Greg Mankiw on Health Insurance

I was at the Cengage Learning annual teaching conference on Friday and had a great time.  Gail Hoyt gave a seminar for grad students about the top 5 tips for effective teaching & top 5 tips for the job market.  That was really good and followed by N. Gregory Mankiw's keynote address at lunch.  What Mankiw said really resonated with me.  I had no idea that he was so light-hearted and funny...I feel like he could give Yoram Bauman (the stand-up economist) a run for his money if he tried.

Mankiw's speech was about the fiscal challenge ahead.  I really liked what Mankiw had to say about gas taxes (there should be a ~$2.00/gallon tax on gas to help correct the negative externalities generated by driving) and getting rid of the mortgage interest deduction on taxes (even though I own a house, I realize that this is a terribly inequitable tax and costs our government lots of revenues).  What really resonated with me was his take on medical insurance.  I've actually had much the same conversation with my girlfriend and it was super duper neat-o to hear Dr. Mankiw express my views from his mouth to a room full of people/webcast full of viewers.  Here's the upshot of the problems with medical insurance:

People are using medical insurance as non-insurance.  Insurance should be for unexpected events, not regular medicine or treatments.  Since medical insurance compensation is tax deductible, people have too much of it.  To see why, consider what would happen if your auto insurance was tax deductible.  You would tell your employer that you're willing to take a pay cut if he pays for your auto insurance policy.  You would want better coverage than you currently have (as long as insurance is a normal good, which it's hard to argue otherwise).  Normal auto insurance now covers incidental things like accidents but it does not cover regular maintenance items like new tires, burned out headlights, oil changes, and filter replacement.  If you had the tax deductible setup, then you'd want as much of your car expenses to be covered by insurance (with a more expensive policy).  We would probably see clauses allowing insurance to cover filter replacement and oil changes.  People might even want to go as far as to have their policy cover gasoline fill-ups.

If this sounds ridiculous to you, consider someone with a monthly prescription that is covered by their insurance.  That might be too much insurance coverage.  I think that there are ways around "insuring" monthly prescriptions.  One reason why it's attractive to have insurance coverage for monthly prescriptions is the difference in cost between paying out-of-pocket vs. paying through insurance.  Part of the reason for the price difference is the market power of the insurance company compared to that of an individual consumer.  The insurance company can negotiate lower rates.  Another reason is that healthy people are subsidizing pill takers.  That setup might make sense for temporary prescriptions but not regular recurring prescriptions (which is like auto insurance covering gasoline).

If my gasoline were subsidized, you can bet that I'd drive more than I do now.  So would everyone else.  It's a tragedy of the commons type problem.  The monetary outlays on gasoline would increase and people would be concerned about the rising costs of auto insurance...but they wouldn't want to remove the moral hazard (speaking just about the gas and not about reckless driving) associated with purchasing that insurance.

Speaking of the rising cost of medical insurance, Mankiw does not think this is a bad thing.  One reason why the cost has increased is that the productivity of medical capital has increased.  We are also able to do amazing things with medical technology that we couldn't in the past.  When I broke my wrists, I was able to regain a near full range of motion.  I was informed by my surgeon that I would have about half the range of motion in each plane had this accident occurred only 5 years earlier.  Mankiw offers a thought experiment:  would you agree to pay the rate on medical treatment paid by your grandfather (in his 40s) in exchange for only getting the care that he could have received all those years ago.  Mankiw's personal answer is no.  My answer is no.  What about yours?  Consider the drugs that have been invented since then.  The MRI technology, laser surgery, etc.  Those things are more expensive than the older alternatives, but they're also more effective.  Mankiw further points out that we do not seem to experience diminishing marginal utility in years of life like we do for consuming other goods.  Nobody says "I've made it to 74 and it's all downhill from here...I don't care if I live another year."  We do say "I've had 47 slices of apple pie...I would hate to eat a 48th."  Given that a goal of medical care is to prolong life (or to improve the quality) then he thinks that we'd be willing to spend plenty more on it.  Perhaps with everything else getting cheaper we have more money to spend on medical care.  He would like to see medical care keep increasing in cost to keep up with the technological improvements.

I think another reason medical costs have risen is the shift in demand for medical services caused by insured people.  I'll admit that I've gone to the clinic at school for a sore throat because the visit was free.  I would not have driven to the doctor's office and paid $100 for a similar visit.  Driving down the cost of medical care will require: 1) aligning doctors' incentives to provide cheaper medical care, 2) driving down demand for medical services...perhaps by a preference shift toward healthier lifestyles or sudden death inducing activities and/or 3) a bigger increase in the supply of medical inputs.

I hope I've done some justice to his talk.  I've added some of my own thoughts along the way, so don't get mad at Greg if you disagree with anything above unless directly attributed to him.