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Why Do We Want Prices in Health Care?

Other governments use fiat to set prices in the health care market. I talk to economist Bart Wilson about the potential pitfalls.

A couple of days ago I fell to talking about price-setting in health care with a certified Very Smart Economist. Bart Wilson is the Donald P Kennedy Professor of Economics and Law at Chapman University, where he works with Vernon Smith, the chap who won the Nobel Prize for helping to invent experimental economics.

We had both watched the same web video, where certified Very Smart Health Care Wonks Ezra Klein and Sarah Kliff argued . . . well, conversed . . . in favor of some sort of central rate setting to control health care costs.

Bart’s research focuses on building virtual markets in his lab, which means that he spends almost all day, every day, thinking about prices: how markets find them, and what they do. He’s not a health care wonk, but a market wonk, someone who thinks a lot, and deeply, about the mechanics of getting markets to allocate resources efficiently. So I asked him to spend a couple of hours on gchat talking about what prices do in markets, and why it’s not so easy to set them.

Of course, we’re vulnerable to the charge that this is all airy fairy theory and models, far removed from the real-world nitty gritty of health care markets. But Wilson and Smith’s models have serious real world implications—for example back in 2000, they predicted the meltdown in the California energy markets before it happened. Sometimes it’s useful to pull back a little from the specifics, and think a little bit about the deep principles that govern how those specifics work out. So what follows is an airy-fairy, theoretical, very useful discussion of the role that prices play in markets, including health care.  It's been edited slightly to enhance readability.

Higher Education Bubble

The Hidden Trap of Income Based Repayment

It sounds like a great deal . . . until you get the tax bill.

In 2007, the Bush administration pioneered a new approach to student loan debt: income-based repayment.  The idea was that you'd pay some fraction of your income every year for 25 years, and then any balances would be forgiven . . . which is to say, the government would pay them off.  

Some version of this has been proposed for decades (usually with the idea that private equity types will buy stock in your future income).  But it's never really gone anywhere, because the moral hazard issues are obvious: you're encouraging people to run up a bunch of debt and then take a relatively low-paying job.  

But with more and more people drowning in student loans, the administration was willing to try something.  They passed IBR in 2007, and a couple of years later, the Obama administration lowered the income limits--you now only have to pay 10% of your income if you qualify.  

Is this going to cause students to load up on un-repayable debt?  Too soon to tell.  But there's one thing that's in little doubt: in about 25 years, the government is going to be on the hook for some huge loan balances, particularly for graduate professional education--architects, lawyers, vetrinarians and so forth who never hit the big time.  

Euro Crisis

Euro Crisis: Reheated

Italy's elections make default look more likely. But not without consequences.

The Italians are fed up with austerity.

No real surprise here, of course; everyone in Europe is fed up with austerity, except the people who are still lending money.  And since moneylenders are not a majority of the Italian electorate, the result is what we saw a couple of days ago: an Italian election that delivered gridlock.  Italy now has a divided government whose only mandate is to make the pain stop.  

Naturally, markets freaked out, because unlike Greece, Italy is actually in a position to do so.  The country has been running a "primary surplus" for a while, which means that if you strip out interest payments, the budget more than balances.  Since Italy does not need a cash infusion from Germany to keep its current level of government surpluses, the third-largest economy in the eurozone has two options open to ease its current misery: default on its debt, or withdraw from the euro, and let devaluation vaporize much of that debt's face value.  

This would not only relieve their debt burden, but might also give the country a bit of an economic boost.  For many years, Italy maintained its competitiveness by serial devaluations.  The favorable exchange rate made it possible for relatively inefficient, often family-owned, firms to sell quite a lot of product abroad.  That's why many of my readers probably own Italian furniture or leather goods.  Entering the euro improved credit conditions, but at the cost of manufacturing competitiveness.  Exit might give them a nice export boost, relieving some of the crippling unemployment currently afflicting Italian workers.

Ask the Blogger

A Declaration of Financial Independence

Emergency fund or investment? Do I need to diversify my retirement accounts? And how to save money on food?

Dear Blogger:

I am a recent college grad (23 years old) with about $20K in student loan debt, which I am paying off fairly aggressively. I have about $2K in a savings account and just began contributing to my 403(b).

1. Do you think it's smart to contribute, even though I am still in debt? I plan to invest in an index fund or something aggressive since I have lots of time.
2. Do you think I should invest $1K of my savings account money into the stock market? (Knowing full well that I would have to leave it alone for at least 5 years.)

I am not so worried about having a 3 month salary cushion as I could always move home if I get fired.

Dozens of teenagers mobbing stores for a simultaneous shoplifting spree. How are merchants supposed to defend against this sort of mass attack?

Last night, someone in my neighborhood sent a query to the police district listserv:

Around 11PM, I was out with my dog and there was an ambulance transporting a victim from the 7-11. There were no less than 8 police cars marked and unmarked and police behind the counter looking for something and police outside with flashlights looking for something.

One office announced that 7-11 was closed to some teens that were trying to go in there.

Was this a shooting or a stabbing or what? Has anyone been caught?

The Cleveland Clinic

The Cleveland Clinic in Cleveland, Oho. (J.D. Pooley/Getty)

Salaried doctors. Great care. The administration used them as a model and a goal for Obamacare. But will it work outside of Cleveland?

"The best doctors are not motivated by money."  It's a common sentiment (this particular example comes from the comments section of Felix Salmon's blog, but you see it anywhere that doctor salaries are discussed.)  

We all seem to believe it.  And yet, we don't act on it.  When we get sick, we don't head straight for the nearest county charitable hospital; we head for the biggest, shiniest facility we can find, one where the doctor's parking lot is full of luxury automobiles.  The implication is that we do think good doctors are attracted to money, same as the rest of us.

Perhaps as a result of this belief, American doctor salaries are some of the highest in the world.  And there's quite a lot of dark suspicion that the desire to get paid drives a lot of bad health care: that doctors do procedures because they are lucrative, rather than because they are best for the patient.  Nor is the suspicion limited to doctors.  Steven Brill's 22,000 word article in TIME points the finger at hospital administrators and device manufacturers, among others.  The gist of the expert consensus is that as long as we're willing to pay for whatever they decide to do, health care is going to cost an exorbitant amount of money.  

But what if we actually did take money out of the equation?  What if we put doctors on salary and substituted relentless cost-control for "anything goes"?  


Can Barnes and Noble Be Saved?

The founder wants to buy the company back. Why?

Leonard Riggio, the founder of Barnes and Noble, wants to buy his company back.  Or at least the retail parts.  Matt Yglesias notes that this seems to suggest that the Nook is doomed; it may be a good product, but it can't compete in a space crowded by Amazon, Google, and Apple.  I think he's right.

But I'm not sure the retail stores are a much better business.  When I looked at the Big Box market last fall, I emerged deeply skeptical that anything can be done to save that particular business model.  Not with the floor space that these stores have.  Stores like Best Buy and Barnes and Noble used to be the leaders in both price and selection (which is why they put so many smaller stores out of business.  Now that leader is Amazon.   And I don't see any way for either company to get that title back.  Amazon's giant warehouses afford it huge economies of sale, but they're also cheaper to operate simply because they don't require smiling employees, inviting decor, and prime locations.  They're on dirt cheap land in the middle of nowhere, and the goods are packed in endless rows, and the employees can be driven to previously untold heights of productivity.  Eventually robots may let the company get rid of most of those employees, too.  

These companies are going to have to reinvent themselves, but that's very difficult to do with all that expensive, prime real estate sucking up cash and attention.  It will be even harder if they do an LBO.  If I were Mr. Riggio, I'd go back and try to reconceptualize the bookstore from scratch, starting small and expanding as needed, rather than trying to salvage the brilliant idea of three decades ago.  On the other hand, I don't have a successful company to save.

Friday Forum

Upgrading Ain't What It Used to Be

Why are people so desperate to have the very latest Apple device?

Apparently, a Brazilian group is actually suing Apple because the iPad 4 is too awesome.  No, seriously.  They're mad that they went out and bought iPad 3s and now the iPad 4 is better and Apple should just have not made the iPad 3 so that they'd have waited to get a 4 and . . . seriously?  

I mean, forget the incredible entitlement of this argument . . . "Apple made an iPad 3 which is basically just the same as conning grandmothers out of their life savings with fake charities!"  I've gotten over that.  Whiny self-entitlement seems to be what the internet is for.  No, what surprises me is that there are still people getting caught up in the Apple upgrade cycle.  That feels so 2007, you know what I mean?  

Of course, I would say that: I use an iPad 1, which might as well have been carved out of a block of flint as far as the Fast Cyclers are concerned.  In my defense, we bought this iPad on our honeymoon, and I'm rather attached.  Okay, also I am far too cheap to buy a new device while the old one is working fine.  

But that's the thing: it's working fine.  I read and play games on it.  I'm not trying to calculate the perihelion of Jupiter or do 3D renderings of the National Cathedral.  I barely even use it to check email.  

Health Care Costs

How Hospital Administrators Hide the Umbrella

Hospital pricing is famously opaque. And until we understand it, we'll have a hard time controlling costs.

Steven Brill has a long, long piece for Time Magazine on hospital pricing.  I'm still reading and digesting it, so expect more later.  But here's an excerpt that sums up the core of the piece:  

The total cost, in advance, for Sean to get his treatment plan and initial doses of chemotherapy was $83,900.


The first of the 344 lines printed out across eight pages of his hospital bill — filled with indecipherable numerical codes and acronyms — seemed innocuous. But it set the tone for all that followed. It read, “1 ACETAMINOPHE TABS 325 MG.” The charge was only $1.50, but it was for a generic version of a Tylenol pill. You can buy 100 of them on Amazon for $1.49 even without a hospital’s purchasing power.

Friday Puppy Love

The Economics of Puppy Management

Everything I needed to know about sales force compensation, I learned by getting a puppy

Last week, my home was invaded by a sort of intelligent alien with phenominal psi powers.  It not only seems to know what we are thinking, but more ominously, seems to be able to manipulate our emotions with a brutal precision that totalitarian brainwashing experts could only dream of.  It's not merely that we're being manipulated, but also that we crave its manipulation.  We rearrange our schedules so that we can spend more time catering to its every whim.

In short, we have adopted a puppy.  

Fitzgerald is almost 8 weeks old, and as cute as, well, an eight week old bullmastiff puppy.  With his melting gray eyes and inveterate desire to cuddle, he is the sweetheart of all right-thinking people, friend to the world . . . and the mortal enemy of hardwood floors.  How to get Fitzgerald house trained before the floorboards begin to warp?  

National Debt

Could US Debt Reach a Tipping Point?

How high is too high?

How much debt is too much?  Or more specifically, how much debt can a country take on before it risks hitting a "tipping point": the point where you risk spiralling into a vicious cycle of higher interest rates putting pressure on your budget, which makes the debt riskier and causes interest rates to rise further.

David Greenlaw, James Hamilton, Peter Hooper and Frederick Mishkin have a new paper out on this question.  Their answer is "80% of GDP".  Neil Irwin has a very good summary, as well as some useful critique:

Considering that the paper was presented at a monetary policy conference, and that its authors include a former Federal Reserve governor (Mishkin), it seems not to grapple enough with the crucial difference between the United States and many of the countries that are among the nations included in the historical analysis the paper is based on. Almost all of the countries that have experienced major financial crises in the recent past have in some way lacked control over their currency. For Greece and Ireland, that is because they use the euro, whose value is determined by the European Central Bank, the value of which is better suited for Germany and France than for those troubled peripheral European economies. In the East Asian crisis of the late 1990s, much of the damage came about because the countries involved had borrowed money in dollars, so when the value of their domestic currencies fell they suddenly had more onerous debt burdens than they had expected.

So for the U.S. fiscal picture to be as dangerous as the paper suggests, one needs a story of how a crisis of confidence in U.S. debt leads to an outflow of capital and no offsetting effort by the Fed to ease policy, simultaneously strengthening growth and making interest rates lower. This paper doesn’t do that.

Higher Education

What's the Use of a PhD?

Can we remake the humanities PhD to have better job prospects?

I read with great interest a column by Michael Berube on rethinking the role and structure of the humanities PhD.  This is largely an internal discussion about fights in which I have no dog (except that I think that Berube and I are agreed that people shouldn't spend ten years toiling in poverty for a degree that leaves them with little earning capacity or job security when they are done.)  

So I read it mostly the way I read Derek Lowe's blog: with an outsider's interest in an insider's discussion of his own world.  

However, in one place Berube touches on a subject that I do know a bit about: the job market outside of academia.  It seems that in the absence of enough academic jobs for their students, graduate programs are talking about "alt-ac" (alternative to academic) routes for the people they train:  

The alt-ac option, as it is widely known, has generated much debate in the humanities, but so far little sense of what the viable "alternatives" to academic employment might be. The situation is vastly different in the arts, where M.F.A. or Ph.D. holders typically expect to find employment in a far wider array of cultural institutions than humanists—orchestras, dance companies, design companies, museums, theaters, nonprofits. But of course, the cultural institutions to which degree holders in the arts aspire are often in states of distress similar to those affecting universities, albeit for different structural reasons.

Education and Earnings

America’s New Mandarins

The paths to power and success are narrowing. So is the worldview of the powerful.

Yesterday, I wrote about the silliness of requiring a file clerk to have a college degree. This morning, a friend sent me the following note about the narrowing of opportunity in modern America:

Random thought inspired by the NYT article re: requiring BAs for everything and your post, especially the note about your IT team and their varied backgrounds, which is far less likely to be true today.

It seems to me that a similar version of that narrowing-entry option is occurring in many fields

You've written in the past about how the top banks have steadily narrowed the pool of candidates whom they'll consider - e.g., only 5-6 schools will even be looked at. A similar phenomenon has been occurring in law as well, and not just post-08 . . . even before the recession.

Not sure I have a handle on the larger meaning of it all: it just seems like a generalized phenomenon to me that entry pathways are narrowing all over

He also pointed me to a telling passage in Diary of a Very Bad Year, Keith Gessen's interviews with a hedge-fund manager:  

Higher Education Bubble

Higher Education and Earnings: Now With Graphs

There's a big premium on college degrees--but it's biggest at the top

In my last post, I mentioned the college earnings premium.  It's real, and it's huge.  Just look at the difference that education makes to earnings potential.  The difference applies to everyone from entry level workers to the highest earners; in fact, the top earning high-school dropouts don't average much better than the bottom-earners with advanced degrees:


You can see the big discontinuity between education levels: high school dropouts, high school graduates, and those with some college tend to be clustered at the bottom, while the incomes of the educated pull away.

Here's the data organized by educational level, instead of income quartile:

You need a BA to file papers. Is a master's in burger-flipping next?

Last September, I wrote a lengthy cover story asking whether a college diploma is still worth it.  In some sense, it obviously is--there's a substantial wage premium for college graduates.  But in other ways, it's very much an open question.  For starters, the marginal kids who we are now adding to college classes may not get the benefit of the degree: they're more likely to drop out, and less likely to have the complementary assets, like connections and social capital, that help maximize the value of your BA.  

More worrying is the way in which a BA is now becoming a minimum requirement for jobs that simply don't require any of the skills you learn in college: receptionist, file clerk, secretary. The New York Times has a lengthy article exploring this phenomenon through the lens of a law firm which requires everyone, even the lowliest clerical worker, to have a college degree:

This prerequisite applies to everyone, including the receptionist, paralegals, administrative assistants and file clerks. Even the office “runner” — the in-house courier who, for $10 an hour, ferries documents back and forth between the courthouse and the office — went to a four-year school.

“College graduates are just more career-oriented,” said Adam Slipakoff, the firm’s managing partner. “Going to college means they are making a real commitment to their futures. They’re not just looking for a paycheck.”

About the Author

Author headshot

Megan McArdle

Megan McArdle is a special correspondent for Newsweek and The Daily Beast covering business, economics, and public policy. A former senior editor at The Atlantic and writer for The Economist, Megan has a diverse work history including three small startups and a disaster recovery firm at Ground Zero.

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