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Tuesday, September 16, 2008

David Cutler, Brad Delong and Anne Marie Marciarille
Boldly Charge Into Enemy Territory with this awesome op-ed in the Wall Street Journal.

It is so good at a) explaining economics in plain English and b) presenting hard heading and clearly valid arguments that show that Obama's plan is more efficient no matter how one defines efficiency, that it might even convince one or two regular readers of The Wall Street Journal's editorial pages (it's never to late to mend and hope springs eternal).

Three cheers.

Given the excellence of the Obama plan and the awfulness of the McCain plan, only a total fool would rake over old tired arguments about mandates which are not the topic of the current debate anyway.

I am that total fool.

OK so here goes.

Cutler, DeLong and Marciarille write

- Pooling. The Obama plan would give individuals and small firms the option of joining large insurance pools. With large patient pools, a few people incurring high medical costs will not topple the entire system, so insurers would no longer need to waste time, money and resources weeding out the healthy from the sick, and businesses and individuals would no longer have to subject themselves to that costly and stressful process.

For small firms, this makes sense (although if it makes that much sense for all concerned I don't know why insurance companies can't make money setting up such pools). For individuals less so.

The problem with insurance which pooling addresses is adverse selection -- sick people are those most eager to buy health insurance. This can lead to a case in which, even if everyone would benefit from universal insurance, insurance can't take off as the first to sign up are the sickest and that means premiums have to be so high that healthy people don't join. Even if there is insurance now, it can vanish due to the adverse selection death spiral where the healthiest decide to go without, so costs per client increase, so the second healthiest decide to go without so etc till we're all on our own.

Here free choice for each consumer, each individual is free to sign up with each insurance company, implies that all consumers end up without something that they all want.
If people were in pools assembled at random and each pool voted on whether to get insurance, all would get insurance and the problem would be solved. However if individuals are free to join pools or not, I don't see any improvement over the current individual market. There is just one more layer of organization. With pools insurance companies can't exclude individuals and don't have to worry about only the sickest signing and the problem is solved so long as the pools can't exclude individuals and don't have to worry about only the sickest showing up.

So far, the claim seems to be that renaming an agent a "pool" not an "insurance company" magically solves the problem. Obama decided to leave people free to choose (knowing that they are free to choose someone other than Obama for president and hate the word mandate). There is only so much he can do about adverse selection.

Now the Obama plan is better than a Wall Street Journal op-ed regular readable 700 word summary. I think the point of the pools is that they will be non-profit monopolies not competitive firms. I described adverse selection for a monopolist, but the problem is much worse if competing firms poach the healthiest clients from each other. It is also worse if the firms set premiums to maximize profits and not to cover costs (same if there were perfect competition higher with lower coverage possible spiraling to zero in the real world of imperfect competition).

Obama proposes pools because he believes that regulated monopolies will deliver a more efficient outcome that competing profit maximizing firms. Economic theory suggests that he is right. Common sense convinces Cutler, DeLong and Marciarille that they better not try to convince Wall Street Journal Op-Ed readers of that one.

update: This is awesome too. Bob Herbert explains the adverse selection death spiral and why McCain's plan would be a disaster. Oh and Sharry Glied might not remember this, but she smiled and winked at me once (not a hint just being polite, actually less than saying hello but I remember).

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