Is it correlation, or, causality? I forget which…

In today’s WSJ, Todd Zywicki paraphrases Elizabeth Warren confusing correlation for causality:

She says that such a commission is necessary because consumers cannot buy a toaster that has a one-in-five chance of exploding, but they can get a subprime mortgage that has a one-in-five chance of ending in foreclosure.

The same Elizabeth Warren, Lady Overseer of TARP? No way she gets that wrong. Wait for it… A Google search brings me her article from the May-June 2008 issue of Harvard Magazine:

It is impossible to buy a toaster that has a one-in-five chance of bursting into flames and burning down your house. But it is possible to refinance your home with a mortgage that has the same one-in-five chance of putting your family out on the street—and the mortgage won’t even carry a disclosure of that fact.

She really thinks people don’t understand what their getting themselves into. Buying a house is risky. The modal way of life for Americans is living paycheck to paycheck. Mandating the use of vanilla mortgages is not going to remove the risks of buying a house. “Creative” mortgages were indeed a disaster, but there is an underlying issue to that problem, and it has nothing to do with the terms of debt obligations.

Mr. Zywicki goes on to explain why mortages and toasters are not good for comparison:

And unlike toasters, borrowers have substantial say over whether their loan “explodes.”

This reminds me of a discussion of seatbelts, airbags, and other devices that make cars safer, but increases the riskiness of driving. If you follow the last link, you’ll be treated with an introduction to “Tullock Airbags.” I get excited when I get to share that one with people.

When you lower the percieved costs of risky behavior, driving or buying a house, people substitute towards consuming more of said risky behavior. Like driving faster, or buying bigger houses. Effectively what Elizabeth Warren wants, is for consumers to outsource their due diligence to a safety commission.

Even cartoonists know the difference:

Ending Speculation?

The NYT reports: US Considers Curbing Speculation on Oil.

That’s a bad move if we give it the go ahead. My prediction is that, if enacted, the price of oil becomes more volatile as a result of this decree. Meaning higher prices at the gas pumps.

On page 184 of Hidden Order, David Friedman outlines what speculation really does:

Speculators, if successful, smooth out price movements, buying goods when they are below their long-run price and selling them when they are above it, raising the price toward equilibrium in the one case and lowering it toward equilibrium in the other. They do what governmental “price stabilization” schemes claim to do– reduce short-run fluctuations in prices. In the process, they frequently interfere with such price-stabilization schemes, most of which are run by producing countries and designed to “stabilize” prices as high as possible.

Q & A with Austan Goolsbee

Excerpt from this Q&A, emphasis mine:

What kind of progression in marginal tax rates do you think is ideal? There was a big hubbub over the U.K. getting to 50 percent on their top rate; could we be heading there too, and would it be helpful or harmful? — Tucker

There is no “ideal” tax rate in isolation. Among other things, it depends what the government does with the money. Whether we are making key investments versus spending on wasteful programs that don’t work makes a big difference in what you think the tax rate should be.

Dr. Goolsbee, I respectfully disagree. Taking any amount of money higher than what is necessary to maintain a functional federal government, represents a threat to individual liberty. I don’t care what they spend it on.

Buiter on Negative Interest Rates

Paging Dr. Mankiw…

Willem Buiter has a new NBER working paper (.pdf)  on negative interest rates:

The paper considers three methods for eliminating the zero lower bound on nominal interest rates and thus for restoring symmetry to domain over which the central bank can vary its policy rate. They are: (1) abolishing currency (which would also be a useful crime-fighting measure); (2) paying negative interest on currency by taxing currency; and (3) decoupling the numeraire from the currency/medium of exchange/means of payment and introducing an exchange rate between the numeraire and the currency which can be set to achieve a forward discount (expected depreciation) of the currency vis-a-vis the numeraire when the nominal interest rate in terms of the numeraire is set at a negative level for monetary policy purposes.

I know we have the technology to abolish currency right now, by attaching bank accounts to cell phones like Japan, but I wonder how long it would take for us to put it into action. My guess is there would be more resistance than one thinks.

Wal-mart Supports Healthcare Mandate?

Call me surprised to see this in the Wall Street Journal today. Maybe I’m just being cynical, but what is Wal-Mart’s angle here?

A quick glance says maybe by tying their own hands to tougher standards for all, it could put their competitors at a disadvantage relative to Wal-Mart. Could there possibly be some first-mover-advantage here? Maybe Wal-Mart is better prepared to absorb such a mandate?

Wal-mart is certainly within their right as a company to join in the health insurance debate and to try and influence public policy more generally, but I’d rather they just led by example. Why not put your money where your mouth is and give all your employees health insurance now?

Kevin Murphy on the “War on Drugs”

An excerpt from this Kevin Murphy interview (My emphasis in bold):

Region: What are the implications of rational addiction theory for public policy on currently illegal drugs—that is, enforcing prohibition versus legalization and taxation?

Murphy: There we started out from the point of view of how does an economist think about a prohibition? The way I think about prohibition, why does prohibition on drugs curtail drug consumption? Well, the primary way is it makes drugs more expensive. It raises the street price of drugs from what they would be if people could freely bring them into the country and freely distribute them. It raises the price by making them less available. If I want to get drugs, I can’t just go down to the supermarket or the drugstore and buy my drugs. I’ve got to go to a neighborhood, maybe it’s dangerous. I also have to worry about the strength and quality of the drugs. Am I going to get drugs that are tainted?

All those things make drugs more expensive than they would otherwise be. And what do we know about demand for any commodity, whether it’s drugs or haircuts or strawberries? You make them more expensive, people consume less. So our view of the world is that, basically the way drug policy works in the United States at least, is it tries to make drugs more expensive, less attractive, and cause people to consume less. In economic terms, it pushes us back up the demand curve. And rough estimates say we’ve quadrupled the cost of drugs relative to what they would be in a world without this interdiction.

If you quadruple the price of something, people are going to buy less of it. But, unfortunately, the way we bring about that quadrupling of price is by increasing the cost of supplying drugs. The amount of money people are spending on drugs is actually higher than it would be if the price were lower, because the demand for drugs is not very elastic.

Region: You’ve shifted the supply curve, and moved up the demand curve.

Murphy: Exactly. So think about a simple world where the elasticity of demand is about a half. You quadruple the price of drugs, and the quantity of drugs is cut in half. So you’ve got four times the price, half the quantity. You’ve doubled expenditures. People are spending twice as much and consuming half as much.

Well, where did that added expenditure go? It goes to the drug dealers. It doesn’t go to the government; it doesn’t stay with the consumers. It goes to drug dealers. And that revenue actually finances the supply of drugs and finances the drug lords who supply drugs to the United States. So what we’ve really done in this case is financed the people who are on the other side of the War on Drugs. So, the War on Drugs, in our view, has been kind of doomed by its basic economics. That is, the harder you fight the war, the higher you push up the price. The higher the price, the higher the revenue of suppliers; the higher the price, the greater the incentive to supply drugs to the United States.

Now, what are the costs to the suppliers? Well, they have to avoid detection. They fight over turf for drug territories. They pay people off. They may go to prison. All those costs are pretty much bad things. They use violence to enforce their contracts and the like. Not a good outcome.

But when you put people in prison, you have to consider not only does it cost society in the form of people in prison who could otherwise be gainfully employed, but it also costs us money to put them there. So for every dollar of cost we impose on the drug suppliers, we spend at least a dollar of our own money on top of it to keep them there. If we normalize what we would have spent in a free market on drugs at $100, consumers are now spending $200 on half the quantity of drugs and then spending another $100 on top of that to put all those people in jail. So we’re paying three times as much for half as much output. From an economic point of view, that’s more than a little bit counterproductive.

Usually you think, if I’m going to produce less output at least it should cost me less.

Region: So, rational addiction but irrational …

Murphy: Irrational policy, right. So, what’s the answer? If you want to reduce consumption, raise the price. What’s the natural way to raise the price of something? Tax it.

Region: That is, something you want to discourage.

Murphy: Something you want to discourage, exactly. We want to discourage smoking, so we tax cigarettes. If we want to discourage greenhouse gases, we’ll tax carbon emissions. Whatever it is, if you want to discourage it, tax it. The advantage of that is, you get the same reduction in output; the cost of production rather than going up, goes down. It costs less to produce half as much output as it does to produce the full amount of output. And the extra money that would have been wasted is now going to the government in the form of tax revenues, which would allow us to reduce other taxes, or do other things.

So, a system where we make drugs legal and tax them makes a lot of economic sense relative to the current system. People say, wait a minute, we can’t make drugs legal. Don’t drugs cause all these horrible problems?

The problem is, most of the things that people point to when they talk about the horrible things generated by drugs are actually the horrible things generated by the War on Drugs. The violence and the corruption we have, and the corruption in foreign governments—that’s because drugs are illegal. If drugs were legal, we wouldn’t have a violence problem. We wouldn’t have tons of people in prison. Those people are there not because drugs did anything but because we made these things illegal. People still wanted them, and when people still want something that’s illegal, we have a black market. And if we imprison people who engage in a black market, we’re going to increase the size of the prison population and make all the associated expenditures.

We see that in the recent War on Drugs. We saw that with prohibition in the 1920s. It’s an old phenomenon. You may enact a prohibition, but it doesn’t get rid of demand. People still want the commodity. You’ve just forced production to occur in the black market, and when demand is inelastic—and that’s what’s key—when people are going to still demand it even as you push the price up, the black market is very inefficient, because you’re raising costs and expenditure at the same time.

Not Enough Time to Develop a Third Party?

Peter Schiff offers some interesting advice for Libertarians:

(HT Mike Munger)

Nate says “One of These Things is Not Like the Other”

Yesterday, over at FiveThirtyEight Nate Silver sternly questions George F. Will’s latest column. In doing so, Nate commits an error that is made frequently in the healthcare debate. Saying profoundly that healthcare is “different”:

I’m a big believer in the profit motive in 99 percent of all cases. If the government decided to open a non-profit hamburger stand, I doubt that it would compete successfully against Five Guys. If it tried to open a non-profit airline, I doubt that it could offer the same value as JetBlue. Insert joke about General Motors and/or the Post Office here. The point is, I think the profit motive is generally well worth it in terms of the incentives it creates to cut costs, develop new products, improve customer service, and so forth.

But health insurance is not like those things.

I’ll agree that it’s different, but only that it’s artificially so. We made it that way. We created this monster. And therefore we can destroy it.

So exactly why are FiveGuys and JetBlue different than health insurance? Nate’s explanation:

Insurance exists because of the decreasing marginal utility of income: most people would rather have a 100% chance of paying $300 a month than a 1% chance of paying $30,000 a month. In fact, our hypothetical customer — let’s call him Frederick, after George F. Will’s middle name — might very well accept a 100% chance of paying $400 a month rather than take 1% chance of having to pay $30,000, which he might not be able to afford. This is true even though Frederick will lose $100 on this deal in an average month.

There’s nothing wrong with this arrangement — the customer has improved his marginal utility and the insurance company has made $100. It’s a win-win.

He starts out fine, giving a clear textbook-style example of risk aversion. But then takes a turn I was not expecting from a Chicago-trained academic:

The thing is, though, that the insurer hasn’t had to work particularly hard for his $100. He hasn’t had to figure out how to cook up tastier fries or save you a few bucks off the cost of your next flight to Orlando. All he has to do is to have a bunch of money pooled together, such that he has a different marginal utility curve than you do. He has the luxury to accept the risk of unlikely outcomes, particularly if he can hedge his position by making the same deal with other customers, most of whom won’t wind up requiring an angioplasty or cataract surgery, even if Frederick does.

The insurer hasn’t worked hard? Tell me you have a real argument, please. The insurer innovated. He created this neat thing called a risk-pool and combined it with the law of large numbers to give consumers something of value. That value is then worth something in the market. This innovation clearly filled a need for this world of risk averse people. Who cares if the insurer “didn’t work hard” to create it. If consumers are being provided with a service they clearly demand, then what’s the problem?

There is a local car washing facility up the street from my house, where I go and I pay to wash my own car. I never see the owner there and he has never so much as lifted a finger in my general direction, yet he makes money from the building he set up to provide such a service. Is he evil?

Banking is eerily similar to insurance pools. Are bankers evil too? Wait. Don’t answer that one.

Health insurance is different, I’ll admit it again. But Nate never really offers a sufficient reason why.

Now, what’s supposed to happen in the free market is that another company will come in and offer Frederick a better deal: they’ll offer him the same coverage for $350 a month, accepting a smaller profit, and Frederick will happily take the deal. There are at least a couple of reasons, however, why this may not be happening in the insurance industry. The first is that Frederick might not realize he’s paying $400 every month for insurance. That’s because if he’s like the majority of Americans, he’s getting his insurance through his work, and except when the HR lady gave him a shiny brochure on his first day at the office, he’s probably never thought very much about what this insurance is costing him in terms of foregone salary. This is particularly so because health insurance benefits, unlike other types of income, aren’t taxed, and so Fredrick is less cognizant of them if show up on his paycheck at all. Not only, then, is the free market maxim of perfect information violated, but it’s violated in such a way that creates artificial profits for the insurance industry: the government is effectively subsidizing every dollar that Frederick’s company is willing to spend on his insurance benefit.

The profits the insurance industry is making, of course — profits artificially boosted by an enormous backdoor tax subsidy — don’t seem to be buying the customer much of anything in terms of improved service or cost savings. On the contrary, health care costs are rising by as much as 9-10 percent per year, without any concomitant increase in the level of service. If JetBlue were raising the cost of its fares by 10 percent per year, they’d be out of business.

The reason the insurers are staying in business, though, is because barriers to entry in the health insurance industry are in practice quite high. Insurers benefit from pooling risk. The larger the pool, the better in terms of the insurer’s ability to hedge its risk and build negotiating leverage with its providers. That makes it very difficult for a Five Guys or a JetBlue type of start-up to compete: they’ll have trouble getting together enough customers to pool their risk adequately, and even if they do, they won’t have as much negotiating leverage as the big guys. Health care providers may demand a better deal or refuse to accept them. As such, they’ll never get off the ground.

So health insurance is different because it’s subsidized? And that it has barriers to entry? The payment system is confusing and masks the true costs? These are not arguments that health insurance is intrinsically different than burgers or plane tickets. The government could set up a subsidy for cows and lower the price of ground beef, the government could set up a Civil Aeronautics Board and block airline entry, and I know employers who allow workers to keep their airline miles even when the company reimburses the ticket. Thats a benefit that could otherwise be paid in cash. So that’s not it either.

Health insurance is different because of the third party-payer system. When I buy a burger, I eat it. When I want to fly, I buy a plane ticket. Direct costs come out of my pockets and the direct benefits accrue solely to me. We buy health insurance hoping we don’t have to use it. But what does it get us? Health insurance has become a method of carte-blanching our way to consuming health care services. The users of insurance dictate the cost structure. We’re not paying for the tests, our insurer is, so we get them. Every one of them the insurer agrees to.

Imagine if I paid Five Guys $7-8 bucks to get in door and then they let me in the kitchen and build my own burger. I’d make one-heck of a burger before I left. Oh and don’t forget about the fries, I’m taking a cart load of those home too. Five Guys would close shop within days.

The key difference here is that the people who get the benefits of health care don’t face the costs of their choices. And no one spends my money more prudently than I do. Milton Friedman wrote the same thing in 2001, so I don’t claim this to be original thought here, but his wisdom is no less true today:

Two simple observations are key to explaining both the high level of spending on medical care and the dissatisfaction with that spending. The first is that most payments to physicians or hospitals or other caregivers for medical care are made not by the patient but by a third party—an insurance company or employer or governmental body. The second is that nobody spends somebody else’s money as wisely or as frugally as he spends his own.

What we need to control health care costs is a system where individuals pay their own way for most routine health care services and prescriptions. But then the government insures everyone with a lower-premium catastrophic health insurance plan.

Heathcare Reform

I’ve been having a great e-mail exchange with a college friend of mine over the healthcare debate. This post is going to be a collection of my thoughts on various plans and links other healthcare debaters have put out recently. An attempt to aggregate a large cross section of ideas in one place.

Liberals want government sponsored healthcare. Conservatives are worried about paying for it. Libertarian-types are worried about the growth of a single party and the growth of government in general.

Mythbusters: Mankiw tackles the healthcare numbers. Maya MacGuineas weighs in on the cost savings myth. Arnold Kling screams Free Lunch!. Mankiw on the healthcare- international-competitiveness-fallacy. Again. And again. Mankiw even cites Krugman! Ryan Avent disagrees with Mankiw. Ezra invokes Stein’s Law. Megan McArdle responds.

Nate Silver looks at the numbers and shows what effect lobbyists are having. David Leonhardt talks rationing. Russell Roberts responds to Leonhardt. I’ve discussed Leonhardt’s piece before.
My thoughts:

I’m inclined to believe that compensation levels are dictated by the labor market. Such compensation includes both wages and non-cash benefits like healthcare; an accounting identity. There exists a sort of stickiness to the labor market because we have wage contracts and union agreements etc. So if healthcare costs grow rapidly, workers are going to become expensive to employers relative to the benefits of having the employees. If they want to keep their jobs they’ll have to take pay-cuts or, at a minimum, accept not getting raises. If the government takes healthcare off the books of firms, it may make things simpler for the firms, but this new found “competitive advantage” will largely be eaten up by higher wages for workers the next time negotiations are made, either individually or collectively. I’ll conceed this adjustment is long-run in nature and the transference may not be dollar-for-dollar. Markets aren’t perfect, they’re just the best we have.

Does this new government solution solve the crushing growth of healthcare spending? I am deeply skeptical. The CBO scored the bill Congress is proposing. I do not trust our current Congress to reign in spending. They can reference comparative effectiveness research all they want. Politicians don’t know how to say no. Arnold Kling captures the dichotomy perfectly. For a lengthier explanation by Kling and Roberts, listen to this podcast. Or read Arnold’s book.

If the Obama Administration gets healthcare in the public budget, expect higher taxes. Sooner than one thinks.

They can try to force the insurance companies to cover more stuff, legislate against pre-existing condition denials, or even install “compensation caps” for doctors and nurses. They tried that with Wall Street and the bankers jumped ship. Do you think doctors won’t follow suit?

Congress can rail for hours about how spending now creates savings later. Nonsense. As long as we have a third-party-payer system, costs will tend to rise, not fall. People providing services (such as healthcare) respond to the pressure exerted by the people who are responsible for payment. Right now this mean insurance companies. A government plan would mean some bureaucrat is calling the shots. Not my idea of change. Until the patient becomes the center of the care providers attention, we won’t see much change in the way of costs or outcomes. Bryan Caplan knows how to tell which services are reasonably priced. We could all learn a few things by re-reading Milton Friedman.

Incentives matter. If the patient is responsible for the payment of services received, the provider will have a strong incentive to make certain the patient experiences the best outcome possible. Or the patients won’t come back. And since the patient is likely to be on a budget, the healthcare provider has to reign in costs if they want to perform such services. Evil profit motive! What pair of incentives could possibly be stronger forces than the two I’ve just described?

I’ll have more details on what such a system would look like in the near future. I’m still working out the details in my head, but I’m sure I’ll have an outline sketched before Congress does something worthwhile.

Teaching Kids to Hate Math

Thanks to Mike Munger for passing this along.

Mike’s excerpt:

A musician wakes from a terrible nightmare. In his dream he finds himself in a society where music education has been made mandatory. “We are helping our students become more competitive in an increasingly sound-filled world.” Educators, school systems, and the state are put in charge of this vital project. Studies are commissioned, committees are formed, and decisions are made— all without the advice or participation of a single working musician or composer.

Since musicians are known to set down their ideas in the form of sheet music, these curious black dots and lines must constitute the “language of music.” It is imperative that students become fluent in this language if they are to attain any degree of musical competence; indeed, it would be ludicrous to expect a child to sing a song or play an instrument without having a thorough grounding in music notation and theory. Playing and listening to music, let alone composing an original piece, are considered very advanced topics and are generally put off until college, and more often graduate school.

…

Sadly, our present system of mathematics education is precisely this kind of nightmare. In fact, if I had to design a mechanism for the express purpose of destroying a child’s natural curiosity and love of pattern-making, I couldn’t possibly do as good a job as is currently being done— I simply wouldn’t have the imagination to come up with the kind of senseless, soulcrushing ideas that constitute contemporary mathematics education.

Everyone knows that something is wrong. The politicians say, “we need higher standards.” The schools say, “we need more money and equipment.” Educators say one thing, and teachers say another. They are all wrong. The only people who understand what is going on are the ones most often blamed and least often heard: the students. They say, “math class is stupid and boring,” and they are right.

This speaks directly to my own experience. During my high school days, several attempts were made by the math team coach to get me to participate because I showed good mathematics potential. Not seeing any immediate uses for it, I resisted (probably for other reasons too).  Then when I went to college, I started down a management major path that ended up being largely unsatisfying. I took a few economics classes and the underlying math began to sing overtures at me. Math can do some very cool things. Somehow we need to help students make that connection earlier.