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BY SOREN LARSON

In print | Published September 24, 2009

Health policy is complicated. The impacts of pharmaceutical price regulations are hidden, the intuitive appeal of exploiting single payer purchasing power is great, and the realities of insurance market competition are opaque. I suppose it’s not so shocking, then, that some people advocate a public option “to keep [evil] insurance companies honest.” Since health care consumption makes up 17.6 percent of GDP, they smugly say, pleased that they’ve remembered some hardly quantitative evidence, we need government to mitigate the nefariousness of health service suppliers, who primarily and iniquitously follow their own vile interests of profit maximization that stem from savage and not-at-all-productive “free” (if only they were) markets.

Of course, being an even-handed guy, I can’t forget obfuscations by former Alaskan Governor Sarah Palin and talk radio host Rush Limbaugh, among others. Their potent political poison makes it all too easy for credulous Americans, wary of their declining role in American civil and economic life, to believe that a fascist and communist dictator will stop at nothing to destroy all liberty with an iron fist. Similar to their liberal counterparts, these self-titled “libertarians” complacently pontificate on their satisfyingly unfashionable ideas, believing the unpopularity of their opinions surely symbolizes their super smarts.

It’s hard to blame any of these Americans though. After all, 67 percent of Americans concede that they don’t really understand health care reform ideas, according to a recent CBS News poll.
And when the debate over health care reform is exclusively chronicled by the personal medical narrative, it’s no surprise we lose track of the evidence that motivated our policy initiatives in the first place.

So before we proceed with Senate Finance Chairman Max Baucus’ plan — which will discourage employers from hiring low-income workers, increase costs by demanding that all Americans purchase “qualified coverage” or face “a very harsh, stiff penalty,” and require huge subsidies to finance coverage for all those who cannot afford it, according to recent CBO analysis — we should have some idea what the problem is. Because as President, author, former law professor, father, elocutionist and I guess now … Doctor Obama must know, if the diagnosis is wrong, it’s unlikely the treatment will be right.

It seems all discussions of health care are infected by some citation of Organization for Economic Cooperation and Development, or OECD, numbers that compare health care spending to gross national product, or GNP, across OECD countries and juxtapose statistics of national health care outcomes to these ratios. Although the health care outcome comparisons are flawed, the primary concern here is why Americans are so fascinated by the percentage of GNP devoted to health care.
While recent auto bailouts and passed protectionist policies suggest that many Americans and much of Washington still perceive tangible manufactured products as the primary source of our nation’s output, an economic perspective yields another point of view. With a few exceptions, anything on which consumers are willing to spend money is important to our economy.

This idea, however, is hard to understand. Since health care is a service-based industry and the value of services is much less quantifiable than that of tangible goods like manufactured steel or tires, it’s easy to see why Americans are so concerned about spending lots on something intangible.
Nevertheless, assuming perfect competition (which is unreasonable given heavy state regulation of the industry), if consumers are willing to pay lots of money for good health, prices will necessarily be high. Instead of getting anxious about actuarial health care spending across OECD countries, we should compare the opportunity cost of our large health care expenditure.

Opportunity cost is the value of the next best alternative forgone to pursue some production or consumption choice. Given this definition, Americans’ great spending on health care is a problem if and only if the value of the medical services Americans now consume is less than the value of the goods and services consumers forgo to make way for current consumption. Although few deny that reform is needed to cut costs, it is essential we differentiate between costs resulting from market inefficiencies and the costs associated with preferences for good health.

Mark Pauly, Wharton School of Business professor of health economics, completed such an analysis. In it, he compared opportunity costs across OECD countries by recalculating OECD health expenditures when all countries pay medical workers the same average wage paid to medical care labor in the U.S. Using average U.S. wages of medical care labor as a proxy for consumer preferences, we can genuinely compare international health expenditures because Pauly equalized preferences for medical care labor across OECD countries. Without this, we can’t determine whether larger shares of GNP result from different preferences for health across countries or market inefficiencies.

His results are surprising. Instead of having the highest proportion of health care spending to GNP, the United States actually has one of the lowest!

In the prestigious Quarterly Journal of Economics, Stanford economists Robert E. Hall and Charles I. Jones advance a parallel argument that seeks to determine the ideal allocation of resources with respect to health care. Instead of evaluating the effectiveness of current resource allocation under existing institutions and regulations, the economists develop a model to describe the share of gross domestic product, or GDP, that Americans should spend on health care to maximize social welfare. (For my purposes, it’s fine to equate GNP with GDP.)

Standard assumptions about consumer preferences say that the income elasticity of demand for health care is greater than one, meaning that health care is a superior good (as opposed to an inferior good) to which consumers devote increasing amounts of income as they become wealthier.
The intuition behind this is simple: Consumers have diminishing returns to non-health consumption. Although one Ferrari will make some consumer very happy, adding a Maserati to a collection of nine other foreign cars will make this consumer only marginally happier. In contrast to non-health spending, however, are no diminishing returns to consumption of goods and services that promote good health.

Ipso facto, we can increase total lifetime happiness, or utility, by spending more on health care and less on other things. Doing so extends the amount of time we have to enjoy non-health consumption, like Ferraris. Thus as national wealth increases, we can make ourselves better off by spending proportionately more on efficiently delivered health, even if we casually perceive this expenditure to be excessive. Hall and Jones conclude that in order to maximize social welfare, the U.S. will have to devote “30 percent or more of GDP on health by the middle of the century.”

Although the summer is over, some of the furor at town hall meetings lingers in some corners. For many progressives, it’s hard not to believe that all conservatives resist reform because they want President Obama to fail. Paradoxically, it seems the best way to ensure the failure of the Obama administration is for Republicans to endorse the proposals sponsored by the most liberal Democrats. No Republican sits on the hill without some understanding of how the failures of the Carter administration led to the free-market policies of the Reagan administration.

When progressives superciliously ask what health care solutions Republicans are proposing, I wonder whether progressives are too focused on learning how Republicans aim to derail reform, instead of considering the merits of the Republicans’ criticisms and recommendations.

As President Obama concluded in his August NYT op-ed piece, “[Health care reform] is a complicated issue, and it deserves serious debate. … We are bound to disagree,” he acknowledged, “but let’s disagree over issues that are real, and not wild misrepresentations that bear no resemblance to anything that anyone has actually proposed.” Although Obama’s endorsement of debate is encouraging, his dismissal of criticisms that respond to implications of legislation is not. Politicians of all stripes rarely have complete information, so we shouldn’t discount Americans’ reasoned concerns that proposals will cause larger consequences not specified in current proposals. As I have shown here, consumers have good reason to spend lots on health care, and it’s likely they’ll continue to spend as they seek to promote increasingly better health and quality of life. Government has no business dictating to Americans what it arbitrarily believes is a sensible amount to spend on health.

Instead of becoming consumed by bean counting, we should aim to maximize American welfare. This effort should aim to cut costs by reducing market distortions and perfecting competition. Little good results when lawyers pretend they’re economists. If we’re interested in a bipartisan solution, we must understand what the parties want and why.

Soren is a junior. You can reach him at slarson1@swarthmore.edu.

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