Handwaving on health care

There's a particular style of argument that some conservative economists use to dismiss calls for government intervention in markets:

Step 1: Either assert or assume that free markets work best in general.

Step 2: List the reasons why this particular market might be unusual.

Step 3: Dismiss each reason with a combination of skeptical harumphing, handwaving, anecdotes, and/or informal evidence.

Step 4: Conclude that this market should be free from government intervention.

In a recent rebuttal to a Greg Mankiw column on health care policy, John Cochrane displays this argumentation style in near-perfect form. It is a master class in harrumphing conservative prior-stating, delivered in the ancient traditional style. Young grasshoppers, take note.

Mankiw's article was basically a rundown of reasons that health care shouldn't be considered like a normal market. He covers externalities, adverse selection, incomplete information, unusually high idiosyncratic risk, and behavioral factors (overconsumption).

Cochrane makes a guess at the motivation of Mankiw's column:

I suspect I know what happened. It sounded like a good column idea, "I'll just run down the econ 101 list of potential problems with health care and insurance and do my job as an economic educator."

That sounds about right. In fact, that actually was the reason for my similar column in Bloomberg a few months ago. Frankly, I think bringing readers up to speed on Arrow's classic piece on health care is a pretty good idea for a column. Mankiw generally did a better job than I did, although he didn't mention norms, which I think are ultimately the most important piece of the puzzle (more on that later).

Anyway, Cochrane wrote a pretty unfair and over-the-top response to that Bloomberg post of mine, which also made a rather unintelligent pun using my first name (there's an extra syllable in there, dude!). His response to Mankiw has more meat to it and less dudgeon, but is still rather ascerbic. Cochrane writes:

I am surprised that Greg, usually a good free marketer, would stoop to the noblesse oblige, the cute little peasants are too dumb to know what's good for them argument... 

[I]s this a case of two year old with hammer?... 

I suspect I know what happened. It sounded like a good column idea, "I'll just run down the econ 101 list of potential problems with health care and insurance and do my job as an economic educator." If so, Greg failed his job of public intellectual... 

The last section of After the ACA goes through all these arguments and more, and is better written. I hope blog regulars will forgive the self-promotion, but if Greg hasn't read it, perhaps some of you haven't read it either.

Grumpy indeed!

So, Cochrane's post consists of him hand-waving away the notion that externalities, high idiosyncratic risk, and adverse selection might matter enough in health care markets to justify large-scale government intervention. 

To summarize Cochrane's points about externalities:

• Health externalities affect only a small subset of the things that Obamacare deals with.

• Lots of other markets have externalities. 

To summarize Cochane's point about high idiosyncratic risk:

• That's what insurance markets are for, duh!

To summarize Cochrane's points about adverse selection:

• Doctors know more about your health than you do.

• Adverse selection assumes rational patients, while behavioral effects assume irrational patients.

• The government forces insurers not to charge people different prices based on their health status.

• Other insurance markets, like car insurance, function without breaking down due to adverse selection.

• Services to mitigate adverse selection exist in other insurance markets.

• Most health expenses are predictable, and thus not subject to adverse selection. 

So, to rebut these, I could go through each point one by one and do counter-hand-waving. For example:

• The idea that doctors know more about your health than you do assumes that you've already bought health care and are already receiving examinations. Prior to buying, you know your health better. 

• People can be irrational in some ways (or in some situations) and rational in others, obviously.

• The fact that the government forces insurers to pay the same price is part of the policy that's intended to mitigate adverse selection, and therefore can't be used as proof that adverse selection doesn't exist in the absence of government intervention.

• Markets might have different amounts of adverse selection. For example, insurers might be able to tell that I'm a bad driver, but not that I just found a potentially cancerous lump in my testicle.

• Adverse selection mitigation services are socially costly, and Carmax for health care might work much worse than Carmax for cars.

...and so on.

But who would be right? It really comes down to your priors. Priors about how irrational people are. Priors about how much asymmetric information exists and how much it matters in various markets, Priors about how costly and feasible Carmax for health care would be. Priors about how reputational effects work in health care markets. Priors about how efficient government is at fixing market failures. And so on. Priors, priors, priors.

Reiteration of priors can get tiresome.

Instead, here is a novel idea: We could look at the evidence. Instead of thinking a priori about how important we think adverse selection is in health care markets, we could think "Hey, some smart and careful economist or ten has probably done serious, careful empirical work on this topic!" And then we could fire up Google Scholar and look for papers, or perhaps go ask a friend who works in applied microeconomics or the economics of health care. 

In his health care article, "After the ACA", Cochrane cites a wide variety of sources, including New Yorker and Wall Street Journal and New York Times and Washington Post articles, a JAMA article and a NEJM, some law articles, a number of blog posts, a JEP article and a JEL article, some conservative think tank reports, Akerlof's "Market for Lemons" article, the comments section of his own blog, and a YouTube video entitled "If Air Travel Worked Like Health Care". (This last one is particularly funny, given that Cochrane excoriated me for claiming that he compared the health insurance industry to the food industry. As if he would ever imply such a thing!)

As silly as a couple of these sources may be, overall this is a fine list - it's good to cite and to have read a breadth of sources, especially on an issue as complex and multifaceted as health care. I certainly cannot claim to have read anywhere nearly as deeply on the subject. 

But as far as I can see, Cochrane does not engage with the empirical literature on adverse selection in health insurance markets. He may have read it, but he does not cite it or engage with it in this blog post, or in his his "After the ACA" piece, or anywhere I can find.

This is a shame, because when he bothers to read the literature, Cochrane is quite formidable. When he engaged with Robert Shiller's evidence on excess volatility in financial markets, and when he engaged with New Keynesian theory, Cochrane taught us new and interesting things about both of these issues. In both of these cases, Cochrane approached the issue from a perspective of free-market orthodoxy, and advanced the free-market (or efficient-market) case like a lawyer. But in both cases, he did so in a brilliant way that respected his opponents' arguments and evidence, and ultimately yielded new insight. 

But in the case of adverse selection in health insurance, Cochrane does not engage with the literature. And although I haven't read much of that literature, I know it exists, because I've read this 2000 literature review by David Cutler and Richard Zeckhauser. Starting on page 606, Cutler and Zeckhauser first present the basic theory of adverse selection, and then proceed to discuss a large number of studies that use a large and diverse array of techniques to measure the presence of adverse selection in health insurance. They write:

A substantial literature has examined adverse selection in insurance markets. Table 9 summarizes this literature, breaking selection into three categories: traditional insurance versus managed care; overall levels of insurance coverage; and high versus low option coverage.  

Most empirical work on adverse selection involves data from employers who allow choices of different health insurance plans of varying generosity; a minority of studies look at the Medicare market, where choices are also given. Within these contexts, adverse selection can be quantified in a variety of fashions. Some authors report the difference in premiums or claims generated by adverse selection after controlling for other relevant factors [for example, Price and Mays (1985). Brown at al. (1993)]. Other papers examine the likelihood of enrollment in a generous plan conditional on expected health status [for example, Cutler and Reber (1998)]. A third group measure the predominance of known risk factors among enrollees of more generous health plans compared to those in less generous plans [for example, Ellis (1989)].  

Regardless of the exact measurement strategy, however, the data nearly uniformly suggest that adverse selection is quantitatively large. Adverse selection is present in the choice between fee-for-service and managed care plans (8 out of 12 studies, with 2 findings of favorable selection and 3 studies ambiguous), in the choice between being insured and being uninsured (3 out of 4 studies, with 1 ambiguous finding), and in the choice between high-option and low-option plans within a given type (14 out of 14 studies). 

They proceed to list the studies in a table, along with brief summaries of the methods and the results.

Have I read any of these studies? In fact, I have read only one of them - a 1998 study of some government and university employees, also by Cutler and Zeckhauser. They document a market breakdown - the disappearance of high-coverage health plans. And they present evidence that this breakdown was due to the so-called "adverse selection death spiral", in which healthy people leave high-coverage plans until the plans can no longer be offered. And they show that a similar thing was starting to happen to the Group Insurance Commission of Massachussetts, before major reforms were made to the system that prevented the death spiral. 

So there is some evidence that adverse selection not only exists and creates costs in (at least some!) health insurance markets, but is so severe that it can cause market breakdown of the classic Akerlofian type. 

If I were setting out to dismiss the possibility of this sort of major adverse selection, I would read a number of these papers, or at least skim their results. I would also look for more recent work on the subject. 

I would also read the literature on adverse selection in other insurance markets, to see whether there's a noticeable difference between types of insurance. I'd read this Chiappori and Salanie paper on auto insurance, for example (which I had to study in grad school), which finds no evidence of adverse selection in car insurance. That would make me think "Hmm, maybe car insurance and health insurance are two very different markets."

I am not setting out to dismiss adverse selection, however. Nor am I setting out to claim that it's a big enough problem that it requires major government regulation of the health insurance market. Nor am I claiming that Obamacare passes a cost-benefit test as a remedy for adverse selection. In fact, I don't even think that adverse selection is the main reason we regulate health care! I think it's kind of a sideshow - an annoyance that we have to deal with, but not the central issue. I think the central issue of health care regulation is just a social norm - the widespread belief that everyone ought to have health care, and that the cost of health care ought to depend only on your ability to pay. Those norms, I believe, are why people embrace universal health care, and why they are now coming to embrace the radical solution of single-payer health care.

But that's just me. Cochrane thinks adverse selection is the big issue, so he goes after it, but without standing on the shoulders of the giants who have investigated the matter before. Instead, he waves the problem away. Unlike me, who am but a lowly journalist, Cochrane is a celebrated professional economist. He has done much better in the past, and he could do better now if he chose.