Healthcare Reform on the Supply Side

Since the beginning of the Great Healthcare Debate of 2009 and 2010 just over a year ago, I’ve felt that Democrats and Republicans have both been missing a very important point. Mr. Obama and the members of his party in Congress have offered proposals aimed at dramatically expanding access to health insurance and offering coverage to tens of millions of the uninsured. Republicans counter that such plans will only worsen the problem of rampant medical inflation as price signals are further distorted in the market for healthcare and more people demand services that are already scarce. Their counterproposals, a number of which have been adopted in one form or another into the legislation that will presumably be reconsidered sometime soon, have mostly consisted of attempts to rein in costs through a combination of malpractice reform, decreased regulation of insurers, and incentives for people to save for their own healthcare expenses, thereby discouraging unnecessary spending by making consumers more aware of the true cost of their own decisions.

But both of these approaches only deal with half of the problem. Just as the Federal Reserve found itself trying to fight a supply-side problem with demand-side weapons during the era of stagflation in the 1970’s and 1980’s, Congress today finds itself attempting to resolve the healthcare issue halfway, by making changes that will only affect the nature of demand for healthcare and not its supply. It’s probably true that efforts to expand coverage will lead to more people wanting more services, but the critics offer no workable alternative.

Unlike most markets, where sustained increases in demand lead to more sellers supplying consumers with what they want, the market for healthcare is fundamentally unable to expand in such a way. Drug companies can produce more drugs, device makers can make more devices, but the amount of healthcare that can be supplied at any given time is still constrained by the number of doctors, and the number of doctors is constrained by the number of medical schools.

There’s no question that more and more people are trying to get into medical school, but getting in is becoming increasingly difficult, even for qualified candidates. President Obama has actually discussed the idea of offering better funding for medical students so that they aren’t rewarded for their toils with crushing debt upon graduation, but this doesn’t really address the root of the problem. So what if more people can pay for medical school? What if there aren’t enough medical schools?

Fortunately, the tide may be turning. An article published early last week in the New York Times discusses the fact that new medical schools all over the country are beginning the process of accreditation. It notes that there are currently 131 schools in the United States, and that only one new one opened during the 1980’s and 1990’s. In contrast, there are around two dozen that are currently close to opening, such as those affiliated with Quinnipiac and Hofstra Universities.

The article takes the contrarian view that this might not actually be as good a thing as it sounds. Not only will we not see a dramatic increase in the number of physicians anytime soon, but there is no guarantee that these doctors will end up in the rural and impoverished areas where they are so desperately needed, or that they won’t just create demand for their own services, thereby worsening the problem of access.

But in economics, there’s no such thing as a free lunch, and I for one would much rather pay for my lunch than go hungry. The system by which healthcare is provided and paid for in the United States is highly dysfunctional, but there is a limit to what demand management policies can accomplish. Without more doctors and nurses, our quandary will only get worse.

"A Night of Social Commentary With Christopher Hitchens"

I recently had the good fortune to meet and have dinner with Christopher Hitchens, the English-American secularist and self-styled polemicist who has written prolifically on everything from Islamic extremism to Mother Theresa to his own self-inflicted waterboarding. Aside from noticing his works while browsing the religion section of my local Borders, I first discovered Hitchens when watching an online documentary called “The Four Horsemen,” the title of which refers to four giants of the modern atheist movement: Oxford biologist Richard Dawkins, author Sam Harris, Hitchens, and Tufts University philosophy professor Dan Dennett, who I believe to be one of the greatest intellectuals of our day.

What was remarkable about the dialogue was that it revealed the genuine disagreement that exists among atheists about the role of their belief system in contemporary society and the approach that they ought to adopt when dealing with the religious. Dawkins, in his typically acerbic style, argues for the utter dissolution of all forms of religion, and denies that spirituality qua spirituality has ever been a force for good in the world. Rather, he claims that any apparent good done in the name of religion has actually been motivated by secularism, and only adopts the mantle of religion to protect itself from a largely orthodox zeitgeist. Hitchens, with some exceptions, generally agrees with this view. The most interesting argument made in the film, and one that he elaborates on further in his 2006 book Breaking the Spell, is Dan Dennett’s claim that moderate religion not only has the potential to be beneficial, but may even be necessary if we are to rid the world of religious extremism. More on this in a moment.

It was only a few weeks after I had watched “The Four Horsemen” that I found out that my college would be hosting Hitchens for “a night of social commentary,” and I was fortunate enough to be included in a group of about ten students invited to have dinner with him before his presentation. In real life, Hitchens is exactly what he appears to be in televised interviews or YouTube videos: sarcastically witty, profoundly knowledgeable, and completely at home in the realm of rhetoric. He has an uncanny ability to immediately appreciate the flaws in any argument, and his facility with language is dazzling; his most intellectually complex statements are tossed around like casual bromides, and even those reactions that seem impulsive and instinctive come out sounding polished and organic. It also helps that he has a British accent.

His talk dealt with “threats to free expression,” examples of which included the fatwa pronounced on author Salman Rushdie by the Ayatollah Khomenei of Iran after the publication of Rushdie’s controversial book “The Satanic Verses,” and the furor that erupted in 2005 over a Danish cartoonist’s depiction of the prophet Muhammad. To Hitchens, the evil of religious censorship is only part of the problem. The true horror is the relative ease with which others capitulate in the face of extremist anger. He decried not only the Ayatollah and all those who called for the killing of Rushdie in the aftermath of the fatwa, but also every bookstore that refused to sell the book and every library that refused to keep it on its shelves. In discussing the Danish Muhammad cartoon, Hitchens criticized CNN for not airing any actual image of the item that was causing so much controversy. He further claimed that he asked the producers of a CNN program on which he appeared to discuss the matter whether they were displaying such sensitivity because they were afraid. The answer, allegedly, was yes.

During the question-and-answer period that followed the talk, Hitchens was no less incisive, at one point replying to a student by wondering aloud why she wasn’t “able to make an actual question out of that.” I asked him if he could ever conceive of a situation in which censorship of any kind might be justified. He explained that, in principle, national security may at times require it, but that in most circumstances nobody is “good enough” to deserve the title of censor.

At the dinner before the talk, Hitchens got into a spirited back-and-forth with a student regarding his support for the Iraq War. He expertly rebutted the criticisms of his position, concluding the debate by adding that “if you try to say anything else at this point, you will only convict yourself of not knowing what you’re talking about” (my paraphrase).

It was at that point that I decided to steer the conversation away from foreign affairs by asking whether he agreed with the view that Dan Dennett expresses in “The Four Horsemen” that moderate religion is essential to eradicating extremism, and that atheists have not and cannot in principle make any dent in the problem because their views are dismissed from the outset by the dogmatists they hope to persuade. According to this thinking, reform can only be realized if it is spearheaded by moderates within a religious tradition who are willing to engage their more orthodox brethren in a dialogue about their respective theological positions.

Hitchens scoffed at the notion and told me it was absurd to believe that extremists are only angry because people like him are making them angry. I told him this wasn’t what I meant at all. What I was asking was whether he thought it prudent to criticize moderate religion when it might hold the elusive key to ending fundamentalism – a goal that Dennett and I believe might be beyond the ability of atheists to accomplish. He conceded that in certain parts of Africa, Christian organizations have been more effective than secular ones at getting ideological reactionaries to agree to stop practicing female genital mutilation.

Did I actually win an argument against Christopher Hitchens? Probably not, but considering what happened to everyone else who tried to challenge him, I’m happy to chalk up a draw as a victory.

Moderate Conservatism Goes Mainstream

Over the course of the first year of the Obama Administration - and some would argue, because of it - moderate Republicanism has all but ceased to exist. Dealmakers like Olympia Snowe are looked upon by the party establishment as defectors willing to cooperate with the evil socialist agenda of the White House. Center-right Senate candidates are being overtaken in public opinion polls by staunch conservatives like Marco Rubio and Rand Paul. Sarah Palin has assumed a new role as the face of the populist Tea Party movement. Her former running mate, an erstwhile champion of true bipartisanship, may very well lose his long-held Arizona Senate seat this November. And not because he's a Republican, but because he isn't Republican enough.

The GOP seems to be concluding exactly the opposite of what they had hoped Obama would: moving to the center is not the answer. Becoming more radical is.

It's hard to see how this could possibly be a good thing for America. During the 1990's, the nation experienced a time of unprecedented peace and prosperity, largely as a result of divided government. Bill Clinton was forced to abandon some of his more ambitious liberal goals with the election of a Republican Congress in 1994, but so too were the Republicans compelled to lay aside their more ideologically-driven aspirations. Clinton vetoed welfare reform several times before signing a version he approved of, and deals were struck that, while far from perfect, represented true sacrifice in the name of bipartisanship. The "Don't Ask Don't Tell" policy, which is rightly being put on a path to repeal, was arguably a significant accomplishment in its day.

Paul Krugman observed recently in his New York Times column that the Republican opposition seems to find political potential in making the country literally ungovernable. This is indeed a disturbing trend, but my hope is that the defenders of centrism among those on the right may yet prevail.

I was particularly encouraged by two columns out today, one in the Washington Post by George Will, in which he argues that Palin is not qualified to be President and that the GOP should turn to more reasonable alternatives; and the other in the Wall Street Journal by Karl Rove, who urges the Tea Party to disown its radical fringe and divorce itself from 9/11 denialism and charges that Obama was not born in the United States. Both convinced me that something profound is happening: moderate conservatism is finally returning to the mainstream. Conservative commentators are no longer just taking shots at Obama, but are finally trying to reverse the slide of their party to the far right by pointing out the very real virtues of centrism.

Either that, or they're just following Olympia Snowe in cooperating with the enemy.

"Fear the Boom and Bust"

I originally found this little gem on Greg Mankiw's blog. It appears that it's the only piece that Econstories.tv has produced thus far, but I expect that many great things are yet to come.

Pelosi and Partisanship

“We’ll go through the gate. If the gate’s closed, we’ll go over the fence. If the fence is too high, we’ll pole-vault in. If that doesn’t work, we’ll parachute in. But we’re going to get health care reform passed for the American people, for their own personal health and economic security, and for the important role that it will play in reducing the deficit.”

- Nancy Pelosi, on a proposal to pass comprehensive healthcare reform as a series of separate bills

GDP and Bowling Analogies

The Wall Street Journal reports that the U.S. economy grew at an annualized rate of 5.7% in the fourth quarter of 2009, and provides an excellent interactive graphic that tells the story of Adam, a (horribly inefficient) bowling pin manufacturer, as a way of explaining the effect of inventory drawdowns on the measurement of GDP.

An Economic Review of Ron Paul's "End the Fed"

I’ve always had a somewhat conflicted view of Ron Paul. During the 2008 Republican primaries, I found myself rooting for him, impressed by his honesty and his willingness to advocate ideas for their philosophical merit rather than their political expediency. After all, anyone who speaks openly about writing earmarks for his congressional district into spending bills and then voting against them obviously does so not because he’s grasping for soundbites that will make him more electable, but because he read some Rand and truly believes it. At the same time, he advocates a number of positions that are absolutist and far from mainstream in our contemporary political discourse, even among conservatives. He also once called Brüno “queerer th‘n th’ blazes”.

A few weeks ago, I happened upon his new book End the Fed while I was perusing the shelves of a local Borders. Given my lack of a clear position on his thinking, I decided that I’d read it and sort out the legitimate arguments from the anarchist paranoia for myself. What follows is my earnest attempt to give Paul’s economic philosophy a fair and balanced analysis – something it gets from neither his foes on the left nor from his teabag-waving, money-burning supporters on the libertarian right.

I must admit that End the Fed is incredibly persuasive. Aside from the fact that over half of its references are either to materials printed by the sympathetic Ludwig von Mises Institute in Auburn, Alabama (which promotes the teaching of the Austrian School of classical liberalism) or to things written by Ayn Rand, its scholarship is extensive and solid, and its argumentation sound and intellectual. It even includes a recommended reading list divided into categories based on level of familiarity with economics.

My overall impression of the book is that it correctly and incisively exposes the flaws that have become virtually inherent in the conduct of American monetary and fiscal policy and the ways in which irresponsible decision-making by our political leaders has exacerbated the wild fluctuations of the business cycle. It concludes from this, however, that the only workable alternative is an ideology that strictly prohibits the government from getting involved in the economy at all. The need for substantial reform is duly noted, and this reform may even have to consist of significantly crippling the powers of the Federal Reserve. It certainly does not mean that government should have no role in the economy, or that a return to the gold standard (the second main argument of the book) is necessary or desirable.


The Gold Standard

I’ll address this latter issue first, since it consumes a good part of End the Fed’s 210 pages. Paul repeatedly calls for a return to “sound money,” and indeed this is a worthy goal. Wealth is only truly safe from the “inflation tax” when it can be secured in a form that is not subject to changing political tides. Though he claims that he has no bias for gold in particular, and that any “system that would permit markets to once again choose the most suitable money, whatever that turns out to be”, would be acceptable, he also argues that “gold has all the qualities that we associate most with good money: divisibility, portability, high value per unit of weight, durability, and uniform quality” (pg. 71). He further claims that there is no need to ever change the size of the money supply, since “any quantity of money will do, so long as the money is sound. … New quantities of money injected into society confer no social benefit.” (pg. 203) In principle, this is true. Since wealth is created by the act of production, the physical supply of money (or even the nonphysical supply, as determined by a metric like M3) is secondary, a mere representation of something more abstract.

But the problem is that Paul attempts to conclude from this that there would be no inflation in an economy where manipulation of the money supply is not an option, since “inflation is always and everywhere a monetary phenomenon.” This assertion, originally stated by Milton Friedman and reiterated by Paul and others like him, is largely incorrect. Though inflation certainly can be precipitated by monetary policy (extreme examples are Weimar Germany and Zimbabwe prior to dollarization), the more common forms are due to changes in aggregate demand (“demand-pull inflation”) and changes in aggregate supply as a result of fluctuating factor prices or exogenous cost shocks (“cost-push” or “wage-push inflation”). Inflationary expectations can easily make either of these chronic and unstoppable, necessitating intervention. Even if inflation did disappear in Paul’s Fed-less America, growth with a fixed money supply would likely cause significant deflation, which entails its own very real costs.

End the Fed includes a partial transcript of a congressional hearing from July of 2005, in which Alan Greenspan replies to a question fielded by Ron Paul about the possibility of returning the U.S. to the gold standard:

Would there be any advantage, at this particular stage, in going back to the gold standard? And the answer is: I don’t think so, because we’re acting as though we were there. (pg. 91)

In other words, the “soundness” of money has nothing to do with what that money is, or even how it’s backed, but rather with how the supply of it is manipulated by governments (or by gold miners – a fact that seems lost on Paul). True, commodity money whose value is managed by markets rather than by central banks is less susceptible to such manipulation, but it is by no means safe from the threat of becoming unsound for other reasons. Greenspan rightly points out that the blame for chronic boom-bust cycles rests not with fiat money as such, but with the people who print it.


Paul: The Patron Saint of Economic Morality?

Before I address Paul’s specific criticisms of the Fed, I want to touch upon his free-market ideology. Though he provides numerous examples of inefficient government interference in the economy (e.g. wage and price controls during World War II and the 1970’s), it is also true that markets do not always achieve the most efficient outcome, a phenomenon known as market failure. There are certainly government failures as well, in which government action does not achieve the most efficient outcome, but the existence of one does not negate the existence of the other. The Austrians would have you believe that market failures never happen – because they’ve defined markets as mechanisms that are incapable of any meaningful kind of failure. This is clearly disingenuous. The Austrians are guilty of intellectual dishonesty, for this and for the fact that they claim economics cannot be empirically studied (which conveniently renders their critics unable to prove them incorrect).

In the context of American politics, even strict constitutionalists and limited government-ers like Paul, whether knowingly or not, concede the need for some government involvement in the economy. I submit that the Constitution not only mentions but actually grants the federal government the right to address various types of market failure. Article I, Section 8 lists among the enumerated powers of Congress the power to “establish Post Offices and Post Roads” (provide nonexcludable public goods), “fix the Standard of Weights and Measures” (impose standards for the sake of efficiency in markets that do not automatically converge to their own), and to “promote the Progress of Science and useful Arts, by securing for limited Times to Authors and Inventors the exclusive Right to their respective Writings and Discoveries” (manipulate the ability of firms to acquire market power). The bottom line is that Paul’s ideology is deeply inconsistent, and his criticisms of the Fed should be approached with caution.


Where Paul Gets It Right (But Then Very Wrong)

Nevertheless, I would like to deal with one criticism in particular, namely that the Federal Reserve sets the stage for recessions and depressions by distorting market signals. I’ll briefly deal with this argument before explaining why the Fed is ultimately necessary and how we can learn from Ron Paul’s whistleblowing and make the system better.

Paul, on regulation:

The idea that we can depend on the [regulators] to protect us significantly contributes to moral hazard. More risks are taken believing the government will protect us, and our guard against evil is diminished. Easy credit by the Fed sets the stage for excesses… The entire system… is like a super Ponzi scheme (if we can’t pay it back, let’s just create more!)… (pg. 187)

In other words, the mere existence of the Fed can encourage irresponsible behavior – even by the Fed itself. By setting interest rates lower than the market would on its own, it gives entrepreneurs and investors the impression that more financial capital is available than actually is, and the construction of a house of cards begins. There are other problems too. As Paul points out, a central bank with money-printing powers can strongly tempt politicians to abandon a sense of fiscal discipline, and, he alleges, may even do much worse (“[If the Fed were ended, no longer would presidents be in a position to lean on the central bank to artificially boost the economy before elections…” (pg. 8)).

He also attempts to argue that a banking system akin to the kind that existed for most of the 1800’s would be more desirable than the status quo:

But would this be “wildcat banking” of the sort that is frequently condemned from the nineteenth century? No more so than we have “wildcat restaurants” or “wildcat shoe companies.” Markets are self-regulating, responding to the wishes of consumers. It would be the same in banking. (pg. 190)

Not quite. Paul cites research that claims that the panics of the 1800’s were healthy for the system in that they destroyed banks that performed badly, and indeed Friedman argues elsewhere that attempts to stop banks from failing at the start of the Great Depression prolonged pain that would otherwise have been relatively self-limited. For all its merits, the problem with this thinking is twofold.

For one, banks and financial institutions today are remarkably interconnected in ways that could not have been dreamt of 150 years ago, and information about institutional instability is spread much more quickly. No longer is there a sense that a bank failure 100 miles away is not my problem. Secondly, the psychological impact of a bank failure is radically different from that of the failure of any other type of firm. Despite Paul’s assertion that “bank failures are no more to be regretted than any other business failures” (pg. 27), banks are not just “any other business.” They protect personal savings and the financial capital that is essential for future growth. The failure of a bank does not just cause people to decide that that bank was poorly run; it sows doubt as to whether any and all other banks are suffering from similar internal problems. The market may very well not self-correct. The economy could be paralyzed by systemic fear. The only way out is for an unshakable central bank to restore public confidence in a consistent and predictable way that minimizes the threat of moral hazard (Bear Stearns was allowed to fail, so why not Bank of America too?).


“The Way Out”

As he explains in the last chapter of the book, entitled “The Way Out,” Paul’s first step toward abolition of the Fed is to bring its activities under greater Congressional scrutiny by allowing the Government Accountability Office (GAO) to audit any and all of its decisions and transactions. In fact, an amendment he introduced to do just that passed the House on 19 November 2009, and will presumably be considered by the Senate after Obama’s healthcare saga comes to an end. The Fed was intended to be a completely apolitical entity, and while this is probably an unrealistic vision, bringing more of the Fed’s powers under the purview of Congress only worsens the problem. An audit is called for, but it would be better to have it done by a private sector firm than by another government agency. As for how to reconcile the need for a central bank with the need to keep it as politically detached as possible, I would propose a system under which monetary policy is run by a pool of academic economists. This group of experts (the bigger, the better) could be polled on whether or not to approve certain actions, with only a random subset of those votes actually counting. This would help to limit the amount of political pressure that could be exerted on the system by keeping it decentralized and partly anonymous.

Saith Paul, in the dramatic conclusion of his book: “We have a natural, God-given right to our lives, our liberties, and the fruits of our labor.” (pg. 210) I couldn’t agree more. But to paraphrase Galileo, a God who would give us the faculty of reason would not also encourage us to abandon its use. The science of economics has taught us much about how to better our lives, and while “liberty” is an appealing virtue, it is not the kind of nuanced answer required by the complex problems that face our society.


Moral of the Story

End the Fed is well worth the read, but like me, you might consider waiting until you can buy it for 50% off. Or until you have a giftcard, in which case somebody else is paying for it.


Addendum

I wrote roughly 80% of this note before I happened upon a similar commentary from a Time column called “The Curious Capitalist," which raises many of the arguments I've explicated and more.