The Lone Economist Does Obamacare

In a previous post I said that Obamacare’s long-term chances of survival are poor. And that assumes that enforcement of the individual mandate is eventually reinstated.

So why am I so pessimistic with regards to Obamacare? It’s popular and it’s responsible for a sizable decline in the number of people without health insurance.

Well, I’m not called the Country Contrarian for nothing. My contrariness is a product of my odd personality and mixture of backgrounds. As I stated in my first blog post, unlike most economists, I have had a hard time committing to a specialty. Before entering graduate school, I was a COBOL programmer and before that an accountant. Graduate economic students usually choose two fields, I chose four: monetary economics, industrial organization, public finance and econometrics. Monetary is a macroeconomics field and industrial organization is a microeconomics field. Public finance is a combination of the two and econometrics is all about statistical models.

I have taught my fair share of money and banking courses and even published a peer-reviewed article in the Journal of Money, Credit and Banking. But for the last twenty years I have devoted most of my research to health economics. Most health economists use a mixture of biostatistics and epidemiology to estimate incremental cost-effectiveness ratios. They know very little about monetary systems and macroeconomics in general.

“What does Obamacare have to do with monetary economics?” you might ask. Well, let me explain. The establishment of Obamacare is the latest episode in the long-running struggle to fix adverse selection in the health insurance market. This problem is often described in terms of fairness or rather the lack thereof, i.e. the inability of the chronically sick and elderly to obtain affordable health insurance. But in market terminology, it is the inability of health insurance markets to maintain stable equilibria.

Despite the obvious need to solve this instability problem, government intervention in the health insurance market is very controversial because it has a big impact on the distribution of wealth. Consequently, it divides our political parties with Democrats being “for” and Republicans being “against”. This health insurance dialectic has dragged on for decades and has yet to reach its synthesis.

Something quite similar to this has happened before in our nation’s history. Like insurance companies, banks are also financial intermediaries with an instability problem. Banks collect money from depositors and then lend some of those funds to borrowers. This creates the illusion that the depositors and borrowers possess more wealth than physically exists. As long as this illusion is maintained the amount of bank deposits continue to grow in a positive feedback loop.

Yet inevitably the illusion fails. A shock to the financial system, like a failed business venture, causes a few depositors to stop believing the bank has the funds to match their deposits. The sudden rush of withdrawals quickly becomes a self-fulfilling prophecy and the banking system mirage evaporates in a negative feedback loop.

Starting in the 17th century, central banks were established in Europe to solve this instability problem. By acting as both regulator (to prevent the rapid growth of the money supply and inflation, i.e. moral hazard) and lender of last resort (to prevent banking panics and deflation), central banks, such as the Bank of England, brought stability to an otherwise unstable system.

Alexander Hamilton, the first secretary of the treasury, established our first official central bank, the Bank of the United States, in 1791. But unlike the monarchies of Europe, the establishment of a central bank in a popular democracy like the U.S. proved to be very controversial. Like today’s health insurance debate, the establishment of a central bank had a huge impact on the distribution of wealth. The political parties of that time diverged on this issue with Hamilton’s Federalists being “for” and Thomas Jefferson’s Democratic-Republicans being “against”.

This political conflagration lasted for nearly half a century, only ending in 1836 when President Andrew Jackson closed the Second Bank of the United States. Without a functioning central bank, the U.S. experienced seven banking panics and their resulting economic depressions prior to the establishment of the Federal Reserve Bank in 1913. 

A central bank in theory only, the Fed’s very existence was controversial and the result of many political compromises. To limit its power, the Fed was composed of 12 separate regional banks with no clear central command structure. This lack of cohesiveness proved disastrous when the New York Stock Exchange crashed in 1929 resulting in the banking panics of the 1930’s and the Great Depression. By only appearing to be a lender of last resort that would come to the rescue to prevent banking panics, while failing to prevent the explosive growth of the money supply of the 1920’s, the Fed greatly magnified and prolonged the very economic disaster it was designed to prevent.

In the aftermath of this debacle it became clear that a decentralized central bank made no sense. How could we have been so stupid? Why didn’t we see this coming?

The Fed was repurposed and many laws were passed to prevent this from happening again. But guess what? It did happen again in 2008 with the collapse of the housing market and the Great Recession. Those safeguards enacted in the 1930’s had eroded to the point that the largest banks in the country were “too big to fail” and required massive bailouts to be kept afloat. This was a result of moral hazard on an enormous scale that the Fed had ignored for many years.

New safeguards were erected and many a central banker vowed to never let this happen again. But there are already signs that the new safeguards are being eroded. And so it goes, until the next time.

“What does Obamacare have to do with monetary economics?” you might ask again, this time with a wisp of annoyance. Well I see several parallels between the multi-decade health insurance debate and the multi-century central bank debate. Both are controversial government interventions that split the political divide and are designed to stabilize a financial market. Both are products of political compromise and wishful thinking. And both have the potential to do more harm than good.

In the case of Obamacare, the compromise I allude to is the infamous individual mandate, i.e. the requirement that everybody, even young healthy people, purchase health insurance. This is a necessary evil that would eliminate the scourge of premium-financed health insurance, adverse selection.

The only trouble is, we don’t have an individual mandate. A mandate is a requirement, not an option. What we have (or rather had) is a slap-on-the wrist that millions of people ignored even when it was being enforced. Without a real mandate, there will not be a circuit breaker to stop the negative feedback loop of adverse selection.

This is how I see things playing out.  A recession starts and the unemployment rate rises. The newly unemployed with no health problems stop paying their health insurance premiums while the ones with expensive health problems find a way to keep paying theirs. The insurance companies see a big drop in revenues without a proportional drop in costs. They increase their premium rates to avoid insolvency. Even more people with low healthcare bills stop paying their premiums. The cycle continues until the exchange market propped up by Obamacare ceases to exist.

It is always possible that a massive bailout could save Obamacare, but that would just be throwing good money after bad. The fact is, the American political system does not have the stomach to enforce an effective mandate. Pretending that it does was always wishful thinking.

If the goal of Obamacare was to provide insurance to the uninsured, then it was only half successful at twice the cost. Its biggest beneficiaries by far are healthcare providers not consumers. That’s not a good deal for taxpayers and the uninsured and portraying it as such is just one more example of wishful thinking.

This will end badly.

Published by TheLoneEconomist

I am a PhD economist who studies just about anything and proudly specializes in nothing.

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