Job lock versus moral hazard

Filed Under (Health Care) by Tatyana Deryugina on Feb 10, 2014

A new CBO report on the Affordable Care Act was recently released. One of the findings, described in an Appendix, is that the implementation of the ACA would result in about 2.3 million fewer full-time jobs by the year 2021. Most of this would be due to workers voluntarily cutting back on work. This has created quite a stir, with some arguing that the ACA is bad for the economy while others arguing that as long as it’s the workers making the decision, there’s nothing wrong with lost jobs.

Jon Stewart tried to point out the hypocrisy of Republicans who rallied against “job lock” in previous years, but are now pointing to the CBO report as evidence that Obamacare is bad for the economy. But Jon appears to have misunderstood (as probably other many people do) the exact meaning of “job lock” and the difference between it and what the CBO finds.

Job lock arises because health insurance on the individual market is much more expensive than what an employer typically pays for it, partly because of the tax deductibility of employer premiums and partly because adverse selection used to be a bigger problem on the individual market (we’ll see if that remains true now). Moreover, workers with pre-existing conditions may have not been able to get health insurance at all if they left their jobs. These conditions create incentives for workers to keep working at their current job mainly for the purpose of maintaining their health insurance coverage ( = “job lock”).

It’s certainly likely that the Affordable Care Act eliminates some job lock. But it also does something else. By tying premium subsidies to income, the government is effectively creating incentives to work less. This has nothing to do with job lock – it’s called “moral hazard,” and most economists would agree that it’s a bad thing. And it’s not a hypothetical effect that evil people made up as an excuse to not help people get health insurance. Several empirical studies, cited by the CBO, find that it exists and is significant. Most of the estimated reduction in employment appears to be coming from moral hazard rather than the elimination of job lock. Thus, the voluntary reduction in employment is not something to cheer about, but something to view as a cost of the Affordable Care Act.

For more, see Casey Mulligan’s discussion of how to think about this loss of jobs.

Crop Insurance in the News

Filed Under (Environmental Policy) by Tatyana Deryugina on Sep 19, 2013

Bloomberg recently published a series of articles criticizing the United States crop insurance program. Given my own interest in insurance generally and crop insurance specifically, I wanted to address some of the claims made by the articles.

There is no doubt that the federal crop insurance program is very flawed, with the largest flaw, by far, being the insane premium subsidies. Farmers currently pay less than half of their premiums, on average, with the rest being covered by the government. Moreover, between 1990 and 2009, Congress has routinely passed additional legislation giving special payments to farmers who suffered crop losses due to disasters.

However, there two features of crop insurance that Bloomberg portrayed as negatives but that are actually positive. First, one article quotes an “uneasy” beneficiary as saying, “I like to think of myself as an independent who’s willing to take risk. [...] With insurance, it takes the risk out of it.” This is actually a good thing from society’s point of view. No one goes around saying, “Man, things are just not fun anymore now that I have health insurance. If I fall down and break my leg, I no longer have to spend thousands of dollars.” The notion that farming should remain risky is simply misguided (of course, farmers are free to forgo insurance if they wish).

Second, the fact that “more than seven in 10 policies guarantee income rather than yield” is actually a good thing from an insurance point of view. Farmers care about their income rather than just about how much corn they have. They face both the risk that their yields will be low and the risk that prices will be low. Considering the two in combination rather than focusing on yields alone is preferable from the point of view of risk reduction.

So the real problem with crop insurance is not that it takes the risk out of farming, but that it is heavily subsidized by the government and supplemented with extra disaster payments. The subsidies have previously been justified by the adverse selection that would result if premiums were not subsidized. However, a much cheaper way to deal with adverse selection is to mandate that every farmer buy insurance. There are probably better things to do with taxpayer money (for example, see this recent National Review article).


Free advice to airlines

Filed Under (Other Topics) by Tatyana Deryugina on Aug 26, 2012

This past week, I reached Gold Status on American Airlines, which, along with some economics credentials, makes me qualified to give airlines some advice.

In my opinion, the most frustrating experiences of flying are the lines: bag check, security, boarding. I’m not going to debate security procedures here, but I will talk about the best way to reduce the boarding line: start charging passengers for carry-on baggage that doesn’t fit under their seat.

There’s nothing more frustrating than watching a long line of people try to stuff their clearly too-large roller suitcases into the overhead bins. Actually, there is: when it turns out that there isn’t enough space in the overhead bins and people have to start checking their carry-ons. The delay created by these phenomena costs the airlines a lot of money. A few years ago, a study calculated that padded schedules, which happen because airlines anticipate delays, cost them about $4.1 billion that year. Reducing the time that it takes people to board the plane could shave off some of that cost. Reducing the amount of stuff people bring on the plane would definitely reduce boarding time.

What would happen if airlines started charging for carry-on bags? Presumably, people would (a) pack fewer things and (b) check more bags. An alternative would be to stop charging for checked bags. However, that option would probably raise costs because people would pack more things into their suitcases and bring more suitcases with them. Fuel costs already make up around 40% of airlines’ costs, so adding more bags (and thus weight) to planes by not charging people what they cost to transport is not desirable.

Why don’t airlines charge for carry-on bags already? I’m guessing it’s some kind of game theoretic equilibrium where it’s good for everyone to charge for carry-ons, but bad to be the first mover. This is certainly consistent with what happened to free bags and meals: once someone started charging for checked bags and stopped serving meals, everyone else followed. Though Spirit already charges $20 per carry-on and will start charging $25 in November. Care to follow, anyone?

Heat waves and climate change

Filed Under (Environmental Policy) by Tatyana Deryugina on Jul 10, 2012

The recent weather extremes over much of the US have created a flood of articles about the link between these heat waves and climate change. Here is one example. For other examples, just go to Google news and search for “heat wave climate change”. Or you can just keep reading this blog post.

Are these recent events being caused by climate change? The answer is “maybe”. Certainly, climate change is predicted to increase the number of heat waves. But attributing a particular event to climate change is very difficult, even when the event is as extreme as the heat waves of the last two weeks. Of course, if such events are more likely under the “climate change” scenario than under the “no climate change” scenario, we should reasonably think that climate change is more likely than not. But because such heat waves are possible during the “no climate change” scenario as well, we cannot rule out that these temperatures would have occurred even if climate change were not a possibility. So all we can do is make statements like, “There’s an 80% chance that the heat wave was due to climate change, and a 20% chance that it was part of natural fluctuations.” (like this guy).

What should we do in light of this uncertainty? Pay attention to the science and the scientists rather than the weather fluctuations. 97% of scientists agree that climate change is real and caused by humans (see this paper for details). Given the high degree of consensus and the time it takes to for carbon dioxide to dissipate in the atmosphere, we shouldn’t wait until we’re sure that we’re experiencing the predicted effects of climate change firsthand. As evidenced by the deaths and misery in the past weeks (see this article for more), extreme weather still has the power to kill, even in developed nations. Trying to figure out a cost-effective way to address climate change is what we should focus our efforts on (more on that in a later post).

Regulating working conditions

Filed Under (Other Topics) by Tatyana Deryugina on Jan 30, 2012

Recently, New York Times ran an article on working conditions in Apple’s factories in China. This article surfaced on my Facebook feed and instead of posting my thought into the crammed comments section, I decided to write a more extensive blog post.

How should we should think about regulating working conditions? The first rule of economics is: if labor markets are competitive, don’t mess with them. What does it mean then to have a competitive labor market? It doesn’t mean that wages are high or “fair”. It doesn’t mean that workers put in 40 hours a week and no more. It means that there are lots of companies and lots of workers. Workers know what the working conditions are like and voluntarily enter into a labor contract. In other words, there is no market power and everyone knows what they’re getting themselves into. The result might be people working 80 hours days for low wages, but if we were to say this was unacceptable, we would be infringing on individual rights to choose for themselves and possibly making those workers worse off.

Even concerns about fairness can have unintended effects. Sure, if we could magically provide everyone with better working conditions, without putting some people out of work and without raising the prices of the goods, no one would be against that. But there’s no such things a free lunch. What is likely to happen if higher standards are imposed is that prices of the product will go up, demand for the product will go down, and some unlucky workers (who were perfectly happy working there before) will end up unemployed. Even if we as a society decide that we don’t mind the first two effects, we probably don’t want the last one.

What if labor markets aren’t competitive? First, workers could be physically coerced into working at the factories. No one thinks slavery should be tolerated. That doesn’t seem to be the case here – from what we can tell, the workers went willingly. However, if the company prevented existing workers from leaving by withholding wages in a way that wasn’t part of the original deal, that could also be a type of coercion.

There is another kind of coercion that deserves serious consideration in this case. Economists have always recognized that monopolies are bad for society. So are its lesser-known cousins – monopsonies. Here, a big firm is able to exercise market power as a buyer. Foxconn is a large employer and it’s plausible to think that it may have the power to depress wages (and working conditions) below what would be the competitive market outcome. China is large too, so it’s not clear that Foxconn is “big enough”, but it’s certainly a possibility.

The second major source of problems here could be biased information. Workers may believe that working conditions or wages are better than they really are when they sign up to work there. If information doesn’t travel well, this is entirely possible. Biased beliefs have to be combined with significant moving or quitting costs, however. Otherwise, workers would simply leave the job once they find out how bad the conditions are. Unfortunately, the article says almost nothing about what the workers believe when they decide to take these jobs.

The NYT piece isn’t the first article on poor working conditions in developing countries and it won’t be the last. There may be lots of reasons to think that, in this case, regulation, better enforcement and public pressure are warranted. But the questions we should be asking are not “Are wages low?” or “Are working conditions dangerous?” or “Would I take this job?”, but whether there are labor market failures that resemble those described above.

One reason not to buy homeowner’s, flood, or earthquake insurance

Filed Under (Environmental Policy) by Tatyana Deryugina on Dec 8, 2011

A frequent claim about homeowner’s, flood, and earthquake insurance (I will use the term “home insurance” for short) is that not enough people have it and those who do don’t have enough of it. Lots of explanations have been put forward, ranging from underestimation of risks to expectations of government aid. But there is at least one more (rarely discussed) rational reason for some US residents to not buy home insurance – the US tax code.

You cannot deduct home insurance premiums from your taxes. The legislators probably figured that it’s a purchase like any other, so why should you be able to get a break for buying it (let’s forget about the deductions for having children and a mortgage for a second)? However, you can deduct disaster-related losses from your taxes. Again, that may be a reasonable rule on its own – we can think of the loss as a loss of income that you had at some point.

When you put these two things together, you get a real disincentive to buy comprehensive insurance. In some cases, homeowners can even deduct losses from past tax returns and get those taxes back. I’m not going to claim that this means people should have no insurance. But for most people, it will make sense to have a fairly high deductible. To clarify, a fairly high deductible (as much as the homeowner can comfortably afford) is already recommended by most experts based on insurance prices, but my claim is that people should choose a deductible that’s even higher.

Here’s a numerical example. Suppose that your taxable income has been $50,000 a year for the past three years and your federal income tax rate is 10% (or $5,000). You own a $200,000 home that’s located in a flood plain. For simplicity, let’s say the only risk is a 1% annual chance of $100,000 damage to your home. Actuarially fair insurance would then cost $1,000 per year. So if you buy insurance, you pay $1,000 per year for certain but don’t have to suffer any losses.

Now suppose you choose not to buy insurance and you suffer the loss. You can deduct it from your tax returns for this year and next year (or even last year in some cases), which would get you $10,000 of that loss back. So it’s as if you only lost $90,000. Of course, that’s still a lot of money, but now that actuarially fair insurance looks like it has a load factor of 0.9. And, by the way, you probably can’t get actuarially fair insurance in the first place.

Finally, suppose you can get a loan to repair your home. You borrow $90,000 (because you got $10,000 from the government) at 5% interest for 5 years. According to a handy online mortgage calculator, the monthly payments for that kind of loan will be $1,698.41 and this loan will cost you $101,904.66. Not bad, considering you didn’t have to pay premiums for all those years.

To summarize, if the interest rate that you can get is low enough and you’re young enough, you may be better off buying insurance with a very high deductible (or foregoing it altogether), deducting the resulting losses from your taxes, and getting a loan to repair the damage. Of course, bigger losses will make insurance more appealing, but if the loss is moderate relative to your income, absorbing it shouldn’t be that hard. And if I were an insurance company, I would campaign hard to make insurance payments tax-deductible.

A brief update on Netflix

Filed Under (Other Topics) by Tatyana Deryugina on Oct 26, 2011

As you may have heard, Netflix nixed its plan to split its services into two – a mail DVD delivery service and an online streaming service, each with its own website. It now appears that, even though the plan was never realized, this was a very costly experiment. Netflix stock is down, 800,000 subscribers left, and the split wasn’t even implemented. Of course, this may have been the result of the earlier price hike. But judging by the outrage at the split plan, I don’t think that’s the whole story.

Economists often wonder why companies don’t experiment more. It’s well-known that prices are “sticky” and many economists think that firms should to change them more often to figure out the profit-maximizing price. I think the Netflix example suggests one explanation for why companies are reluctant to experiment – consumers appear to really not like it.

Reframing Obamacare

Filed Under (Health Care) by Tatyana Deryugina on Oct 20, 2011

Most  economists would say there is conceptually no difference between a coffee shop (a) charging 5 cents more for each drink and giving a 5 cent discount to people who bring their own mugs and (b) charging 5 cents more to people who don’t bring their own mug. The price you pay for a drink is the same in each situation (both when you have your mug and when you don’t).

However, to some people the distinction is a big deal. Most grocery stores give customers discounts for bringing their own bags, but protest against proposed requirements to charge for each plastic bag. Apparently, judges, lawyers and much of the US population also don’t agree that the two situations are equivalent. The mandate to buy insurance has led over half the US States to challenge its constitutionality. But is that requirement really that different from some other incentives that US citizens have faced for decades?

The way the Obama administration chose to write the law is as follows. Everyone is “required” to buy insurance. But clearly, the government cannot truly force people to buy it or impose severe punishments. Thus, the “price” for not buying insurance is a tax penalty. By now, it should be clear that the Obama administration could have gone a different route. Instead of imposing a tax penalty and calling it a “mandate”, it could have simply raised taxes and introduced a tax deduction for people who buy health insurance. Same exact incentives, much less legal trouble. We don’t call the mortgage interest deduction a “mandate to buy a house” and we don’t call the deduction for dependents a “mandate to have a child”. No one has sued over them (at least that I know of). But changing something from a reward to a penalty is apparently enough to land you in the Supreme Court.

Maybe the Obama administration knew that people would react to the other framing differently? Although I don’t know of any studies that show this, people appear to dislike explicitly paying more for not doing something, like not bringing their own mug or grocery bag and not buying health care (even though you are implicitly paying more when you forget that mug). This would imply that people are much more sensitive to tax “penalties” than to tax “deductions”. I’m guessing that calling something “mandatory” and penalizing non-compliers has larger effects on take-up than simply providing a tax deduction for doing something.

Of course, it’s also possible that a proposal which raised taxes and introduced tax deductions for buying health insurance would have never passed Congress (or that the administration never imagined so many states would challenge the law).

How to have a bigger budget deficit

Filed Under (Environmental Policy) by Tatyana Deryugina on Oct 10, 2011

I usually learn something new at every conference, and this weekend was no exception. Timothy Fidzgerald of Montana State University presented a joint paper on the Wild Horse and Burro Program. I didn’t know this, but the Western US has a substantial (nearly 40,000) population of wild horses and burros, which originated from the escaped animal population of early settlers. Today, they are officially protected by the US government (i.e., you cannot capture or kill them). It also happens that these horses have no natural predators, so their population would constantly be rising were it not for periodic “gathers” of these horses. Now, don’t worry, these horses aren’t then killed. They’re de-wormed, vaccinated and put up for adoption or sale (but not to slaughterhouses).

So what is a post like this doing on a policy blog? Well, the cost of this program last year was $65 million and is continuously rising. The problem is that holding a horse costs about $13,000, but most end up being sold at a fraction of that price. The largest cost of the program is holding the horses and the revenue is not nearly high enough to offset that. The only population controls are the periodic gathers of the horses; there is no sterilization program. Moreover, there is a price floor on the adoption fee for the horses, even though a good portion of the horses is not adopted.

Don’t get me wrong; I’m a big advocate of the humane treatment of animals. But it seems as though sterilizing and re-releasing some of these horses would be a much more cost-effective way to control their population (and the horses might prefer that too!). No one would suggest that sterilizing dogs and cats is inhumane; in fact, most animal groups believe that IS the humane thing to do. Unfortunately, it also seems as though there are relatively powerful horse advocates out there who are staunch opponents of sterilization. So once again the government is captured by an interest group which insists that we continue to spend money on an unsustainable (and I would argue not well thought-out) program.

This does not seem like a sustainable program to me. Luckily, it is costing us only $70 million (at least this year), which is small change compared to some other government programs. But (a) it is growing at an unsustainable pace and (b) it makes me wonder how many other such programs are out there.

PS Many of the facts are taken from Fidzgerald’s paper, but all the opinions are my own.

The Netflix split

Filed Under (Other Topics) by Tatyana Deryugina on Sep 20, 2011

Netflix has been in the news quite a bit in the last couple of months, in a way that should provide a good case study for the question “Is any publicity good publicity?” In July, Netflix announced a significant change in its prices, which left some subscribers facing a 60% price increase. Then, late this Sunday, Netflix announced that it is splitting into two companies. One will be focusing on streaming content and will keep the name Netflix. The other will be for mailing DVDs and will get the new name “Qwikster”. In the announcement, the CEO of Netflix, Reed Hastings, said that the company felt that splitting up the streaming content from the physical DVDs was going to help them become better at both. The reaction of consumers is illustrated quite amusingly in this comic.

How can this possibly be a good move for Netflix? In general, it may be true that by specializing, companies can perform better in each area. But is there no economies of scope from combining online streaming with mailing DVDs? For example, Netflix spent a non-trivial amount of money (and probably effort) on creating its system of recommendations. Once Netflix splits into two websites, one of two things will happen to the recommendation system. Assuming Netflix still has subscribers that get both streaming and DVDs, one possibility is that the quality of recommendations will be lower (unless the websites will share information with each other, which doesn’t seem to be the case). Alternatively, the cost of getting quality recommendations to customers will be higher because those that subscribe to both services will have to rate movies on both websites.

The set of customers who subscribe to the online content and get the DVDs is large as a fraction of total subscribers. According to one website I found, Netflix expects to have 9.8 million streaming only subscribers by the end of the third quarter, 2.2 million DVD only subscribers, and 12 million users who subscribe to both services. Thus, a lot of people seem to treat streaming and DVD as complements, not substitutes, even AFTER the price increase that made it more expensive to have both services.

However, this move may make more consumers rethink their Netflix subscriptions; I would bet there are many subscribers out there who pay for the service but almost never use it. By making the cost of having the subscription more salient, the firm might cause people who otherwise would have gone on paying for a service they don’t use to cancel or downgrade.

Even assuming that the number who cancel or downgrade is small, it’s not clear that the split is worth it unless it helps Netflix improve its streaming content. It seems to be at the forefront of the pack in its streaming technology. I can vouch for that as someone who’s compared Netflix to other streaming websites on devices ranging from laptops, iPads, and Blu-Ray players to Wiis, Rokus and Apple TV’s (yes, I have access to lots of technology). The image quality and continuity of streaming is better than any other website. Its physical delivery system also seems to work well. I would be surprised if splitting the two services can help Netflix improve along these dimensions.

To summarize my two cents, the only way this move makes sense to me is if Netflix is planning on selling off its mail-in DVD business completely, in which case this is a reasonable transition step.