Because the Affordable Care Act has become such a political football, I shied away from discussing it in class yesterday, even though it would be a way to bring in current events into what we are studying. But I will talk about healthcare some in this post and try to do so in as dispassionate a way as I can.
First, however, we should consider that labor contracts have an insurance aspect to them, particularly when employees are on salary or when they work at an hourly wage for a pre-specified number of hours per week. Abstracting from inflation risk and the possibility of losing the job entirely, the income of such workers is predictable and therefore is safe. Productivity (and here we don't just mean the physical output but also want to include the demand for the product being produced) is likely to be risky. If employees have fixed income contracts then it is the employer who bears the productivity risk. There is some argument that employees should share in that risk, to increase their sense of ownership in the firm. But on straight risk aversion grounds, it is reasonable to assume that the employer is less risk averse than the employees. Indeed, one real reason to have large corporations with shares of stock that are publicly traded is that owners diversify their holdings in many such firms, which greatly reduces the idiosyncratic firm risk in their portfolio (though systematic market risk remains). If you treat shareholders as achieving good diversification and/or the company is largely held by a rich person who can achieve diverse holdings and/or self-insure, then flat payments to employees makes sense. The implicit contracts view of the labor market then would suggest that in exchange for the firm absorbing the productivity risk the employees reward the firm with loyalty, which is valuable, especially in tight labor markets.
Starting with this as a basis, the role of bonus payments to employees, as well as compensating employees with stock rather than with wages, now fairly common practices, requires some explanation. Bonuses themselves are of multiple types. One sort of bonus is awarded to each employee when the firm itself does well. Another type of bonus is awarded to a particular employee when that employee has performed well. In each of the cases, the employees are absorbing some of the productivity risk. The question is why. One possible explanation is that the employer can't diversify nearly as well as was assumed in the previous paragraph. Another is that these forms of compensation are there for incentive reasons to motivate the employee (this is the most commonly held explanation). A third reason might be to reflect market power in the labor market by the employer.
Let's consider one other aspect of this, which is how wages and salaries change over time. If there is a jobladder, then normally employees are paid more as they climb the ladder. Within rank, payments may go up over time to reflect some return to seniority and/or to serve as implicit cost of living adjustments. Employees do bear some of the risk in climbing the job ladder, particularly of the sort where the next rung is already jammed with people so the firm doesn't promote an otherwise deserving person until the next rung clears out some. This is a form of coordination problem that does induce income risk. A complete safety play for employees doesn't exist; even having tenure at a university is not a completely safe situation income-wise.
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I want to turn to the economics of healthcare - just a little bit - so you can relate the theory we did to some real world issues.
First, let me observe that much healthcare is routine and predictable. For example, I am at the age where my primary care physician wants to see me on a regular basis (every six months or so). There is no moral hazard in this sort of thing, yet there is a co-pay with each visit. The question is why. (Or put another way, why isn't the co-pay instead bundled into the premium?) The answer, I believe, is that there is some advantage to the provider in keeping premiums down when it bids for the state contract. Higher premiums make the bid appear less attractive. (Incidentally, this same reason offers some explanation for why much government procurement ends up in cost-overruns.) But the provider still must recover its costs, so user fees for visits emerge as one way to do that. My HMO calls that user fee a co-pay. When it is evident that there is no moral hazard, the co-pay should be zero, according to the theory. But once the provider has a way to charge co-pays in other circumstances where it does make sense, then co-pays can be employed for this other purpose as well.
Second, in our very simple model of insurance the loss was L. For automobile accidents, the adjuster can determine L quite precisely. For a serious health problem, however, determining L can be much harder and interpretation of the evidence can vary (which is why sometimes patients will get a second opinion). Thus, coverage is often not based on determining L. Rather it is based on the treatment that the doctor prescribes or the procedures that the doctor performed on the patient. This sort of relationship between coverage and treatment is sometimes referred to as fee for service. Doctors have some incentive to act opportunistically in this respect to collect more in fees. The moral hazard in this case plays out with the doctor decisions biased towards more treatment than good defensive medicine would indicate.
This issue is coupled with the matter of doctor liability in the event of malpractice. While the insurance company might object to procedures that don't seem necessary, the patient will never do so if there is no adverse consequence from the procedure. Patients are much more likely to object if after the fact the outcome is poor for them and if some procedure that had not been performed might have made the outcome better. This is the general circumstance behind getting sued for malpractice. Getting sued is costly, even when there was no malpractice. So to avoid that contingency, there is an incentive to over prescribe treatments. These factors contribute to the high cost of health care.
Another factor that influences health care costs, much less commented on, is how much doctors communicate with one another when treating a very ill patient. Given our current focus on teamwork, you can think of a high level of communication among the doctors as a well functioning team. All too often, however, specialists act in an uncoordinated way. That can really pile on the costs and make the treatment worse. This piece, well worth the read, illustrates these matters nicely.
I will not comment at all about prescription drug prices other than to note that I believe the main issue is market power.
So I will close on something else, which is depressing to consider but necessary, if we are to get a hold on keeping healthcare costs manageable. This is about expenditure on healthcare during the last year of life. On this I want to separate out care for a child or a teenager with a horrible disease from care for an elderly person. I will consider only the latter. The data show very high expenditure to prolong life just a little bit. The issues are fundamentally ethical. Economics doesn't seem to help here in explaining what is going on. I have lived through this in the case of each of my parents. It is a very emotional thing and the emotions get tied up with the economic decisions. Based on my experience I can say there are no right answers here, just lots of unsatisfactory alternatives.
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