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Krugman, Health Care, and the Free Market

July 28, 2009

Paul Krugman has a recent post, giving two reasons why the free market cannot cure health care. As should be no surprise to a Mises.org reader, Krugman is quite wrong.Drawing from a classic article by Kenneth Arrow, Krugman gives two main reasons that health care is something that cannot be left to a free market.

First, health care expenses are characterized by risk. That is: there is a relatively low probability of having a very large expense. Typically, these large expenses are such that an individual could not afford to pay them out of pocket, should the need arise.

The conclusion: health insurance is necessary.

As far as this goes, Krugman is largely correct. Health care is largely characterized by having a low probability of getting hit with some very expensive medical conditions, so some sort of insurance is a sensible solution.

However, there is no reason to claim that insurance of this type is not a “free market” phenomenon. Now, it is definitely true that our current health “insurance” scheme is not really very “insurance” like, for the most part. (Auto insurance doesn’t pay for oil changes – nor should health insurance pay for predictable annual physicals, if it exists to protect against unforeseen events.) However, this does not rule out the possibility of actual insurance in health care.

So far, we’ve seen that Krugman’s first point – though correct on the surface – does not show that the free market can’t cure health care. All he has done is predict HOW the free market would sensibly do it. This leaves a question: How does Krugman come to his conclusion from this point? Well, he makes a few claims about insurance that simply aren’t true.

“It [health care] must be largely paid for by some kind of insurance. And this in turn means that someone other than the patient ends up making decisions about what to buy.”

This does not follow at all. Now, it is true that someone other than the patient MIGHT end up making decisions about what to buy. But, there is no reason at all that this is the way things must be. For example, one could easily imagine a health insurance setup in which insurance companies paid a flat amount of money for a particular diagnosis, and leaves it up to the patient to decide how to spend that money. (For example, a cancer patient may decide to take a trip around the world rather than seeking treatment.) If we assume that the free market insurance scheme MUST work like the one we have, then what Krugman says is true – but that assumption is far too strong. Whenever markets are freed, they tend to breed variety – so it is very likely that at least some insurance companies would have a payment scheme like the one I suggest here.

“This problem is made worse by the fact that actually paying for your health care is a loss from an insurers’ point of view — they actually refer to it as ‘medical costs.’ This means both that insurers try to deny as many claims as possible, and that they try to avoid covering people who are actually likely to need care.”

The first part is, in fact, always the case with insurance – or gambling, for that matter. Yet, when it comes down to it, most insurers (and casinos) do pay in the event that they are supposed to according to their contract. Apart from any legal ramifications from a contract breach, insurance companies also have to deal with negative consequences arising from customers being dissatisfied. If my mechanic cuts corners and puts only water in my radiator rather than coolant, then I will stop going to that mechanic – and you can bet that I’ll bad-mouth him on my personal blog, and give him a negative review with AAA. (Note: I’m actually quite satisfied with my mechanic – so no worries.) Insurance companies – in a free market – would be under precisely the same pressure. If they refuse to pay when they obviously should, then they will lose customers and develop a bad reputation. This encourages insurance companies to actually pay when they are contractually obligated to.

As far as avoiding covering people that are likely to need care – this is not so. In a free market, people who are in poor health will likely still be able to get health insurance – it will just be quite expensive for them. This is, of course, natural. Teenager drivers (or drivers with accidents on their record) are bigger risks – therefore, the fair thing to do is charge them more for insurance. The same goes for those that are under signficant health risks.

Now, it is true that, on some level, this strikes people as “unfair”. There is something in most people that makes them feel quite uncomfortable with charging the sick more than the healthy. We have a sense that “they’ve already been through enough”. Here, there’s a simple solution: private, voluntary charity. As Mises pointed out, action can be thought of as an attempt to remove a “felt uneasiness”. Certainly, seeing the chronically ill have to pay a lot for their medical expenses creates a felt uneasiness in many, and therefore it is quite likely that private charities will be set up to help alleviate the cost for sufferers of various chronic conditions. The marvelous thing about this system is that it is precisely those conditions that society actually feels compassionate toward that will receive the compassion, as it is quite likely that at least some of these charities will be disease-specific (after all, we already have numerous disease-specific foundations that fund research – so why not ones that fund actual treatment?).

So, what is clear: Professor Krugman’s first point is not anywhere close to sufficient to showing that a free market cannot solve the health care problem. Even if we grant that insurance will exist (and it probably will), it does not follow that health insurance companies in a free market will perform poorly.

“The second thing about health care is that it’s complicated, and you can’t rely on experience or comparison shopping.”

I could grant Krugman his first claim. But, I cannot grant him this one. From what is written here, it is immediately obvious that Prof. Krugman has not faced any serious illnesses. If he had, he would be aware of something called a “second opinion”. It is not the least bit uncommon for people to seek a second opinion, or, when one procedure has failed to prove effective, to try another – often from a different doctor with different ideas. Effectively, what all of this is is “comparison shopping that relies on experience”. So, based on a purely empirical level, Krugman’s claim is false. Now, it is true that because of our current insurance scheme that we don’t compare along the lines of price most of the time. But, we certainly would if prices were paid more directly by the consumer. (Note: I know that, for me, there is a significant exception to this rule. When I seek treatment, I choose a visit with my primary care physician if possible. The reason? Because the copay on my other options – urgent care and the emergency room – are significantly higher than for my doctor. Put simply: people do respond to prices!)

As an additional point, Krugman’s argument is sneaky. For a moment I was going to suggest that Krugman’s connection between “complicated” and “can’t comparison shop” was false. Then I noticed: he actually doesn’t connect the two. He doesn’t say “it’s complicated, therefore we can’t comparison shop.” He says “it’s complicated, and we can’t comparison shop.” These are two different points. I’ve already dealt with comparison shopping, so let’s go back to complication.

Let’s face it – lots of things are complicated. A car is a sophisticated piece of machinery. The laptop I’m typing on is sophisticated. Lots of things are sophisticated. True, the human body is several times more sophisticated. But, I don’t have to be a mechanic to know that my car isn’t running “right”. I don’t have to be a computer expert to know when my internet connection is “laggy”. And I don’t have to be a doctor to know that I “don’t feel good”. The fact is that what matters in my experience as a consumer of various services is my experience as a consumer of various services. The only reason complication matters is because it causes me to seek out an expert rather than try to solve the problem directly myself. But, once I follow the expert’s advice, I am capable of evaluating whether it worked – in as far as I care as a consumer.

In fact, as Austrians know, complication is a point for the free market. As Hayek noted, one significant problem with central planning is the information problem. There is simply too much information in the economy for a central authority to be able to process it effectively (or even gather it, as a very large portion of the information is actually not directly observable). So, given this complication, it makes far more sense to have consumers decide what matters and what doesn’t – as only consumers have the most important information: does their experience match what they want from their health care system? If we want to get a “yes” answer from that question, we should adopt a system in which consumers have choices. And, as we all know, the free market provides far more choices than any centrally planned system could.

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