My Arguments in Charts

Just wanted to add to my post yesterday with a graphical explanation. I’m trying to run out of the door physical therapy, so I’ll try and make it quick. This is what the industry supposes:

flatinvestment

In this world, the marginal value of dollars invested in innovation is fairly linear. More dollars equal more innovation, and by the same token, less dollars in investment mean less innovation. Here’s what I’m saying things look like:

realityviewIn this world — which I believe is the one we inhabit — you reach a steeply declining level of marginal value for dollars invested in innovation. In other words, once you reach a critical point you can’t just throw money at cancer and develop a cure. Given the amount of money on treatments that don’t improve outcomes, it seems to me to be a reasonable assumption that we are somewhere on the very steep part of the curve. As such, marginal reductions in investment will not be met by a commensurately large drop in medical innovation.

And of course, none of this even deals with issues of demand.

Medical Innovation and Pareto Optimality

Vilfredo Pareto

Vilfredo Pareto

Via Kevin Drum, Connor Friesersdorf raises something I’d been thinking a bit about lately: namely the theory that one of the key drivers of medical innovation is America’s willingness to spend significantly more on health care than other countries, thus creating a free-loader problem. More to the point though, the argument implies that if the U.S. implements a universal system that controls costs through non-market mechanisms (i.e., top-down rationing), medical innovation will shrink on the margins, thus reducing the likelihood of future groundbreaking treatments. In theory, the argument appears to make a lot of sense, and what’s more, being non-falsifiable in the present, is hard to rebut. Kevin Drum says this:

This is actually the only objection to national healthcare that I find sort of interesting.  But here’s the problem: the reason it’s hard to find a convincing rebuttal is because the argument itself is purely speculative in the first place.

Well, sort of (as Johnathan Cohn argues in depth here). But for the sake of discussion, let’s consider this in the realm of theory and think about the assumptions required to reach the conclusion of “lowered costs will reduce medical innovation”:

  1. “Medical Innovation” is a purely market good
  2. “Medical Innovation” is an elastic good
  3. “Medical Innovation” is at Pareto optimality*

Without being presumptuous, I think it should be pretty uncontroversial to remark that these three assumptions don’t resemble the reality we inhabit. For one, “Medical Innovation” is not a purely market good. In fact, a great deal of medical breakthroughs are made by academic researchers (to name a few: polio vaccination, penicillin, the MRI, human genome mapping, and stem cell research emerged or are being led by non-profit institutions). Second,”Medical Innovation” is not a highly elastic commodity, at least insofar as we can safely assume most people value their health. People need insulin, lower cholesterol, high t-cell counts, cancer treatment, etc. Even treatments for things like droopy-dick-disease and crazy-head restless leg syndrome aren’t particularly elastic. There’s just no substitute good for a boner.

But, let’s throw out these sensible objections and remain in the world of theory.

The most problematic part of this argument is that it’s grounding assumption provides that the current level of medical innovation is not Pareto optimal. Thus, proponents of the argument that universal health care will reduce innovation have a dilemma. On the one hand, they can hold the assumption of a “free-loader problem.” If this is the case, a slackening in demand in the United States should be picked up by increased demand elsewhere, and the free-loader problem is solved. On the other hand, it’s also possible that demand will not be picked up elsewhere, which would essentially expose the “free-loader problem” as a massive de facto subsidy for profit-seeking companies. And that, is a bad argument for profit-seeking companies to make, which, I imagine, is why you don’t hear the argument taken much further than platitudes about “preserving innovation.”

*UPDATE: I want to explain my reasoning here a little bit, because there are plenty of non-Pareto optimal situations where it’s possible, and in fact normal, to see a decline in production result from a decline in demand. However, if “Medical Innovation” were at such a level, you’d see pharmaceutical companies and other such medical innovators making the argument that current profitability levels are too low, and that explicit subsidy — direct or otherwise — would be required to meet demand for innovation. Because this proposition is on its face risible (as it happens, estimates of wasted care range from 10 to 30 percent of spending), the only other scenario in which a decline in demand would necessarily lead to a decline in innovation would be a point of Pareto optimality.

McArdle: Failure To Implement Cost Controls In Past Proves Cost Conrols Don’t Work

On controlling Medicare costs, Megan McArdle says this:

I’d say we have substantial empirical evidence that we are not going to control the health care cost inflation which is busting Medicare’s budget, much less the new costs the administration is planning to add.  We have been trying to control health care costs since the 1970s made it clear that Medicare was going to get really, really expensive.  And any idea that you care to name, from comparative effectiveness research to healthcare IT to preventive medicine . . . these have all been on the table for more than thirty years, under one name or another.  They haven’t happened.

The answer that those promising magical cost reductions need to ask is “Why haven’t they happened?” and “What has changed to make them feasible now?”  But when I ask this question, I get angry demands that I put forward my plan for cost control, rather than merely critiquing everyone else’s. This seems rather like demanding that I put forward my design for a perpetual motion machine before I am allowed to point out problems in the US energy market.

Kevin Drum replies, “[t]his is an entirely reasonable position,” before rightly explaining that cost controls haven’t been enacted because health care costs are largely hidden from view, either through employer based coverage or because taxes for Medicare haven’t reflected rising costs (these have weighed on the deficit). All of this is quite right, except for the fact Megan’s position is in fact entirely unreasonable because her argument makes absolutely no sense.

If I follow Megan correctly, because the cost controls “on the table…haven’t happened,” therefore these policies are infeasible? What? Kevin Drum’s response correctly identifies the key political impediments to enacting cost control measures, but why on earth does our failure to implement cost controls suggest that the proposals themselves won’t work if implemented? As Megan herself notes, these same reforms have worked in other countries, all of whom spend less per capita for similar or better results. I mean, am I missing something here?

Now, in fairness, Megan’s post argues primarily that health care reform has become the “Laffer curve of the left,” and that health care reforms have become a way for Democrats to argue that their policies have no cost, in the same way that Republicans argue that lowering taxes will raise government revenues. Maybe so, but given that the US spends more than any other country on health care per capita, and doesn’t manage to get better resutls for the effort, I think it’s pretty safe to say we’re on the wrong side of the curve.

Precedent

Thomas Ricks has an interesting post up at Foreign Policy on the Roman financial crisis of 33 A.D. I’ll just quote it.

It all began when Emperor Tiberius enforced a ceiling on interest rates, which caused a severe credit crunch, Tacitus relates in The Annals (book VI, 16-17). “Hence followed a scarcity of money, a great shock being given to all credit, the current coin too.” This was of course followed by deflation of the sort we are seeing now in housing — “a fall of prices, and the deeper a man was in debt, the more reluctantly did he part with his property, and many were utterly ruined.” This is what business nowadays terms “distressed sales.”

The Roman equivalent of the Fed then pumped tons of money into the financial system, and also cut interest rates to zero, which is about where we are now in our own mess. As Tacitus puts it:

The destruction of private wealth precipitated the fall of rank and reputation, till at last the emperor interposed his aid by distributing throughout the banks a hundred million sesterces, and allowing freedom to borrow without interest for three years, provided the borrower gave security to the State in land to double the amount. Credit was thus restored, and gradually private lenders were found.”

Tiberius also raised funds by accusing Sextus Marius, the richest man in Spain, of incest — almost certainly a trumped-up charge — and then having him thrown headlong from the Tarpeian Rock (see below), a cliff at the edge of Rome’s Capitoline Hill. “Tiberius kept his gold mines for himself,” Tacitus notes. It makes me think that Wall Street is getting off easy.

While we’re at it, why not feed John Thain to the lions?

Tied Together

I was a in recent debate with a friend of mine about the dangers of accumulating foreign debt. His contention was that the risk of foreign governments abruptly “calling in our debt” would have catastrophic ramifications. My point, in the broadest sense, was that because of the interconnectivity of the global economy, it wouldn’t really be in anyone’s interest — and in particular, not China’s — to sink the world’s largest consumer economy. That is, China has lent us a great deal of money, which has in turn allowed us to buy a great deal of Chinese goods. This is part of the reason China has sustained unprecedented growth, and indeed, part of the reason the Communist party has held such a grip on government. If economic growth halts, the Communist party risks fomenting dissent. It is therefore in the best interest of both China’s economy and the government in power not to cripple the American economy. But why take my word for it? Here’s Gao Xiqing, president of the China Investment Corporation, which manages most of China’s the “high-visibility investments.”

With so much of China’s money at stake, did U.S. officials consult the Chinese about the rescue plan?

Not directly. We were talking to people there, and they were hoping that we would be supportive by not pulling out our money. We know that by pulling out money, we’re not serving anyone’s good. Including ourselves. So we’re trying to help, at least by not aggravating the problem.

Let me start by saying I could be completely wrong about this, but it seems to me that it doesn’t even matter to China whether or not we ever pay them back, so long as we have the ability to do so. China’s finances are trusted, in large part, precisely because they own so much US debt. Furthermore, barring utterly catastrophic economic collapse (they run a yearly surplus), China wouldn’t need to call in American debt because they can simply print money with the understanding that it’s backed by the $17 trillion yearly US economy. This is why we are no longer use commodity based money.

This is not to say there aren’t long term scenarios that present less than ideal outcomes for Americans. For example, if the Chinese are able to induce domestic demand for Chinese products (not at all a given thanks to cultural considerations that heavily value saving), the need for American trade is lessened quite a bit.

Anyone who knows more about global economics than me is welcome to comment.

Econ Team

Good news that the Obama Administration might be pushing for a stimulus package approaching $700 billion ready for executive signature on January 20th. As expected, Congressional Republicans think that the solution is cutting the capital gains tax, because god only knows the onerous drag taxes on stock market gains are placing on job creation.

Meanwhile, Obama here’s Obamas economic team. As expected, Tim Geithner will run the Treasury.

Also, during his press conference, Obama says he’s going to make health care reform a large part of his economic recovery package in addition to infrastructure development and foreclosure reform. Good.

The Non-Problem of Social Security

A friend mentioned to me the other day something to the effect that Social Security is essentially failing and that it can’t be expected to be there in the future. This is a rather common perception, and often encouraged by the press, so it’s tough to fault anyone for this belief, but it’s basically completely untrue. Here’s Dean Baker.

The Congressional Budget Office projects the program to be fully solvent through 2049, more than 30 years after the latest date that the next president can leave office. Social Security is an issue like U.S. relations with Denmark, it’s not a problem, however much the Post might like to make it one.

Here’s the CBO’s report.