate, or at least greatly reduce, go-for-broke incentives. But the prospects for success in this domain are slim. (I was in the Clinton administration in 1993 when we tried — and failed miserably.) The executives, lawyers and accountants who design compensation systems are imaginative, skilled and definitely not disinterested. Congress and government bureaucrats won’t beat them at this game.

I might disagree with the emphasis–I would say that even if government could be successful at regulating pay practices it shouldn’t do it, but the point is certainly a good one.  Blinder is also right on when he notes the benefits in this regard of partnerships over public corporations, a persuasive point Larry Ribstein has been making for a long while.

But the premise of the op-ed–and a lot of corporate governance talk these days–strikes me as problematic, incomplete and revisionist.  Here’s a key bit:

Take a typical trader at a bank, investment bank, hedge fund or whatever. Darwinian selection ensures us that these folks are generally smart young people with more than the usual appetite for both money and risk-taking. Unfortunately, their compensation schemes exacerbate these natural tendencies by offering them the following sort of go-for-broke incentives when they place financial bets: Heads, you become richer than Croesus; tails, you get no bonus, receive instead about four times the national average salary, and may (or may not) have to look for a new job. These bright young people are no dummies. Faced with such skewed incentives, they place lots of big bets. If tails come up, OPM will absorb almost all of the losses anyway.

The op-ed has been cited favorably by commentators ranging from the predictably-tiresome-and-unlikely-to-know-better (Frank Pasquale) to the informative-but-reflexively-pro-regulation (James Kwak) to the always-interesting-and-not-normally-in the-company-of-the-likes-of-Frank-Pasquale (Marc Hodak).

But it strikes me as shocking that Blinder (and his supporters)–who expresses surprise as well as dismay at the extent to which compensation schemes reward the upside so heavily and induce risk-taking–doesn’t even mention Agency Theory.

While Blinder may be surprised that corporate boards have been making such silly mistakes for so long, I would think that every professor or finance, corporate governance, corporate law, securities, and a few other disciplines besides would know that one of the fundamental problems of the corporate form is aligning risk-averse managerial interests with risk-preferring, diversified, shareholder interests.  Remove insider trading and short-selling from the equation and you’re left with potentially-large stock options and other forms of performance-based, deferred compensation.  Which have been lauded and paraded around for years as the salvation of entire industries.  So before we stare in amazement that firms are engaging in these sorts of compensation schemes (schemes that may lead to huge upside paydays, and even some large downside paydays, as well) perhaps we should understand the basic theory behind such behavior–as well as the raft of empirical studies supporting the theory.

Look–this isn’t to say that there might not be problems.  Efforts to align incentives may be out of whack, of course–only a fool would presume perfection on the part of market actors.  But only a greater fool would grant the government the power to control compensation schemes, and do so without acknowledging that there are incentive alignment problems; that there are agency costs; and that firms–to say nothing of broader markets–are complex entities not amenable to easy political solutions.  Alan Blinder should know this, and while his restraint is admirable (at least now–I guess he was more ambitious when he was in the Clinton administration) this is just fodder for the corporate governance revisionists who act like agency theory doesn’t exist and only criminals and greedy bloodsuckers design (and receive) executive compensation schemes.  (Actually, come to think of it, once the government starts setting corporate pay, this will almost be true!  I kid, I’m kidding.  Mostly).

Addendum: I should note two more things.  First, I was being a bit flip.  Blinder is clearly (and appropriately) sensitive to the agency problem of the separation of ownership and control inherent in compensation committees’ paying executives with shareholders’ money.  The problem I have is in the failure to acknowledge that there is another agency problem to deal with:  It is too facile to solve the one without concern for the other.

The second point I should make is that Marc Hodak, at least, among the op-ed’s fans, understands the agency problem, and shouldn’t be tarred with my criticism.  His citation to Jensen & Murphy’s “It’s not How Much You Pay, But How” article reflects exactly this concern–the focus should be structuring compensation to account for various agency problems, not blithely limiting its size.  The irony (to answer, I think, Marc’s riddle) is that Jensen and Murphy noted that, at least in 1990, all else equal, the size of executive compensation seemed low.  Again–the real concern was/is with appropriate structure, but at the end of the day, appropriate structure would, I think, for Jensen and Murphy in 1990, have resulted in higher payouts.  Blinder and, to name a few others, Obama, Barney Frank and Chuck Schumer, don’t seem to see it this way at all.

A few blog posts that caught me eye today:

• Justin Wolfers with an accessible explanation of the identification problem with broadband usage data
• WSJ: The rumored EU remedy for the “new” Microsoft browser case — requiring the firm to distribute its product with “a so-called ballot screen that would present a new computer user with a choice of browsers to install, and the option to designate one of them as a default” — appears to erroneously equate the consumer choice or increased variety (measured at a particular point in time) with consumer welfare
• Everybody should read Tom Smith
• Want to advertise on one of Brian Leiter’s blogs?
• RIP UCSD’s Clive Granger