The following content is
provided under a Creative
Commons license.
Your support will help MIT
OpenCourseWare continue to
offer high quality educational
resources for free.
To make a donation or view
additional materials from
hundreds of MIT courses, visit
mitopencourseware@ocw.mit.edu.
PROFESSOR: So to review, what
we've been doing in the last
two lectures, we talked about
equity versus efficiency, and
the equity efficiency
trade off.
We then talked about
redistribution and the leaky
bucket, and basically how both
taxation and distortions and
welfare programs lead to
leaks in the bucket.
And we talked about
we do in the US to
try to transfer income.
The last lecture, we focused on
the fact that most of the
US government transfers are not
about just the rich to the
poor, they're about fixing
problems with our insurance
markets in the form of
social insurance.
And we ended last time by
talking about the nation's
largest social insurance
program, social security.
What I want to talk about today
is a particularly timely
topic, which is the biggest
single issue in social
insurance, indeed the biggest
single fiscal issue facing the
US government over
your lifetimes,
which is health care.
Health care in the US today
consumes about 17% of our
nation's income, so that
one in every $6
goes to health care.
By 2075, so when you guys are
elders, when I'm no longer
with you and you guys are
elders, health care will
consume about 40% of our
nation's product, so $4 in
every $10 will go
to health care.
By 100 years later, when your
grandkids are elders, health
will consume 100% of our
nation's product.
That is literally if nothing's
done, every single dollar we
earn will go to health care.
Now, obviously that is
not sustainable.
That's not a legitimate
outcome to envision.
So something must be done, and
that has led to an enormous
discussion about this area.
Another way to think about this
is, if you think about
the US, we haven't talked about
budgetary issues in this
course, think about US
government having a budget,
money it collects through taxes
and money it spends
through revenues.
We all know the US government
has a big budget deficit right
now, about $1.3 trillion.
Another way to think about that
is if you look at the US
government and all the promises
it's made to pay for
health care alone, forget
everything else, just for
health care, we've promised to
pay, above and beyond any
taxes we're planning to collect,
$100 trillion in
health care promises to the
Medicare and Medicaid program,
above and beyond any taxes
we'll collect.
So if we do nothing, we're
facing a $100 trillion long
term deficit in health care.
Now, a year ago, that would
have sounded more stunning
because a year ago, we didn't
use to talk in trillions.
We only talked in billions.
Now, we're all talking
trillions, so it doesn't sound
that impressive, but believe
me that's a big number.
So basically, we've got enormous
problem facing our
country with health care, both
in terms of the country's
devotion of resources, and in
terms of the government's
devotion of its budget.
Now, you might say, well, the
government should just get out
of this activity, but that goes
back to the last lecture,
which is why is government
in this activity?
Because there's a market failure
for health insurance.
We talked last time about
adverse selection, and the
problem that, if the government
doesn't get
involved, health insurance
markets might fail, and in
practice we've seen that
in the United States.
We've see a failure of health
insurance markets.
Now, most people get
their health
insurance through big companies.
So I get mine through MIT.
You get yours through MIT or
through your parents and the
big companies where they work.
And in those markets, health
insurance works well.
And health insurance works
well through a simple
statistical fact many of us
learned about in high school,
which is the Law of
Large Numbers.
The Law of Large Numbers simply
says that for most
distributions we know, certainly
normal distribution,
as the sample gets large
enough, the mean is
predictable, and basically,
that's the principle under
which insurers operate.
So I talked about you, last
time, starting your MIT
insurance company, where
you would go
and insure MIT graduates.
Well, as long as you have a
large sample of MIT graduates,
and you knew they were all going
to buy health insurance,
then you could clearly predict
what you'd have to spend,
through the Law of Large
Numbers, and you could have a
functioning insurance market
where you charge that plus a
little money to make, to
pay for your profits.
And that's how large
business works.
So MIT has insurers, the MIT
insurers know MIT has about
10,000 employees altogether,
12,000 maybe.
The insurers say, look, that's
a large enough sample that we
can basically predict what MIT
is going to cost, and we can
basically figure out what to
charge them for premiums. MIT
says, well gee, we wish it was
less, but that's fair.
We understand what health care
costs, and we're done.
That's not true if you don't
work for a large firm,
particularly for
an individual.
So let's say you've got your MIT
health insurance company.
You've graduated, you're
successful, you set up a
program insuring all
MIT graduates.
Let's say, MIT forces everyone
to buy health insurance, so
you've got a nice, predictable
distribution of risks, and
you're making your money.
And then I walk in the door, and
I don't have to buy health
insurance from you.
I'm just a regular guy
off the street.
I say, hey, I hear you've
got this great
health insurance product.
I want in.
And you look at me say, wait a
second, why do you want in?
You probably only want in
because you're sick, and you
know that you're going to need
health care, and that's why
you want to buy from me.
So no I'm not going
to sell to you.
And that's the problem
individuals face who want to
buy health insurance on their
own, is the problem of
asymmetric information goes away
when you've got a large
pool of people who are all
buying health insurance.
For any one individual trying to
walk in off the street, the
problem of asymmetric
information means that
insurers will be unwilling to
sell to them, and if insurers
are unwilling to sell to
them, those individuals
might end up uninsured.
Currently in the US, we have
about 50 million uninsured
people, so that about 18%
of our non-elderly
population is uninsured.
Remember, the elderly, as I
discussed last time, get
universal health coverage
through the Medicare program.
But about 18% of our non-elderly
population, around
50 million people, are
uninsured, and one of the
reasons they're uninsured is
because of this insurance
market failure.
And to see that insurance market
failure, you can just
look at what happens when
people try to get health
insurance outside of large
employers, through what we
call the non-group
insurance market.
In the non-group insurance
market, when people try to get
health insurance, it's typically
incredibly expensive
because insurers are worried
you're sick, so they charge
you a high price.
I talked about that last time.
That the lemons problem.
Insurers also, in trying
to deal with asymmetric
information, the way they
deal with it is by being
discriminatory.
So if you're an insurer who's
allowed to, what you can do is
to say, fine, I'm going to
insure you, but I'm not going
to insure you for any sickness
you previously had because I
know that's something that
might flare up again.
That's called a pre-existing
condition.
I'm not going to insure
you for any
pre-existing condition.
Moreover, I'm going to
go even further.
If you get sick, I'm
going to drop you.
You might say, wait a second,
the whole idea of insurance is
you cover me if I get sick, but
in fact, in most states'
insurers, it's totally
legal to do.
Insurers can simply say we're
not renewing you.
You got sick.
Well, that clearly
is a problem.
That clearly means that adverse
selection's led to
market failure because of
what we discussed in the
uncertainty lectures.
You should go back and review
that, in the uncertainty
lecture, we talked about why
individuals would value
insurance, why they pay a risk
premium for insurance, well,
if insurers simply won't sell
to them once they get sick,
the individuals aren't getting
something they value, and the
market's failed.
So we've got a situation in
the US where we've got
insurance that works for many,
many people, those that work
for large firms. But insurance
markets that are failed for
individuals, and small firms
are sort of in between, and
that leads to 50 million
uninsured people.
So we got this problem.
We got all these uninsured
people on the one hand.
On the other hand, we have
incredibly rapidly rising
health care costs.
We, by far, devote the
largest share of our
economy to health care.
We're about twice the average
of industrialized countries,
and our costs are rising
incredibly rapidly, although
that's true around the
world, as well.
So that's the sort of situation
we face ourselves
in, and that's thte motivation
that underlies the discussion
you're hearing now about
health care reform.
And in particular, you're
hearing a lot of discussion
now about the Patient Protection
and Affordable Care
Act, which passed
last March 23.
This was the single most
important piece of government
legislation, perhaps,
since World War II.
Certainly, the most significant
piece of domestic
social policy legislation
since Medicare was
introduced in 1965.
What does this bill do?
Full disclaimer, I'm going to
describe objectively, but I
helped write it.
I'll try to be objective, but
just full disclaimer, I was
involved with writing
the legislation.
So there is some bias
involved here.
But what does this piece of
legislation try to do?
What it tries to do is deal
with the second of the
problems I discussed, which is
the insurance market failure,
and it makes a vague stab at the
first, which is the fact
that health costs are getting
very, very expensive.
Since more economics is involved
in that second, in
the insurance market failure,
let's talk about that.
So how do you solve insurance
market failure?
You've got this problem that
there are 50 million people
without health insurance, often
because this asymmetric
information problem.
50 million people without
health insurance.
Many more are in this market
that sort of can drop you when
you get sick.
We discussed the reasons last
time, so what are the two
options we discussed last time
for what the government might
do if they want to solve
this problem?
Yeah.
AUDIENCE: Subsidizing the
insurance companies--
PROFESSOR: Subsidizing
the people and
the insurance companies.
So one thing I could do is I
could say, look, let's just
make insurance free
for everyone.
That way everyone will sign
up, and then insurance
companies can offer
fair prices.
And that's a solution that's
pursued by Canada.
Canada has free universal
health care coverage.
Everyone in the country is
covered by birth for their
health insurance expenditures
under one, single government
insurance company.
But it wouldn't have to be
one, single government
insurance company.
That part's distinct.
We could separate who provides
insurance versus
who pays for it.
OK, so let's just focus on
the who pays for it part.
If we make health insurance
free, sign up everyone from
birth, then we've solved the
adverse selection problem, but
that costs a lot of money.
To sign up everyone from birth
and cover them with insurance
at the full government cost,
would cost on the order of $2
trillion a year.
That's a lot of money.
That's pretty hard to imagine
the US government raising
taxes enough to cover that
kind of new program.
So the second solution we talked
about was a mandate,
was to say, OK fine,
we can't make
insurance free for everyone.
What we can do is we make sure
everyone buys, so that we
fixed this adverse selection
problem.
So that insurers can know they
are getting everyone, so they
can price insurance fairly.
And basically, that's
what PPACA does.
It does three things.
The first thing is it says to
insurance companies, we're
going to give you an
individual mandate.
So starting 2014, every person
in the US will have to buy
health insurance.
Now, it's not quite
every person.
There's exemptions.
For example, it doesn't apply
to illegal immigrants, it
doesn't apply to people for
whom health insurance is
particularly expensive,
et cetera.
But the estimate is this mandate
would cause about 60%
of the uninsured get coverage.
So about 47% of the uninsured
will slip through the cracks,
but about 60% will
get coverage.
The second thing it does, it
says, OK, insurance companies,
since we're giving you the
mandate, we're going to say
you can no longer discriminate
in health insurance.
OK, no more discrimination in
health insurance, so what
that's saying is, now, you can
no longer, for example, drop
people when they get sick.
You can no longer exclude people
for their pre-existing
conditions.
You have to basically offer
insurance the way we described
it when we talked about
insurance in
the uncertainty lecture.
Once you get sick, you're
covered, and anyone can get
it, and it's priced fairly.
So basically, the trade-off
is we're saying, insurance
companies, we'll give you a
broad distribution of risks.
On the other hand, you
can't discriminate
anymore in health insurance.
Let's give everyone the same
kind of health insurance that
MIT gives people, that large
companies give people.
But then finally, the final
thing the bill does is, to
make that work, we have to
recognize that you can't
mandate people to buy health
insurance if they
can't afford it.
Health insurance is
pretty expensive.
My MIT health insurance policy
for my family cost about
$14,000 a year.
MIT pays about 10,
I pay about four.
Remember we talked
about poverty.
The poverty line now for a
family is about $22,000.
You can't take a family earning
$22,000 and say I'm
going to mandate you to spend
$14,000 on health insurance.
That's just impossible.
They couldn't live.
So the third thing the bill does
is it introduces a whole
bunch of subsidies, so in some
sense, it uses both the
solutions we talked
about last time.
Both making insurance cheap for
people, so they can afford
it, but instead of spending $2
trillion a year, it spends
like $120 billion
a year on this.
So it just subsidizes the very
poorest people, and mandates
the other people to buy.
So it's sort of a
mixed solution.
We talked about two solutions
you could do to solve the
asymmetric information
problem.
You could subsidize insurance
and make it cheap, or you
could mandate people to buy.
This bill does both.
It subsidizes it for the very
lowest income people and
mandates it for people
who can afford it.
So that's essentially what the
bill does to try to solve this
problem, and we don't know
whether that will work.
We have our best estimates,
but this is a radical new
intervention.
The best estimates suggest it'll
cover about 60% of the
uninsured, but this is a pretty
brand new intervention,
so we'll have to see, actually,
how that shakes out.
But that's the basic structure
of what the bill's trying to
do to try to solve this
asymmetric information problem.
Are there questions about that,
how it relates to what
we learned in the last
couple lectures?
So that's one problem that we're
trying to address with
this legislation, is solving
that asymmetric information
problem using both the mandate
and subsidy tools.
And as I said, if you want to
learn more, I talk a lot more
about stuff like this
in my course 14.41.
This is sort of an example of
how government can use its
tools to address the kind of
fundamental information
failures that we talked
about last time.
But we don't get into, in this
course, politics, but of
course, we can't talk about a
government intervention this
massive without talking about
politics for a minute, and
recognize that this is going
to involve some sacrifice.
I made it sound pretty easy.
Well, we've got this asymmetric
information
problem, we put in the
solution, we're done.
But there's two problems
with the solution.
The first problem
is you've got to
pay for these subsidies.
And this comes back to our
discussion of equity
efficiency, the bill features
an enormous tax increase on
the wealthiest Americans.
The bill raises about $450
billion over the next decade
from the richest, about 5%
of American families.
So going back to our equity
efficiency discussion, is that
a good thing or bad thing?
That depends on our social
welfare function.
If our social welfare function
is very progressive, Rawlsian
or some forms of utilitarian,
that's probably OK.
If it's not, if it's a Nozickian
world, where we just
think that people should just
be left alone and not taking
money away from the rich just
because they're rich, then
that's not OK.
So that ties into our other
discussion of equity
efficiency.
So we have to pay for this, but
obviously, politically,
that raises problems. That's
going to upset a large set of
people who are going to have
to pay those taxes.
The other issue of course this
is with the mandate, we talked
about, well gee, you can't do it
by subsidies alone, that's
too expense.
You have to mandate.
Well, the mandate isn't
free either.
The mandate basically amounts
to a tax on people who don't
want to buy health insurance.
What's the mandate?
A mandate is saying you didn't
want to buy health insurance,
and now you have to.
That's going to upset a lot
of people, as well.
A lot of people out there
don't want to buy health
insurance, and you're telling
them they have to.
You don't make a change this
big without causing some
problems, and these are the
problems that arise.
This isn't a painless solution,
and so that's, once
again, why they call this
the dismal science.
We're all about the trade-offs,
and the trade-offs
here are, you fix the market
failure that we learned about
last lecture, but at, well,
the potential cost of the
inefficiency of taxing people.
Whether that's a good thing or
not depends on our social
welfare function.
And also the inequity,
potentially, of forcing people
to buy health insurance
who didn't want it.
Yeah.
AUDIENCE: How do they suggest
that you enforce the mandate?
PROFESSOR: The mandate
is enforced
through a tax penalty.
We actually have
Massachusetts.
We put in this system in
Massachusetts a few years ago.
We pioneered it, basically.
And the way it works in
Massachusetts is, every year,
I get something called the
1099-HC from my insurance
company, which says
here's proof that
you have health insurance.
I attach that to my tax
form, and I'm done.
If you don't attach a 1099-HC,
you have to pay a tax penalty.
In Massachusetts, it's about
$1,000 a year if you don't
have health insurance.
The federal tax penalty will
be about $700 a year.
So it's going to be enforced
through a penalty if you don't
show, on your taxes, that you
have health insurance.
Other questions about this?
Now, of course, I haven't
talked about the bigger
problem, which is what about the
fact that we have enormous
cost control problem.
Now, last time I talked about
two kinds of asymmetric
information, two
problems in the
social insurance trade-off.
On the one hand, there's adverse
selection, that fact
that insurance markets might
not fail, but I also talked
about moral hazard.
I also talk about moral hazard,
and the fact that, if
you insure individuals
for adverse events,
they will act adversely.
Now, there's several kinds of
moral hazard, and health care
is rife with them.
One kind of moral hazard is a
type we talked about, which is
the classic moral hazard, which
is sort of individual
precaution.
So the story here is, if I have
fire insurance for my
house, I don't bother buying
a fire extinguisher.
Or if I have health insurance,
I don't bother wearing a
helmet when I bicycle.
So these are basically
individuals not taking caution
because they're insured for
this adverse event.
We don't think that's
that big a deal.
I mean, we don't think that your
decision about whether to
wear a helmet or not is much
affected by whether you have
health insurance.
It's probably not
that big a deal.
The bigger type of moral
hazard is resource
over-utilization, which is
that, basically, because
people are insured, they will
overuse medical care.
So basically, here's the way
we think about that.
It's a standard dead weight
loss kind of argument.
So think about the market
for medical care.
Think about the market
for doctors visits.
There's some quantity of
doctor's visits and some price
of doctor's visits.
And let's say that there's
a flat marginal
cost of doctor's visit.
Let's say delivering a doctor's
visit costs $100.
So delivering a doctor's
visit costs $100.
And let's say there's some
demand for doctor's visits.
And importantly, I'm going to
make this downward sloping.
Now, this is important.
You might say, gee, wait a
second, shouldn't the demand
for doctor's visits
be inelastic?
Shouldn't people just go to the
doctor when they're sick,
and not when they're not?
And why would the
price matter?
In fact, it's uncertain, from
theory, whether this should be
inelastic or elastic.
It's uncertain how elastic
demand should be, if people
only go to the doctor
when they're sick.
I hope you understand, the thing
about elasticity, it's a
good thing to understand for
basic principles, if people
only go to the doctor when
they're sick, that curve
should be vertical because it
shouldn't depend on price.
But if people care about the
price, and they decide to go
to the doctor, then it could
be downwards sloping.
In fact, there's excellent
evidence from a actual
experiment that was
run in the US.
In the 1970s, there was
something called the Rand
Health Insurance Experiment.
Rand is a company out
in California,
a consulting company.
They ran a health insurance
experiment where they
literally, experimentally, gave
people health insurance
of different generosity.
You've got to plan the coverage,
everything, you've
got to plan with a
big deductible.
So they gave people plans of
different generosity and asked
how much different medical
care did they us.
Remember when we talked about,
when doing empirical work,
what you'd like to do is think
about a randomized trial.
They essentially ran a
randomized trial, where
different people had different
prices, and they found demand
was downward sloping.
People who were charged
more for health care
used less of it.
So there is a downward-sloping
demand.
And so what that says is, if
this is the marginal cost, and
this is the marginal benefit of
getting health care, then
the optimal amount of doctors
is just Q*, that basically,
the socially efficient level
of doctors is Q*.
However, when they're insured,
people don't face this $100.
When you go to doctor, you
just pay $10, typically.
Well now, this is the social
marginal cost, but your
private marginal cost, what
it costs you, is only $10.
So what do you do?
You use a level of health care,
Q super p, for private.
You use too much health care.
You overuse the doctor's
office.
Now when you think of this
intuitively, forgetting the
graph, you just say intuitively,
if a doctor's
visit is going to cost $10
instead of the $100 it should,
you use too many of them.
But graphically, the point is
that the underlying cost of
the doctor's visit is $100, but
because you're insured,
and the marginal cost to you is
only $10, you overuse the
doctor's office.
You use too many doctor's
visits.
This leads to a dead
weight loss.
This leads to a dead weight loss
from people over using
the doctor's office.
OK And that the second kind
of moral hazard, which is
resource over-utilization.
Questions about that?
Yeah.
AUDIENCE: How do you
define too much?
If everybody else--
you said Qp is just right, and
Q* is like people go to the
doctor too few times?
PROFESSOR: That that's
a great question.
If everything is working
perfectly, then Q* is, by
definition, right.
We talked about, earlier in
this course, about how the
private market competitive
outcome is welfare maximizing.
The private market competitive
outcome is where marginal cost
equals marginal benefit,
supply equals demand.
That's the optimal outcome
if there's no
other market failures.
So in this course up to a few
lectures ago, you shouldn't
have even asked that question,
we know Q* is optimal because
we know the private market
outcome's optimal.
Now, you might say, OK well,
there's lots of reasons to
think Q* might not be optimal.
For example, many people aren't
fully informed about
the right level of medical
care to use.
Then you're right, then it might
be that Qp is optimal,
but the point is, absent
other market failures--
We know Q* is the socially
maximizing point where
marginal cost equals
marginal benefits.
We developed that earlier.
So if people use more than
that, that's inefficient.
So you might say, well
gee, how do we know?
Well, actually it turns
out we can tell.
Let's go back the Rand Health
Insurance experiment.
Same person, see if you
can figure it out.
How could we use that same
experiment to tell whether it
was optimal that people used
fewer or more doctor's visits?
What could you do?
Or anyone?
What could you do using that
same experiment to see whether
Q* was optimal or
Qp was optimal?
Yeah.
AUDIENCE: Take a look at
who gets sick less.
PROFESSOR: Look at
their health.
You've got a randomized
experiment.
Some people are at Q*.
Some people randomly
are moving to Qp.
Look at their health.
Well, it turns out, health is
totally unaffected, that the
health of people at Q* was
the same as the health
as people at Qp.
People who had big deductibles
and used health care a lot
less were no sicker than
people who used
health care a lot.
The answer is because
in America, we
overuse health care.
We do know Qp is too much.
In America, we overuse health
care because it's so cheap,
and so the way we can prove
that, this experiment showed
it, that we caused people
to say stop overusing.
I'll make you actually
bear the full price.
Do the Q*, people were no
sicker, and they used less
health care.
And that was a striking
finding out of this
experiment, that in fact, we
were overusing health care.
There was a real problem
of Qp being too big.
That's not the only form
of moral hazard.
There's another one we even
talked about, which is
provider moral hazard.
We've blamed everything so far
on people, but doctors are
people, too.
And in fact, much of what's done
to you was determined,
not by your decision, but by
your doctor's decision.
So now we have to think
about the doctors and
how they make decisions.
We can teach a whole course on
that, but basically, if we
think about doctors, we're going
to recognize that what
doctors primarily care
about is making
their patients better.
But at the same time, doctors
are people, too, and they also
care about how much
money they make.
Let's say for example, doctors
didn't care about how much
money they make.
All they care about is making
their patients better.
And let's say, I come into my
doctor's office, and I've got
a headache.
I say, Doc, I've had a headache
for like four days
that's not going away.
Well, the doctor says,
well, there's a point
0.0000000000001 chance you've
got a brain tumor.
I can find that with
a CAT scan.
Now, it's really so small, it's
not worth it, but the
same time, why not?
It doesn't cost you anything.
It just costs you Qp,
which is $10.
Just costs you $10, so you don't
care about getting it,
and I'll just order it.
It's fine, why not?
So because I'm over insured,
that doesn't just cause me to
demand more medical care, it
causes my doctor to give me
more medical care.
Now, add on top of that the fact
the doctor makes money
off the MRI.
The doctor makes money
off the CAT scan.
Now, he might say, gee, if it
doesn't do you any good at
all, I still might
give it to you.
If you're interested at all in
health care, the first thing
you have to read is a terrific
article in the June 9, 2009,
New Yorker by a guy name Atul
Gawande, who's a practicing
physician and excellent author,
who wrote about a
place called McAllen, Texas.
McAllen, Texas, is the place in
America that where people
spend the single largest amount
per person on health
care in the Medicare program.
He compared McAllen, Texas, to a
nearby town, El Paso, Texas.
Very similar demographically,
very similar towns, but in
McAllen, they spend twice
as much on health care.
Why?
Because they get six times as
many CAT scans, they have
three times as many surgeries.
Basically, doctors go nuts
treating people in McAllen,
Texas, and the doctors are
really, really rich.
They're not hurting people.
There's no evidence
that the over
treatment is hurting people.
There's just no evidence
that it's helping them.
So doctors are like why not?
Doesn't cost the people
anything, and I
make money off it.
So that's another kind
of moral hazard.
By providing insurance for
medical care, we've induced
this over provision of medical
care, both because people want
it because it's cheap, and
because doctors want it
because they get paid for it.
And that's a lot of the problem
in our health care
system in the US.
And once again, going back to
the question back there, if
you look at McAllen, Texas,
where they spend twice as much
on health care as El Paso,
people are no healthier.
They're no healthier despite
the fact the
spend twice as much.
And indeed, based on facts
such as this, the best
estimates are that the US wastes
about 1/3 of all of our
medical spending, that
we could literally
spent 2/3 as much.
Or literally, at this point, we
could say we spend almost
$1 trillion less per
year on health care
and be no less healthy.
And that is the thing we have
to grapple with now.
It's the fact that if we can
deal with that problem, we
could solve this long-running
cost growth problem, and our
long-running fiscal problem, if
we just stop doing health
care that didn't make
us any healthier.
The problem is that's a lot
easier said than done.
It's easier said than done
for two reasons.
First reason is because people
make money off that health
care we don't need, so the
first thing's political.
The only way we're going to do
that is to tell some people
they can't make money
they've been making.
That's a hard thing
to do politically.
The second problem is
scientific, which is we don't
exactly know which is the 1/3rd
of health care that's
being wasted and which is
the 1/3rd that's not.
So let's put it another way.
Since 1950, the share of our
economy we spend on health
care has more than tripled.
But you know what?
Health care is a ton
better than 1950.
Health care sucked in 1950.
In 1950, the typical baby born
had more than twice as high a
chance of dying in the first
year of life as today.
Someone had a heart attack,
lived 1/3rd as long after a
heart attack as they do today.
Or to put in terms young healthy
people might care
about, in 1950, if you hurt your
knee skiing, if you tore
your ACL skiing, you went into
the hospital for a week, had
major surgery, were on crutches
for six weeks,
couldn't really do sports or
anything effective for about
six months, and arthritis for
the rest of your life.
Today, if you hurt your knee
skiing, you go to outpatient
surgery for an hour and a half,
you get it scoped, a
little camera, they fix it, and
then you're back skiing
two weeks later.
No permanent long run damage.
Health care is just
better today.
It just is.
That's why we don't see any
health insurance plan saying
we offer 1950s health care at
1950s prices because no one
would want it.
Even though it would be 1/10th
as cheap, no one would want
because it would suck.
So basically the problem is
health care's better over all,
but at the same time, we're
wasting a lot of money, and
that's why health care cost
control is really hard.
That's because moral hazard
is hard to deal with.
Moral hazard is hard to deal
with because it's hard to find
because it's an information
asymmetry.
If every procedure had attached
to it a magic
identifier, which said this is
a waste and this is not, we'd
have no moral hazard.
Imagine every procedure
hospitals did had a magic
identifier, which said this is
worth it, this is not, then
you could set up the optimal
insurance company.
You could simply say, for those
that are worth it, we'll
insure you.
For those that aren't worth it,
we won't, and you'd solve
moral hazard.
Then we could be fine.
We could insure people, we'd
solve both information
problems.
But of course, we
don't know that.
And so as we solve the first
information problem, which is
adverse selection, by getting
more people health insurance,
we're making the second problem
worse, moral hazard,
by putting more people into a
system which wastes a lot of
money because of these problems.
And that's the
difficult part about
health care.
So what do we do about that?
Well, I told you what we do to
solve the first problem.
What to do to solve the second
problem is a lot harder, and
we don't really know.
But we have some ideas about
what might work.
The first thing we know might
work is a lot more work on
what's call comparative
effectiveness, which is a
fancy way of saying
understanding what works and
what doesn't, and in particular,
what works better
than what else.
Many of you know about the
FDA, the Food and Drug
Administration.
They approve medical devices, so
if you want to introduce a
new drug or a new medical
device, it has to be approved
by the FDA.
The way their approval runs is
they say, is it effective in
curing what it's supposed to
cure, and if it is they
approve it.
They never say is it any more
effective than something that
already exists, or even more is
it actually cost effective.
So for example, in the treatment
of prostate cancer
over the last decade, we've
moved to more and more
expensive radioactive
laser-based treatments for
prostate cancer.
We used to treat prostate cancer
about a 10th the cost
of treating it now with no
evidence that we're actually
doing men any good through
these treatments.
But they don't do harm, they
work, they do what they're
supposed to do, so the FDA
keeps approving them.
So comparative effectiveness
will be to actually say we're
only going to pay for what works
better than something
that exists already
more effectively.
That's one direction
we can go in.
The other direction we can go in
is we can start working to
change the financial incentives
for both patients
and providers.
For patients, we can make them
pay more of the cost of health
care, so that they move back
up this curve a little bit.
Still insuring them, but
making them pay more.
So for example, we could move
to systems where poor people
are fully insured because
they can't afford it.
But someone who's higher income,
they should have a
high deductible, they should
bear the cost some of their
health care because they can
afford it, and that will make
them make their health care
decisions more wisely.
We can work on the individual
moral hazard by making people
pay more for their
health care.
We can work on the provider
moral hazard by removing the
financial incentives to
providers to provide excessive
care, and the way we do this
is by something called
prospective reimbursement.
Prospective reimbursement is
basically saying to providers,
look, the way things work now
is you do a CAT scan on the
guy we pay you for the
CAT scan on the guy.
You do a surgery on the
guy, we pay for your
surgery on the guy.
How about a different
way to approach it?
How about we say this
guy is your patient?
A guy like him, a 25 year old
healthy guy costs, on average,
$1,500 a year.
We will give you, at the end the
year, a check for $1,500.
You do what you want.
You do nothing, you
keep the $1,500.
You go crazy and you make 1,000
CAT scans and it costs
$100,000, you eat
the difference.
You doctors bear the risk.
Pros, instead of we, the public
and the insurance
companies and the individuals,
bearing the costs when you
give me an extra CAT scan, you,
the doctor, bear the cost
when you get the
extra CAT scan.
We've turned the financial
incentives on their head.
Now, instead of making money by
giving CAT scans, you lose
money by giving CAT scans.
Yeah.
AUDIENCE: But might that have
some negative side effects on
the health care of patients?
Doctors are going to want to
check how much they are going
to make [INAUDIBLE]
PROFESSOR: Great question,
like the question before.
How do we know that doesn't
go too far?
Right now, you could think about
it, we're in a place for
both patients and doctors
where there is
clearly over treatment.
There, of course, exists under
treatment as a problem, and we
know that both making patients
pay more and putting risk on
providers, through making them
bear the cost of CAT scans out
of their pocket, will move
us in this direction.
The question is, does it move
us past the happy medium, or
does it just move us towards
the happy medium?
In the back was asked a
question about patient
payments, and here we know the
answer, which is making
patients pay more reduces
utilization but still leaves
us on the right side of a
laughter curve if we come to
our tax analysis.
It still leaves us in the place
where we're still, on
average, still probably doing
too much care, but
less too much care.
What about providers?
Well, we have evidence on that,
which is we've put in
prospective payment systems
in a number of different
contexts, and typically we also
find it does not hurt
health, that providers still
provide, if anything, too much
care and not too little.
Now, we've never put
in a pure system of
the kind I've described.
We've always put in sort of
mixed systems, where you get a
$1,500 check, but if you do a
lot of stuff, we'll also pay
you extra, a little bit.
So we've never put in a pure
prospective system.
So for example, we put in a
system like this for Medicare,
the way Medicare
pays hospitals.
Medicare use to pay hospitals,
that when you went to the
hospital, and the hospital
billed Medicare,
they just paid it.
Medicare then put in something
which said, look, if someone
goes in the hospital with this
given diagnosis, we'll pay you
this fixed amount, so it's
more prospective.
What they found was an amazing
reduction in how intensely
elders were being treated.
The average length of stay for
an elderly person in the
hospital fell 20% in one year.
There's an enormous reduction
in how long elders were kept
in hospital and how intensely
they were treated, yet elders
were no worse off.
So we moved in this direction,
but we clearly haven't moved
passed the middle.
Questions about that?
So basically, what the bill
does is it tries to set up
incentives, on both patients and
providers, to behave more
economically, but the answer
is it's still very small.
We're still years away from
really putting those
incentives in place in a major
way, and that's sort of the
next round of health care reform
that has to go on.
And that's all.
I don't want to go
on too long.
I just wanted to give you an
overview of one example of how
we take a public policy tool and
deal with these problems
that we've raised earlier
in the course.
