Diatribes of Jay

This is a blog of essays on public policy. It shuns ideology and applies facts, logic and math to economic, social and political problems. It has a subject-matter index, a list of recent posts, and permalinks at the ends of posts. Comments are moderated and may take time to appear. Note: Profile updated 4/7/12

24 October 2009

Getting Smart

Our late, fleeting Indian summer came and went. Fall is setting in. Chipmunks scrounge frenetically for the last rotten nuts, and the weather is miserable. If you can stay optimistic at this time of year, your reasons must be real. And I can.

As I predicted, China is leading the world out of the Great Recession. Its domestic demand is rising fast enough for it to begin curbing its massive stimulus. Its leaders, ever cautious and thoughtful, are confident of continued growth. Whether China will take over our role as the world’s chief economic engine remains to be seen. But at least it’s a strong and capable auxiliary.

Paul Krugman frets about China’s pegging its currency to the dollar. But if China sold its $ 2.1 trillion in Treasury securities quickly, the dollar would plummet. Inflation here would rise, forcing the Fed to increase interest rates. In time, the dollar’s fall would increase our exports and job growth would return. But in the interim we would suffer the “stagflation” of the seventies and its high “misery index.” So maybe China’s obsession with stability and lazy change is not all that bad.

On the domestic economic front, things are better than they have been in years. We appear to have avoided a second Great Depression, although the return to full employment will be slow and painful.

Even more important, there are signs we are beginning to take serious problems seriously. Congress looks as if it might pass some sort of public option to give our monopolistic and oligopolistic health insurers a little competition. Congress might even take away the industry’s antitrust exemption and subject it to the same rules that govern every other U.S. industry (except professional baseball)!

No doubt we owe these salubrious changes to polls showing, among other things, a public 57% to 40% in favor of a public option. But let’s give Congress the benefit of the doubt. Maybe its members finally get it. Maybe they see that a century is far too long for Americans to solve a problem that all our trading partners solved long ago. Maybe they understand that multiply balkanized markets do not competition make.

Cap and trade is next on the list. Six years ago a United States Senator with zero scientific knowledge or training stood up on the Senate floor and declared global warming a “hoax.” Today we are actually trying to do something about it. And three major private utilities have quit the U.S. Chamber of Commerce for dragging its feet. Rationality and receptivity to evidence appear to be breaking out all over.

Executive pay is small potatoes compared with health insurance and climate change. But thinking is running rampant even there. Just days after Kenneth Feinberg announced his careful “balancing act,” cutting pay to the top-25 executives in seven bailed-out firms by an average of fifty percent, private firms began to announce their own similar voluntary plans.

Why? Because everyone suddenly sees that arranging compensation to reward people for taking the money and running produces exactly that behavior. As recently as two decades ago, executives had to wait three to five years for stock options to vest, even in Silicon Valley. And those companies were start-ups, with understandably low basic salaries, not staid banks and insurance companies. Still grumbling and huffing about “government meddling,” even the private sector now begins to see the merits of leaders with longer views than their next bonus.

Thinking is infecting foreign policy, too. Many scoffed when the President reached out to engage Iran. But would Ahmadinejad have had to steal the election if someone like Dubya were still in office? Obama’s reaching out gave his internal rivals enormous moral support and political legitimacy.

When the time for engagement came, we were smart. We said to Iran, “You want fuel for nuclear reactors? Fine. Let Russia refine your fuel.” That put Iran in a box. If it said “no,” everyone would know it was hell bent on making nuclear weapons. If it said “yes,” Russia’s handling of the fuel would make it much harder to develop them quickly.

I don’t know who thought that ploy up, whether the President or one of his advisers. But it was brilliant. It was so smart that it split Iran’s government right down the middle. Iran’s nuclear negotiators made a public break with their own government. The ultimate effects are still unknown, but this incident can’t help but promote democratic forces in Iran and cooperation by our allies around the world.

As in Iran, so in Afghanistan. Dick Cheney accused the President of “dithering.” But thinking—a process with which Dick Cheney seems unacquainted—is not dithering.

Patience is another virtue that few in Dubya’s administration possessed and that has recently paid off handsomely. While we were thinking, Pakistan made its most serious moves ever against the Taliban, first in the Swat Valley, and now in South Waziristan. The Taliban blundered by undertaking the same sort of suicide attacks that led to the Sunni Awakening in Iraq. Hamid Karzai, under enormous pressure from John Kerry and everyone else, finally relented to a runoff that might just give his administration a patina of legitimacy. And NATO, embarrassed by its foot-dragging support, is falling all over itself to help. Waiting and thinking were the right things to do, if only because they strengthened our international political and moral position enormously and allowed the situation to “gel” before our strategic decision.

Even the Wall Street Journal has caught the spirit. Just today it published one of the most nuanced and thoughtful pieces on wartime strategy that I have read in its pages in a quarter century. The piece had no name-calling, no accusations of “cut and run,” no “Defeatocrats.” It was just good, analytical reporting on the Administration’s thinking process and its strategy.

And at least two weeks must have passed since I last read a piece in the Journal lamenting government’s audacity in trying to keep rotten business from swindling consumers. What a difference a year makes!

If this pandemic of thinking an accident? Does it mark a mere recovery from addiction to Dubya’s platitudes after nine months of cold turkey?

I don’t think so. There was one—and only one—self-evidently smart and capable person in Dubya’s administration, SecDef Gates. He’s still there. But now he has lots of company, including the President, virtually every cabinet member, and all the important theater commanders of our military. Education Secretary Arne Duncan and the President earned praise from conservative commentator David Brooks for perseverance in holding teachers accountable and improving their performance. And without fanfare Attorney General Eric Holder just announced the arrest of 300 members of “La Familia,” the Michoacan drug cartel—as if he weren’t doing enough just closing Guantánamo.

Holder’s professional approach to these nacroterrorists will no doubt encourage Mexico’s new police leaders to cooperate with us. That sort of cooperation—not Dubya’s unilaterialism—is exactly what our times call for, whether in reducing the risk of a narcostate on our southern border or in fighting the Taliban on the Afghanistan/Pakistan border.

And lest you think it’s all about government, think again. Our financial sector may be ravaged by greed and stupidity, but our industrial sector is not. Stodgy old GM is on track to produce the world’s first serial hybrid car—essentially an electric vehicle—in about a year. Boeing Aircraft is preparing to test fly its 787 “Dreamliner,” the world’s most energy-efficient aircraft. China may have recently passed us in wind power generated, but we are number two. And the most popular and best-designed computer operating systems—both American products—recently underwent radical redesigns to make them smaller, sleeker and faster.

So don’t sell America short just yet. We are an unruly bunch, prone to bouts of pride, stubbornness and stupidity. But when the wind is southerly, we know a hawk from a handsaw.

Now we know that brains and thinking matter. We have a President and a Cabinet whose low-key, thoughtful approach to solving problems provides a model for the nation and the world. And miraculously their skills seem to be rubbing off not only on Congress, but on industry and our media as well. If these trends continue, we’ll do just fine.


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17 October 2009

A Turning in Waziristan

    “There’s a divinity that shapes our ends, rough-hew them how we will.”  William Shakespeare, Hamlet, Act V, Scene II.
That deathless line has a simple but vital message for military commanders and their Commander-in-Chief: stay current. Don’t fight the last war or the last battle in the current war. Know what’s happening now and respond quickly and cleverly.

Two stories on last night’s Lehrer New Hour brought all this to mind. In the first, Margaret Warner interviewed Bruce Riedel (pronounced “Rye-DELL”), a former CIA officer with over thirty years’ experience.

Riedel had had the unique experience of helping Afghans defeat the Soviets in the seventies and fight the Taliban now. He was articulate and forceful—a man who had made up his mind. The brief he presented for a “surge” in Afghanistan was undistinguished; almost anyone with his point of view could have done as good a job.

But Riedel did say one extraordinary thing. Rarely in history, he said, does a single nation get to fight the same war from opposite sides. “Our” side won in the seventies, he pointed out, because the Afghan insurgents that we supported then had had safe haven in Pakistan. Now we face the same insurmountable obstacle from the other side: both Taliban and Al Qaeda insurgents have safe haven in Pakistan.

Riedel’s insight is self-evidently valid. We can’t “win” in Afghanistan—and certainly can’t defeat the insurgency—if it can sneak over the border, survive and regroup despite our best efforts.

But on the very same newscast something else was happening, too. A week-long string of Taliban-mounted or Taliban-sponsored attacks in Pakistan continued unabated with a devastating assault on a police station in Peshawar.

What does this spate of attacks mean? Some may think it means that General McChrystal was right, that the situation in Pakistan is growing more perilous more quickly than even he anticipated. But McChrystal was describing the situation in Afghanistan, not Pakistan. No one—not even he—could predict how the Waziri Taliban would react to the death of its leader Baitullah Mehsud in a drone attack.

Some might think that the spate of the attacks shows Pakistan’s weakness before a rising insurgency. Some might even fear the vulnerability of Pakistan’s nuclear weapons. Possible, but highly doubtful. A strengthening democracy of 180 million people, which not long ago was a benign military dictatorship, is not so easily defeated.

No, as bloody and terrible as it has been, the recent spate of Taliban attacks is the first big break in our favor in a long, long time. The Pakistani Taliban (or at least the part of it now controlled by Hakimullah Mehsud) have vastly overplayed their hand and made a key strategic blunder. What they have done is analogous to the overreaching by Al Qaeda in Iraq that led to the Sunni Awakening and the success of our not-so-big “surge” there.

As Riedel so sagely noted, the Afghanistan-Pakistan border is the Taliban’s strongest fortification. Although only an invisible abstraction, it has been stronger than a wall of steel. Pakistan’s military won’t cross it because the Afghans don’t trust them (with good reason), and we are there. We and the Afghans won’t cross it in the other direction for fear of violating Pakistani sovereignty. This state of affairs has allowed the Taliban, although just a ragged insurgency, to pursue a “divide and conquer” strategy in the border areas against two much larger, stronger adversaries.

That’s why we have been trying, mostly in vain, to persuade the Pakistani military to attack the Taliban on their side of the border for eight long years. Now the young Mehsud appears to have given us our strongest arguments ever.

The explosions he has caused in Pakistan’s crowded cities are already having three beneficial (for us) effects. First, the resulting pointless carnage is deeply alienating the vast majority of Pakistan’s peaceful, democratic population. Second, it is turning moderate and even some radical Muslims away from the Taliban’s cause. It’s one thing to dream of the purity and simplicity of Islamic law and a re-risen, benign worldwide Caliphate. It’s quite another to witness the blood and guts of your co-workers, friends and family strewn about the street. The Taliban’s methods provide better propaganda against them than any we could concoct.

Last but most important, the recent spate of attacks is turning the most crucial battle—the one inside Pakistan’s military and intelligence services—in our favor. Arguing that the Taliban are useful allies, let alone “friends,” of Pakistan is no longer tenable. The blood and guts on the ground—plus that fact that most Taliban are Pashtun, while most highly-placed Pakistani soldiers and spies are Punjabi—makes the job of Taliban sympathizers inside Pakistani councils all but impossible.

Hakimullah Mehsud gives every indication of being a poor leader. He is brash, impulsive, and heedless of the veil of secrecy that has allowed his movement to survive for nearly a decade after defeat. Overconfidence is poison in military conflict, and Hakimullah appears to have lots of it. He seems to have done all he can not to avert, but to provoke, a massive incursion by the Pakistani military into Waziristan, just like the recent successful foray into the Swat Valley.

The fight in Waziristan will not be as easy. The Mehsud Taliban faction reportedly has 5,000 hardened fighters under arms. Others may join them against “foreign invaders” in the form of Punjabi Pakistanis. But it is doubtful that they can mount a successful defense against a determined, full-scale Pakistani military assault. And if they flee, they will be much easier to pick off from the air while on the run. If this happens, the invisible fortification that the Taliban have enjoyed for eight years may fall, and with it any serious chances for a Taliban victory in Afghanistan.

In Iraq, the outcome is still in doubt. But whatever ultimately happens there, a victory of Al Qaeda is extremely unlikely. What changed the picture irrevocably was not just our “surge”—which might well have failed under other circumstances—but Al Qaeda’s strategic blunder, which drove the Sunni Awakening.

Just so in Afghanistan, a brash, new, untested leader of Waziristan’s Taliban has made a grave strategic blunder. That die is cast; there is no going back. He can’t restore the hundreds killed and maimed, nor can he calm the outrage of those whose lives he ruined. We need only await the natural results of his folly.

Our Commander in Chief should exploit this “divinity” to the fullest. The reasons for giving General McChrystal the troops he asked for are no longer just political and tactical: (1) our 2010 elections, (2) a chance of negotiating with neighbors and “reconcilable” Taliban from a position of strength, and (3) the need to give our forces time to adapt to a change in strategy.

Now we have a clear strategic opening to exploit. In fact, the President might consider giving McChrystal more troops than requested for a credible anti-insurgency force in Afghanistan. Additional troops, acting in cooperation with the Pakistanis, might help crush the Waziristan Taliban movement in joint action from both sides. Since that movement appears to be the Taliban’s stronghold, a quicker victory than anyone now expects might follow.

Footnote: It is unclear whether Hakimullah Mehsud, the Waziri Taliban’s current leader, is the son of the Baitullah Mehsud, its late leader. Separate photographs of the two suggest a family resemblance, but the late leader was reportedly killed while visiting one of his wives for the purpose of making a male baby as heir.

That story might well be Taliban disinformation. The current leader’s brash and desperate reaction might be a son’s spastic attempt to avenge his father’s death. In fact, the strategic blunder resembles our own spastic invasion of Iraq, in the middle of our “war” against the Taliban, motivated partly by Dubya’s desire to avenge a much earlier attempt on his father’s life. Shakespearean tragedies continue to this day.


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13 October 2009

Time to Twist Arms

[For comment on the effort to repeal the McCarran-Ferguson Act and create a semblance of competition in the health-insurance industry, click here.]

The insurance-industry pirates have shown their true colors. They’ve raised the Jolly Roger and let fly a late-fall bombshell. They just released a commissioned report asserting that health-insurance premiums will go up if the insurance reform now before Congress (the so-called “Baucus bill”) becomes law.

There are two things to know about this report. First, it is an act of domestic treachery of the same caliber as Imperial Japan’s sneak attack on Pearl Harbor. It gives the lie to whatever may remain of the President’s “kumbaya” philosophy. The insurance-industry lion simply won’t lie down with the lambs (us, the people) and share its monopoly profits for the public good. Is anyone surprised?

This is not a bargaining ploy, as an insurance-industry PR hack tried to claim [search for “leverage”]. What the insurance industry appears to want—lower or no taxes on “Cadillac” health-insurance plans—is simply too small potatoes to risk the work of a century of progress toward health-insurance reform, not to mention the billions of dollars that some 37 million new customers would put into the industry’s coffers every year, partly paid for by us taxpayers. The industry, apparently, is willing to give all that up to keep the status quo.

No, the report is what it appears to be: simple treachery by a turncoat industry that never wanted reform and was waiting patiently for the best time and means to kill it. The report gives aid, comfort and political cover to Republicans who’ve wanted only for the President and reform to fail, from the very beginning. It gives cover to Blue Dogs who are too timid to support their party’s principles, and to all the members of Congress, including Max Baucus, whom the industry has worked so effectively to buy [search for “Baucus”].

The second thing to understand about the insurance industry’s report is that it’s probably right. Insurance premiums will go up if the Baucus bill passes in its present form. The reason is simple. There are only two ways to hold down prices in a free-market economy—regulation and competition—and the bill has neither. The demand pressure of all those mandated new customers will drive prices up because nothing in the bill will keep them down.

The bill has no price regulation, although the New York Times’ editorial board believes that it would prohibit insurers “from denying coverage or charging higher premiums for patients in poor health.” But even the Times doesn’t say the bill would regulate premiums for people who have no insurance now, because they have pre-existing conditions. Those lambs could buy new insurance under the new rules, but the lion would set what they pay.

In the absence of meaningful regulation, only competition can keep prices down. But nothing in the Baucus bill would promote the kind of competition that might actually achieve that goal. Nothing would eliminate state regulation and the balkanized, monopolized or oligopolized state markets that it creates, many of which have risk pools too small to deserve the name “insurance.” Nothing in it would require standardized minimum (or even model) terms and conditions to promote comparison shopping by consumers and employers.

And of course there is no public option in the Baucus bill. So nothing in it would come close to creating the kind of robust national competition that might actually drive down prices under time-tested free-market principles. The insurance “exchanges” and “co-ops” are just fig leaves to cover the bill’s nakedness.

So what should the Administration and the Democrats do? They should respond to this raw act of domestic treachery just as the nation responded to Pear Harbor. They should declare all-out war.

The Administration and Democrats in Congress should insist on a public option that would actually create competition and bring prices down. And they should use every means available, including budget reconciliation, to make it happen. No more Mr. Nice Guy.

The sole female with a role to play, Speaker Pelosi, seems to know what to do. She has never given up on the public option. Now she should appoint the House’s biggest bulldogs to the conference committee—ones who know where the bodies are buried and can twist arms like Lyndon Johnson. And she should tell them to pull out all the stops.

Wimpy Senate Majority Leader Harry Reid should try to recall the boxer he used to be. He should not just count votes, but coerce them. Lyndon Johnson he’ll never be. But he should try to take a few pages out of the old master’s book.

There are lots of ways that a party one vote shy of a filibuster-proof majority can cause recalcitrant members pain. There are senatorial “holds” on appointments. There are superfluous military bases and other boondoggles in members’ districts that need closing but remain open to support local employment and local pride. There are pet projects that get by as “earmarks” but that a clever leader who knows Senate procedure can block. Reid should threaten to use all these tools (and should follow up, if necessary) to change votes.

We’ve heard a lot about “pork” the last few years. But we’ve heard little about another traditional Senate practice: “log-rolling.” Leader Reid should make clear that votes against health-insurance reform, with a public option, will produce log-rolling in reverse.

Last but by no means least, the President should loose his Pit Bull-in-Chief, Rahm Emanuel, on the Senate, with instructions to make Lyndon Johnson look tame. Rahm should do whatever it takes to get the votes. And the President himself should give a no-holds-barred speech telling the nation exactly who is responsible for this act of treachery. There is no longer any reason to coddle the insurance industry after it stabbed him in the back.

Will this work? I don’t know. But the President promised to fight for reform, and we’ve seen little fight so far. We’ve seen a lot of trying to make friends with natural enemies. We’ve seen a lot of “cooperative” back-pedaling. But we haven’t seen much recognition that, to paraphrase Von Clausewitz, politics is war by other means.

The insurance-industry’s treacherous report provides the perfect opening. The President should make a prime-time speech like FDR’s right after the attack at Pear Harbor. He should say something like this:
“The insurance-industry fat cats have stabbed me in the back. Through me, they’ve stabbed you, the people.”

"And you know what, they’re right. Premiums will go up if this bill passes in its current form, because it doesn’t have a public option to drive prices down with real competition. So the industry, which opposed the public option all along, is now trying to use the very defect it caused to kill reform entirely. It forced Congress to swallow a poison pill and now is waiting for the bill to die.”

“Well, you didn’t elect me to fall for that kind of domestic treachery, and I’m not going to stand for it. So we’re going to do what we have to do to get reform enacted, with a public option, which will drive premiums down. We ask for your support.”
I can’t think of any better way for the President to bring his party back together and to prepare for the 2010 congressional elections. And nothing would make me prouder of my President and more ready to open my wallet for him and the DCCC.

Did the Mouse Roar?

If you blinked this week, you might have missed the most important news story on health care since Max Baucus and the Gang of Six, gorged on contributions [search for “Baucus”] from the health-insurance industry, killed the public option in the Senate Finance Committee. Our own little senatorial wimp, Harry Reid, got up on his hind legs and proposed repealing the McCarran-Ferguson Act.

That law is hardly sexy. You have to know something about economics and industry structure just to appreciate the evil it does. It exempts insurance—including health insurance—from our antitrust laws in favor of state regulation. In other words, it is the primary culprit responsible for health insurance operating in a series of too-small-for-risk-spreading monopolies and oligopolies, instead of a single, competitive, national insurance market.

Never missing an opportunity to miss the point, the mainstream media reported none of this. What it did report was a bit of trivia: Reid’s irrelevant observation that McCarran was a Nevadan like him, and that it might take one Nevadan to undo the evil that another had done. Maybe the media, like Reid, thought basic economics is too much for the uneducated goons that pass for citizens these days. Where the hell is David Leonhardt (our best economics reporter) when we need him?

But adequately reported or not, the effort to repeal McCarran-Ferguson is big news. It’s unclear now whether it’s just a feint—a shot across the bow of the treacherous insurance industry which, after months of making nice, is now trying hard to kill reform once again. If the effort bears fruit, it could actually create competition in health insurance where (in most markets) none has ever existed. It could provide a credible second-best solution to a robust public option.

Don’t take my word for it. Take the word of David Frum, an honest and cerebral conservative currently out of favor with the nutty neos who have driven the GOP off its ideological cliff. Two months ago he endorsed [search for “national market”] federal regulation (and therefore competition) as a solution to rising health-insurance and health-care costs on which liberals and conservatives could agree.

If you want to find common ground, why not go back to the basics of a free-market economy? Competition is good. Monopoly and oligopoly are bad. They are especially bad when created artificially not by private action, but by federal legislation that treats insurance like no other industry. Duh.

So lets all give a hand to Harry Reid, the mouse who may have roared. And lets all run, not walk, to demand that our representatives in Congress stop touting a “free-market” health-insurance system that isn’t and can’t be and make it so.

Footnote: The reason that the largely Democratic effort to repeal McCarran-Ferguson might be a feint is that the law covers all insurance, not just health insurance. The Democrats may be hoping that auto, fire, casualty and other insurance companies, which often share common corporate families with health insurers, will be scared to death by the prospect of losing their uniquely privileged position in American industry and put pressure on health insurers to tone down their opposition to reform for the greatest good for the greatest number (of fat cats). That approach certainly sounds utilitarian to me.


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09 October 2009

War against War

[Yesterday’s post explored the risk of a double-dip recession and an economic warning implied in the President’s Nobel Peace Prize. Today’s post explores the Prize’s primary and explicit meaning: international endorsement and approval of the President’s bold new directions in foreign policy.]

A cold war is transpiring globally as we watch. It’s not a new conflict between Russia and America. Two leaders of uncommon intelligence, Barack Obama and Vladimir Putin, seem to have put that cold war to bed, at least for now.

The cold war on which I write is a universal civil war. It embroils every nation and society. It divides the President’s advisers, the Kremlin’s most secret operatives, and the councils of China, Europe, the two Koreas, Iran and Japan. It infects the Israelis and the Palestinians, as well as their partisans, and divides them among themselves. Undoubtedly it touches even the Taliban and some members of Al Qaeda.

This cold war is not one among nations, religions, or tribes. It is a war between those who think that war is inherent in the human condition and those who dare to think otherwise. It is a war between those who prepare incessantly for war and organize to fight and win—often heedless of consequences—and those who devote their skill and humanity to avoiding and ending war. It is a war against war.

There is nothing new about this cold war. It is as old as humankind. History offers many examples of decisive battles.

Women led some. They include the probably fictional sexual “strike” of Aristophanes’ Lysistrata, Queen Elizabeth I diverting Britain from incessant internecine conflict to global commerce and trade, and the Russian mothers’ letter-writing campaign that helped end the Soviets’ war in Afghanistan.

Others battles in this cold war had male leadership. They included Nazi officers’ belated attempt (in 1944) to assassinate Hitler, as fictionally portrayed in the recent movie Valkyrie, Mahatma Gandhi’s successful nonviolent campaign to free India from British colonial rule, Nelson Mandela’s struggle to end apartheid in South Africa, and Martin Luther King, Jr.’s successful similar campaign to free African-Americans from legalized racist oppression. Modern media, including the Internet, have helped spread these sagas of war against war and have made them as compelling as bloody battles.

The Norwegians granting the Nobel Peace Prize to President Obama may mark a turning point in this age-old cold war. Many decried a reward for aspiration before achievement. But it was not really a prize in the usual sense at all. It was a declaration of alliance.

Norwegians of all political stripes, including the far right, declared their admiration of and allegiance to a young leader in the struggle against war and the spread of nuclear weapons. By implication—and by generally favorable reaction—the whole EU endorsed this informal alliance.

The EU knows something about “hot” war, having experienced tribal, religious and imperial wars for over two millennia, including history’s most brutal conflict. Perhaps because of that hard experience, EU leaders seem to have placed their hands on the President’s in a pledge to end war, or at least the threat of nuclear war.

Barack Obama’s ideals and aspirations are hardly unique. Many throughout human history have shared them. Besides the historical leaders mentioned above, there was Woodrow Wilson. He also won the Nobel Peace Prize. But he had his dreams of a war to end war shattered by unthinking opposition from both allies and enemies, inadequate economic understanding, and the resentment of an aggrieved Germany.

Now things may be different. President Obama commands a position unique in human history. Never before has an enemy of war led a superpower with thousands of nuclear weapons and the best trained, best equipped, and best led (if small) military forces on the planet. Never before has an enemy of war led the most innovative nation on the planet, which developed controlled flight, nuclear weapons, and the Internet and put men on the Moon. Never before has an enemy of war controlled a Navy from which a single nuclear submarine could utterly annihilate a troublemaker like Iran or North Korea in fifteen minutes. Never before has a leader with all this military power commanded sufficient practical knowledge of economics to improve life substantially for everyone, whether friend or foe.

Never before, in other words, has an enemy of war commanded such immense practical power both to destroy and to build. It is as if someone had given Queen Elizabeth I, Mahatma Gandhi, Nelson Mandela and Martin Luther King, Jr., the strength and knowledge of gods to match their wisdom and self-restraint.

No one lacking the President’s humility and self-restraint should ever command such power. But with the help of those qualities, that power could turn the tide of history.

Where all this will lead is still unknown. Humanity is in uncharted territory. War’s proponents are already up in arms, doing their best to rekindle the fires of fear, hatred and tribalism. That’s all they know.

But slowly, inexorably—with the Internet’s aid—the notion of peace as a possible practical reality is spreading globally. For the first time in human history, the proponents of peace can prevail in war, certainly any war of destruction. They also have the knowledge to offer a glowing alternative. That strength and knowledge may give them the upper hand in the war against war.

That’s why so many hailed the President’s Peace Prize and why he accepted an award based on aspirations, not achievement. No one can know what the Prize and the nascent global alliance it symbolizes means for the future. But we can know that the world has never seen a peacemaker in such a position of strength, knowledge and global popularity before. The possibilities of that novelty are awe-inspiring.


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A Double Dip?

October can be a difficult month. It’s a time when exuberance—rational or not—yields to craving for security and warmth. It’s a time when squirrels hoard their nuts. It’s a time of great turning in human affairs. The Russian Revolution and the Crash of 1929 both came in October.

Could this fall be like that for us? No one yet can tell for sure. But there are signs that analysts could cite (after the fact) as omens of a double dip, a “W-shaped” recession.

Our government’s rescue of our financial system may not be a fait accomplis, but a work still in progress. A bankruptcy of CIT—the lender of choice for small business—would be a threat in name only. CIT presents a $ 7.6 billion problem, which is not even pocket change today. It’s a rounding error in our $ 3 trillion government bailout.

But darker clouds are on the horizon. FHA may be next. That’s probably less than a $ 100 billion problem: manageable but still troubling. Yet an FHA failure or pullback might exacerbate the mortgage crisis and delay a recovery in housing.

The housing market once seemed on the way to a slow and cautious rebound, but millions of foreclosures still lurk out there. Housing’s intrinsic illiquidity, coupled with banks’ reluctance to write things down, always dictated a slow-motion train wreck, not a fast one. Without continued, expensive government intervention, the worst may be yet to come.

Yet there is more. Now comes the threat of a meltdown in commercial real estate. Like the housing meltdown, it will be a slow-motion train wreck, perhaps even slower than in housing. Apparently commercial lenders are less eager to foreclose on borrowers of their own class and station, when more money is at stake, than on helpless, frightened home owners. But whatever the reason, defaulting mortgages on commercial real estate are potentially a trillion-dollar problem in New York City alone. Bailing that out would put us well beyond TARP territory.

Nobel-prize winning economist Paul Krugman sees another big problem: a falloff in international trade worse than in the Great Depression. I see that as a symptom, not a cause, of global economic woes. Despite the President’s recent jab at Chinese tires, no nation (including our own), has made a serious move toward trade protectionism. Trade channels are still open; they’re just not being used as much. There is nothing (yet) like the sudden trade blockage and hoarding that led Imperial Japan to seize the Malaysian rubber fields and Nazi Germany to grab the oil in Romania and the Caucasus. Oil and other basic commodities still flow in a global market; some economists even believe they are now in glut.

Yet declining trade could presage further trouble in one respect. Trade is what joins the globe in a common economic fate. It’s what “couples” our fragile economy to the rest of the world. So it could spread our continuing contagion to otherwise healthy lands. We now account for only a quarter of global economic activity, but another precipitous drop in the quarter that we represent might drag the other three quarters down.

What will make the difference is confidence. That, or the lack of it, is what causes runs on banks and economic downturns. We are still the global economic leader, and the world is looking for signs that continued confidence in our leadership is rational.

Some things on the horizon might justify that confidence. Production and delivery of Boeing’s “Dreamliner” seem just around the corner. Apple never tells in advance, but there are rumors that it has a world-beating netbook (or a cell phone that acts like one) in process. GM’s Chevy Volt—the world’s first modern electric car—is just over a year away from scheduled mass production. If we can avoid a severe double dip for another year, the rest of the world may regain some confidence in us as an engine of innovation and real growth.

More entertaining Internet get-rich-quick schemes like Facebook and Twitter won’t do the job. Nor will internal sales of dresses and jeans, which are mostly made in China anyway. The world wants to see evidence that the US has something besides surplus food and risky financial schemes to sell before it can believe in us again.

All but two of the seven factors that caused me to predict a global recovery last spring are still in evidence. The world is indeed a far different and better place today than in 1929. Except for our still concentrated and still pathological financial sector, we have a far more robust and diversified economy now than then. The world is smarter now; Marx and Engels, Smoot and Hawley are all long dead. At a quarter of global GDP and falling, we are less important now. Huge sums of cash are still sloshing about, waiting for something real to invest in.

But the last two of my seven factors still hang in the balance. Whether we can contain a second dip here at home within our financial, auto and housing sectors remains to be seen. If a double dip were to motivate China and other lenders to stop lending—or even to demand higher interest rates—all bets would be off. The whole house of cards might collapse into “stagflation” here at home and global economic calamity.

So everything depends on the very last factor: whether the rest of the world believes we have rational leadership again. There my optimism of April, which focused mainly on our popular new president, may have been premature. In economic matters, no president acts alone.

Imagine how you might feel today as a foreigner. An economic superpower over which you have no control has just caused a global economic meltdown. To be more precise, outrageously stupid, greedy and selfish behavior on the part of a small group of wealthy financiers in that superpower caused it. Yet the superpower’s legislature won’t do a thing to regulate, let alone discipline, the miscreants who caused the calamity. Not only that: the legislature won’t even prevent them from throwing another derivatives party or protect its own consumers against further predation.

Now imagine that your own country has an effective, smoothly running health-care system operated, insured or managed by your government. Imagine further that all of your major trading partners have the same, except for one: that selfsame superpower that just caused the global economic meltdown. Would you be eager to follow that superpower’s “leadership” when, after a century of trying, it still can’t still enact a similar system, but instead insists on continuing to spend twice what everyone else spends on health care for worse results? And how would you feel, knowing that the reason for this failure is the belief, held by a substantial minority of that superpower’s voters and leaders, that that superpower’s own government is incompetent and evil?

It’s not just that the superpower won’t fix the what caused the economic meltdown or its own decades-long health-care crisis. You fear that its hubris and poor contact with reality might infect other things, like the global effort to arrest climate change.

You fear that the superpower will continue to gnaw on its own governmental belly, ignoring facts and evidence and urgent global priorities. You wonder whether its sense of superiority and exceptionalism will lead it to question not just the global consensus on health care, but eventually the very laws of economics and physics. In short, you wonder whether the superpower that led the globe out of the chaos of humanity’s greatest war has lost its mind.

That, I think, is the hidden meaning of our President winning the Nobel Peace Prize today. Of course he deserves it. And of course the stark contrast between his intelligent but guarded optimism and his predecessor’s obnoxious “Texas swagger” was in part responsible.

But I think the Nowegians were also sending a message to Congress and the American people. The world’s patience with us is limited. The rest of the globe will not wait forever while small minds from small states, time after time, delay and thwart the changes and repairs that we must make to retain our global leadership. It will not stand idly by and watch the “indispensable nation’s” delusions of superiority and exceptionalism destroy the global economic system which took half a century to build.

The world is watching to see whether the confidence that keeps oil on the dollar standard and our bond interest low is justified. It is waiting to see whether we have recovered from our ideological disease and are sane again.

If Congress fails to justify that confidence, no one can predict what will happen. Oil off the dollar standard, rising interest rates and stagflation here at home might be just the beginning.

Ever cheerful and positive, the gentle Norwegians have clothed a warning in an award. And we had damn well better heed it.

Correction: An earlier version of this post referred to an award by the Swedes. Although Swedish industrialist Alfred Nobel established and funded most prizes in his name, Norwegians choose the winner of the Peace Prize (but not the other prizes).


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04 October 2009

Health Insurance That Isn’t

[For a brief comment on Ireland’s approval of a stronger Europe, click here.]

1. Monopoly
2. Competition
3. Oligopoly
4. Natural monopoly and regulation
5. The uniqueness of insurance
6. Our broken system
7. How to fix it
8. Innovation and health

Why is our health-insurance system so hard to fix? The answer lies in the “dismal science” of economics. From an economic perspective, our system is not even “insurance.” It’s very structure contradicts the most basic characteristic of insurance: building the broadest risk pool possible to share risk as widely as possible.

From an economic perspective, any insurance industry—health insurance included—is special. Its special characteristics as insurance run counter to modern economic understanding about how best to structure and run industries generally.

This contradiction is intrinsic and fundamental. There is no magic wand—and certainly no legislation—that can make it go away. The only thing anyone can do is try to deal with it intelligently.

The contradiction between how insurance works and general economic learning is responsible for another apparent contradiction. Except for our own, virtually every developed nation has substantial government involvement in health insurance. In many, the government runs the system.

Nearly all of these nations (for example, Japan and the EU nations) have free-market systems, just as do we. They understand the benefits of private enterprise, free markets and competition just as well as we. They are not stupid. But they have chosen greater government involvement because of the unique characteristics of insurance as a product and an industry.

In contrast, we have tried to square the circle. We have ignored the fundamental conceptual contradiction between the very nature of insurance and the usual rules for free markets. There may be ways to round the corners and make the square look more like a circle. But the system we have is probably the worst that one could imagine. It provides health insurance that doesn’t really insure, i.e., health insurance that isn’t.

Worse yet, none of the bills now before Congress even addresses this fundamental contradiction. The Baucus bill would make it worse, much worse.

To appreciate all this, even in bare concept, takes a bit of explaining. So stay with me.

1. Monopoly. The starting point for understanding how markets and industries work in free-market economies is the notion of monopoly. Simply defined, a “monopoly” is an industry run—or a market served—by a single firm without competitors.

We all know that monopoly is bad, but few know in detail why. Modern economic theory does. It teaches that monopoly—as compared to competition—provides higher prices, lower output, slower innovation, reduced responsiveness to customers, and reduced product variety. These are the “evils” of monopoly, known to economists by a less loaded name: “inefficiencies.”

With the help of a few graphs and a bit of calculus (one first derivative), economists can actually prove the first two evils—higher prices and lower output—mathematically. But classical economics generally accepts all of them as non-controversial consequences of monopoly for industries and markets in general. There are a few exceptions (one of which we discuss below), but these principles work well for the vast majority of industries and markets. In most cases, they accurately describe the real world.

It is vital to appreciate that these evils have nothing to do with greed or human motivation. The graphical-mathematical proof that monopolies produce higher prices and lower output than competitive industries assumes that all firms have the very same profit motive. It assumes, if you like, that all businesses are equally greedy. Monopoly produces lower output and higher prices not because of some special human fallibility, but because of the way that markets work.

Although most educated folk are vaguely aware of these evils, they are not always conscious of their precise consequences. There is still a lot of confusion, for example, about why Communism failed decisively in both the Soviet Union (now Russia) and China. The reason is not so much government control of industry as monopoly.

Communism failed primarily because state ownership and control of the whole economy produced universal monopoly. Under Communism, every industry, from cars to canned food, was a monopoly. In the entire economy there was no competition at all. That was the real problem, not government control.

The politicians who ran the show in these Communist countries were not demonstrably greedier, stupider or more corrupt than their counterparts in free-market societies. Many (although obviously not Stalin and his ilk) were smart, dedicated people who had their societies’ best interests at heart. But the bare fact that their system created a monopoly in every industry gave them the worst of all industrial worlds. They could no more overcome that decisive economic disadvantage—built into the very structure of their system—than a fish could swim outside the water that surrounds and supports him.

2. Competition. Competition is the antithesis of monopoly. As compared to monopoly, it produces lower prices, higher output, faster innovation, greater responsiveness to customers, and greater product variety. The more robust the competition—the more competitors there are and the more vigorously they compete—the greater these benefits.

As with the evils of monopoly, economists generally accept these benefits of competition as proven in both theory and practice. Innumerable theoretical and empirical studies verify them, with few exceptions. They are the reasons why free-market societies have been so much more successful than monopolistic ones, whether of the left (Communism, state socialism) or of the right (fascist or “corporatist” states).

3. Oligopoly. Today many understand the evils of absolute monopoly and the benefits of pure and robust competition. But real-world markets seldom mimic either of these two extremes precisely. A pure monopoly would have only a single firm in an industry. Pure competition would involve tens or hundreds of firms, all competing vigorously. Very few industries have either extreme structure; most have somewhere between two and a dozen firms, which sometimes compete and sometimes cooperate.

So how can we classify and understand industries in the real world, which seldom fit either extreme theoretical model? Enter the “oligopoly.”

A “oligopoly” is a shared monopoly, in which several independent firms participate. The number of firms can be anywhere from two to a dozen or more, although usually it is less than a handful. But in identifying oligopoly the number of firms is less important than their behavior. Even a two-firm market can seem competitive or oligopolistic, depending on the two firms’ behavior.

For example, consider Airbus and Boeing. They are the world’s only two firms making big, long-range commercial aircraft. Yet despite their government subsidies (about which both sides complain), they both develop new airplanes continuously, and they compete vigorously for sales. They even produce decent product variety. For example, Airbus offers the huge, 600-passenger, double-decker A380, while Boeing is in the final stages of developing the smaller and more efficient “Dreamliner.” Both aircraft are designed for long-haul international travel, and all airlines are considering them seriously. These sole two firms are competing vigorously despite considerable government involvement in their financing and operation and the fact that their products are among the most complex and challenging to design and produce in all of industry.

It would be nice if the Russian industry begun over half a century ago by the great aircraft designer Tupolev had not dropped out of international commercial competition. Then we would have a three-firm industry and even more vigorous competition. But the industry we do have, with only two-firms, is about as competitive as any two-firm industry could be.

In contrast, consider the very same industrial sector (air travel) in a different market. Suppose you live in a medium-sized city served by only two commercial airlines. If both have flights between your city and the nearest major-city airline “gateway,” chances are you will find their prices for flights identical, often down to the penny. Why? Because they are comfortably sharing their joint monopoly in flights between your city and the gateway, in which no other airline competes.

If the route is too long for convenient car, bus or train travel, then so much the better for them. Then the two firms have a complete duopoly (two-firm shared monopoly) in the travel market between your city and the gateway. Their duopoly shares all the evils of monopoly, including lower output, higher prices, slower innovation, reduced responsiveness to customers and lower service variety.

You can understand all this without being an economist by watching what happens when a new firm enters this duopolistic market. Prices go down, output goes up, traffic increases dramatically, and places in the airport parking lot become harder to find. Just ask anyone who lives in a smaller city with monopoly or duopoly air service when an aggressive competitor like Southwest or Jet Blue moves in.

So that’s how you identify oligopoly: by the evils of monopoly spread among a small number of firms. It’s not the number of firms that counts, but their behavior and their market’s performance. By their performance ye shall know them.

4. “Natural” monopoly and regulation. So far we have discussed three economic “models” of industries and markets: (1) monopoly, in which a single firm dominates, (2) competition, in which a number of firms compete, and (3) oligopoly, in which a small number of firms cooperates to share a collective monopoly, rather than competing. You can tell how well real-world markets match each of these models by looking at both the number of firms in the market and the market’s performance in price, output, innovation, customer service and product variety.

But what happens when the very nature of the industry accommodates only a single firm? Examples are water and power. It wouldn’t make much sense to have multiple firms competing to build, maintain and operate separate water mains or electrical trunk lines, plus a myriad of separate branch and supply lines to every house and business. That approach would be duplicative and wasteful. It would also cause gargantuan administrative expense and governance nightmares.

So it makes sense to appoint a single firm to deliver water or electrical power (or natural gas) to your door, and to give that firm a monopoly of distribution. Circumstances (namely, the duplication, cost and waste of doing otherwise) compel allowing a monopoly in these cases. Economists call such industries or markets “natural” monopolies.

But the mere fact that a monopoly is “natural” because competition would be duplicative and wasteful does not reduce the “evils” of monopoly one iota. The resulting “natural” monopoly still produces higher prices, lower output, slower innovation, reduced customer service and less variety than would a hypothetical competitive industry that would be duplicative and wasteful in other ways.

In other words, the evils of monopoly don’t vanish simply because the nature of the economic activity precludes competition in practice. In fact, they may get worse. Water, for example, is a necessity of life with a highly inelastic demand curve. If an unrestrained private firm controlled its delivery to your home, it could charge whatever it pleased, including a substantial fraction of your income, for supplying you with the water that keeps you and your family alive.

So far economic science has found only two general solutions to this dilemma. The first is to outlaw the profit motive and have the government (or a nonprofit company under some degree of government control) own and operate the monopoly on a nonprofit basis. That’s what most cities and towns do with their systems for distributing water and electricity.

The second solution is to keep the natural monopoly privately owned and operated—and allow it to make a decent profit—but to regulate its prices and other aspects of its business so as to protect the public that it serves. That approach is called “regulated natural monopoly.” It is widely practiced with respect to such things as water, electricity, gas, telephone and cable TV today.

The theory of regulated (private) monopoly, as distinguished from government ownership, is that the profit motive provides greater impetus for private investment in innovation, plant maintenance and good service. Of course the incentives for those benefits depend directly on how much profit the government regulator allows the private industry to make. In regulated natural monopolies, the government determines that profit in long, complex and contentious public hearings. The result, sometimes, is a serious time lag between changes in technology or economic conditions and changes in the allowed profit to accommodate them.

Regulated natural monopoly is thus a complicated, unwieldy system that takes a lot of expertise, patience and educated government management. The best that can be said for it is that it is often better than the alternatives, i.e., unregulated (and therefore predatory) private monopoly or government ownership and control, without any incentive for private investment or innovation. Many states and localities run their water, power, gas, telephone, and cable TV industries in part or in whole as regulated utilities, i.e., regulated natural monopolies.

5. The uniqueness of insurance. After all this discussion, we now have four fundamental economic models under our belt: monopoly, competition, oligopoly and regulated natural monopoly. We will soon analyze which of them our health-insurance markets most closely resemble. But before we do that, we must explore how the nature of insurance itself affects that analysis.

The basic theory of insurance is simple. An insurer collects premiums from a group of people who fear a particular, rarely-occurring risk. When a risk becomes real and one of the group members suffers an insured loss, the insurer uses the collected premiums to pay that loss, up to the limits of the insurance policy. If the insurer does its homework and properly estimates the level of risk, it will be able to pay all the losses in the group, plus its management and administrative expenses, and still have something left over for profit. That, in essence, is the insurance business.

It doesn’t matter what the risk is. It can be a risk of fire, property damage due to inclement weather, theft or crime, or (in the case of health insurance) the risk of disease or injury. As long as losses are rare enough, and the cost of each loss (even if high individually) is low enough collectively for the aggregated premiums to cover it, plus expenses and profit, the business is viable. The insurance company covers its expenses of operation and makes a profit, and the insurance protects every insured person against a rare but possibly devastating loss.

There is, however, something special about the insurance business. It works only when the customer base—the group insured—is large enough. If health insurance covered only the group of people waiting for liver transplants, for example, its cost would be astronomical. In fact, if every insured were waiting for a transplant, each premium would have to include the average cost of one, plus a pro-rata share of expenses and profit. In that case the insurance would be useless: the “customers” would do better by paying for their own transplants and saving their shares of the insurer’s administrative expenses and profit.

Health insurance can work—even for liver transplants—as long as the whole population is insured and the need for liver transplants among the general population is small. Then every insured person chips in a small premium against the small chance that he or she might get incurable liver disease and need a transplant. If the pool of premiums (and insureds) is large enough, it can cover all the enormous expenses of transplants for those few who need them, plus the insurer’s administrative expenses and profit.

If health insurance is to work, it has to cover all the injuries and ills to which we humans are heir, not just liver disease. Doing so requires a very wide pool indeed, in order to make the premiums affordable.

And there’s the rub. There are so many ailments requiring prevention, diagnosis and treatment, and so many possible wounds and injuries, that only the broadest pool of insured people will do. Perhaps there is some maximum size after which the same statistical occurrence of each type of loss merely repeats itself, so that further increases in pool size do not further lower the average risk, and therefore the required premium. That is, there may be some maximum size of health-insurance pool, after which further increases in size pass the point of diminishing returns.

If it exists at all, that point of diminishing returns surely must be in the many millions. Yet only thirty of our fifty states have populations over three million people, and seven have fewer than a million. So the optimum size of a health-insurance pool probably exceeds the populations of a substantial number of states.

Those facts are unfortunate for two reasons. First, at present we regulate health insurance almost entirely at the state level. Regulators in each of our fifty states license health insurers, fix the terms and conditions of their operation, inspect and discipline them and often (depending upon the state) prescribe detailed rules for their operations and the insurance they can issue. These terms, conditions and rules vary widely from state to state.

The second reason why these facts are unfortunate is more important. State-by-state regulation creates separate and individual health-insurance markets in each of the fifty states. Many, if not most, of those separate markets would be suboptimal in size even if only a single health insurer served them. But people seldom buy more than one policy of health insurance, so a customer of one insurer is lost to another. As a result, having more than one insurer in each state “splits” the pool of insureds even more than state regulation and makes the size of the risk pool even less optimal. The more firms that compete in a single state’s market, the more they split the pool, and the less adequate each of the splintered pools becomes.

As this analysis shows, the very nature of insurance, especially health insurance, contradicts the general economic command that competition is best. The more competitors in a limited market, the more they split the pool of possible insureds, and the less effectively works the fundamental concept of insurance—spreading the risk of loss over the widest possible pool. The fundamental goal of insurance thus contradicts the general economic rule that competition is good, and the more the better.

In this respect, insurance markets resemble natural monopolies. Risk-spreading works best when the entire at-risk population is in a single risk pool. This point applies especially to health insurance because the risk of getting sick or injured is much higher, for example, than the risk of a destructive home fire or an auto accident. Therefore the optimal size of a risk pool for health insurance is much larger than that for home or auto insurance.

So any insurance industry has some aspects of natural monopoly. Needing a larger risk-spreading pool, the health-insurance market resembles a natural monopoly far more than other insurance markets.

But now recall the usual “solutions” for natural monopoly. Only two have wide acceptance both in economic theory and in practice : (1) government ownership of the industry and (2) government regulation of private industry. This analysis gives us a hint why virtually all other developed countries have opted for government-sponsored health care, government insurance of private health care, or substantial government participation in private insurance of private health care. Other nations need single markets even more than we do because their populations are smaller. (In population, the United States is the world’s fourth largest single market, after China, India and the EU.)

6. Our broken system. We Americans think we are different. Our myth of “American exceptionalism” leads us to believe that the principles that apply to others don’t apply to us. Because we idolize free markets and competition, we have ignored the fundamental contradiction between competition and the nature of insurance. So we have tried to square the circle. We have tried to have our cake and eat it, too.

The result? We pay twice as much per capita for health care as any other nation and we have no better results. In fact, for infant mortality and post-60 life expectancy, we are among the worst of developed nations.

Some of this dismal performance derives from inefficiencies and perverse incentives in our health-care system. Some of it derives from the extraordinarily privileged position in which we place our physicians, who (except for the rare malpractice action) have less institutional public accountability for their actions than any other profession, with the possible exceptions of priests and tenured professors.

But insofar as concerns health insurance, the failure of our system derives directly from our failure properly to consider the nature of insurance itself. Insurance is an industry whose rules of operation contradict the fundamental rule of free markets in general: that competition among many firms works best.

Not only have we failed to appreciate that fundamental contradiction. The health-insurance system we have built in America directly flouts the most basic command of all insurance—increase the size of the risk pool!

It does so in four ways. First, our state-by-state regulation has balkanized what might have been a huge national pool of 307 million insureds into fifty separately regulated and managed jurisdictions, 29 of which have fewer than five million people. Second, within those jurisdictions, we have further fragmented risk pools by organizing health insurance around employers, nearly all of which have far fewer employees than an optimal risk pool would. Third, within those twice-balkanized pools, we have further balkanized each employer’s pool by trying to create competition for its employees’ business. Each employer offers several separate health insurance plans to its employees, which further divide the risk pool to provide “consumer choice.” Last but not least, we have allowed our insurers to further divide even these thrice-balkanized risk pools by cherry-picking customers which such things as age requirements and pre-existing-condition exclusions.

To appreciate how much this state of affairs contradicts the basic notion of insurance, do a little arithmetic. We have a total population of some 307 million people. If each state has only twenty different insurance plans (say, four each for five major employers), there are 1,000 different policies in our nation. The maximum pool for each would be 307,000 people, even if all signed up, which of course they don’t. It doesn’t take much statistical intuition to understand that numbers like that (several hundred thousand) are far too low to provide an adequate risk pool for all the innumerable ailments, conditions and injuries to which flesh is heir, and all the even more innumerable preventatives, diagnostic tools, and treatments that might result.

If you set out deliberately to design a system that would create the maximum number of badly sub-optimal risk pools, and that would maximize duplication, waste and inefficiency, it would be hard to design a “better” health-insurance system than the one we have. A rational person, knowing the economic goals of health insurance analyzed above, would have to conclude that either a madman or Satan designed our health-insurance system.

7. How to fix it. With this analysis is mind, we can now understand why so many of our developed-country competitors have adopted “single-payer” systems for health insurance. A single-payer system maximizes the risk pool, thereby spreading the risk as widely as possible. This point has particular importance in many foreign countries, some of which have smaller populations than our larger states.

A single-payer system avoids balkanizing the risk pool and therefore the temptation to cherry-pick “customers,” for example, by disfavoring unfortunates with pre-existing conditions or by charging them higher premiums.

But risk-pool balkanization is not the only evil of an atomized system of health insurance relying on multiple, separate private firms. Such an atomized system also increases administrative costs dramatically. With a single set of computer protocols, a single maintenance service, and a single set of (preferably digital) claim and other administrative forms, a single-payer system permits obvious administrative savings as compared to the balkanized, poorly digitized and therefore exorbitantly inefficient system that we have. In addition, a single-payer system can be run on a non-profit basis, thereby also avoiding the extra expense of private profit and the further administrative expense of accounting for it. This is why careful studies show administrative costs for private systems three or four times larger than those for single-payer systems.

People who prefer a single-payer system don’t prefer it because they like “big government,” government in general, or big organizations in general. They prefer it because a single-payer system spreads the risk of loss as broadly as possible, reduces administrative expense with uniform software, computer systems and administrative tools, and (because of the resulting standardization in forms and computer systems) provides the greatest transparency and accountability.

In the insurance business, size matters. Bigger is better because bigger better spreads risk and administrative cost over a wider customer base.

The very same rationales underlie the push for a “public option” for health insurance. It doesn’t matter much whether the public option is owned and operated by the government or given a bit of initial seed capital and pushed out of the nest to fly on its own. What matters is that the public option have as many customers as possible, so as to lower each one’s proportionate share of risk of loss and administrative expense.

It helps if the public option is nonprofit. Then its premiums will be lower still—by the proportionate share of profit that a for-profit insurer would have demanded. But even if you have a theological preference for private profit, private capital and capitalist incentives in the boring business of health insurance (as distinguished from health care), we could do a whole lot better with better industry structure.

The issue is not profit versus nonprofit, capitalistic incentives versus government politics, or free enterprise versus socialism. The issue is size. Bigger risk pools lower per-capita risk and administrative expense, and therefore premiums. Bigger risk pools also lower administrative expense generally by standardizing computer systems and protocols and administrative procedures. That is, they have economies of scale.

8. Innovation and health. I hasten to recall that we are talking about health insurance, not health care. Our largely private health-care system also has enormous administrative inefficiencies which derive from its balkanized—if not atomized—institutional structure. When every medical group and hospital, if not every doctor and nurse, operates privately and separately, there are obvious sources of waste and duplication. They include thousands of separately owned and maintained (and therefore mutually incompatible) computer and administrative systems, and the further administrative waste of accounting, in detail, for all the individual profits of owners and shareholders of thousands of separate and independent legal entities.

But there is one valid argument for private profit incentives in health care. They may help keep our largely private health-care system innovative. No one has even begun to prove that proposition in any quantitative way, but it is plausible. The resulting increase in innovation, if real, may justify the enormous waste inherent in an atomized system that is largely dysfunctional in terms of administration and computer compatibility.

But that’s health care. Even if private incentives increase the rate of innovation in health care enough to justify the enormous waste of resources in an atomized private system, there is no evidence of—and not even any credible theory for—a corresponding tradeoff in health insurance.

One reason is that there’s not much with which to innovate in health insurance. It’s a boring business of recording, verifying, assessing and paying claims of loss. It makes banking look exciting and innovative.

And in any event the historical record of innovation in health insurance is abysmal. Scientists and engineers began automating in the 1970s, lawyers and small businesses in the 1980s. Yet my own insurers were still using paper forms as recently as a year ago, although some of them now have websites (of widely varying quality and utility). If you were to grade the health-insurance industry on innovative use of digital computers—a fifty-year-old technology!—you would have to give it an F.

So the need for and record of innovation in health insurance, as distinguished from health care, hardly justifies the demonstrable evils of wildly sub-optimal risk pools and the waste of extraordinary administrative expense in accounting for thousands of separate firms and policies, all in the service of private profit.

Conclusion. A rational and thorough examination of our nation’s largely private health-insurance system compels the conclusion that it is wildly and extravagantly inefficient. It fragments risk pools by state and employer. In the name of free enterprise, it further fragments risk pools by inviting multiple competitors into each of these fragmented markets. The result is risk pools of suboptimal size, and in many markets wildly suboptimal size.

At the same time, as the President himself has noted, the industry structure in many states resembles monopoly or oligopoly far more than competition. So in practice the cost of suboptimal risk pools doesn’t even buy the benefit it is supposed to provide, i.e., effective competition. The result is the worst of both worlds: fragmented markets with small risk pools that operate as monopolies or oligopolies, with little or no effective competition.

If the Baucus bill becomes law, it will make all this still worse. It will further fragment risk pools by pre-existing conditions. By requiring those conditions to be covered but not regulating how, it will invite atomized private insurers to offer a different policy, with a different premium, for each serious pre-existing condition (e.g., diabetes, heart disease, cancer, HIV/AIDS). The result will be badly suboptimal risk-pool size, as in our liver-transplant example above. It would be hard to imagine a more counterproductive approach to insurance and one that more strongly contradicts the very nature and purpose of insurance itself.

The risk pools in our system are already too small to offer affordable premiums to the vast majority of consumers. If the Baucus bill passes, they will become even more so. The ban on pre-existing condition exclusions may increase coverage in theory, but in practice few consumers with pre-existing conditions will be able to afford the premiums that multiply balkanized risk pools will produce.

There are only two rational economic justifications for such a counterproductive system. One is the enormous profits that it provides a select few. The second is the employment it provides to otherwise unemployable workers who, like clerks in Dickensian England, use centuries-old paper methods to process claims in the Internet age.

It should be apparent even to the dimmest-witted member of Congress that continuing this madman’s system for another few decades will not promote the general welfare. The real question is how to take something so fundamentally flawed as the Baucus bill, which doesn’t even attempt to address any of these fundamental conceptual problems, and make a silk purse out of a sow’s ear. Without a public option to provide a large risk pool and some semblance of competition, the best approach may be to junk the bill and start over.

Unfortunately, the competing bills moving through the Senate are not much better. All fail to come to grips with the fundamental conceptual contradiction that makes our American insurance system so much less effective than its foreign counterparts. “Solutions” based on failure to understand a problem have a habit of not working. When part of their motivation is campaign contributions from people with a vested interest in it not working, so much the worse.

Short Subject: Europe Rising.

Although unrelated to the vital (to us) issue of health care, an enormously encouraging thing happened yesterday, on which I cannot refrain from commenting. I refer to Ireland’s belated approval of the new EU treaty, which would vastly expand the scope of European integration.

It’s hard to overemphasize how important and inspiring this news is. In a recent post, I outlined how the EU, like the US, was designed on rational principles, independent of race, ethnicity and the agonies of history. In the long sweep of human affairs, Ireland’s decision to make the EU stronger may be one of the most important things to happen in this decade, if not our whole new century.

We Americans have a young society. Like youth everywhere, we believe we are special and exceptional, immune to the forces of history. In contrast, Europe is mature. Countless wars and social upheavals over two millennia have chastened it and made it wise.

Unlike us, Europe has no fear of abstract labels. It has tried both socialism and fascism and has seen their results first hand. Now, much like China, it enjoys a mature pragmatism that suspects abstract ideologies and respects what works (in health care as in other things).

As our intractable structural problems push us Americans deeper into social and economic decline, an effective counterweight to advancing China—let alone one based on the Western Enlightenment—will be enormously beneficial to global progress. Peaceful competition is a good thing, and competition based on great ideas is even better.

Any student of science or mathematics knows that most of the great advances of the nineteenth and twentieth centuries came from Europe. America’s predominance in the twentieth century owed much to Europe’s great wars and social upheavals, which drove its brightest minds in refuge to our shores. Several of those great minds worked in the Manhattan Project that gave us atomic weapons. Many of them stayed in our great universities to learn and teach.

Now that Europe is getting its peaceful act together, maybe advancement of human knowledge will shift back there, as well as to China. The Large Hadron Collider sits at Europe’s very center.

All is not yet certain. Poland and the Czech Republic still have to vote. But the Times reports that Poland’s “approval is all but assured.” As a people at the epicenter of every upheaval of the last century, the Czechs should know what is good for them, too. In the meantime, let every civilized person raise a glass and shout “Erin Go Bragh,” within the context of a strong and peaceful Europe.

Footnote: In his health-care speech before the joint session of Congress, the President said:
My guiding principle is, and always has been, that consumers do better when there is choice and competition. Unfortunately, in 34 states, 75% of the insurance market is controlled by five or fewer companies. In Alabama, almost 90% is controlled by just one company. Without competition, the price of insurance goes up and the quality goes down.”


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