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

A very Happy Thanksgiving to all of our readers out there!

In a recently completed article titled “The Allocation of Permits in U.S. Climate Change Legislation”, Daniel Karney and I analyze the allocation of permits for a cap-and-trade plan recently enacted by the U.S. House of Representatives.  (For an explanation of cap-and-trade, please see my previous post.)  We argue that freely allocating permits to firms on the basis of historic emission rates is unnecessary.  Instead, permit allocation should be focused on other goals, such as helping to cushion the financial impact of higher electricity prices on low-income households.

The figure below shows the percent of household expenditures on electricity for seven different income groups for two regions (Midwest and South).  The figure demonstrates two interesting trends.  First, low-income households spend a higher fraction of their income on electricity compared to high-income households.  Indeed, low-income households spend relatively more on almost all energy-intensive goods and services.  Second, Southern states spend a higher percentage on electricity at every income level (due to air-conditioning use in the summer).

Fossil fuels are used to generate most of the electricity in the United States; the cap-and-trade policy would raise the cost of carbon emissions and therefore would raise the price of electricity.  Thus, low-income households face a higher burden, regardless of region.

Electricity production in the Midwest mainly comes from coal-fired power plants, the heaviest emitters of CO2 pollution. In contrast, Southern states have a large portfolio of hydroelectric dams (see Tennessee Valley Authority) that emit no CO2 , and they have natural gas-fired power plants with low CO2 emissions.  A quick calculation reveals that in 2005, Midwest electricity generation uses twice the carbon dioxide per capita.

Thus, some argue that Southern states would not be affected by cap-and-trade as much as Midwestern states.  They further argue that the use of permit allocation or permit revenue to help low-income individuals should be directed to Midwestern states.  After all, households in that region would see a larger percentage increase in electricity prices.  Yet, because the logic of this allocation is based on historic emission rates, it is a form of grandfathering.  The proponents of such a policy are not taking into account an important technological change that alters the analysis.

The same legislation that enacts a cap-and-trade policy also funds the construction of a “smart” electricity grid.  With lower transmission barriers, electricity prices will converge across regions.  In turn, this means the carbon price impact in Midwestern states will spread to Southern states.  If permit allocations to help low-income families are based on historic emission rates, then Southern households are in much worse shape, because they spend approximately 1-2% more per year of household expenditures on electricity compared to Midwestern states.

In other words, grandfathering permits is generally a bad idea, and this example is just one example of what can go wrong.

The Baltimore Post presents: “The Benefits of the Bird.”

“Get into an L-tryptophan-tastic Mood. Did you know that eating turkey can improve you mood and calm you down? Among other nutrients, turkey is rich in an amino acid called L-tryptophan, which the body turns into the neurotransmitter chemical serotonin. Serotonin can improve mood and foster a sense of well-being. And yes, it makes some people sleepy, hence the need for so many Thanksgiving celebrants to take a nap after dinner.”

Gobble gobble!

Deep within the “Patient Protection and Affordable Care Act” – the short title of the 2000+ page health care bill winding its way through the Senate – is a provision that came from legislation previously known as the CLASS Act.  The CLASS acronym stands for “Community Living Assistance Services and Supports” and is a plan to “establish a national voluntary insurance program for purchasing community living assistance services.”  Essentially, this legislation would create a voluntary, public long-term care insurance program.      

This provision has received almost no attention from the press, which is actually pretty surprising given that it would represent a major change in the federal government’s role in providing insurance for long-term care.  It would be a voluntary program through which individuals – in return for paying premiums to the government program for 5 years – would be eligible for a benefit of approximately $50 per day that they are receiving eligible care (where eligibility is triggered by an individual’s inability to engage in activities known as “Activities of Daily Living,” or ADLs – things such as bathing – without assistance.)

It is understandable that there is tremendous interest in rethinking our approach to long-term care.  The private market for long-term care insurance is quite small (e.g., only about 10 percent of the age 50-70 population is covered, and only about 4-5 percent of long-term care expenses are covered).  The government is already the largest source of payment for long-term care services through Medicare and Medicaid.  These expenditures are expected to grow rapidly in the coming decades due to population aging, among other factors. 

But as I read this legislation, the same question keeps nagging me over and over.  The reason it is nagging at me is that I cannot figure out the answer.  The question is, “exactly what problem is this legislation meant to address?” 

The legislation would create a public insurance program under the assumption that people cannot get the insurance privately.  In other words, it seems to be assuming that the problem is that private insurers can’t or won’t provide good insurance.  But there is not much evidence of this.  To be clear, we know the private market is imperfect.  My own research with Amy Finkelstein has shown that prices are higher than actuarially fair, and the benefits provided are not very comprehensive.  But we also show that the limited size of the overall market is almost surely driven by limits to consumer demand for these products, not because of problems with insurers providing insurance.  

So if the government wants to solve the problem of people being inadequately insured against long-term care expenses, it needs to address the issue of demand.  But, best I can tell, this legislation does virtually nothing on this front.  For example, if you think people are not buying it because they underestimate the risk, or because they are in denial about needing care, or because they think they have substitute forms of care, there is nothing in this legislation that will change this.  It is, after all, still voluntary to purchase it and simply having a government-run program is not going to change these beliefs.

On the other hand, Amy and I also show in our research that the Medicaid program serves as an enormous disincentive for purchasing private insurance.  In a nutshell, people do not want to pay for private insurance if most of the benefits they are paying for are simply duplicative of what Medicaid would have provided for free had they not purchased private insurance.  This public program would have the same problem – why should I pay premiums for this program so long as Medicaid will still pick up the tab if I fail to pay the premiums?  The feature that allows individuals to keep part of the benefit when Medicaid picks up the tab is presumably meant to address this, but I’m afraid it simply is not going to be sufficient to overcome this concern.

The government seems to implicitly understand that there are limits on demand - their own estimates are that only 5% of the population will take up this insurance.  That hardly sounds like a resounding success to me.

In short, it seems that the government has developed a solution to a supply problem that does not exist, but has failed to address the demand problems that do exist.  Needless to say, I am not optimistic as to this program’s future … 

This week the United States Preventive Services Task Force, an independent panel appointed by the Department of Health and Human Services to create guidelines for preventive care, revised the recommended screening regimen for breast cancer.  The New York Times reported on it here.  The USPSTF report appears in the Annals of Internal Medicine here.  The new guidelines, and the reactions to it, provide an interesting window on the battle ahead for those who would try to improve the efficiency of our health care system.

The main revisions of the guidelines is to recommend that, for most women without particular risk factors like a family history of breast cancer, regular mammography should begin at age 50 rather than age 40, and that for those aged 50 – 74, they should get screened every two years instead of every year.  These recommendations are based on new evidence regarding the benefits and costs of early screening.

The benefits of early detection are clear.  If a cancer is detected early the patient’s prognosis improves significantly.  However, according to the USPSTF report, this benefit is greater for women aged 50 to 74 than for women in their 40s.

In addition to the benefit of screening, the USPSTF also identifies costs of screening in a section entitled “Harms of Detection and Early Intervention:” 

The harms resulting from screening for breast cancer include psychological harms, unnecessary imaging tests and biopsies in women without cancer, and inconvenience due to false-positive screening results. Furthermore, one must also consider the harms associated with treatment of cancer that would not become clinically apparent during a woman’s lifetime (overdiagnosis), as well as the harms of unnecessary earlier treatment of breast cancer that would have become clinically apparent but would not have shortened a woman’s life. Radiation exposure (from radiologic tests), although a minor concern, is also a consideration.

The report identifies false positives as being particularly likely among women in their 40s.

Why the change in the cut-off?  The USPSTF study found that screening reduced the relative risk of death from breast cancer by about 15% for both women in their 40s and women in their 50s.  However, because breast cancer is more common among women in their 50s, they would need to screen 1904 women in their 40s to prevent 1 breast cancer death, while they would only need to screen 1339 women in their 50s to prevent a breast cancer death.  Although the benefits of screening are similar, the risk of breast cancer is higher for those in their 50s than those in their 40s, and this, coupled with the harm from screening discussed above, led them to revise their recommendation.

The New York Times reports that the physician group that advises the National Cancer Institute on new cancer research, has decided that the new evidence merits inclusion in the body of information it distributes to interested parties.   In particular, the previous screening recommendations, issued in 2002, came out at a time when there was “limited research on overdiagnosis and no statistical modeling asking how often women should get mammograms.”  And, the problem of overdiagnosis is the primary reason the USPSTF cited for changing the recommendation. 

Whatever, you think of the recommendation, that’s what it is.  Agencies like the American Cancer Society are studying the recommendation and the underlying evidence and may or may not revise their recommendations.  However, the reactions have provided an interesting insight into what happens when someone recommends reducing the use of a medical procedure.

Kathleen Parker in the Washington Post suggests that the timing might be political.  “Could the research be aimed at cutting costs at the expense of women’s health?”

A group of female House Republicans are arguing that this is what happens when you put the government in charge of health.  From the NY Times’ Caucus blog, according to Rep. Cathy McMorris Rogers of Washington, it’s “an example of how government-run decisions could be made,” and “The timing is very curious to me.”  Marsha Blackburn of Tennessee said “This is the little toe in the water and this is how you start getting a bureaucrat between you and your health care.”

Doctors have also been reluctant to embrace the guidelines.   Some argue that their patients are going to want the test, anyway.  In addition, if we screen fewer patients, there are going to be more women in their 40s who get cancers that are not discovered until later than they would have been if they had been given yearly mammograms.  This will lead to additional deaths.  If we screen every two years instead of every year, there will be women in their 50s whose cancers grow for a year longer before they are detected, which will also lead to additional deaths.  Doctors are understandably reluctant to take responsibility for these additional cancer deaths.  Public health is about averages, while a doctor’s practice is about a relative small group of actual people.  If the guidelines have served them well so far, why should they deviate?

And this brings us to the personal dimension.  Many people can point to an actual person who survived cancer because of early detection, or to someone who might have survived cancer if their cancer had been detected earlier.  This provides a very personal reminder that reduced screening means more deaths.  Even if it is a small number of deaths, and even if the small number of deaths is dwarfed by the cost, and even if the money used on screening women in their 40s for cancer could save more lives if used to screen some other group for a different disease.  People are fundamentally not wired to set aside these “real” lives in favor of statistical lives and someone else’s dollars.

I started writing this on Monday, when the new recommendations were first announced.  The final word came down today when I picked up the New York Times and say the headline “Screening Policy Won’t Change, U.S. Officials Say.”

The Obama administration distanced itself Wednesday from new standards on breast cancer screening that were recommended this week by a federally appointed task force, saying government insurance programs would continue to cover routine mammograms for women starting at age 40.

Perhaps the new recommendations are right, and perhaps they’re wrong.  I don’t know.  If it were my friend or relative, I’d probably say it is too early to discard the old recommendations, especially if .  But, what is clear is that if we are going to reduce the cost of medical care, we are going to have to start making choices of this sort.  Much of the Obama administration’s promised reduction in health care spending is supposed to come from using Blue Ribbon Panels of experts like this to evaluate scientific evidence and recommend ways in which we can provide better care at lower cost.  If we do this (and I think we need to, since the alternative will be reducing care based on something other than scientific evidence) we’re going to have to trade off statistical lives against dollars spent in various different ways in attempt to get the most bang for our medical buck, and recommend doing less of some things and more of others.  Doing so is going to give ammunition to politicians looking to score points, threaten providers, stoke advocates, and twist the emotions of everyday people.  Along the way we are going to have to interpret complex scientific and statistical evidence that does not definitively establish what the right thing to do is.

This case study may night provide a lot of insight how we will solve this problem in the future, but I think it says a lot about how we got where we are today.

Last Friday, the Pension Benefit Guaranty Corporation (PBGC) announced that its deficit had doubled over the past year.  The PBGC is the government agency that insures defined benefit (DB) pension plans in the U.S.  While this doubling of the deficit was widely reported in the press, the only thing surprising about this announcement was that anyone was surprised by it.

Since the PBGC was created through the passage of ERISA in 1974, the basic design of the program has been fundamentally flawed.  As I have discussed in several papers, the PBGC fails to price this insurance properly, fails to provide adequate incentives for funding, and fails to provide adequate information to market participants.  As a result, DB plan sponsors have the incentive – and the legal right – to fund their pensions in a manner that imposes large future obligations on U.S. taxpayers.  (And as for the PBGC experts out there who will quickly point out that the PBGC is not funded by taxpayer dollars, I ask you only one question – given our experience of the past 15 months in which the U.S. government has not only bailed out government sponsored enterprises such as Fannie and Freddie, but also private sector companies such as G.M., do you really think Congress will let millions of pensioners lose their benefits when the PBGC runs out of money?)

Given that the program’s finances have been underwater for years, and given that numerous academics, think-tanks, and government policy experts such as the GAO and the CBO have all pointed out that the PBGC is on an unsustainable course, the latest numbers simply confirm what we already intuitively know – the PBGC’s finances are deteriorating rapidly.

Here are the facts as of September 30, 2009:

-         The PBGC had only $68.7 billion in assets to cover an estimated $89.8 billion in liabilities.

-         The PBGC “acquired” responsibility for an additional 144 plans during the year.

-         27 large plans – with liabilities of over $1.6 billion are now listed as “probably losses” on the PBGC’s balance sheet

-         The PBGC notes that “potential exposure to future pension losses from financially weak companies” is approximately $168 billion.

I do, of course, realize that it is difficult to get people exercised about this issue.  Even $168 billion, let alone $22 billion, no longer seems like a big number coming in a year after trillions have been spent on stimulus plans and TARP-like programs.  Nor does it seem large relative to the tens of trillions in unfunded liabilities facing Social Security or Medicare.  But $168 billion is still real money – even in Washington. 

What needs to change?  One useful first step would be to give the PBGC the authority to charge market-based premiums for the insurance it provides.  It is true that this might hasten the decline of DB plans in some sectors.  But I would submit that if making firms pay the true cost of their pensions means that they no longer find it attractive to offer them, then perhaps the efficient outcome is for them to end the plans before they dig the fiscal hole any deeper.

In SuperFreakonomics, the new book by Steven Levitt and Steven Dubner, the authors suggest geoengineering as a possible solution to climate change.  Their assertion has been so controversial that they devoted a long blog entry to its defense.  What is geoengineering, and how should economists think about it?

The National Academy of Sciences defines geoengineering as “options that would involve large-scale engineering of our environment in order to combat or counteract the effects of changes in atmospheric chemistry.”  The specific geoengineering that Levitt and Dubner analyze calls for injecting sulfate aerosols into the stratosphere.  The idea is that the aerosols form a shield to reflect sunlight, thus lowering global temperature.  A similar cooling effect occurs naturally after large volcanic eruptions.  Paul Crutzen, the Nobel Prize winning chemist, estimates that $25-50 billion could be enough to construct a sulfate aerosol shield to counteract a doubling in the current atmospheric concentration of greenhouse gases (see “Albedo Enhancement by Stratospheric Sulfur Injections: A Contribution to Resolve a Policy Dilemma”, Climate Change 77: 211-200).

The traditional solution to climate change calls for limiting greenhouse gas (GHG) emissions that cause global warming.  In a “meta-analysis” discussed in the Stern Review (p.242),  a 50% reduction in worldwide greenhouse gas emissions could cost 2% of world GDP or more.  Let’s see,  world GDP is about $70 trillion, so a 2% reduction in GDP costs $1.4 trillion.   While the comparison here is not exactly apples-to-apples, the point is that these mitigation cost estimates are significantly higher than geoengineering cost estimates ($25-50 billion).  Thus, it superficially appears that geoengineering is the “correct” economic solution to climate change.

However, geoengineering is an ex post solution, where society waits for the symptoms of climate change to become so severe that geoengineering is the only remedy to treat the symptoms.  In contrast, GHG mitigation tries to prevent the symptoms from ever occurring by trying to correct the root cause.

Many present the geoengineering solution as an insurance policy against the disaster of runaway climate change.   Shall we rely on the theory that temperatures can be reduced later, while we continue unlimited burning of carbon?  What if that insurance doesn’t work.  What if geoengineering doesn’t cool the planet as theorized?  What if the sulfates cause other environmental problems?  In addition, geoengineering cannot necessarily counteract the economic effects of severe climate change.  Imagine that society waits for “proof” of climate change, such as waiting for large sections of Arctic ice sheets to break off and raise sea level by a few feet.  At that point the economic damage is irreversible – regardless of the geoengineering temperature correction – with millions of people displaced from low-lying areas, billions (if not trillions) of physical capital submerged, and severe disruption to economic activity.  Then would GHG mitigation look like the bargain solution?

Last week I suggested that the road to improving health may be to keep people basically “in good health” for longer, and that one way to do this might be increased focus on preventive care through early- and late- middle age.  However, it is a stretch to go from “preventive care improves health” to “preventive care reduces the cost of health care.”  And, the latter point is one that more often comes up in the context of health reform.

The logic behind preventive care is straightforward.  By increasing screening you identify diseases at an earlier stage.  And, if diseases are identified before they become serious, they can be treated and/or managed at a lower overall cost than if the diseases are identified only later once they do become serious.

Sounds good.  So, what’s the problem?  The problem is that screening costs money.  And, you will screen many, many people in order to identify a small number who can benefit from early treatment.  Even though screening is relatively cheap, and the benefits for the small number of people are large, the sheer number of screens that must be done to convey this benefit to a small number of people can often make early screening for a population very costly relative to the benefit derived from it.

This leaves several possibilities with regard to preventive care.  One: the preventive measure lowers overall cost.  Two: the preventive measure increases cost, but the medical benefits associated with it justify the increased cost.  Three: the preventive measure increases overall cost without commensurate medical benefits.  There is widespread agreement that we should adopt measures of the first kind and avoid measures of the third kind.  In the frenzy to reduce the overall cost of the health care system, measures of the second kind are often overlooked.  If, compared to how we currently spend medical dollars, a particular treatment (whether it is preventive or not) has a ratio of health benefit to cost that is significantly larger than typical treatments in our current arsenal, then we should do more of the new treatment and less of the current ones.  Although we are understandably reluctant to increase the cost of care, the necessity of improving the quality of our health care implies that we should make changes of this sort whenever we identify them.

Enter a 2008 study entitled “Does Preventive Care Save Mondy? Health Economics and the Presidential Candidates,” by Joshua Cohen, Peter Neumann and Milton Weinstein that appeared in the New England Journal of Medicine that looks at the costs and benefits of preventive care.  The study finds that, in general, blanket statements about how preventive care can reduce cost are not justified.  Taken as a whole, there is a distribution of cost/effectiveness ratios for preventive care that looks a lot like the distribution of treatments for existing conditions.  In other words, preventive care in general is not superior to waiting for conditions to emerge and treating them only then.

While preventive care in general does not appear to be cost-saving, some particular treatments, such as flu vaccinations for toddlers and colonoscopies for men aged 60 – 64 do appear to reduce overall costs.  Other preventive measures, such as screening newborns for certain enzyme deficiencies and high-intensity programs to prevent former smokers from relapsing, have very high cost/effectiveness ratios (i.e., they are the second type of program above) and should probably be encouraged.

So, can preventive care save our health care system?  The short answer is no.  In a letter in response to an inquiry by the House Subcommittee on Health, the Congressional Budget Office argues that, “for most preventive services, expanded utilization leads to higher, not lower, medical spending overall.”  A particularly compelling example is the following:

[A] recent study conducted by researchers from the American Diabetes Association, the American Heart Association, and the American Cancer Society estimated the effects of achieving widespread use of several highly recommended preventive measures aimed at cardiovascular disease—such as monitoring blood pressure levels for diabetics and cholesterol levels for individuals at high risk of heart disease and using medications to reduce those levels.4 The researchers found that those steps would substantially reduce the projected number of heart attacks and strokes that occurred but would also increase total spending on medical care because the ultimate savings would offset only about 10 percent of the costs of the preventive services, on average. Of particular note, that study sought to capture both the costs and benefits of providing preventive care over a 30-year period.

So much for the silver bullet.

Twenty years ago today, I stood – along with hundreds of German citizens - on top of the Berlin Wall in front of the Brandenburg Gate.  The night before – November 9, 1989 – East Berlin’s Communist party spokesman, Gunther Schabowski, had announced that East Germans would be allowed to travel to West Germany.  After 28 years of travel restrictions, East and West Berliners alike immediately took to the streets.  By the time I arrived at the Brandenburg Gate on the night of November 10, chaos still reined.  Indeed, as I climbed up the wall and jumped down onto the East Side of the Wall – after ceremoniously taking a whack at it with a hammer borrowed from an ecstatic West Berliner – my progress was immediately blocked by a line of East German soldiers.  There they stood, shoulder-to-shoulder, standing before a line of water cannons that were aimed straight at those of us foolish enough to jump down onto their side of the Wall.  Coming only 5 months after the Tiananmen Square massacre in Beijing, none of us knew just how the East German military would react.  Fortunately, this demonstration turned out very differently. 

I knew at the time, of course, that I was witnessing history.  After all, the Berlin Wall was the ultimate, tangible symbol of the East-West divide that marked the Cold War.  As an undergraduate at the time (it would be another decade before I earned my economics PhD), however, I did not have the training to fully appreciate that I was also witnessing the end of the most powerful and persuasive economic experiment ever conducted on the relative merits of free-market capitalism versus central government planning.  Even lacking the terminology to fully describe it, however, I could see the results of the experiment.  As I walked the nearly-deserted streets of East Berlin on November 11, I was stunned by the obvious economic decay in the East: the old cars that spewed emissions, the often-bare shelves in the stores, the poor quality food, the decaying buildings.  Not to mention the enormous display of “revealed preference” by the tens of thousands of East Berliners so anxious to escape to the West. 

It was one of those experiences that left an indelible mark on my thinking.  And while I could not quite find the words to describe it at the time, I instinctively understood that whatever they were doing in East Berlin, it clearly had not worked.  In the following weeks, as I also visited Prague during its democratic demonstrations, as well as Budapest, I quickly discovered that the failings of central planning were not unique to East Berlin.  It has been a disaster everywhere.    

I credit Alan Greenspan’s book, “The Age of Turbulence,” for helping me put it all into appropriate perspective many years later.  He noted (page 131) that:

“Controlled experiments almost never happen in economics. But you could not have created a better one than East and West Germany, even if you had done it in a lab.  Both countries started with the same culture, the same language, the same history, and the same value systems.  Then for forty years they competed on opposite sides of a line, with very little commerce between them.  The major difference subject to test was their political and economic systems: market capitalism versus central planning.  Many thought it was a close race.”

He goes on (page 132) to note that:

“The fall of the wall exposed a degree of economic decay so devastating that it astonished even the skeptics.  The East German workforce, it turned out, had little more than one-third the productivity of its western counterpart … The same applied to the population’s standard of living.  East German factories produced such shoddy goods, and East German services were so carelessly managed, that modernization was going to cost hundreds of billions of dollars.”

Finally, (p. 382) he notes that “The fall of the Berlin Wall exposed a state of economic ruin so devastating that central planning, earlier applauded as a “scientific” substitute for the “chaos” of the marketplace, fell into terminal disrepute.  There was no eulogy or economic postmortem.  It just disappeared …”

The economic and financial market disruption of the past 24 months has been difficult for many in the U.S. and around the world.  To those who have lost jobs, witnessed their 401(k) values plummet, or watched helplessly as their house values fell below the balance of their mortgage, it is tempting to want the government to protect us from these risks. But we should be careful what we ask for. 

The lessons learned from the failed central planning experiments of the Cold War are not just lessons of history.  They are fundamental lessons about how to successfully structure an economic system.  Given a choice between a system that assumes the government knows best and a system that allows individuals and markets to operate freely, I will always choose the latter.  

In 2007, the Supreme Court ruled that the Environmental Protection Agency (EPA) has the authority to regulate greenhouse gas (GHG) emissions under the Clean Air Act (link).  This fall the EPA announced its plan to regulate GHG emissions, including carbon-dioxide, by requiring large emitters to adopt state-of-the-art, best-practice pollution abatement technologies (link).  Yet the EPA’s new regulatory plan may rely upon costly methods of reducing GHG pollution.

Under the Clean Air Act, the EPA can only promulgate rules or “mandates” to control pollution.  Requiring every emitter to adopt best-practice pollution abatement technology is an example of a mandate, where the regulator dictates how the emitter must reduce its pollution.

In contrast, economists have long advocated market based approaches to pollution abatement – either a carbon tax or a cap-and-trade system.  Indeed, it is a cap-and-trade policy that passed the House during the summer and is currently being debated in the Senate.

The “cap” sets a hard limit on total pollution, and it then gets tighter and tighter over time, reducing emissions gradually.  Meanwhile, the “trade” part of the policy allows private markets to allocate pollution rights (permits) efficiently among thousands of emission sources.  Capping emissions causes pollution rights to become scarce, and thus the ability to pollute has economic value.  This value is the price at which permits are bought and sold.  If a company holds permits and can reduce GHG emissions more cheaply than the prevailing price, then it sells permits and makes money on the difference; otherwise it may buy permits.  This allows for companies with only expensive pollution abatement options to buy the right to emit at a price lower than they would otherwise incur, thus reducing the cost to society.

In addition, the explicit price on pollution induces profit-maximizing firms to research and implement new and cheaper ways of reducing GHG emissions.  This is a key difference when comparing cap-and-trade vs. mandates.  The price signal of the market based approach induces innovation.  Individual entities acting in their own self-interest will have the incentive to find new and cheaper forms of pollution abatement.  Those future innovations cannot be foreseen, and thus the cost projections of current legislative proposals cannot take them into account.  The costs of reducing GHG emissions are real, but under a cap-and-trade system, U.S. ingenuity and innovation will lower the cost of compliance relatively to current projections.  Why am I confident?  It has happened before.  The cap-and-trade policy to reduce sulfur dioxide pollution from coal-fired power plants cost one-fourth of the project price tag precisely due to unanticipated adaption and innovation by U.S. businesses (link).

A couple of weeks ago I wrote about how Americans may spend more on health care because we are sicker than those in other countries.  A recent paper provides additional evidence on this point.  (Thanks to the Economic Logic blog, which pointed out the paper.)   The paper, by RAND Corporation researchers Pierre-Carl Michaud, Dana Goldman, Darius Lakdawalla, Adam Gailey and Yuhui Zheng, is entitled “International Differences in Longevity and Health and their Economic Consequences”, and it begins by noting that in 1975, life expectancy at age 50 was about the same in the U.S. and Europe.  Since then, however, Europeans have gained more than Americans.  In 2004, a typical 50 year old Eurpoean expected to live another 32.5 years, while his American counterpart expected to live only 31 more years.  Next, they note that Americans appear worse on several health indicators than Europeans.  For example, the U.S. looks worse than the group of Eurpean countries they study (Demnark, France, Germany, Greece, Italy, The Netherlands, Spain, Sweden) in terms of obesity, whether the person has ever smoked, heart disease, diabetes, stroke, lung disease, cancer, hypertension and disability.  This leads to the main question of the paper: how much of the difference in life expectancy from age 50 is driven by these differences in health?  If observed differences in health do not account for the difference in longevity, then it is possible that “‘being American’ an independent mortality risk factor, in the same way that being poor or being black increase risk above and beyond observed health.”  This ‘being American’ effect could be due to shortcomings of our health care system relative to that of other countries.

The main finding of the paper is that, if Americans had the same baseline health status as the Europeans in the study, they would live about 1.2 years longer.  So, differences in health status account for about 80% of the 1.5 year difference.

Of course, differences in health status at age 50 could, themselves, be a product of the health care system.  So, it is not immediately clear from the Michaud et al. paper that Americans are genetically sicker or that we make behavioral choices (e.g., eat too much) that make us sicker.  It could be that we get worse health care throughout our lives, and this leaves us sicker at age 50.  I suspect that this is not the case, but it is certainly a possibility.

This reminded me of a paper I saw a few years ago by Daniel Polsky and others entitled “The Health Effects of Medicare for the Near-Elderly Uninsured.”  The study found that if a person was basically in good health when they went on Medicare at age 65, Medicare helped to keep them that way.  But, for those who were already in declining health, Medicare was not that effective.  Now, if as the previous study showed, Americans have higher prevalence of chronic disease at age 50 than other countries, it may be that we, for whatever reason, enter the period of “declining health” earlier than Europeans do.  If insurance (as proxied by Medicare) is more effective in maintaining good health than restoring one to good health once deterioration has begun, then this suggests that the place to focus our efforts if we want to close the longevity gap with Europe would be in increased prevention and disease management efforts in middle age.

Next week: does preventative care save money?