The Looming Health Care Crisis

What exactly is the problem with Health Care? What is all the buzz?

What is the basic reason that all the politicians are proposing policies to influence the Health Care Industry?

The answer sits on the Balance Sheet.

Take a look at the expenses of the Government run health insurance programs: Medicaid and Medicare.

These expenses are the largest rising share of US GDP, while the resources given to the programs hasn't grown with them.

What are the government's options?

1. Give more resources
   
2. Lower costs
   

   
   

   First, let's consider (1).
   

   Government budgets are very lean across the board right now, there is no extra money available.
   

   Therefore, the government can either cut resources from other programs to cover Health Insurance costs, or raise taxes.
   

   If raise taxes, raise taxes from where?
   

   The poor are already poor. The rich provide the jobs and the industries. Taxing their income only incentives their industries less. Maybe there is some government revenue to be had by taxing the incomes of the rich, but not much. A famous Econ textbook publisher recently remarked that he will only be able to keep 7 cents for every extra $ he earns. He's probably not going to work much harder to drive the economy.
   

   We could tax capital, but that only lowers savings. We already face a 'lack of savings' problem, and nobody wants another Social Security program where the government does our savings for us.
   

   
   

   Therefore, let's consider option (2) for the government to deal with the rising expenses of Health Care.
   

   Are there any expenses that we can cut?
   

   Well, analysis shows that some of the expense increases come from the improved Medical service being provided; better equipment, better trained physicians, and better techniques.
   

   We don't want to cut quality of Health Care, are there other growing components of Health Care expenses that can be cut?
   

   
   

   The answer is yes, but it is not easy.
   

   The insurance industry is prone to 2 market failures (moral hazard, and adverse selection).
   

   Targeting these holds promise for decreasing health expenses.
   

   
   

   Eliminating moral hazard would make individuals only go for operations they would get if they were paying for the operation.
   

   Eliminating adverse selection would cut down major insurance screening costs to make sure they don't sign on people with unobservable expensive prior conditions (note, I am not saying don't provide health care to these individuals in need, I am for reducing the costs that everyone pays the insurance companies to deal with screening).
   

   
   

   I am pretty busy right now, so I think I will save the details of how best to target these problems for my next post.
   

   
   

   I will outline the basic strategies that are used to target these expensive market frictions.
   

   
   

   To eliminate moral hazard, individuals must internalize more of their own medical cost. This is how we get closer to realizing when individuals would really go for care. Also, this would incentivize Americans to lead healthier lifestyles. I do not propose pay-your-own-way, there are benefits to having insurance for unforeseen and unpreventable illnesses; all I am saying is that there are definite moral hazard costs for having too much insurance.
   

   
   

   To eliminate adverse selection, the costly screening by insurance companies, the government should require some low level baseline insurance to cover emergencies and prior existing conditions. The idea is analogous to how everyone must hold car insurance for the damage they may cause others. Since, doctors and hospitals won't let individuals with emergency medical needs perish on the doorsteps, everyone should hold some insurance and that pool covers the emergencies. With everybody then having to hold some insurance for the emergency procedures and prior conditions, insurers don't have to expend as much resources screening.
   

   
   

   As can be seen, as in all economics, there is a balance to be struck here. Not too much insurance or we get moral hazard, but require some to diminish adverse selection.
   

Goal of Econ, Goal of US Const, Goal of America

Imagine you are in charge of all the goods, resources, and services in the US. Now, you are charged with the task of allocating those goods among all the people subject to the condition that after you allocate, you could not make any one person better without making another worse. This conditions is a little stronger than making sure you allocate all the goods, its called the Pareto Condition. Consider the following reason.

 
 

One of your resources is Lake Michigan, and there is a factory located on its shore. It costs the factory $10 more to discard of its byproducts cleanly than to disperse them into the lake. On the other hand, the factory polluting the lake costs the fishermen $30 of lost fish. If you had allocated the goods such that you gave the water rights to the factory, you did not satisfy the Pareto condition. You could have allocated the water rights to the fishermen and then taken $11 from the fishermen to give to the factory. Under this reallocation you would have made everyone better without anyone worse off. The fishermen get $19 instead of zero. The factory disposes its byproduct cleanly, and makes $1.

 
 

Economics literally means "the study of the allocation of limited resources." Finding optimal allocations is not the difficult part of the process. The famous mathematician LaGrange gave us a very powerful tool for finding optimal allocations under constraints. If we had a benevolent social planner, he or she could take all the peoples' preferences and the resource constraints facing our country, simply apply Lagrange's method, and achieve the social welfare maximizing allocations.

 
 

Although some dictators claim they are benevolent social planners, no country truly has a benevolent social planner with access to a detailed Social Welfare Function, a hypothetical description of all peoples' preferences. Is it possible to achieve the same allocations that a perfectly intelligent and benevolent social planner would have chosen without such a social planner and without access to everybody's preferences?

 
 

Believe it or not, the answer is a glorious yes. The great Scottish economist Adam Smith conjectured that allowing potential buyers and sellers to freely meet in the market place and trade their goods until content results in Pareto allocations. Smith's conjecture was studied greatly. Finally, in the middle of the 20th century, it was proven that, with the exception of a few named market imperfections, free markets do achieve Pareto allocations without a social planner and without access to everyone's preferences: The Fundamental Welfare Theorem of Economics. To all but econ grad students, this may sound impossible, but it's true. To me, this theorem's characterization of market allocations is awesome.

 
 

With this useful Theorem in hand, and recognizing that omniscient and benevolent Social planners do not exist, countries faced a decision. Do they institute social planners, and give them powers to dictate to their citizens in hopes of eventually achieving social planner-like allocations; or 2) learn how to correct the market perfections, leave all freedoms and liberties in the hands of the citizens, and allow the marketplaces to flourish.

 
 

Many nations chose the former option. It was a formidable challenge. With teams of brilliant physicists, mathematicians, and economists studying optimal allocations they still often fell short. Those of you in my generation may recall images on TV of ultra-long lines at Soviet bakeries. First the USSR had under allocated baking ovens, under allocated distribution venues for the bread, and sometimes hadn't grown the proper combinations of flour and yeast to make bread efficiently. They suffered surpluses in some commodities, and shortages in other. Dictating all the commodities in an economy is an overwhelming task. There is no doubt that the soviets tried very hard, but also that politics and personal preferences also get in the way efficient planner allocations. Today many nations continue to try the command economy. Some have realized it is absolutely impossible to govern all commodities, and so they have decentralized some, but retain control over as many as possible. These countries are characterized by large governments, high tax rates, and few small businesses: examples include, Cuba, Venezuela, North Korea. China is an example of a country which has persevered and is actually realizing decent allocations for their people, although their people still do not enjoy all the freedoms and liberties of a decentralized economy.

 
 

Alternatively, some nations chose option 2, learning how to correct market imperfections subtly. The objective for these nations was to have a government that stood only to correct the market imperfections. With markets corrected, individuals can go to their marketplaces, trade and acquire Pareto allocations, all while preserving individual liberties and freedoms (no extraneous government dictations over their actions). This was the idealistic goal of the United States who led the charge and supported other nations who wanted to participate in the glamorous experiment. The US has definitely not been perfect in their implementation of this ideal. Politics and breakdowns in our system of government has ignored some of our citizens and over represented others. The result of these political breakdowns has often been imperfect market solutions biased for the over-represented special-interest contributors, and has held our country back from achieving the destined goal of Pareto allocations.

 
 

I do not intend to insult our form of governance, only suggest that there is some work left to do. Our constitution, in my mind, is the greatest document of all time. It has bound our diverse and challenged nation for hundreds of years. It is the longest standing charter of any nation, and also the shortest in length. It was written in 1789 by the polymath James Madison, before Adam Smith's auspicious conjecture. It has had to be amended (27 times in fact), and therefore is a working document for us to improve upon as new economic discoveries are made, but the constitution itself is what authorizes it to be amended. Let us not shirk on our responsibility to continue the journey of crafting the constitution so that US citizens can enjoy Pareto allocations all while fully enjoying individual liberties and freedoms.

 
 

 
 

 
 

 
 

finger shoes

http://www.vibramfivefingers.com/

Have you seen anybody running in those new finger shoes, the shoes
with sleeves for each toe?


I got a pair to try them out after the article in Runner’s World.
The idea is basically a really light track shoe with toes separated.


They look really weird, but I love them.
I feel my whole stride changing, muscles in my feet, ankles, and
calves getting stronger.
My stride got a lot more ginger (probably because they don’t have
nearly as much cushion).
Also, I feel that I am running on the outside of my foot a little more
and rolling over the ball of my foot like I’m supposed to.
And, I’ve been able to use my freakish toes to push off on every
step.
That’s why I think my calves are a little sore.


Altogether, feel a lot stronger and faster. I’m a big fan.
Interested on if you’ve tried them, seen them, or heard any reports.


Previously crippled by cushion,


NM

RE: Bailout

116 "academic" economists signed a petition against the bailout. stating this is all "fabricated" by wall street.  What say you ?

 
 

Very divisive issue.

Almost all economists are adamantly against, except the most democratic Keynesians.

The surprising factor is that Bernanke endorses it.  He endorsed it even as the original Paulson plan.  Really weird.

But, the fact that he endorsed suggested that it might have merit because just about everyone respects Bernanke.

I talked to one of our most respected professors in monetary policy the other day, and he said that Bernanke is endorsing it because he did his dissertation on the Great Depression, is afraid that the cosmos is realigning, and doesn't want it to happen on his watch.

 
 

Even with the latest version of the plan, there are ample problems.

Democrats demand equity stake in the companies, but this will have very specific problems in the future as the government tries to auction off its t-bills, but will have bias towards the bidders to which it holds equity stake.  Very touchy.

 
 

The good news is that the house voted down the bill endorsed by democrats and the administration might be signaling that the Republican party is actually coming back to its platform of minimalist government intervention and divorcing itself from the current administration. 

Or, since it looks like the Fed and world bank and …. are going to cover the bailout anyway, they may have voted it down in a surreptitious move to prevent the Dodd-plan regulation in the banking industry and still steal $700B.

Your guess.  Are you optimistic or pessimistic about House Republicans.

 
 

The only real solution is, we should never have gotten in this mess in the first place.  Where the hell was the SEC?

 
 

 
 

 
 

PolCo Video

3 Loopholes

James Madison is to me the hero of heroes among our founding fathers. He wanted to achieve a single objective; align the interests of the ruling policy makers with the interests of the general citizenry. His intended solution was to make the citizenry the ruling policy makers.

Given the communication limitations of his time, implementation of his plan had the citizens democratically elect a representative. Madison required the representatives to then be subject to frequent re-elections so that if the citizens believed their representative was not accurately representing their interests, he or she would be replaced by another candidate.

Madison wrote our constitution trying to ensure citizens interests would always be represented in the policy decisions. The antagonist of this objective was any group that might achieve power and then exercise it to retain power so that they could influence policy decisions for their own interest.

Madison called these groups factions, realized they were always circling the peoples' government looking for an opening, and therefore he had to make the Constitution, the foundation of our government, ironclad to their devices. For a more in-depth description of Madison, Alexander Hamilton, and John Jay's attempts to make our government impenetrable to factions and protect our policy from manipulation by a ruling minority, see The Federalist Papers.

The great news is that the resulting Constitution is the longest-running basis-of-power document for any standing government. Equally impressive, it is also the shortest in length. Our Constitution has stood the test of time, the challenges of a large, growing, and diversified nation all while providing its citizens unprecedented liberties. It has had to be amended, but remember, it grants power to amend itself in a peaceful method.

Now, 219 years later, if we look closely at its hull, there are at least 3 fissures; loopholes that have begun to allow the entry and proliferation of destructive factions. These vulnerabilities are known about, but are not necessarily easy to solve, especially by a governing body suffering from their effects.

These Constitutional loopholes that allow for culmination and abuse of power to effect policy for private interest are 1) Campaign Finance, 2) Gerrymandering of electoral districts, and 3) Committee-member ranking incentives.

I will attempt to explain each of these Constitutional fissures in turn in following posts.

What's wrong with Cheap Insurance?

In continuation of 2 posts prior, Securities Trading: The Wild West.

I suggest that there is a problem with cheap insurance, in addition to the problems caused by lack of regulation in securities markets.

The problem with cheaper insurance is that people will buy more insurance, and thus our economy will suffer more from the 2 market failures caused by insurance: Moral Hazard and Adverse Selection.

Moral Hazard is the change in behavior caused by insuring. If I have health insurance, I will go to the doctor more often and incur higher health expenses for my insurance provider than I would have had if I were directly responsible for my own health expenses. If I have car insurance, I will be more likely to take a few more risks on the road. Or, if I am a company and am insured under higher costs, then I will take less effort to ensure lower future costs.

Due to private information, information unavailable to the insurance provider, individuals and corporations act slightly less responsible when they are insured. Unfortunate, but true.

Adverse Selection is the tendency for a disproportionate amount of those in need of insurance to buy insurance. Those who are unhealthy or have indications that they will be sick buy more health insurance. Health insurance providers try to control for this fact by analyzing your families medical history and charging you a higher premium if there is indication that you will suffer illness and cause them higher costs. Corporations that have inside information that their profitability will decrease are more likely to insure themselves by selling securities.

Again, due to private information, information advantage of the individual or corporation, insurance providers are at a disadvantage.

The moral of the story is that while it is good that companies have found cheaper means of insuring against risk through the securities markets, the proliferation of insurance does carry a non-negligible cost. More insurance means more moral hazard behavior (less rigorous investment in the future by corporations) and more adverse selection (more junk bonds/ more securities that wind up being worthless).

Identifying moral hazard and adverse-selection behavior econometrically has long been a daunting task. It requires estimation of a system of stochastic simultaneous equations. Progress has been made however, and as can be seen in my Public Finance project on Health Care (http://mastroresearch.googlepages.com/ , (private info in health care, on the right side)), is now identifiable.

Using similar techniques adapted to the securities markets, I believe that it can be shown that corporations trading a higher volume of securities experience lower stock returns. Similarly, in the field of International Finance, I purport that countries trading a higher volume of securities experience lower growth.

Overall, cheap insurance is good, but more intricate contract terms (like HMOs have implemented in the health insurance market) or regulations are needed in the securities markets to prevent our economy from taking two-steps forward and one-step back.

WorkOut

Somehow I forgot to post this.

Earlier this month, Bobbie and I stopped by Whole Foods downtown Austin for a breakfast Taco after a Saturday morning workout. Later that day Bobbie had plans to go to the Austin fitness expo to see TV workout celebrity from Bravo, Jackie Warner. http://www.jackiewarner.com/

Anyway, on our way out of the store, as Bobbie was looking at some stand at the checkout, I see this lady come walking in with an interesting unique/familiar look and quite the air of confidence. Jackie walked right by us.

Just something weird about seeing celebrity personalities right next to you.

Securities Trading: The Wild West

The recent world of Securities Trading is a very dangerous place; a modern day equivalent of the wild west, very limited law and enforcement.

Everyone wants to 'hedge their risks' with securities. Banks, ibanks, hedgefunds, and companies themselves are choosing to insure in a more sophisticated and inexpensive way than the traditional insurance provider. Why pay the premium?

Every company has risk. For example, Delta Air Lines will lose profitability when oil prices rise.
Delta could take out an insurance policy that says
"in the case that oil goes up at least $4/barrel, I want to be covered for $10M."
A traditional insurance company would say "sure, let's calculate what that would cost."
If the acknowledge probability that oil will go up $4/barrel is 20%, then we expect that will cost us $2M.
Plus, we charge a standard 6% premium, so that insurance policy will cost 2x1.06=$2.12M

Or, Delta could insure through selling securities: derivatives of its stock.
If oil does not go up, Delta expects its stock to sell at $10/share.
If oil does go up, then Delta expects its stock to sell at $9/share.
Given the 20% chance of oil going up, you would expect Delta shares to be selling today for $9.80

To insure through securities, Delta could sell it's stock today with the condition that

if oil does not go up, they will buy it back from you for $10.20
and if it does go up, then they will buy it back from you for $8.

If Delta can sell 10 million of those derivatives, it gets the same insurance as the policy offered for 0 premium, saving $120K.

Even if Delta sold the security that

If oil does not go up, they will buy it back from you for $10.21

And if it does go up, they will buy it back from you for $8

And they sold 10 million of those, they are getting the same insurance policy for $2.1M and saving $20k.

Everybody except the insurance company wins. If you buy that security, you expect a 5% return on average, and Delta saves $20k.

Delta can actually do even better.

If an oil company happened to come around, then Delta might even get the insurance for a negative premium.

Since, if oil goes up, oil companies do better and if oil goes down, they do worse, Delta and the oil company happen to compatible conditions to mutually insure.

If oil goes up, Delta doesn't do well but the oil companies do.

If oil doesn't go up, oil companies don't do well, but Delta does.

Thus, the two companies could work out an arrangement to ensure that they both get insured at a 0% premium.

It's not always easy to find just the right company or combination of companies that would provide your mutual insurance. Then, you go to a bank, ibank, or hedgefund. They'll provide the service for you for a small cut. And the same idea goes for virtually every market, not just oil.

Consider a Countrywide selling mortgages for an interest rate. There's a good chance that the home-buyer will default, in which case Countrywide will not be profitable. Let's not insure against that risk for a 6% premium, let's sell a derivative of our stock through a hedgefund who can find a buyer with mutual insuring conditions.

So, what's the problem? As a libertarian I'm sorry to say, the problem is inadequate legislation.

These "securities" are really very risky assets. Yes, they act as insurance for the selling company by securing a less volatile financial future, but for the buyer, they are risky. People and companies buy $millions worth of these risky assets, and sometimes the buyer's losing side materializes. Many times, people can't cover their losses. They had bought more risk than they could afford and have to file bankruptcy. In this case, everybody loses. The gambling buyer is bankrupt, and they company who wanted insurance, is no unable to get paid. Sorry.

The problem really is as simple as this. Sure, the situations aren't usually just two cases and therefore the probabilities and prices aren't always easy to figure out, but people do (this is the heavy math of financial engineering). I remember reading a while back that Tim Geithner, president of the New York Federal Reserve Board, was fighting for a piece of legislation to get more accurate auditing of financial portfolios and prohibit the purchase of assets that the buyer would be unable to cover in some case.

The volume of derivatives traded is enormous and the turnover is very fast. Consider what happened to Delta. They had a good size of securities for the case of an increase in oil. They buyer resold the asset and the same thing again. When it was time to collect, it was found that the company now holding the derivatives was bankrupt and could not be collected from. Delta had counted on that insurance, and eventually had to file bankruptcy themselves. An unfortunate domino effect with negative implications for our economy, all of which could have been prevented with a simple piece of legislation authorizing more accurate portfolio audits and prohibiting the purchase of excess risk.

There is actually a second problem with securities trading, but I'll save that for another post.

Golden Flow

This week I was called in to meet the new Colonel in charge of UT AF Rotc. After our meeting I was informed that I was randomly selected for urinalysis (golden flow). Since the usual monitor wasn't available, I had to drive the gold government minivan 1.5 hours to San Antonio to have my urine inspected there.

I thought that it might be useful to check to see if any of the state office building in Austin required drug testing, but that search was not fruitful. Further, there's an Army National Guard Post in Austin, I thought they might perform the test there. I was told that they might, but it's not guaranteed that the Army standards are the same as the Air Force standards.

Anyway you cut it, I had to make the drive and hold my urge. Mission accomplished (but barely)

Teachers vs Peers

I've been meaning to post this little tidbit for a while now. It was presented to us at the UT Econ department this spring, and is quite appropriate now that I have been assigned to be an instructor at the Air Force Academy next fall.

In a study conducted by USAFA Ecnomists including the famed Col Fullerton, and an Economist at UC Davis (who previously was an officer instructor at USAFA), it was determined that the "effect that close-knit peer groups" (USAFA Squadrons) is double "the effect of the quality of instructors" on cadets' academic success.
Moreover, it was found that the best predictor of the quality of peer-group quality was their SAT verbal scores.

What is this information good for? Well, i believe the economics department was charged with configuring the optimal squadron groupings for incoming freshmen. So, it depends. If the academy favored having some extremely successful cadets and some really lousy cadets, they would cluster high SAT verbal students together. If the academy favored having a cadet class with great equality (low variation in academic success), then they would make sure to spread the SAT verbal talent around uniformly.

ND Football 07 & Contract Failures

In economics,there is a topic called "contract theory." One particularly important result of Contract Theory states that when two parties enter into a contract (for example one firm hires the products or services of another firm), if the new relationship requires any relationship specific investment, then there is an optimal contract duration.

For example, if coal-mining firm enters in a contract to supply a coal-burning power plant with coal and the power plant will benefit from investment in its factory to tailor its coal-burning process for the type of coal its new partner is supplying, then the two parties would benefit from specifying that their relationship is guaranteed for some particular duration, and early termination by a party incurs a penalty.

To see why, imagine that the two parties agree to maintain their relationship only for a period of time less than the optimal duration. The power plant will not be incentivized to fully invest in the relationship specific assets needed to get the most from the coal. The power plant will therefore get less profit from each unit of coal and therefore not be willing to pay as much to the coal supplier as if they contracted for a longer duration.

There is still a problem. Suppose that the coal-provider and the power-plant contract for the optimal duration. If relationship specific assets depreciate at all, the second after the contract is initiated, from the power plant's perspective, the remaining duration no longer warrants the same degree of relationship specific investment. The power plant will choose not to invest in replacement of depreciated relationship specific assets.

How do the two parties perpetually stay on the margin, always keeping the optimal contract duration in the future. The answer is a continually self-renewing contract, the Evergreen contract. Instead of contracting for a fixed duration, the parties contract to remain in the relationship until one party calls for termination at which point, after a fixed length of time the contract is over. This way, a sufficient amount of duration always remains on the horizon to justify optimal investment in relationship specific assets.

There are many industries in which Evergreen contracts are prevalent and often the norm. Restaurants hiring wait staff generally require a 2-week termination notice. Some people think that the time is so that the restaurant can find and train replacement (which is partially true), but a major reason is so that the restaurant can be justified to provide the wait staff proper training, development of a special relationship specific, the wait staffs knowledge of the restaurant. Evergreen contracts have also become popular in oil and oil-service contracts.

Perhaps Notre Dame' s Athletic Director could benefit from practicing some contract theory. Kevin White's problem is not contracting for too short a time period, but for longer than optimal duration. Who can really blame Charlie Weiss for looking past the near term, either consciously or sub-consciously? When you are provided with a 10-year contract extension, over investment in relationship specific assets becomes a real problem in the near term. You begin to redecorate your office, make sure your child is in the right school district, you treat your staff more congenially, you revamp your recruitment travel process all because you know you will be benefitting from these actions for the next 10 years. Yeah, these actions should pay dividends in the future, but the near term performance is gonna suffer.

It would be nice if ND football could be awesome today, and awesome tomorrow. Maybe it could be if ND's AD offered Coach Weiss an Evergreen contract. We would be getting that type of season that we will be getting in 5 or 6 years today and every year onward. Let's just hope that our near-term suffering isn't bad enough to drive away recruits for the long-term. Luckily it hasn't appeared so yet. Since NBC doesn't Evergreen contract with ND, we're able to get recruits who want to be seen on tv for the next 5 years even though we were abysmal last year. Two wrongs can sometimes make a right.

There are plenty of other explanations for ND's season last year. Coach Weiss wasn't acclimated to the college scene and ran the program too much like a pro program the first year and never developed his youth… All are probably true, but I just wanted to lend an economic perspective to the discussion. There is a pattern of behavior there. Coach Willingham's contract didn't end up being optimal duration either.