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Are Economists Starting To Think About Their Failures?

photo: radiospike photography (flickr)

Uwe Rhinehardt, a Princeton economics professor and blogger for the New York Times at Economix, has four posts that might be the beginning of a public effort to rethink the role of economists in planning social policy. They lay out in layman’s terms the main points of economic theory, and show that the main theorems used by economists to prescribe solutions to social problems are highly suspect. Each of the posts is a gem, well worth reading.

The first asks whether health care is different from other goods and services offered in the market place. Rhinehardt discusses a seminal paper on the market for health care written by Professor Kenneth Arrow in 1963, when Medicare was the big issue (this link gives the full paper, Rhinehardt links to one which has been shortened).

Rhinehardt starts by listing the characteristics of a perfectly competitive market:

(1) that all of the quality dimensions of the good or service traded in that market are accurately understood by buyer and seller; (2) that potential buyers have full transparency on the price they will have to pay per unit of that good or service; (3) that it is easy and relatively costless for potential sellers to enter and exit this market; (4) and that there are so many potential buyers and sellers that none individually can affect the market price of the thing being traded.

Neither Arrow nor Rhinehardt thinks that the health care market is perfectly competitive. They agree that sellers of health care services know vastly more than consumers, that doctors know more than worried and sick patients. This simple fact should tell us that economics doesn’t have much to tell us about how society should arrange a system for providing health care.

It is true, of course, that customers have plenty of resources that were not available in 1963.

For example, I have an eye problem. The doctor, who I know is an expert, tells me I have a choice of three treatments: lucentis, avastin, or a steroid. They cost $2,500, $1,600 and $1,205 respectively. I have good insurance. He asks me what I want to do. I suppose I could try WebMD and the Google, but how would I evaluate what I read? I did what everyone does: I asked him what I should do, looked on-line to satisfy myself that I understood as much as I could, discussed it with my wife, and did what he said.

Will it work? He doesn’t know, but it’s his professional judgment that it gives me my best chance. That’s another way of saying that even though I have some idea about my share of the price of treatment, no one has a clue about the cost/benefit ratio of a given treatment. Since it involves my sight, price isn’t really an issue.

From this example, we can see that one element of any plausible health care reform is the establishment of best practices for specific problems. That would include both a recommended treatment and a list of reasons why other treatments might be better.

Entry into the health care business is highly restricted. However, we could work on this area, for example by greater use of nurse practioners and other well-trained people to handle a greater number of minor cases.

This analysis shows that there is no competitive market for health care services. Instead, we rely on health care professionals and hope for the best. Arrow points out that we deal with market imperfection in health care with a number of external controls to insure fair and sensible treatment, including licensing bodies, regulators, torts and other systems. These systems should increase the chances that professionals act professionally, and do not use their market superiority to cheat people.

Neither Arrow nor Rhinehardt wants to take on the question of how do we allocate health care, beyond saying that the more money you have, the more likely you are to get good health care. They refuse to address any of the moral or social issues about allocation of health care.

This leads to a number of interesting questions. Are any US markets perfectly competitive? How close to perfect competition do we have to get before we feel comfortable using economic theory? What are the benefits of perfectly competitive markets? Why would a model which fails in step one be used as a foundation for further analysis?

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