June 2006

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Privatization of Roads

June 30, 2006 in Public Policy | Permalink

On Gary Becker and Richard Posner’s blog, there is a spirited debate regarding whether or not we should privatize roads in the United States.  The two focus on Indiana’s recent decision to sell the rights to collect tolls on the Indiana toll road to a Spanish-Australian consortium for $3.85 billion.  The Pittsburgh Post-Gazette reports in a recent article that “Indiana drivers and interstate truckers were almost uniformly against what the state has done.”

Some points made by Gary Becker:

  • “A very important part of this argument is that technological progress is faster with private monopolies than with public monopolies.”
  • “Due to economies of scale, it may not be efficient, for example, to have another highway built across Indiana to compete against the Indiana toll road”
  • Becker notes that a state government’s receive lump sum payments from private firms in exchange for the right to collect tolls on the road.  He does not, however, note that since most politicians are only in office for a limited time, the politicians will often go on a spending spree instead of smoothing spending patterns over many years.  This is likely not in the public interest.

Posner responds:

  • “Private companies are more efficient than public ones, at least in the limited sense of economizing on costs.”  Posner does note that often this can lead private monopolies to reduce maintenence on roads.
  • Posner, like Becker, worry that the private monopoly will set tolls at monopoly rates.  “Drivers who do not have good alternatives to using the Indiana Toll Road can be made to pay tolls that exceed wear and tear, congestion effects, social costs of pollution, and other costs of the road, engendering inefficient substitutions by drivers unwilling to pay those tolls.” Posner does note that the private company cannot raise tolls until 2010, so this may be less of a concern in the Indiana case.

Living in Southern California, I believe that charging tolls on freeways will 1) reduce congestion, 2) decrease smog and 3) make cities denser.  The public outcry would likely be great, but in the long run tolls would be good for the area.  Should the tolls be administered by public or private monopolies?  Some of the pros and cons are listed above, but as always, your comments are appreciated.

Off-label drug use is…good?!?!

June 29, 2006 in Pharmaceuticals | Permalink

I claim that ‘off label’ drug use is good.  But according to a recent Forbes article “the practice is potentially risky, since three-quarters of these off-label uses lack scientific support.”  The article (“Off-label…“) claims that this practice is very common and that one in five prescriptions for drugs are for an off-label use.and effective.  If efficacy is shown for one disease, the company must re-run some of their trials at great expense in order to prove that the drug is effective for other diseases.  Because of this, pharmaceutical companies prefer to rely on their marketing team to explain alternative uses to physicians instead of obtaining explicit FDA approval.  Waiting for additional FDA approval would mean that many patients will go without treatment while the drug application is stuck in the bureaucratic process.    

A better alternative would be for the FDA to only require a drug to be safe.  In the UK, safety–but not efficacy–is the current standard for prescription drug approval.  This way, off-label uses would be out in the open.  Private agencies–such as Underwriters Laboratories–could certify that the drug is effective and an open debate could be held about which drug is the best, instead of having these decisions made behind closed doors.

One drawback to requiring only safety is that physicians may begin to over-prescribe some medicines.  If the drug is safe, but ineffective, the provider may decide to recommend it to patients simply to earn more cash.  The principal-agent problem would be strong since the doctor would not fear significant adverse effects since the drug was already considered safe by the FDA.  Thus, medical costs and unnecessary care could increase.  

Overall, however, I believe requiring safety only and allowing the market, physicians, and patients–instead of bureaucrats–to decide which drugs are the most effective will lead to a better healthcare system

HWR #10 posted

June 29, 2006 in Miscellaneous | Permalink

Health Wonk Review #10 posted at HealthNex.

Do we need specialty hospitals?

June 28, 2006 in Supply of Medical Services | Permalink

According to the Milwaukee Journal-Sentinel (“Orthopedic hospital…“), the Orthopaedic Hospital of Wisconsin posted profit margins of 52%.  The article claims that the healthcare industry generally only has profit margins of around 3%-5%.  Does this mean that the Orthopaedic Hospital of Wisconsin is providing highly valued services?  Is it good at cutting costs?  Or is it simply manipulating the system? 

In Health Affairs, Stuart Guterman (2006) analyzes how specialty hospitals currently operate.  He claims that cardiac most resemble the community hospitals people are accustomed to using.  These hospitals average 52 beds and typically have an emergency room.  On the other hand, orthopedic and surgical hospitals are much smaller.  On average they have sixteen and fourteen beds respectively and few have emergency rooms.

People who are concerned that specialty hospitals are bad for the medical field give the following reasons:

  1. Conflict of Interest: Most of these hospitals are physician owned.  It is possible that these same physicians are advising patients to have unnecessary procedures, simply because it is in their financial interest.
  2. Ignoring the poor: The Guterman study found that these centers often treated those who were richer and better insured.  Fewer Medicaid and uninsured patients are seen in these specialty hospitals than in community hospitals.  Although much of the specialty hospitals market share comes at the expense of community hospitals, Guterman did not find that this fact had a negative impact of the financial stability of community hospitals. 
  3. DRG Creep: Often the specialty hospitals are more profitable than community hospitals, even though MedPAC‘s analysis of 2002 data show that specialty hospitals do not reduce cost once we control for patient mix.  It is possible that the specialty hospitals are simply charging Medicare and private insurance for more lucrative procedures than they are actually preforming. 

Yet many people support the use of specialty hospitals.  Doctors often enjoy more convenient scheduling and more specialized equipment.  Patients may have lower travel costs if the smaller specialty hospitals are less concentrated throughout the city.  Further, overhead costs may decrease from having operations performed in the specialty hospitals than a community hospital (although this finding was not supported by the MedPAC report).  Ineffective specialty hospitals–such as the Heart Hospital of Wisconsin, which closed in 2004–can shut their doors without jeopardizing access to health for a community.  The decentralization of medical care may increase competition between providers.  Further, specialty hospitals have often been innovators in the medical field:

“Children’s hospitals have long been recognized as leaders in the development and delivery of health care to young patients and as assets to their communities and the nation; rehabilitation hospitals also are looked to as sources of specialized care for patients who are temporarily or permanently disabled; psychiatric hospitals address the needs of patients with mental conditions or alcohol- or drug-related problems that require short-term acute care; eye and ear hospitals are viewed as centers for state-of-the art treatment for eye and ear conditions; and a small group of cancer hospitals are generally regarded as being at the forefront of cancer treatment.”

As the trend towards more specialty hospitals continues, further research must be conducted to discover when these ventures are good for society.

Scotland’s Middle class to fund NHS care for poor

June 27, 2006 in Current Events | Permalink

In last week’s Scotsman (“Middle class…“), the National Health Service (NHS) said it would be transferring money from wealthier areas in the east (Edinburgh and Grampian) to poorer areas in the west.  These types of transfers are necessary for a stable society generally most people support some redistribution.  The question remains, why should the Scottish government be transferring bureaucratic money from one region to another?  For any transfer program, we must compare whether or not the program is better than simple monetary transfers to the poor.   

One justification cited in the article is access to care.  The NHS runs most of the medical care is Scotland and claims that the areas in the west are under-served.  On the other hand, if there was a more deregulated medical market, transferring money to poorer areas would increase a doctor’s incentive to move to those areas since the move would now be more lucrative. 

Another justification is paternalism.  In the article, one un-named insider states:

“I you take people in the leafy lanes of Dowanhill or Morningside, they don’t need to be told what needs doing. They know it and they have the personal means of tackling it.” 

This implies that poor people do not know how to take care of themselves, which I do not believe.  Later the insider claims that the poor do know how to tackle their healthcare problems, but do not have the financial means accomplish this.   

Both of the previous reasons I believe are not valid justifications to use bureaucratic transfers of funds in lieu of direct monetary transfers.  One good reason is the “tagging” argument (see June 14th post).  If those who are medically needy are the ones that use the free medical services, than this could be more efficient.  On the other hand, if many people who otherwise would use private health insurance decide to use the free medical services because it is now of a higher quality, it would decrease efficiency.

Why would a person not want to use a free good?  The two main rasons are that 1) there is a time cost of waiting to see the doctor for one’s free medical service and 2) one offers suffers pain or at least discomfort during many medical tests.  These are the difficult decisions which must be made when a nation’s medical care is organized by a central authority.

Healthcare Economist on Vacation

June 19, 2006 in Miscellaneous | Permalink

The Healthcare Economist is going on vacation to his hometown of Milwaukee.  Posts will resume next week.

Mandated Maternity Benefits

June 18, 2006 in Academic Articles, Public Policy | 3 comments

In many cases, the government will mandate that employers provide benefits in lieu of having the government provide the benefit themselves. One example is that the U.S. government mandates that firms purchase Worker’s Compensation insurance. Are these mandated benefits a more or less effective form of social insurance than direct government provision?

Summers (1989) claims that in certain cases, the mandated benefits are welfare improving in comparison to public provision. There are two main reasons for this. First, compelling employers to provide a benefit gives workers a wider choice of benefits–through worker choice of employer or employer-employee negotiation–than if a program was administered by the government. Secondly, the mandated benefits may result in a lower deadweight loss than if the government imposed a general tax and used the funds to finance the benefit. For instance, mandated workers compensation may reduce labor demand by firms (since this is an added cost), but may increase labor supply by workers if they want the benefit. If employees value the benefit at cost, the resulting equilibrium will result in the same level of employment but with the full cost reflected in a lower wages. On the other hand, workers generally do not increase labor supply in response to general taxes to fund public programs since they do not see a direct link between the tax and any benefit they may receive.

Gruber (1994) tests whether or not mandated maternity benefits are captured in lower wages for the affected group. The author claims that if there is not a shifting of the maternity insurance cost to employees, either the employees do not value the benefit or there are wage rigidities impeding wage reductions. He uses variation in state laws between 1975 and 1978 as well as the Pregnancy Discrimination Act (PDA) passed in 1978 by the federal government to identify any wage reduction. A difference-in-difference-in-difference (DDD) is used where the treatment group are married females between 20 and 40 years of age, and the control group is made up of all individuals over 40 years old as well as single males between 20 and 40 years old. Gruber estimates the before and after impact of state and federal laws on these two groups. He then compares the DD results between states where the laws were passed and states where no law was passed to calculate the DDD estimate. Employing a variety of specifications, Gruber finds that the cost of the mandated maternity benefit is fully reflected in lower wages for the ‘treatment’ groups. If we extrapolate this to a proposal which would mandate provision of health insurance by employers, one would expect the cost of the mandated health insurance to be fully reflected in lower wages.

Summers (1989) does note that there are a few problems with mandated benefits. First, they only help those who are employed. Secondly, if there are wage rigidities, then the cost of the benefit can not be reflected in wages and thus, unemployment may result. Finally, with mandated benefits the government is not able to pursue redistributional goals.

Summers (1989), “Some simple economics of mandated benefits,” American Economic Review, 79, pp. 177-184.

Gruber (1994), “The incidence of mandated maternity benefits,” American Economic Review, 84(3), pp. 622-641.

Health Wonk Review #9

June 16, 2006 in Miscellaneous | Permalink

Health Wonk Review #9 is posted at the Workers’ Comp Insider blog. 

Private Information and Long-Term Care Insurance

June 15, 2006 in Academic Articles, Health Insurance | Permalink

‘Adverse selection’ and ‘moral hazard’ are phenomenons which affect any analysis of the insurance market.  For instance, Cutler and Zeckhauser (1997) speak of an adverse selection ‘death spiral’ which made untenable the continued offering of a generous health insurance benefit at Harvard University.  In their NBER paper, Finkelstein and McGarry (2003) attempt to estimate the effect of private information in the long-term care insurance market. In 2000, the authors state that long-term care expenditures in the U.S. comprised 7.5% of all medical expenditures and 1% of GDP for a total of $100 billion.  Thus, analyzing this segment of the health insurance market is non-trivial and it will only increase in importance as baby boomers continue to retire in larger numbers.

The first item Finkelstein and McGarry investigate is whether there is a positive correlation between the amount of long-term care insurance purchased and the likelihood of using the insurance benefit.  If adverse selection is a problem, one would expect people who purchase large amounts of insurance will also be the ones who incur expensive long-term care costs for the insurance companies.  Surprisingly, they encounter no evidence of this.  Using a more specific test for adverse selection, however, the authors do find proof that adverse selection is a problem.  Examining a supplement to the Health and Retirement Study (HRS), they find that people who expect to enter a nursing home in the next five years are 1) more likely to enter a nursing home and 2) more likely to purchase long-term care insurance. 

So what explains the lack of correlation between the amount of long-term care insurance purchased and the likelihood of entering a nursing home if adverse selection is a problem?  It turns out that preferences explain the residual.  The authors posit that risk averse individuals are more likely to undertake preventative health care measures such as having a flu shot, cholesterol test, mammogram or prostate screen.  Using these measures as a proxy for risk aversion, Finkelstein, et al. find that risk adverse individuals are 1) more likely to buy long-term care insurance, but 2) less likely to need the benefit.  We see that the effects of adverse selection are offset by the fact that healthier, risk averse individuals also purchase excess amounts of insurance.  Thus, in aggregate–at least for the long-term care insurance–this market can reach a stable equilibrium. 

Finkelstein and McGarry (2003) “Private information and its effect on market equilibrium: new evidence from long-term care insurance,” NBER WP #9957.

Welfare vs. Workfare

June 14, 2006 in Academic Articles, Public Policy | Permalink

In 1996, the Personal Responsibility and Work Opportunity Act (PRWORA) brought ‘workfare’ into the spotlight.  In addition to replacing the old AFDC program with the new TANF (Temporary Aid to Needy Families), the law required welfare recipients to work or to look for work in order to receive benefits.  This was not the first time in history work requirements have been instituted.  In England, the Poor Law of 1834 granted poor relief through residence in a workhouse.  In 18th century France charity workshops were the means by which poverty relief was granted.  Is workfare good public policy?

Besley and Coate (1992) aim to answer this question theoretically by creating a simple economic model.  They assume two types of people: type ‘a_l‘ are low wage earners and type ‘a_h‘ are high wage workers with an hourly wage of a_l and a_h respectively.  The authors aim to institute a poverty elimination program {b,c} where b is the benefit individuals receive and c is the cost in terms of a work requirement.  The poverty line is at ‘z‘.  Workers earn a*[l(a)-c], where l(a) is the labor supply of the individual.  The goal of the policymaker is to minimize the cost while ensuring that all individuals consume at least ‘z‘.  If income generating abilities are observable, that it is easy to see that the policy is to give [z-y(0,a_l)] to low ability workers and nothing to high ability workers.

What if worker ability is unobservable?  There are two options.  In the first case, we can give both workers [z-y(0,a_l)].  In the other, the work requirement can be used as a screening device so that only low ability individuals will apply for the welfare package {b,c}.  The benefit package will be set [b=z-y(c',a_l); c=c'] so that the high ability individuals will not pretend to be low ability because they benefit (b) is not worth wasting their more valuable time doing (c) hours of workfare. 

One final item of note is that workfare can be used as a deterrent.  It is possible that individuals will not make human capital investments (in education, etc.) if welfare exists since they will be able to consume ‘z‘ regardless of their productivity.  If we impose a high work requirement, a young individual may decide to invest in human capital in order consume more than z and also spend less time in non-productive labor (c).

This model is very simple, but does elucidate workfare’s importance potential as a screening mechanism.  Having the work requirement (c) be entirely non-productive is an inessential assumption but does simplify the analysis.  This argument does not take into account from the possibility of ‘tagging‘ individuals [see Akerlof (AER '78)] which may be efficient more effective.  If we can observe some immutable characteristics which we know lead to low earnings potential (such as being disabled, mentally challenged, etc.), the directing funds to these individuals does not distort work incentives.  Tagging is usually imperfect and does add to the administrative costs of running the welfare program. 

Besley and Coate (1992) “Workfare versus welfare: Incentive arguments for work requirements in poverty-alleviation programs” American Economic Review, 82(1) pp. 249-261.

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