Monthly Archives: July 2008

In the Mail

Prices and Production and Other Works by F.A. Hayek

For years, Monetary Theory and the Trade Cycle and Prices and Production have been scarcely available and consequently at a steep cost. However, the Mises Institute has released a hardback volume that includes both texts as well as several essays by Hayek at a very reasonable price.

Some Health Care Discussion

Paul Krugman writes:

The basic facts on health care are clear: government-run insurance is more efficient than private insurance…

I believe that to be false (more on that later). He continues:

…more generally, the United States, with the most privatized health care in the advanced world, has a wildly inefficient system that costs far more than anyone else’s, yet delivers no better and arguably worse medical care than European systems.

But all of this runs so counter to libertarian assumptions about the superiority of individual choice and market mechanisms that they just can’t take it on board. So we have bald assertions that Europeans receive much less care than Americans, even though the data clearly show that it just ain’t so. And we have assertions that mean-testing Medicare is the answer to our problems.

The link that Krugman provides to justify that these claims “just ain’t so” is an article by Gerard F. Anderson, Uwe E. Reinhardt, Peter S. Hussey and Varduhi Petrosyan from the journal Health Affairs. The paper essentially shows that Europeans obtain the same quantity of services as those in the United States and therefore the difference in spending must be made up by the prices. Here is there conclusion:

In 2000 the United States spent considerably more on health care than any other country, whether measured per capita or as a percentage of GDP. At the same time, most measures of aggregate utilization such as physician visits per capita and hospital days per capita were below the OECD median. Since spending is a product of both the goods and services used and their prices, this implies that much higher prices are paid in the United States than in other countries. But U.S. policymakers need to reflect on what Americans are getting for their greater health spending. They could conclude: It’s the prices, stupid.

The problem with this analysis is that it lacks any measure of quality. The authors acknowledge that this is a problem while pointing out that it is hard to determine the correct measures of quality. However, without such measures, saying that Americans are paying higher prices is an incomplete and, perhaps, a misleading statement. The conclusion that Krugman seems to draw from this paper is that if Americans are paying higher prices for the services, then prices are the problem and a government insurance system could surely lower them. It is possible, however, that the differences in prices are explained by differences in quality. If Americans are paying higher prices for the same number of treatments, the higher price may reflect a quality premium. In which case, reducing the price through government intervention would lead to reductions in quality of service.

This gets us back to my original comment that Krugman is simply not correct to say that government-run systems are more efficient. For example, rather than look at cross-country analysis, let’s begin by analyzing things at home. For example, Medicare Part B forces doctors to choose to accept patients on assignment or not. The doctor’s choice plays a key role in the payment they receive. By accepting assignment, they agree to accept Medicare’s approved rate for services. However, if the doctor chooses not to accept assignment, they can bill the patient for an amount above the Medicare approved rate and Medicare will reimburse the patient for the approved rate minus the 20% co-payment (a process known as balance billing). The process of balance billing essentially allows the doctor to price discriminate. However, the federal government adopted balance billing restrictions of 115% of the approved rate and many states have subsequently adopted balance billing restrictions of their own. A fellow Ph.D. student here at Wayne State is currently writing his dissertation (sorry, it is not yet available online) on the effect of balance billing restrictions on the quality of care. I have been fortunate enough to read a draft of the paper, which provides overwhelming evidence (and the most comprehensive evidence to date) that these restrictions have led to uniform reductions in quality (across a broad spectrum of quality measures). Thus Krugman’s assertion that government-run health care systems are more efficient seems to be quite erroneous.

Would We Be Better Off With $8 Gas?

Joel Stein wishes that we were more like Europe:

If the U.S. were to slowly jack up gas taxes until we’re in the $8 range, life would be better. We’d not only be safer and have reduced greenhouse-gas emissions, we’d probably be happier too. Studies show that the only thing that consistently increases personal happiness is social interaction; high gas prices have led to real estate prices falling faster in suburbs and exurbs than in cities, so we may soon have more content downtown-dwellers. Those same studies show that the thing that makes people least happy is commuting, and telecommuting is way up this year. We could use the tax revenue to fund public transportation. And we’d go back to the days when driving a car was a way to show people what a rich jerk you were. In other words, we would no longer need SUVs for that.

I have stated my opposition to Pigouvian taxes many times (see, for example, here and here). However, this paragraph highlights a major pet peeve of mine with respect to such taxation. Let’s take it point-by-point:

1. “[L]ife would be better.” For whom? Simply stating that lives would be saved on the roadways or that greenhouse gas emissions would be reduced is not enough to automatically assume that life would be better. These benefits must be weighed against the costs (author’s note: I know that it sounds crude to quantify the benefits of extended an individual’s life, but we do this all the time).

2. “Studies show that the only thing that consistently increases personal happiness is social interaction…” I will outsource my thoughts on happiness research in general to Will Wilkinson.

3. Public transportation should never be mentioned in the same paragraph with making people happier. Personally, I would not be happier to know that every gallon of gasoline that I purchased was being used to subsidize an inefficient government-operated system of transportation. I similarly fail to see why having more people live downtown is better for society. Perhaps in Stein’s mind.

Overall, I am opposed to Pigouvian taxation because I think that there is a fundamental knowledge problem that must be overcome in order to set the proper rate of taxation as well as the potential to succumb the public choice problem. Our experiences with taxes on tobacco provide an excellent example of my reasoning. States routinely raise taxes on cigarettes and other tobacco products to close budget shortfalls. This means that one of my points must be fundamentally correct. Either politicians are unable to identify the correct rate of taxation or they simply use the social cost of smoking as the whipping boy to raise tax revenue.

More than anything, however, I do not like the elitist, social planner tone that has come to dominate those who favor the Pigouvian taxation. I am fine with the idea of a debate regarding efficiency and optimal taxation. However, this meme of promoting an ideal society strikes me as elitist and self-serving. Perhaps we should put a tax on Stein’s column.

Treasury Announces Plan to Back Fannie and Freddie

The WSJ reports:

The U.S. Treasury and Federal Reserve, capping a weekend of high-stakes maneuvering, attempted to shore up confidence in Fannie Mae and Freddie Mac by announcing a plan that placed the federal government firmly behind the battered mortgage giants.

In a statement timed to precede the opening of Asian markets Monday, as well as a closely watched auction of debt by Freddie, the Treasury said it plans to seek approval from Congress for a temporary increase in a longstanding Treasury line of credit for the two companies.

The Treasury also said it would seek temporary authority so that it could buy equity in either company “if needed” to ensure they have “sufficient capital to continue to serve their mission” of providing a steady flow of money into home mortgages. The plan, which requires congressional approval, also calls for a provision to give the Federal Reserve a “consultative role” in the process of setting capital requirements and other “prudential standards” for Fannie and Freddie.

The Fed’s Board of Governors met Sunday in Washington and voted to grant the New York Fed authority to lend to Fannie Mae and Freddie Mac “should such lending prove necessary,” the central bank said in a statement. The move would effectively give the two companies access to the Fed’s discount window if necessary, providing a backstop in case the firms were to face a short-term funding crisis down the road.

Officials are hoping that, by promising bold action if needed, they can instill enough confidence in the battered companies that such intervention will ultimately prove unnecessary.

Meanwhile, James Hamilton has written an excellent post on how we got to this point.

Inflation Inequality

The conventional wisdom is that inflation always hits the poor the hardest. Writing over at VoxEU, Christian Broda of the University of Chicago disagrees and suggests that the larger inflation burden falls on the richest households:

Inflation differentials between the rich and poor dramatically change our view of the evolution of inequality in America. Inflation of the richest 10 percent of American households has been 6 percentage points higher than that of the poorest 10 percent over the period 1994 – 2005. This means that real inequality in America, if you measure it correctly, has been roughly unchanged. And the reason is just as dramatic as the result. Why has inflation for the poor been lower than that for the rich? In large part it is because of China and Wal-Mart!

Here is a non-gated link to his recent research paper on the topic.

Keynes and the Crisis

In Keynes’ General Theory, he explained that an equity market collapse could be blamed on either a weakening of confidence or of the state of credit — in modern parlance, these are referred to as “counter-party risk” and “liquidity risk” respectively. The importance of this observation, however, is given by Keynes subsequent assertion that “recovery requires the revival of both” (Keynes, 1936 [1973]: 158).

The point raised by Keynes is especially prescient given the current market turmoil. The realization that asset-backed securities were not worth what investors thought they were led to a collapse of both confidence and the state of credit. Financials were left wondering what the true size of their balance sheet was and therefore liquidity was in short supply, while simultaneously the increase in counter-party risk led these same institutions to be hesitant to lend. The result was a substantial increase in conventional measures of risk as reflected by the LIBOR-OIS spread and the TED spread as well as others. In an effort to ensure that both the collapse in confidence and of liquidity were reversed the Federal Reserve has taken drastic action. They have expanded the scope of the discount window through the Primary Dealer Credit Facility (PDCF) and have created the Term Auction Facility (TAF) to ensure that firms have the liquidity that they need. In addition, the federal funds rate was lowered precipitously to 2%. Thus, the major question is whether this has worked.

The conventional wisdom seems to be that the Federal Reserve has been moderately successful, but that they need to hold their course (i.e. not raise rates) to prevent a further exacerbation of the crisis. On the other hand, I have recently advocated a tightening of the federal funds rate in an attempt to stave off ever-growing inflationary pressures from a world awash in liquidity and therefore would like to submit the current data to closer analysis.

Currently the spread between the 3-month LIBOR (the London Interbank Offer Rate) and the Overnight Indexed Swap remains relatively high. Similarly, although the TED spread has gone down it remains elevated. In a recent paper by John Taylor and John Williams, they argue that these elevated risk spreads in the aftermath of the creation of the TAF suggests that it has not been successful. They may be correct, but I would like to float a different hypothesis. It is my view that the creation of the TAF and the subsequent creation of the PDCF have only satisfied one aspect of the recovery process, namely, an increase in liquidity. Whereas the programs increase the scope of the Federal Reserve’s role as lender of last resort thus ensuring that there is liquidity to be had, the programs have not succeeded in restoring confidence. In other words, the conventional measures of risk are reflecting counter-party risk, rather than liquidity risk. As the allusion to Keynes earlier highlights, it is not enough to start a recovery by merely providing liquidity; confidence must also be restored. Although the Fed had hoped that the creation of such programs would encourage firms to accept the same collateral, they have provided no such increase (or at least very little increase) in the state of confidence (as reflected in the still elevated conventional measures of risk).

If I am correct in my hypothesis, this would suggest that the rate cuts by the Federal Reserve have gone too far and have not contributed substantially to the increase in liquidity nor to the alleviation of the crisis. Under such circumstances, it would therefore prove prudent for the Federal Reserve to begin raising rates to stave off inflationary pressures rather than relying on others to do so. Unfortunately, my hypothesis also suggests that the crisis is here to stay for some time as the financials sort things out and until, ultimately, confidence is restored.

Feldstein on Oil

Martin Feldstein explains a theory of rising oil prices that I am quite partial to:

Unlike perishable agricultural products, oil can be stored in the ground. So when will an owner of oil reduce production or increase inventories instead of selling his oil and converting the proceeds into investible cash? A simplified answer is that he will keep the oil in the ground if its price is expected to rise faster than the interest rate that could be earned on the money obtained from selling the oil. The actual price of oil may rise faster or slower than is expected, but the decision to sell (or hold) the oil depends on the expected price rise.