Equity vs Efficiency in Health Care: Let’s Pretend There’s A Third Way

In a recent post, Mankiw favorably reviews a David Brooks column that argues that health care boils down to an equity/efficiency trade-off—the US vs. Western Europe.  Mankiw concludes:

David Brooks gets it right today about the debate over healthcare reform. The fundamental question is, Should Americans embrace a more robust social safety net at the cost of much higher marginal tax rates, reduced work incentives, and a smaller economic pie?

From a strictly economic perspective, there is no right answer to this question. Arthur Okun said long ago that the big tradeoff in economic policy is between equality and efficiency. The pending healthcare reform bill moves us along that tradeoff. Let’s just not pretend, as some healthcare reformers would have us do, that we can easily get more equality without paying the price in efficiency.

Sounds reasonable, but is it possible there is a third way?  Let’s review the basic issues.   We currently face several problems in health care:

1.  Equity; an affluent society hates to see people suffer and die because they can’t afford health care.

2.  The free-rider problem, uninsured individuals understand their society’s values, and can free ride by not buying health insurance and relying on the mercy of ERs.

3.  Moral hazard; insured individuals over-consume “Cadillac” health care, driving up costs for everyone, even the uninsured.

4.  Government subsidies to help insure the poor require distortionary taxes.

So let’s think about how economic theory might offer insights into how to address these issues:

1.  To deal with the free-rider problem, require everyone to buy health insurance (or self-insure.)

2.  To deal with moral hazard, allow (or encourage) people to self-insure as much as possible, through HSAs.  A mandatory payroll deduction should go into purchasing catastrophic insurance, plus HSAs and/or broader insurance coverage.

3.  To deal with the equity problem, subsidize health insurance for the poor and lower middle class.

At first glance it seems like I haven’t really addressed the equity/efficiency trade-off.  But the system I describe would not necessarily require massive government subsidies (and thus big tax increases.)  Indeed it might be much cheaper than our current health care system.

The US government currently spends about 7% of GDP on health care, and for all that money leaves 45 million uninsured.  Let’s pretend there is a country very similar to the US from both the perspective of per capita GDP and Gini coefficient.  And let’s assume that government spends only a bit over 1% of GDP on health care subsidies.  And let’s pretend that country achieves all of the goals outline above, with a system of very low taxes on labor and no taxes on capital.  Let’s call this imaginary country “Singapore.”

I am sure that there are many reasons why this imaginary system won’t be adopted here.  But I’m not interested in political realities.  I can tell you right now that if your favorite plan is currently politically feasible here, then you have some extremely bad ideas for health care reform.  At this point what we most need is to change mindsets.

There is no way that the US would be moving toward socialized medicine except for the European model.  Socialism was discredited when the Soviet Empire collapsed.  So let’s review why the left is so enamored with socialized medicine:

  1. Europeans spend much less than we do on health care.
  2. Europeans live longer than we do.
  3. Europeans have universal coverage.

Those are very powerful arguments.  Yes, the life expectancy data is not conclusive, in some respects American health care is of higher quality.  But still, it’s a very powerful argument.  In my view you can’t beat something with nothing.  Or with a complete mess, which is how I view our system.  You need persuasive arguments.  Here’s my favorite:

  1. Singapore health care costs only half as much as European health care.
  2. Singapore has universal coverage.
  3. Singaporeans live much longer than Europeans.
  4. Singapore has a far more efficient tax system, and hence is much richer than Europe.

Even better, the Singapore system is pretty much what you would draw up if you looked at my original list of market failures, and tried to devise the least bad solution.  So it “works in theory.”  Just so you don’t think I am too polyannish, let me concede a few points:

1.  Even with their system, we wouldn’t live as long.  Asian-Americans currently live much longer than other Americans.

2.  They have some price controls, and I think we’d want higher quality.  So our government would have to spend more than 1% or 2% of GDP.  But for far less than our current 7%, we could achieve universal coverage with pretty high quality.  Not right away, but over several decades as the new system was gradually phased in.

3.  Forced saving might seem politically unpopular in America.  But recall that the money would be coming out of already existing taxes and/or employer-withheld funds used to subsidize current health insurance plans.  The Singapore plan would not reduce disposable income for anyone other than younger uninsured workers.  And since their health costs are pretty low, they would at least benefit from rapid growth in their HSAs.  Recall that Massachusetts was able to force young uninsured workers into far inferior options (no HSAs unless I am mistaken) with relatively little squabbling.

Yes, it isn’t politically feasible right now.  If it was, I’d be wasting my time.  But we all know the Obama/Pelosi fiscal model will hit a wall in a few years.  And we all know that Democratic voters won’t be happy to learn that they have to pay European-style consumption taxes.  Democrats will be searching for an alternative.  No major health care reforms are likely without at least some Democratic support.  The Singapore plan is consistent with the values of at least a portion of the Democratic Party (centrists like Bill Clinton.)  Thus it is important to talk up the plan as much as possible, until every policy wonk in American understands that for every advantage Europe has over America, Singapore does as well or better than Europe.

About Scott Sumner 490 Articles

Affiliation: Bentley University

Scott Sumner has taught economics at Bentley University for the past 27 years.

He earned a BA in economics at Wisconsin and a PhD at University of Chicago.

Professor Sumner's current research topics include monetary policy targets and the Great Depression. His areas of interest are macroeconomics, monetary theory and policy, and history of economic thought.

Professor Sumner has published articles in the Journal of Political Economy, the Journal of Money, Credit and Banking, and the Bulletin of Economic Research.

Visit: TheMoneyIllusion

2 Comments on Equity vs Efficiency in Health Care: Let’s Pretend There’s A Third Way

  1. This is a fantastic post and I couldn’t agree with you more. There is a reason why policy is not dominated by economic thought. 40+ million Americans uninsured while others consume expensive experimental treatments is both inefficient and unequal. Foreign systems achieve greater measures of both equality and efficiency than ours, so why are people framing the debate as being mutually exclusive between the two measures? The free-rider issue is a key point. Few people expect to be sick – a large number of those who are uninsured feel that based on a cost-benefit analysis that they have little to gain by paying into the system and if something catastrophic were to happen, they could go to the emergency room where the cost would be passed on to those of who did our due diligence by paying into a plan. The current legislation may not be the most inefficient or the most equal but I would argue that it increases both equity and efficiency and stronger legislation would increase both measures further. In addition, by covering more healthy people the exchanges and some sort of affordable public plan, the system can afford to take on more sick people, in fact the legislation forces them to be able to gain coverage. When they can get treatment early on rather than waiting till it gets to a crisis stage, we again increase equity and efficiency. The issue is all in how the debate is framed and I think communication is the biggest issue. You do a great job of it, but neither house of congress nor the President is. For more on this notion, check out the following article: http://www.songofsibyl.com/2009/11/28/can-somebody-paint-me-a-decent-picture-part-1-health-care/

  2. Most European countries do not have socialized medicine, wherein the government owns and operates the health care system. Those that do (Ireland, Italy, Scandinavia, Spain, UK) made the decision to go that way out of pragmatism and not ideology: They drew the conclusion that the free market couldn’t provide value-driven care on a population basis — not an unreasonable view. Their health care bang for the buck is high because basing a system on taxpayer dollars encourages preventive medicine to minimize expense. That’s why each of these countries puts a strong emphasis on primary care and public health policy, which is the real reason for the economy of their outcomes. (Singapore is no different, in this respect.)

    We don’t need socialized medicine to accomplish this, but we do need to reverse the grave shortage of primary care physicians and clinics, and invest in robust public health policies at the federal, state, and community levels. Together, these would save billions each year and give the lie to Brooks’ myopic view of the economic pie, which would grow as a result.

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