Vouching for healthcare, Part 1

Author’s aside:

I have a number of things I want to say about public policy making.  Some of it seems a bit “academic” and some of it is right out of the pages of yesterday’s Times.  Apparently, the second type of posting is more popular than the first type, based upon the pageviews the postings get.  But I don’t want to give up on the slightly deeper ideas that have helped me, and the thousands of students I have taught over the years, to understand what might really be happening in public policy making.  However, I also don’t want to put lots of you to sleep.  So, I am going to try to publish at least two posts per month, one on “current events” and one on ideas that illuminate the import of those events.  I hope you all read both, but “to each his own.”  If you are new to the blog, you might want to go back and check out some of the earlier “ideas” stuff.

Tomorrow, I'll post on why we shouldn't give up on working for progressive change, no matter how badly some of the current participants stink.  Today, markets.

So, lets talk ideas. 

One of the ideas that the right wing is going to pursue in the next few years is replacing Medicare’s simple single-payer system, used successfully and cheaply throughout the developed world, with a voucher system.  (Yes, they balk at calling it a voucher system, but we know what they mean!)

If you live in Wisconsin or Cleveland or a handful of other jurisdictions in the US, you have seen something similar to this in vouchers for public education.  Here is how Medicare vouchers are supposed to work.

Everyone over the age of 64 will get a voucher from the government, and they will be told to go out and purchase their own health insurance with that voucher.  If they want to spend only the value of the voucher, they will get a bronze (or maybe tin?) insurance policy.  If they wish to spend more money on their healthcare insurance, they could get a gold or platinum policy, limited only by their desires and their resources available to meet those desires. 

Then, we will have set up a market place for health insurance for the elderly.  And (irony alert) we all know that markets are the best way to allocate any resource.  Markets, we know, are the most efficient allocation system, and the most supportive of individual freedom.  We also know that government programs, like Medicare and Medicaid (and all those programs in the 32 other developed countries with centrally-controlled payer systems), are inherently inefficient and will provide awful care, and make us take whatever care we are given, usually from a terrible doctor that we have to wait months to see.

How much of that last paragraph is true?  How well do markets work to allocate health care?  Are they inherently preferable to government-run systems?

I want to spend a few blog posts trying to talk about this policy debate: what to allocate through markets and what to allocate through government.  If you want to read more about what we will be talking about, check out Tragic Choices by Calabresi and Bobbitt, as the central themes of the following analysis is taken from that book.  Not the most interesting book you will ever read, but it made me think, when I first read it almost 40 years ago.  Or just keep reading here.

Our marketplace for hats

First, we have to understand how markets work.  Lets see if we can use a small barter-based market for hats to gain some insight.  We will see that markets are, indeed, efficient and promote liberty.  But at a cost, because they don’t allow us to achieve common goals, they overweight the prevailing distribution of resources (the rich get richer. . . ) and they can’t deal with things that are “intrinsically” valuable, and insist upon trying to turn them into things that are “instrumentally” valuable.

To pursue these ideas, we have to start by thinking small, because large markets are notoriously difficult to understand.  Lets start with this market for hats. 

Assume that you and I are part of a group of nine people who each have a hat.  They come in all sizes, shapes, designs and levels of utility.  We are about to start a market place for these hats, but before we do, we want to know how happy each person is with their hat.

So, all of us value our hat, maybe on a scale of -10 to +10.  I like my hat.  It is vaguely referential to Indiana Jones, and fits me perfectly.  I would value my hat at 7.

Wait.  Seven what?  We can’t say “seven dollars,” because we haven’t introduced money into our market place.  Economists talk about “utility,” the value that individuals gain from possessing some resource.  We could call it “seven utils,” but lets just say that I value my hat at 7 points.  Or, I have seven units of happiness.

You have a silly-looking hat, in my opinion.  But you seem to really like it.  It covers your head well, it seems to provide some protection against the elements.  I would trade that hat in a second, but I don’t think you are going to want to.  To each his own.  You value your hat at 7, too.

Nadiah has a solid gold hat.  She is very happy.  Very.  It doesn’t feel all that great to wear, but it is solid gold, and she knows she is set for life.  This hat, thinks Nadiah, is a solid 10.

Tracy has a hat made of lead.  She is very unhappy.  The hat has no use whatsoever.  Tracy values it as -9.  (She is saving minus ten for when she gets stuck with a radioactive hat.)

Ed has a head condition.  He is not well.  And the condition is getting worse.  It is the sort of thing that could be fixed if he had a protective hat, one that covered his whole head and would protect him from the elements.  But he has a feathery, froo froo thing.  -10.

Paul values his hat at +1.  Not great.  Could be worse.  A bit too small.

Sherry values her hat at +4.  Above average, she supposes.  But she really likes my hat, and hers suffers in comparison. 

Celia doesn’t particularly care for her hat.  It scratches a bit, because she has a small head, and it doesn’t fit well. -1.

Patrick has a hat that doesn’t suit his personality well, as far as he sees.  It is sporty, and he is a bit of a nerd.  But it keeps the rain off. +2.

So, where are we in our nine person marketplace? 

Values at Time 0

Person             IU

You                 +7
Me                  +7
Nadiah           +10
Tracy              -9
Ed                  -10
Paul               +1
Sherry           +4
Celia              -1
Patrick          +2

Total               9

Here comes the magic

In the table we have the utility that each individual assigns to their hat at the beginning, which we will call Time 0.  Lets call the value each person has “IU,” for “individual utility.”  If we want to know how much our marketplace values our hat resources, we just add up everyone’s individual utility.  The math expression of this is:

∑IUj

This is the “sum of the individual utility, starting from the first person in the group and going to the last person, or the 'jth' person.”  It is a way of describing, in a mathematical expression, the total value of what you get when you add the individual values of a group of things.

In our example, we have 9 points of utility in our market place.

Now lets see what happens when we let people start trading.  Because trading is what markets are all about.  The key to understanding markets is to follow the impact of “voluntary exchange.”  If you don’t have voluntary exchange, you don’t have a market.

The first person who wants to trade is Sherry.  She wants to trade with me, because she loves my hat, and only likes her hat.  I look at her hat and value it at -1.  Sorry, no trade.

Sherry then looks around some more, and she sees the solid gold hat.  Of course, she wants to trade, but Nadiah isn’t trading with anyone in our market. 

Finally, Sherry approaches Patrick.  She offers to trade.  Patrick accepts.  He thinks her hat is just his style, and she likes the way his hat looks on her head.  Patrick now values his new hat at +6, a step up.  And Sherry is happier, too, at +7.

Did you notice what just happened?  Nobody forced Sherry and Patrick to trade.  This was a voluntary exchange.  And Sherry could only trade with someone that wanted to trade with her.  Yet, after their trade, something magical happens.   ∑IUj goes up! 

Patrick gained 4 points of IU.  And Sherry gained 3 points.  At Time 0, our little marketplace had 9 units of value.  But now, at Time 1 after our first trade, we have 16.  We have the 9 that we started with and the extra seven that came about because of the trade.

So, at Time 1, after the first trade, something special happened to ∑IUj.  It got bigger.  We can express this change like this:

Δ∑IUj = 7

Delta is the math symbol for change.  So, at Time 1, the change in the sum of the individual utility in our marketplace, through all of the people, equals 7. 

The magic happens again

Let’s see that happen again.  Celia has a hat that is too big, and Paul has a hat that is too small.  At Time 2, they trade.  Notice that nobody made them do it.  Strictly voluntary.   Celia is 4 points happier, and Paul is 5 points happier.

Δ ∑IUj = 9

And the magic happens again.  From Time 1, after the first trade, where our total added up happiness was 16, our total now adds up to 25. 

It seems that every time two people engage in voluntary exchange, the change in the sum of individual utility goes up.  That is expressed as:

Δ∑IUj > 0

Every time a trade takes place in the market, the change in the sum of the individual utility is positive, greater than zero.  And that makes perfect sense, because, since this is all about voluntary exchange, only win/win trades are going to take place.  No one would trade unless they perceived a gain from it, so all parties are always happier after the trade.

This is, indeed, one of the marvels of the marketplace.  But of course, there is a darkness embedded in our little scenario.  How shall Ed live?  More on that in the next blog in this series.