Center for Business and Public Policy
at the University of Illinois, Urbana-Champaign

At a remarkably young age, Barrack Obama has been elected to the U. S. Senate and the Presidency and now has been named the Nobel Peace Prize winner while hardly breaking a sweat. This may have understandably created a belief in the administration that any and all challenges can be met and overcome. Unfortunately for the president, policy challenges may not be as tractable to his cool, detached approach as winning elections and gaining international acclaim.

During the early months of his presidency, Obama appears to be following the advice of his Chief of Staff Rahm Emanuel to “never allow a serious crisis to go to waste. There is an opportunity to do big things.” The crisis in point is the recession and financial meltdown that dominated the 2008 election season and continued into his presidency. Rather than focusing primarily on the economic problems at hand, Obama chose to tackle a number of other major issues including health care reform and global warming (through a cap and trade plan) while the country is still engaged in military actions in Iraq and Afghanistan.

This approach is in stark contrast to the unsolicited advice that John Maynard Keynes, the dominant economist in the first half of the twentieth century, gave to President Franklin Roosevelt. Keynes’ name has been in the forefront of the policy debate during the Obama administration because of the massive Keynesian-style stimulus package approved earlier this year.

In an open letter to President Roosevelt on Dec.31, 1933 (10 months into his first term), Keynes offered a number of suggestions, mostly about economic policy. However, he provided some political advice as well. Keynes was concerned that the Roosevelt administration was spreading itself too thin and not concentrating enough on the prime goal of recovery from the depression.

Keynes wrote:

“You (Roosevelt) are engaged on a double task, recovery and reform. …. For the first (recovery), speed and quick results are essential. The second (reform) may be urgent too; but haste will be injurious, and wisdom of long-range purpose is more necessary than immediate achievement. … For it (reform) will upset the confidence of the business world and weaken their existing motives to action, before you have had time to put other motives in their place. It may over-task your bureaucratic machine … And it will confuse the thought and aim of yourself and your administration by giving you too much to think about all at once.”

This advice given 76 years ago, which incidentally was not heeded by Roosevelt, appears to be relevant today. Regardless of their intrinsic merits, the health care plan and the cap and trade legislation now under consideration promise to have huge and uncertain impacts on the economy and the plans of individual businesses and investors. Even if these programs are not ultimately approved, the debates, in Keynes words, “upset the confidence of the business world and weaken their existing motives to action.”

Just as the lack of confidence in the economy and especially the international financial system was a key element leading to the current recession, anything that undermines confidence during the recovery will be counterproductive.

The last part of Keynes’s political advice is telling as well. While the Obama administration has indeed not let the economic “crisis go to waste” by pursuing an aggressive agenda of both recovery and reform, the president’s resources appear to have been “over-tasked” with the resultant confusion of “thought and aim.” A common thread in the formulation of the stimulus package, the cap and trade legislation, and health care reform has been the outsourcing of the details to Congressional Democrats. The administration has provided little leadership in regard to the substance of these programs.

In the case of the stimulus package, this resulted in a poorly targeted, unwieldy spending program that is still yet to have its full impact. In regard to the ongoing health care debate, the president has made this a make or break issue for his administration. As a result, he appears to be willing to accept virtually any program approved by Congress regardless of its merits. Finally, the cap and trade legislation with its huge and largely unseen costs is unlikely to be approved any time soon, especially when these costs become known. This will prove an embarrassment to the president and his leadership on the world stage.

This suggests that process of running for office is quite different from governing. During a campaign, candidates can deal with a number of issues on a relatively superficial level. Candidates do not have to prioritize. In office, the process of governing requires choices to be made and priorities to be established. This is a lesson yet to be learned by the current administration.

This week Jeff wrote about competition in the health insurance industry, wondering if the health insurance industry, while not competitive, might be “competitive enough,” and whether, if it isn’t, whether the government will properly price the public option it hopes will increase competition.

I don’t disagree with any of Jeff’s points.  But, I thought it might be useful as a follow up to write about how competitive the health insurance industry is.  It just so happens that a new National Bureau of Economic Research Working Paper by Leemore Dafny, Mark Duggan, and Subramaniam Ramanarayanan entitled “Paying a Premium on Your Premium? Consolidation in the U.S. Health Insurance Industry” provides new evidence on exactly this point.

But, first, a bit of background.  Economists, and particularly the U.S. Department of Justice, measure concentration in a market by summing the squared market shares of all of the participants.  We call this number the HHI.  DOJ calls a market highly concentrated if the HHI is over 1800.  This would be the case if, for example, there were four firms in the market, each of which has a 25% market share (25*25 = 625, 4*625 = 2500).  In highly concentrated markets, the DOJ has “significant competitive concerns” about any merger that raises the HHI by more than 50 points.  The AMA’s 2007 study on “Competition in U.S. Health Insurance” found that between 96 and 100 percent of health insurance markets were highly concentrated, depending on the market definition.  In terms of market shares, between 64 and 76 percent of health insurance markets have at least one insurer with market share greater than 50 percent.  In around 10 percent of markets, a single insurer has over 90 percent of the market share.

The AMA data suggests that, by any measure, health insurance is dominated by a small number of players.  This does not, in itself, suggest that there is a lack of competition in health insurance.  After all, if there are just two insurers who compete in a cut-throat fashion, this will quickly drive prices to competitive levels.  Or, if there is a threat of entry into health insurance, then potential competition might discipline prices even though those firms do not actually enter the market.  But, the AMA numbers certainly raise suspicion.

The real question regarding concentration in health insurance is whether the high concentration levels in health insurance lead to higher premiums.  The Dafny-Duggan-Ramanarayanan paper looks at this question. They use the 1999 merger between Aetna and Prudential, two of the largest health insurers in the country, to investigate it.  They find that the Aetna-Prudential merger did increase premiums and they estimate that, overall, the wave of insurer consolidations that occurred between 1998 and 2006 increased premiums by about 2 percentage points on average.  In addition, they found that increases in concentration increased the bargaining power of insurance companies with respect to healthcare workers, resulting in lower employment, and lower earnings for physicians.

So, the evidence suggests that the health insurance industry is highly concentrated and that high concentration is probably leading to higher prices.  But, there are several things we still don’t know.  First, do those higher prices translate into abnormally high profits?  Maybe the reason why prices are high and there are not a lot of firms operating in any region is that additional firms cannot profitably enter the market.  In this case, the high levels of concentration and prices would be evidence of market forces working, rather than a sign that further regulation is needed.  Second, if the insurers are earning abnormally high profits, why don’t other firms come along and enter the market, driving down prices?  If the lack of entry is due to practices that are prohibited by current law, then greater enforcement might improve competition.  If, on the other hand, they are due to features of the competitive playing field such as the ability to risk-rate premiums, deny coverage based on pre-existing conditions, difficulties in switching insurers do to the connection between insurance and employment, etc., then addressing these issues (as is done to one extent or another in all of the reform bills currently under consideration) might greatly improve matters.

Jeff’s overall point is still one I agree with.  The government’s success in designing insurance schemes has been mixed at best.  If the government doesn’t know why our current system fails to be competitive (if, indeed, it does), then it is unclear how introducing a government plan, in and of itself, is going to fix things.  In the absence of a clear theory of what is wrong with the market and how a public option solves the problem (rather than vague statements about how it will lead to greater competition) I strongly suspect that we’re more likely to successfully improve health insurance and health care by adjusting the rules of the game and improving the government’s role as referee, rather than by introducing the government as a player.

Senate Majority Leader Harry Reid came out in the past week in favor of a “public option” as part of a health care reform package, giving new life to an idea that many had previously pronounced as on life support in the Senate.  Given this, I thought I would use this week’s post to briefly explain one of the (many) reasons that a public option worries me, namely, the government’s horrible track record of pricing insurance according to basic economic principles.  

Prices play a central role in well-functioning economies because they direct resource allocation, create incentives, and generally serve as signals of value.  In the context of health insurance, advocates of the public option seem to believe that the government has the ability to price the insurance correctly, and that the private sector does not.  Indeed, the belief that the private sector is somehow pricing the insurance incorrectly – thus leading to what public option advocates believe are excessive profits – is part of what lies behind the unfortunate demonization of the insurance industry.  

My own view is that while the health insurance industry may not be the Adam Smith ideal of a perfectly competitive market, it is likely competitive enough – in most markets at least – that it is difficult to sustain abnormally large profits for long. 

But even if that is not the case, there is still an important question that is not being discussed enough.  Is the government capable of pricing insurance effectively?  

This is a complex question, including what we mean by “pricing effectively.”  But for now, I want to keep this discussion at the 30,000 foot level and simply take a look at some insurance markets where the government has intervened.  Earlier this year I organized a conference at the American Enterprise Institute for which I invited six teams of authors to write about government insurance programs.  Specifically, respected experts in each area wrote about the U.S. crop insurance program, the Pension Benefit Guaranty Corporation, the Federal Deposit Insurance Corporation, the U.S. government’s terrorism risk insurance program, the National Flood Insurance Program, and federal and state approaches to insuring natural catastrophes.  

As I wrote in the introductory chapter for the book: “If there is a single theme that comes through loud and clear in all six chapters in this book, it is that the government has a terrible track record at appropriately pricing risk. In the FDIC insurance program, Pennacchi shows, premiums have often been set too low, which leads an increasing proportion of the financial system to seek access to artificially cheap credit, and in turn worsens the stability of the financial system. Biggs and Brown show the lack of risk-adjustment in the PBGC program encourages firms to overinvest in risky assets and discourages them from fully funding their pensions. Russell and Jaffee note that the government does not even pretend to try to price terrorism insurance effectively—on an ex ante basis, it simply gives away the insurance free of charge. Kunreuther and Erwann-Kerjan note that the state of Florida’s catastrophe insurance program is severely underpriced, which can lead, among other things, to overdevelopment in risk-prone areas. Browne and Halek suggest that the flood insurance program has likely led to overdevelopment in flood zones. Goodwin and Smith discuss the land-use misallocation that arises from mispricing in the crop insurance programs.”

To be clear, I am not arguing that a public option will be exactly analogous to any of the above programs.  The analogy is imperfect for dozens of reasons.  What I am arguing is a more general point – namely, that I have yet to find a single government program in which the U.S. government has priced insurance in a manner that even closely approximates an efficient approach.  Put simply, when political considerations bump up against economic efficiency arguments, political considerations typically win.  As a result, even the most intelligently designed public option is unlikely to be intelligently designed once it passes through the Congressional sausage-making process.   

Does any of this matter?  Absolutely.  I don’t know exactly how a public option will be priced, but I am willing to bet it will get it wrong on at least one dimension.  And depending on the nature and degree of mis-pricing, a public option could have any number of bad effects, whether it be the partial (or in the extreme, even the complete) destruction of the private health insurance industry, the creation of an enormous unfunded liability for taxpayers, or even an increase in the level of health care costs in the U.S. as newly insured individuals decide to rationally consume more care.  

We write this blog for the University of Illinois “Center for Business and Public Policy” (CBPP), which is NOT the same as the Center on Budget and Policy Priorities.  That other center provides some useful information, however, such as the new report on state budgets.  It says “48 states have addressed or still face shortfalls in their budgets for fiscal year 2010, totaling $178 billion or 26 percent of state budgets.”

The most famous example of a state fiscal disaster is California, which accumulated a total gap during FY 2009 of $37 billion (equal to 36.7 percent of the states general fund).  The state later issued IOUs instead of actually paying for some services.

While the long-run fiscal problems of the Federal government are severe and well documented, the short-run budgetary problems in Washington, DC are simple compared to those at state capitals across the country for two reasons.

First, almost all states have balanced-budget statues.  (In fact, only Vermont allows deficit spending.)  The inability to run budget deficits during a recession limits the options of governors and state legislatures when dealing with shortfalls.  Indeed, standard doctrine suggests that governments should run deficits during recessions to stimulate economic activity.  Without the deficit spending option, states must cut expenditures or raise taxes, exactly the opposite of what they should be doing to counteract the downturn.

Second, this particular recession has put a great strain on state revenues due to the collapse in housing prices and the steep decline in consumer spending.  Unfortunately, most states rely on property taxes and sales taxes for revenue, instead of income taxes.  Yet housing prices are unlikely to rebound soon, as a glut of foreclosures remains in many states.  Also, it appears that consumers have  shifted to a higher savings rate, which lowers sales tax revenue.  Potentially, tax rates could be increased to cover the budget gaps, but that option is politically difficult during recession.

In response to these two problems, the Federal government has increased transfers to the states as part of the American Investment and Recovery Act.  Since the Federal government CAN run a deficit, these transfers help get around the balanced-budget statutes and allow for less draconian state expenditure cuts.  However, the lag in revenue recovery at the state level still means years of tight budgets ahead.

Last week I wrote about how the US does not seem to compare well to other OECD countries on several outcome measures.  The US doesn’t do well in an absolute sense, and they seem to do especially poorly when you take into account how much the US spends on health care.

I must admit, that I have mixed feelings about those statistics.  On the one hand, the US does spend a lot and our outcomes appear to be no better.  However, as I mentioned, there could be a number of explanations for this, and not all of them imply that there is something wrong with the US health care system.  First and foremost among these is the topic of today’s post.  Maybe the US is just sicker than other countries, and because of this we need to spend more on health care.  Seen in this light, the US health care system may be very productive, since we start at a lower baseline.  What would have happened in the absence of spending on medical care is much worse in the US than other countries, so even though we end up at about the same level in terms of quality, the US health system has produced greater health improvements than other countries’ systems.

The first piece of evidence on this point is a 2006 paper in the Journal of the American Medical Association by James Banks, Michael Marmot, Zoe Oldfield and James Smith, entitled “Disease and Disadvantage in the United States and in England.”  The paper compares various measures of health in residents of the two countries aged 55 – 64.  They find that the US population is significantly sicker than that of England.  The following table reports the percent of the sampled population in each country that reports each of the conditions in the left hand column.

In each case, the United States has a (statistically) significantly higher percentage of each of the conditions.  While some of the differences can be accounted for by differences in behavioral risk factors, in particular by the higher rate of obesity in the US, much of the difference seems to be driven by non-behavioral factors (e.g., genetics, environment, etc.).

The second article I want to mention is one by Samuel Preston that summarizes the findings of some of his joint work.  The paper investigates two possible causes for why the US lags behind other countries in terms of longevity.  First, that the deficit is due to problems with the US health care system.  In a study with Jessica Ho, Preston finds little evidence that the US system has difficulties producing health improvements that contribute to the longevity gap.  (Note – this is not to say that the US system doesn’t have quality problems that should be addressed.  See my previous posts about that.)  Second, and more interestingly, in a study with Dana Glei and John Wilmoth, Preston argues that in the past, the US had a high smoking rate relative to other OECD countries, and that the negative health effects of smoking are still being felt in terms of reduced longevity.  Once the impact of smoking is accounted for, the US compares much better to the rest of the OECD.  For example, eliminating smoking-related deaths would increase US life expectancy at age 50 by 2.6 years for females and 2.8 years for males.  If all smoking-related deaths are removed from the data in all OECD countries, life expectancy at age 50 would move up from ranking 17^th out of 20 to 7^th for men, and from 14^th to 9^th for women.

So, there appears to be some evidence that people in the US are sicker than in other countries.  In light of this, given that we are wealthy even by the standards of the OECD, we should be spending more on health care than other countries.  However, the questions of how much more and whether the dollars we do spend could be used more wisely, remain open.

The past year has not been good for 401(k)s and other retirement plans.  Among many implications of the financial crisis and deep recession, we have seen the dramatic, correlated losses across nearly every major asset class underscore the fragility of a 401(k) system that is focused predominantly on wealth accumulation rather than secure retirement income.  In essence, the 401(k) system was exposed for what it truly is – a promising supplemental savings plan, but an inadequate vehicle for ensuring a secure retirement.  

I’m not alone in this view.  I spend much of my time interacting with people who specialize in thinking about retirement income security – academic researchers, policymakers on both sides of the political aisle, insurance companies, financial advisors, consultants and consumers.  Over the past 12 months I have noticed a striking degree of commonality in their thinking around the fact that we need a better retirement system in the U.S.  This is not to say there are not still important areas of disagreement - for example, I find proposals to increase Social Security benefits, to return to a defined benefit system, and/or to have the government guarantee retirement income to be a combination of naive, reckless and fiscally irresponsible.  But when it comes to the future of private sector retirement plans, I believe there are a number of common themes emerging that make very good sense.

Yesterday, I had the opportunity to speak at the annual conference of the American Council of Life Insurers (www.acli.com) about my proposal for encouraging plan sponsors to use guaranteed lifetime income products as the default distribution option.  Before my session, I had the privilege of hearing Dr. Roger Ferguson, President and CEO of TIAA-CREF – one of the largest providers of retirement income in the world – speak on this issue.  (In the interest of full disclosure, I should note that I am a trustee of TIAA). 

Dr. Ferguson outlined 5 areas that need improvement in our system.  (I should note that I am paraphrasing here and including some of my own thoughts – so please do not interpret this as an exact representation of his remarks!)

1. We need to return to a focus on providing guaranteed income.  During the shift from Defined Benefit (DB) pension plans to Defined Contribution (DC) pension plans like the 401(k) and 403(b), we somehow lost sight of the fact that the point of saving for retirement is to provide income security.  We need to get the focus back on annuitized, lifetime income.  This does not mean a return to the old style DB systems.  It does mean looking for innovative ways to convert 401(k) and 403(b) wealth into income before, during, and after retirement.
2. We need to broaden coverage.  Millions of households do not have access to any employer sponsored retirement plan.  Somehow, someway, we need to fix this.  While it is true that individuals can save on their own, the evidence is overwhelming that “employers matter” in promoting saving.  Social Security alone is sufficient to replace adequate income for only a minority of households.  Indeed, given the poor fiscal trajectory of the program, the rising normal retirement age that will reduce benefits for those who claim at earlier ages, and rising Medicare premiums, its adequacy will only diminish further.    
3. We need to ensure that individuals are broadly diversified.  I, personally, would love to see us put together individualized retirement plans that include a life cycle portfolio trajectory that gradually converts into annuitized income the closer one gets to retirement.  The investment options need to include not just stocks and bonds, but also real estate and other asset classes.  
4. We need to ensure that individuals have access to good information and advice.  Our current regulatory structure – designed to protect consumers from tainted advice by those who might have a conflict of interest – has had the unfortunate effect of making plan sponsors go through a torturous and administratively complex route to provide good advice to participants.  We need to find sensible ways to streamline this process. 
5. We need to provide vehicles for individuals to be able to save for retiree health care expenses.  Health Savings Accounts and other similar tools have a useful role to play here.

To get there from here, we do need some regulatory and policy changes.  I suspect that we may see this discussion rise closer to the top of the agenda after health care reform is behind us …

Officially, in 2008, the U.S. government borrowed $785.1 billion, a deficit equal to 5.4% of GDP.  Yet the fiscal outlook for the federal government is actually worse, in a way that is masked by the government’s accounting rules.  The reason is complicated.  The social security system collects more current taxes than it pays out in current benefits, which reduces the deficit number just mentioned, and yet this addition to the social security trust fund is not enough to pay for the additional FUTURE benefits promised on the basis of the earnings of those working and paying into the system this year.  In other words, the pension promises each year are newly incurred liabilities that are larger than the collected taxes.

Old-Age and Survivors Insurance (OASI) is the largest trust fund in the Social Security system.  In 2008, OASI took in $695.5 billion and paid-out $516.2 billion, so it increased its net assets by $179.3 billion.  According the Social Security Trustee’s Report, however, this short-run increase in net assets hides the fact that OASI will deplete all its assets by 2039.  In all subsequent years, to pay the promised benefits, the shortfall in yearly tax receipts would have to be covered by the Treasury.  So our current social security system is actually adding to the future federal debt while appearing to reduce it.

A different way to state the same problem is that the OASI Trust Fund shows a 75-year actuarial deficit equal to 1.68 percent of taxable payroll.  That is, in order to fully fund OASI, payroll taxes would need to be increased by 1.68 percentage points each year for the next 75 years to provide the promised benefits.  Similar situations hold for the other Social Security programs, such as Disability Insurance (DI) and Hospital Insurance (HI).

Since the federal government does not use actuarially fair accounting when reporting its deficit, the fiscal problems of the United States appear to be merely “bad”, rather than actually “horrible”.  Under current law, Social Security is a massively insolvent program that promises benefits without having the revenue stream to cover its costs.  If it was counted within the official U.S. deficit, the true cost of covering those promised future Social Security benefits would add whole percentage points onto the yearly deficit.

The social security account should be held completely separate from the rest of the government budget.  If so, then BOTH would show deficits.  Instead, despite a long run deficit incurred by the social security system, the current year’s temporary surplus serves to reduce the rest of the government’s stated deficit.  That should be fixed.

In addition, to be fair, a key driver of the problem may not have been foreseen by past lawmakers.  The original social security law set the official retirement age at 65 years of age, which was more than the usual life expectancy at the time.  Since then, life-expectancies have increased dramatically, and the social security system’s defined benefit pension payments must be paid over longer and longer remaining lives.

Many people over 65 are not only living longer lives, but healthier lives.  If the social security system is to change and adjust with the changing and improving health of older Americans, maybe overall solvency requires further increases in the official age of retirement.

 I just returned from a meeting of human service agency heads, foundation officers, non‐profit leaders, and an academic (me) convened to talk about reforming the state’s contracting practices. Just to be clear about it up front – ‘human services’ is a lot more than welfare. Think after‐school programs, child care, mental health and substance abuse services, lifetime support services for the developmentally disabled, and services for the aged and disabled. One thing that everyone in the room agreed on was that human service reform has been hamstrung for many years by the generally woeful underfunding of this sector in the state of Illinois.

If we could figure out the cause of this chronic condition, maybe we could find a cure.  From the discussion, I could parse out a few theories about why Human Services’ time never seems to arrive..

People are complacent by nature. Politicians and voters are people. Ergo, a prerequisite for reform of any sector is an enormous political-fiscal crisis (a.k.a. the ‘big crisis’) that would awaken us all to the necessity of reform. The ‘big crisis’ model is widely believed. In fact, I have heard the “big crisis” idea espoused by legislators at ‘on the record’ events; “don’t worry, the GA will act once there is a big crisis. Until then you can’t expect …[your issue here]… to get off the back burner.” In fact, Governor Quinn trusted the “big crisis” model when he proposed the doomsday budget this summer that would have radically slashed human services funding. His “big crisis” premise was that voters would not tolerate a budget balanced by draconian cuts falling on the most vulnerable. Further, the ‘big crisis’ thinking went, legislators would tremble at the thought of blessing such a situation because of the retribution that angry voters would surely visit upon them at the polls. HA! The Governor’s ultimately well-meaning but dangerous bluff was called. I didn’t notice much spontaneous expression of surprised outrage on the part of the electorate the day this happened, did you?

Once the budget is fixed, human services funding will rebound. This is an appealing notion until you consider that human service funding in key areas has been in actual decline for decades. Clearly, with the enormous structural deficit the state faces, a tax increase is going to be essential. Unfortunately for this theory, though, human services were also underfunded in good (or at least better) times. If the past is any guide, human services will continue to stand at  the back of the funding priorities line, as usual.

Political leaders and voters are ignorant of the essential services provided by government and would act to make changes if better informed. I must admit, as an academic I’m partial to the notion that facts and logic can persuade key actors to care about issues and change political priorities. The current health care reform debate provides strong evidence that many people, including policymakers, so-called policy experts, journalists and pundits, do not know what services the government provides, what various programs do and whom they reach (Medicaid v. Medicare, anyone?). Many also appear quite sure that no friends or relatives of theirs have ever benefited from government services (Medicare and Medicaid, anyone?). While there is considerable evidence that the first part of the hypothesis is true (people are ignorant), assuming that they would act differently if better informed is another matter entirely.

This brings me to the final hypothesis:

Political leaders and voters lack an emotional connection to the issues. One of the problems of being human is that we are bound up in our oh‐so‐limited web of personal experience. Unfortunately, this seems to apply equally to those individuals who have hone to great effort of attaining public office in order to help make wise decisions for all of us (Daniel Patrick Moynihan may have been the exception that proves the rule).  In his address to Congress, President Obama argued that Ted Kennedy’s concern with health care reform stemmed from his “experience of having two children stricken with cancer.”  I can’t count how many times I’ve heard a policymaker trot a personal anecdote about a relative in order to to his or her colleagues why a certain service is actually really, really important.  Apparently, Mr. Spock, this is how humans relate to each other.  It is fascinating but sad fact that most people aren’t very imaginative.

I’m reluctantly partial to the view that if key leaders had direct experience with mental health, substance abuse, developmental disabilities, and poverty issues, real change in the human service area would emerge.  One of the major examples of this is the impact of the Kennedy family had on awareness of developmental disabilities and in shaping public programs for the developmentally disabled.  Very recently, Sarah Palin vowed to become a champion of the developmentally disabled in her prospective role as Vice President (her son has a developmental disability).  Taking this notion seriously implies that advocacy groups should strive to identify politicians and gifted potential candidates with direct experience of their issues if they want real change.

In the past weeks, I’ve argued that the US spends more than other countries on health care.  This fact is not in dispute.  However, one could argue that, if the increased expenditure on health care is buying more health, then the US system might still be efficient.  We’re a rich country, and we choose to spend more on health care and get more health because of it.  If true, there would be nothing wrong with spending a lot on health.

There are a lot of academic studies on this point, and maybe I’ll discuss some of them in future weeks.  (My favorite is a paper by Alan Garber and Jonathan Skinner that appeared in the Journal of Economic Perspectives last year entitled “Is American Health Care Uniquely Inefficient?”  The short answer is, yes.)  Today, I took some time to play around with the OECD health data.  The OECD is a group of 30 wealthy, developed countries.  If we are going to compare ourselves to other countries, then the OECD is probably the right group of countries to look at. 

My findings are in four charts.  I apologize that the country labels blend together, but the US is conveniently so far from everyone else that it is always easy to identify it!

The first compares per capita GDP to per capita health care expenditures.  Here, we see what we expect to see.  The US spends more per capita on health care than the other OECD countries.  One might expect that wealthier countries spend more on health care, and the trend line shows that this is the case.  But, the US is way above the trend line, indicating that our expenditure is more than can be accounted for simply by our high per capita GDP.

The second chart plots life expectancy from birth (2005) against per-capita health expenditure.  Although the trend line shows that, in general, higher health expenditure is associated with higher life expectancy, the US is well below the trend line.

The third chart looks at infant mortality per 1000 live births vs. per capita health expenditure.  Here, the US is well above the trend line, suggesting that our extra health expenditure is not associated with lower infant mortality.

The final chart compares something called “Potential Years of Life Lost” (PYLL) to per capita health expenditure.  The OECD explains PYLL as:

PYLL is preferred as a summary measure of premature mortality since it treats the life year saved – rather than life – as the unit of output.2 In effect, in the calculation of PYLL deaths are weighted according to their prematurity preceding an age limit – 70 in this study. With this age limit, the death of an infant (70 life-years lost) will be given fourteen times the weight given to the death of a person aged 65 (5 years lost). Conventional mortality rates, on the other hand, implicitly give the same weight to all the deaths irrespective of age. Usually, for cross-country comparisons, the number of PYLL is expressed as rate for 100 000 population.

Thus, PYLL is a measure of mortality that gives greater weight to young people who die than older people.  In general, increased expenditure is associated with a decrease in PYLL.  Once again, the US is well above the trend line.  Here’s the chart.

***NOTE: although graphically there appear to be trends in all cases, in the case of infant mortality and PYLL, the statistical relationship for the crude regressions is boarderline significant at best***

So, what do we make of this?  What is clear from the data is that the US spends more on health care than other countries but our results do not, at first glance, appear in line with this increased expenditure.  Before we make too much of it, however, we should all recognize that these charts do not tell a causal story.  If, for example, Americans are sicker than other people, it may be that we have to spend as much as we do in order to achieve the rather poor results illustrated in these charts. If we were to reduce our expenditure to a level more in line with other countries, we might do even worse. If that were the case, I’d be fine with the data.  Maybe we should even be spending more.

In my opinion, the US is so far off the trend line on so many different dimensions of health quality that I tend to believe there is something about our health production function — the way we finance and deliver care in this country — that leads us to spend money without appreciable results.  There seem to be many pieces to the puzzle – overuse of technology, paying for procedures instead of paying for health, defensive medicine, and more.  There probably isn’t a single source, but rather a lot of smoldering fires that combine to create a lot of smoke. And, given that every player in the health reform debate has their own turf to protect, this makes starting to attack the problem all the more difficult.

It is well-known that Illinois has one of the worst track records of funding its public pension plans of any state in the nation.  What is less well-known is that the problem is far, far worse than the official statistics would indicate: indeed, the extent of under-funding may be 2.5 times larger than what is typically reported!

To be clear, this is not because anyone in Illinois state government is doing anything unethical – those responsible for calculating the pension liabilities are presumably doing so in accordance with Government Accounting Standards Board (GASB) procedures.  Even so, there is near unanimity among economists (and yes, unanimity among economists is rare) that GASB rules themselves are deeply misguided. 

This is a complex topic, but I am going to over-simplify for brevity’s sake.  As noted in at least two prior posts, the Illinois state constitution provides a rock-solid guarantee that pension benefits will not be reduced or impaired in any way.  That makes the benefits that participants have accrued virtually risk-free.  It also means that it makes the liability to the State of Illinois risk-free.

Simple (and also advanced) finance theory is unambiguously clear that the appropriate way to discount a risk-free stream of cash flows is to use a risk-free interest rate.  While there is not a perfect risk-free asset available for this purpose, municipal bonds and U.S. treasury securities offer reasonable proxies.  (I have written on this subject in more depth in a paper with David Wilcox published in the American Economic Review, and I will simply refer readers there for a more in-depth discussion).

Instead of using this clear and rigorously grounded approach, GASB allows public pension plans to discount their liabilities using the expected rate of return on plan assets. There is not a shred of logic to this as an approach for valuing liabilities unless one believes that the liabilities share the exact same risk characteristics as the portfolio in which one is investing (and that is certainly not the case in Illinois.  We have riskless liabilities but invest in diversified portfolios of risky assets).

How big of a difference does this make?  A relatively new paper by Robert Novy-Marx (University of Chicago) and Joshua Rauh (Northwestern University) estimates the size of the liabilities when calculated using appropriate discount rates.  (Read their paper here).  What do they find?

In 2008, the four large public pension plans in Illinois had combined assets of $65.7 billion.  The combined liabilities of these four plans (calculated under flawed GASB rules) were $151.1 billion, for a shortfall of $85.4 billion.  

If one uses a more theoretically appropriate rate on treasury yields, the present value of the liabilities is $284.8 billion, for a shortfall of $219.1 billion!  That is more than 2.5 times greater than the official statistics indicate!

What do these numbers really mean?  If the state of Illinois wanted to be certain it had enough money set aside today so that it could meet all public pension benefit obligations that have already been accrued, it would need to set aside an additional $219.1 billion.  For perspective, that is about 1/3 of Illinois GDP, about 1/3 of state revenues, and about four times the outstanding state debt.   

Any amount less than this means that the state would have invest in riskier assets in order to fund the benefits, a strategy that might work … or might make the problem worse. 

We’ve all heard to old adage that the first thing to do when you find yourself in a deep hole is to stop digging.  In this case, we also need to stop denying just how deep the hole is.