Paul Krugman: Notes on 1/22 Column, "Gold-Plated Indifference"
Econ 210a: Jan. 24. The First Age of Globalization [Eichengreen DeLong]

Andrew Samwick, Paul Krugman, Pecuniary Externalities in Health Prices, and Local Monopoly Power Created by Plans that Let You Choose Your Own Doctor

Andrew Samwick, Paul Krugman, Pecuniary Externalities in Health Prices, and Local Monopoly Power Created by Plans that Let You Choose Your Own Doctor.

Andrew Samwick on pecuniary externalities:

Vox Baby: Pecuniary Externalities: For what it's worth, I think Paul Krugman makes some good points about the problems inherent in using the tax code to encourage or discourage the purchase of health insurance in his column.... However, I found this statement (highlighted in bold) in Krugman's column to be odd:

Mr. Bush.... The tax code, he said, "unwisely encourages workers to choose overly expensive, gold-plated plans. The result is that insurance premiums rise, and many Americans cannot afford the coverage they need."... No economic analysis I'm aware of says that when Peter chooses a good health plan, he raises Paul's premiums. And look at the condescension. Will all those who think they have "gold plated" health coverage please raise their hands?...

Andrew says:

That is almost the definition of a pecuniary externality. Wikipedia describes it as follows:

A pecuniary externality is an externality which operates through prices rather than through real resource effects. For example, an influx of city-dwellers buying second homes in a rural area can drive up house prices, making it difficult for young people in the area to get onto the property ladder. This is in contrast with real externalities which have a direct resource effect on a third party. For example, pollution from a factory directly harms the environment. Both pecuniary and real externalities can be either positive or negative.

So in the President's defense, there's a very simple argument to be made here. When one person feels inclined, for whatever reason, to purchase more health care services, that puts upward pressure on the price of health care services (if the supply curve is not flat) and thus the cost to everyone else in the market. Normally, we don't pay any attention to this, because that is precisely the mechanism by which a competitive market achieves economic efficiency.

The President is referring to the pecuniary externality generated by a tax distortion in the treatment of health insurance, which interferes with a market achieiving economic efficiency and thus should concern us. It goes as follows. Premiums are fully excludable from income tax, but out-of-pocket expenses are not tax advantaged. That favors health insurance arrangements in which there are low deductibles and high premiums. Such arrangements can lead to higher utilization of health services, since the insured faces no financial cost at the margin once the low deductible has been met. (This is just a standard moral hazard argument.) Krugman... [is] on shaky ground with his "Wow ... no economic analysis ..." comment.

I think Paul Krugman would say that he believes that health care is a constant-returns-to-scale industry, and that the subsidy provided by the tax code-driven increase in demand and spending increases quantities demanded but not prices in the long run. The supply curve, Paul Krugman thinks, is flat in the long run, and so Andrew Samwick's pecuniary externality argument fail.

It's not clear to me that Paul Krugman is wrong. It is also not clear to me that Paul Krugman is right. One of the things patients are buying with more expensive health-care plans is the freedom to choose their own doctors, and that gives the doctors they choose some monopoly power in their bargaining over reimbursement rates with the insurance companies.

I don't have a handle on how big this effect might be, however.