Which Economist Do You Trust?

by Don Boudreaux on March 8, 2006

in Health

In his January 16, 2006, New York Times column, Paul Krugman denied that people can be trusted to make their own health-care decisions:

But the case of diabetes and other evidence suggest that a third
problem with health savings accounts may be even more important: in
practice, people who are forced to pay for medical care out of pocket
don’t have the ability to make good decisions about what care to
purchase. ”Consumer driven” is a nice slogan, but it turns out that
buying health care isn’t at all like buying clothing.

In today’s Wall Street Journal, my Nobel Laureate colleague Vernon Smith writes about health care (and, by the way, also about higher education).  Vernon’s perspective is about as far from Krugman’s as you can imagine.  Here’s Vernon:

Here is a bare-bones way to think about this situation: A is the
customer, B is the service provider. B informs A what A should buy from
B, and a third entity, C, pays for it from a common pool of funds.

Stated this way, the problem has no known economic solution because
there is no equilibrium. There is no automatic balance between
willingness to pay by the consumer and willingness to accept by the
producer that constrains and limits the choices of each….

….if third-party deep pockets pay whatever is the price
B charges A this year, the effect is to reinforce the incentive to
raise the price next year. Spending escalates, which leads to a demand
for cost control. In health care there is increasing control over
access to medical services. Insurance companies disallow patient free
choice of physicians, clinics and hospitals outside their approved
network. Physicians and medical organizations face escalating
administrative costs of complying with ever more detailed regulations.
The system is overwhelmed by the administrative cost of attempting to
control the cost of medical service delivery….

If there is a solution to this problem, it will take
the form of changing the incentive structure: empowering the consumer
by channeling third-party payment allowances through the patients or
students who are choosing and consuming the service. Each pays the
difference between the price of the service and the insurance or
subsidy allowance. Since he who pays the physician or college calls the
tune, we have a better chance of disciplining cost and tailoring
services to the customer’s willingness to pay.

Many will say that neither the patients nor the
students are competent to make choices. If that is true today, it is
mostly due to the fact that they cannot choose and have no reason to
become competent! Service providers are oriented to whoever pays:
physicians to the insurance companies and the government; universities
to their legislatures. Both should pay more heed to their customers —
which they will if that is where they collect their fees.

Vernon ends his sound economic analysis with this plea: "Would some one please just trust the customer?"

If Vernon Smith trusts people to choose, why doesn’t Paul Krugman do so?

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