Krugman's Logic Death Spiral

One of the fundamental tenets of economic logic is that the farther away one gets from the simple relationship of a consumer paying directly for a good, the more the economic calculation for such exchanges becomes muddled. Thus it is with health insurance.

Think of it; most of us receive insurance from our jobs. We pay a premium, our employer pays part of it, which goes to the insurer, and then the insurer pays the doctors, does the negotiations, sets the standards, etc. This is a recipe for permitting costs to get out of control.

One of the fundamental tenets of Austrian economic theory is that the factors of production gain their value from the value that consumers place upon the final product. (Carl Menger spends a lot of time on this point in the first two chapters of his ground-breaking 1871 classic, Principles of Economics.) It is not hard to see that the way health insurance today is structured, that it is a recipe for out-of-control costs.

Paul Krugman has been writing on health insurance and economics for many years, and from what I have been able to tell, his main points are as follows:

• Health insurers are greedy and raise premiums because they are greedy;
• Health insurers can only make money by denying coverage;
• Medical costs rise because doctors and insurers are greedy;
• Only government price controls and regulation can ensure that medical costs will be low and medical care will be abundant for everyone.

Now, if one sees some internatl contradictions in this whole scenario, well, that person is applying simple logic, something that is missing from most Krugman columns. However, instead of making accusations against Krugman, let him say things in his own words:

Sky-high rate increases make a powerful case for action. And they show, in particular, that we need comprehensive, guaranteed coverage — which is exactly what Democrats are trying to accomplish.

Here’s the story: About 800,000 people in California who buy insurance on the individual market — as opposed to getting it through their employers — are covered by Anthem Blue Cross, a WellPoint subsidiary. These are the people who were recently told to expect dramatic rate increases, in some cases as high as 39 percent.

Why the huge increase? It’s not profiteering, says WellPoint, which claims instead (without using the term) that it’s facing a classic insurance death spiral.

Bear in mind that private health insurance only works if insurers can sell policies to both sick and healthy customers. If too many healthy people decide that they’d rather take their chances and remain uninsured, the risk pool deteriorates, forcing insurers to raise premiums. This, in turn, leads more healthy people to drop coverage, worsening the risk pool even further, and so on.

Now, what WellPoint claims is that it has been forced to raise premiums because of “challenging economic times”: cash-strapped Californians have been dropping their policies or shifting into less-comprehensive plans. Those retaining coverage tend to be people with high current medical expenses. And the result, says the company, is a drastically worsening risk pool: in effect, a death spiral.

So the rate increases, WellPoint insists, aren’t its fault: “Other individual market insurers are facing the same dynamics and are being forced to take similar actions.” Indeed, a report released Thursday by the department of Health and Human Services shows that there have been steep actual or proposed increases in rates by a number of insurers.

In economics, we have another term for what is being described: adverse selection. That is a common problem with insurance, and there are no perfect solutions, since people either will become sick or have accidents or have their houses burned down. That is life. Furthermore, with insurance, any insurer that does not try to control its costs is going to go bankrupt. (The Great Chicago Fire of 1973 was a classic example of the Worst Case Scenario, as a number of insurance companies went under because they had so many claims.)

Now, at one level, Krugman is correct. If we are going to use health insurance as a payment plan for nearly ALL health-based activities, and if health insurance is going to be the gateway for most care, then those who don't have insurance are going to find it more difficult (but certainly not impossible) to receive medical care.

However, what does Krugman suggest? It is something akin to taking the "hair of the dog" when one has had too much to drink. His "hair of the dog" theory of health insurance goes like this: Health insurance is too expensive and is not readily available, so the cure is to have the government impose price controls and provide "insurance" itself, and then everyone will have abundant care.

I don't think so. If, as the Austrians note, the problem is one of economic calculation, throwing even more distance between the consumers and providers of medical care will not solve anything, but, rather, make the problem worse. Yet, that is precisely what Krugman is demanding:

What would work? By all means, let’s ban discrimination on the basis of medical history — but we also have to keep healthy people in the risk pool, which means requiring that people purchase insurance. This, in turn, requires substantial aid to lower-income Americans so that they can afford coverage.

And if you put all of that together, you end up with something very much like the health reform bills that have already passed both the House and the Senate.

What about claims that these bills would force Americans into the clutches of greedy insurance companies? Well, the main answer is stronger regulation; but it would also be a very good idea, politically as well as substantively, for the Senate to use reconciliation to put the public option back into its bill.

Let me translate. The "solution" is more coercion and government-induced price controls. I think that "solution" speaks for itself.