links for 2009-06-29
The Importance of Editors--and Friends

The Public Plan for Health Insurance: In Which Greg Mankiw Confesses to Remarkable Ignorance and Asks a Question that We Answer...

He wonders:

Greg Mankiw's Blog: The Arbiter of Ignorance: In a brief blog post on healthcare, Paul Krugman says that George Will and I are "either remarkably ignorant or simply disingenuous." I cannot speak for George, but I can attest that I am completely ingenuous. So I suppose I must be remarkably ignorant.

There is a lot of that going around lately. In an earlier post on the state of macroeconomics, Paul says, "Brad DeLong and I have been sort of tag-teaming the Great Ignorance which seems to have overtaken much of the economics profession."

What is going through Paul's head as he writes these posts?...

Two things are going through Paul's mind:

  1. That at least since Kenneth Arrow weighed in on the subject... generations ago, there has been a consensus among health economists that adverse selection and moral hazard make properly structuring health-care markets very hard and very tricky, and that even if you do many of the usual benefits of market mechanisms are greatly attenuated in the health sector.

  2. He reads what Mankiw is writing right now--for example: "The Pitfalls of the Public Option in Health Care: [Obama's] economic logic regarding the public option is hard to follow. Consumer choice and honest competition are indeed the foundation of a successful market system, but they are usually achieved without a public provider. We don’t need government-run grocery stores or government-run gas stations to ensure that Americans can buy food and fuel at reasonable prices..."--and he doesn't find any recognition that information and selection problems that are not present in grocery or gasoline markets are of the essence in the health care sector.

The economic logic behind a public plan springs from these information and selection problems. Private health-insurance companies are currently spending a fortune in a negative-sum game by which they try to make other private companies and not themselves actually pay for treating sick people. A public plan run by bureaucrats would not face those incentives, and would not waste money in that way. A public plan would, however, have its own inefficiencies: it would be run by bureaucrats, and would waste money in other ways.

Which set of inefficiencies would be greatest? We don't know. The argument for a public plan is that we should be like the mongoose Rikki-Tikki-Tavi, whose motto is: "run and find out." We should set up a public plan, let it compete with the privates, and see if it can provide care people like more cheaply than the private insurance companies. Friedrich Hayek would approve: the idea is to use the market as an institutional discovery mechanism.

The arguments against a public plan are two:

  1. It would be able to provide people with better health care more cheaply, and would drive the private-insurance companies out of business, and their executives would lose their jobs and be sad, and their shareholders would lose their money and be sad, and their lobbyists would lose their jobs and be sad, and their tame legislators would lose their campaign contributions and be sad.

  2. Mankiw's argument that a public plan will inevitably receive large and wasteful federal subsidies no matter what the initial law says.

The exammple Mankiw uses to back up his argument seems to me to be very strange. It is: "Fannie Mae and Freddie Mac, the mortgage giants created by federal law, were once private companies. Yet many investors believed--correctly, as it turned out--that the federal government would stand behind Fannie’s and Freddie’s debts..." and thus provide them with a subsidy.

There is a problem with this argument.

The problem is that in the past year and a half the Federal government has stood behind the debts of not just Fannie and Freddie, but AIG, Bear Stearns, Merrill Lynch, Bank of America, Morgan Stanley, and Goldman Sachs--none of which bear any resemblance whatsoever to a "public plan." The government has stood behind Fannie and Freddie not because they were, before 1968, public enterprises but because they were--like AIG, Bear Stearns, Merrill Lynch, Bank of America, Morgan Stanley, and Goldman Sachs--too big to fail. The Treasury staff would have loved to have let Fannie and Freddie default on their bonds had they not feared the systemic consequences.

The fact that Mankiw can't find an example of his argument (2) makes me think that it is very weak, and that the real reason people oppose the public plan is (1).