Healthcare economics: not that easy, Dr. Krugman…

In my last post, I used a simple economics approach to describe an intrinsic problem of socialized healthcare. I focused on three principal aspects: the first was explaining that so-called measurable outcomes of healthcare are wrong, because they do not measure standard of care. The second was using a well known economics law (supply and demand) to explain why socialized healthcare systems will end up with shortages and rationing. The third was to list some moral and philosophical choices that may arise from selecting a socialized approach to healthcare. I know it was a superficial approach, but it is effective to start the further investigation of some problems that lay behind healthcare costs.

In another article, I also discussed some trade-offs that are necessary to make when choosing the healthcare system that some government will adopt. It is important to note that there is no perfect system. The resources are always scarce, however, we can optimize their use by allowing market forces to allocate them properly – as it happens in a huge variety of areas. Another important point is that there are no different markets that work completely equally. Supply and demand are always there, prices can reach an equilibrium, even when the agents of these markets impose different actions that will change elasticity of the curves, the responses to regulations, etc. Therefore, it is simplistic (if not completely wrong) to say that because the markets are different, we should regulate one type more than the other. However, it is correct to assume that there is no one-size fits all magic solution for the problems we see, being either market or a socialized approach.

In this text, the idea is debunking Paul Krugman’s article called Faith-based Freaks. There, he tries to prove that a free market approach to healthcare is ineffective and costly, however his arguments are poor and his conclusion is a direct result of his weak approach. Dr. Krugman was motivated by Dr. Noah Smith’s article on the Steven Levitt‘s comments to Prime Minister David Cameron about the NHS problems and the solution Levitt proposes.

First, let’s describe the original discussion. In his first article on the topic, Dr. Smith asks about the lack of comments on adverse selection, moral hazard, principal-agent problems, etc in Levitt’s approach (present in his book Think Like a Freak). However, he forgets that other markets present those same characteristics and we do not keep complaining about the lack of comments on them. In addition, he also chooses to ignore that socialized healthcare still presents the same problems of adverse selection and moral hazard, the system even intensifies them. He further chooses to ignore that the physician has more information about the procedures, but he does not have the full picture of the patient’s condition that is only with the patient – characterizing a principal-agent problem, only, in the reverse perspective of Dr. Smith’s concern.

Nonetheless, I agree with Dr. Smith when he says that Dr. Levitt does not present a model of the problem per se, but a solution that is based on the current status of the problem (socialized healthcare imposing its high costs, rationing and lack of effectiveness). I also agree with Smith’s argument that the solution is problematic especially because it is still based on welfare, just the government would be setting the full payment bar higher. However, his suggestion that Americans pay lot more and it does not reflect in quality is mistaken. More on this topic coming in next posts.

Now, let’s debunk Paul Krugman’s article…

Dr. Paul Krugman (source:
Dr. Paul Krugman (source:

The Nobel Prize Laureate in 2008 and Neo-Keynesian economist tries to complain about free markets in healthcare using arguments that are as mistaken as his conclusion: the European prices are lower (because their “cost” is lower) and their outcome is better than the US, this means that the market is wrong and we should regulate it.

As I discussed previously, the American system has various problems. However, they do not reside on the outcomes, which are usually far better than in any other developed country. Using raw life expectancy, child mortality rate, obesity or other incomplete (or more complex) indicators does not give us a result of the system. Nevertheless, when we control the variables for these measurements we start seeing the impact of healthcare industries. Using this kind of raw data is a result of laziness, lack of knowledge on the topic, or desire to misinform people. I am almost sure that Dr. Krugman lies on the second category, even though he probably bases his assumptions on people who are in the third…

Dr. Krugman starts his article on the right track when he says that there is no perfect solution that solves all the problems. We should analyze them carefully, and sometimes a person who is very knowledgeable in an area ends up misunderstanding another due to his/her bias. It is necessary to consult works of other people who studied the topic, even better when you try to assess different approaches, understanding their pros and cons. Sometimes it is hard to be humble and do that, as it is hard to read articles from a different ideological point of view (especially when they are wrong from the beginning), but it is necessary to have a broader perspective on the topic – what I think lacks for both Levitt and Krugman.

Krugman attacks the resurgence of free market ideas in opposition to his controlled market approaches (Keynesian economics). When he says:

“(…) I’m seeing on multiple fronts signs of an attempt to wave away everything that happened to the world these past seven years and go back to the notion that the market always knows best. Hey, it’s always about allocating scarce resources (never mind all those unemployed workers and zero interest rates), and why would you ever imagine that market prices are wrong (don’t mention the bubble).” (Krugman, P. NYT, 2014/05/16)

He is the one choosing to ignore the facts. The bubbles were result of Keynesian “solutions” similar to what he suggested to fix the Nasdaq crisis, they are not results of free market actions. An analogy would be a person playing with a lion, knowing that the lion will bite in the case of a menace, and complaining when the lion bites after the person punches the animal in the face. The fault is not on the lion, but on the person who punched it… Similar to what happened in 2008, when the government stimulated the house market by demanding reduced criteria on loans and using government funded agencies (Fannie May and Freddie Mac) to finance house for low-income and low-credit score people – Keynesian approach of stimulating the aggregate demand. The result was a crash of the other elements that bought dirty house titles, which ended up without liquidity (Lehman Brothers).

Following this comment, he tries to mock Dr. Milton Friedman’s opinion on models: even though they are based on some untrue (or, more correctly saying, not completely true or not fully measurable) assumptions, they are useful if can give us good predictions. The purpose of a model is trying to describe a complex system. Models will always simplify the reality, therefore, they rely on assumptions that are not necessarily general (which means, they are not always true or, in Krugman’s words, they are untrue). Of course we should try to find the best model. Of course we should rely on completely true (or measurable) assumptions. Of course this is not always possible, for example Dr. Krugman’s line of economics relies on a some huge untrue assumptions… However, a good model still can be used to describe the system and try to predict its behavior, even though it is impossible to guarantee that the results will be the same as the predictions.

In this case, the free market models are good enough because their results are consistent with empirical data – what is not true with Keynesian models, for example. In addition, even though the free market system is based on maximization of profit through mutual cooperation and voluntary exchanges – facts that are not always true -, it says that the equilibrium price is lower than the currently observed and shows that more competition would drive the prices to lower levels (nothing wrong here, Dr. Krugman). The main problem of the free market assumption in this case does not rely on the agents (patients and healthcare providers), but in the government interventions that reduce competition (certificates of need, controlled number of medical schools, reduced sizes of classes), reduce services and goods available (regulations on healthcare professions and drugs), fix prices (Medicare and Medicaid that obliges other prices to raise in order to compensate financial damage) and affect the especially the supply. This governmental elements are key pieces to drive the prices up – not the free market.

Then, Paul Krugman compares different healthcare markets that are far from free – Europeans, Canadian and American -, without labeling his chart, to prove his point that free market does not work. However, he forgets to mention that European and Canadian prices are almost completely controlled by government, therefore they are artificially reduced (which means that comparisons based on the price are not good since this indicator is contaminated). He purposely confuses private sector participation on spending with free market to misguide the interpretation of the data. He forgets to mention the interference that Medicare and Medicaid have on the prices – or, probably, he does not have idea of that. Therefore, his claims are further beyond my concept of what is true.

Finally, he ends saying that private sector spending leads to overcosts and no measurable quality benefits. Meaning that he concludes his mistaken explanation, with a farther “comic” argument. He did not show that the quality is worse (for those with access to the services, it is essentially way better). He did not show that the American case is a free market (only presents a chart – without giving the source of his data – that shows more private spending). He did not prove that the free market increased the costs. However, he concludes saying that those who defend free market are selling pure faith.

My opinion: go back to your office and study a little more, Dr. Krugman. After understanding the scenario, after identifying correctly the players, after understanding what a free market is (hint: it is not only a market with high private spending), and after making strong propositions that hold on to your data, then you can try again. For now, stay on your field trying to defend the anti-alien protection system to foster demand and generate economic growth by consumption, not innovation.


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