The Conundrums in Health Care Reform

The Conundrums in Health Care Reform

August 12, 2009

The political furor over health care reform, and especially the media coverage, may be triggered by right-wing agitprop; but the cynical distortions – death panels! – fed by hard Republican partisans are not responsible for eroding public support. Health care reform will always be a tough sale. Three-quarters of Americans believe we need serious reform; yet two-thirds of those who voted in 2008 have insurance and say they’re satisfied with it. If the President is going to win this fight, he and his people have to unravel this conundrum – and economic logic can help.

People have plenty of complaints about their health care. They don’t like the waits they face to see their doctors, they really don’t like paying the world’s highest insurance premiums and co-payments, and they’re not insensitive to the plight of 50 million uninsured — and the possibility they someday might join them. Yet most of us are deeply risk-adverse about real changes in these arrangements, and the reasons are as basic as they get: We naturally place infinite value on recovering from some terrible, future illness or injury, and so far the current arrangements have kept most of us and our children alive and even reasonably well. So, if the critics’ outlandish claims contain even a small kernel of truth, many of us can (and will) imagine that under the right circumstances, it could cost us the care we might desperately need.

There’s another, equally powerful factor at work here. Health care places most people in the uncomfortable position that economists call “radical information asymmetry,” which means that one party knows much more than the other about something important to both. We feel sick but we don’t know what’s causing it or what to do about it – so we go to a doctor or hospital staffed with people who do have the precious knowledge and skills necessary to make us well again. This genuine sense of ignorance about a matter of potentially life and death importance greatly intensifies our risk adverseness about changing the arrangements under which those all-knowing doctors and hospitals now take care of us. And since we all know that some illness or injury will eventually threaten or end our lives, it’s not a hypothetical concern.

This information asymmetry complicates health care reform in other ways. We can’t shop for the best medical deal or make independent judgments about whether we need one procedure or two, so we have to depend on doctors we know, who have obvious incentives to “sell” us as many expensive services as their Hippocratic oath allows. That’s why proposals to end the tax deductibility of employer-provided insurance probably wouldn’t much affect rising costs: Even with greater incentives to shop for less expensive care, we still lack the knowledge to make intelligent choices.

The policy conundrum for the President is that unless he can reform these arrangements, the pressures that have been driving up health care costs for decades will end up denying care for many more of us. But there’s little reason for most people to support cutting health-care costs, since people know that cutting costs in most areas usually means getting less – and in this case, getting less could cost them their health.

That’s why the action has been shifting from health care reform to insurance reform, by which Washington means new guarantees that insurers must maintain coverage for any serious condition any of us might face, and set premiums without reference to people’s current or past health. Most insurers are willing to go along, so long as Washington also requires all of us to buy their coverage. But their caveat presents another political obstacle ripe for demagoguery, since somebody would have to pay for the subsidies that tens of millions of us will need to afford that coverage.

Insurance reform may be the only change that almost everyone would welcome. But it also will increase costs further, which will eat away at coverage. Moreover, it does nothing about the major forces most responsible for driving up costs – the inexorable aging of the boomers, and the proliferation of new, very costly medical technologies to treat the common conditions that mostly befall older people, especially cancers and heart disease.

It’s obvious by now that there just aren’t any easy answers. The “public option” would probably force insurers to squeeze more efficiencies out of the ways they conduct their business, as could private, non-profit insurance cooperatives. But those efficiency savings would be one-shot deals that can only give us a few years of breathing room – like the shifts to HMOs and PPOs did in the 1990s – before the same problems reemerge.

As to the larger forces, we can’t do anything about the aging of the population, and the only way to control the costs of new technologies is to limit people’s access to them or slow down their advances. And no one is prepared to suggest that, since we all can imagine someday needing a recent breakthrough to preserve our health.

There is another option: Accept that we place unlimited value on gold-plated health care and be prepared to pay for it. Eventually, that will drive us to new, broad-based taxes to finance that gold-plated care for everybody. Since that’s not a topic which our politics can handle today, it looks like we all have to prepare ourselves for many more years of debates over health care reform.

Why, Yes, We Do Have to Regulate Some Executive Pay

August 6, 2009

The House of Representatives has committed some fumbles this year, but the legislation passed last week to regulate executive compensation in large public companies is sorely overdue. By any plausible standard, compensation for the very upper reaches of American business has been out of control for a long time. In 1991, candidate Bill Clinton scolded corporate America for rewarding the average CEO 80 to 90 times what their average worker earned — compared to a pay gap of just 10 times in Japan. Today, the gap here is 250 to 300 times, and it has indirectly contributed to the economic turmoil affecting us all.

There’s an untold story here that shows how genuinely hard it is to regulate how wealthy institutions and their executives conduct themselves, especially when it goes directly to their personal interest. Back in the fall of 1991, the young and still largely unknown Bill Clinton agreed to deliver three major policy addresses at Georgetown University, designed to dispel any doubts in the press about the depth of his knowledge and the breadth of his intellect. (It succeeded brilliantly: By December, the media had anointed him as the frontrunner.)

The first address was on the economy; and on the appointed day, George Stephanopolous (then Clinton’s new top personal aide), Bruce Reed (the campaign issues director) and myself (the chief economic advisor) met to go over last minute changes. Clinton wanted to add a new section on executive pay and offered up his solution: Limit a company’s right to deduct salary expenses to, say, $1 million for each individual. The economist in me warned that this approach probably wouldn’t work: Most companies would find ways to reward their executives outside the limit, and most companies wouldn’t care how much of it was deductible. So, I ventured an alternative: Require a shareholder vote to approve the annual compensation of executives earning more than, say, $1 million (it was 1991). After all, the shareholders are a company’s actual owners. If the owners were okay with a $200 million payday for a successful executive or $20 million for another who drove the company into the ground, who are we to complain — especially since the pay packages ultimately came out of the owner’s own dividends. In practice, the prospect of annual shareholder votes could effectively constrain executive pay, since most companies wouldn’t dare to award their senior people pay packages that their shareholders would publicly reject.

My idea was overruled by the political gurus, who concluded it would be too subtle for the public. So the candidate stuck with limited deductibility, which we now know had no effect on out-of-control executive compensation.

The financial crisis could change all that. Barney Frank — who has truly come into his own as chair of the House Financial Services Committee during this crisis — last week convinced the House to require a “shareholder advisory vote” on executive compensation. The proposal is weaker than it could be — the vote should resolve the matter, not merely suggest an answer. But the basic idea is right: Let a firm’s owners decide how much its executive are worth.

The current arrangements have two glaring defects. The first involves self-dealing or what might be called “crony compensation.” In the cozy arrangement of most large public companies, the pay packages for top executives are set by a firm’s compensation committee, whose members are drawn from the board of directors. As it happens, most of those directors are also chosen by the executives whose pay they then determine; and to top off this mutual back-scratching, the committees often set compensation for the directors, including themselves. The results leave everyone involved a lot richer — except the shareholders — and may account for as much as one-third to one-half of the current cavernous gap between executive and workers’ pay. That’s why it makes eminent sense to have shareholders review these self-interested decisions. Frank’s legislation, which also directs that compensation committees be comprised entirely of “independent” directors (those who are not also executives of the company), would be at least a step forward.

The second defect goes to the particular ways that many executives, in effect, reward themselves: Their compensation arrangements pay them handsomely for short-term gains, with no adjustment or recourse if the same decisions end up producing large losses down the line. The obvious losers, once again, are the shareholders, who pay the dealmakers princely sums for decisions that may end up costing the company dearly. But as the financial crisis has shown, these arrangements can dee
ply distort these managers’ incentives, focusing them on investments and other decisions that produce a quick payday but also involve large long-term risks. When reckless risk-taking becomes endemic — for example, creating trillions of dollars in unsound securities and trillions more in their derivatives, as Wall Street has done in recent years — the fallout can pull down the entire economy. That makes it all of our business, and the Frank legislation also directs federal regulators to define and ban “inappropriate or imprudently risky compensation practices.” It’s a beginning.

There may not be much time, because the old practices that got us into this mess still go on. Goldman Sachs and other financial titans which a few months ago happily took tens of billions of dollars in direct and indirect taxpayer bailouts are already preparing to dole out billions of dollars in new bonuses to their executives and top traders, based on new deals which have generated large, short-term profits but also are said to involve large, long-term risks. It’s no surprise: The compensation committees and their practices haven’t changed, and now they also know that whatever happens, they’ll be bailed out. Ironically, the bailouts that saved us from a second Great Depression may also bolster some of the distortions that threaten to produce it. If we want to avert another, even worse crisis, basic economics tells us that these compensation practices have to go.