Saturday, January 20, 2007

Merit Goods Inflation Part I

I have a few thoughts to share on price inflation in health care and private college education.

Part I

My theory is that inflation in these areas results from solving the problem in the wrong way: by giving more purchasing power to the customer, rather than by providing the service directly.

We want people to be able to afford health care and education, so we help them to pay for it. We subsidize health insurance through the tax code and actually give free health insurance to a portion of the population through Medicare and Medicaid. As for education, we provide Pell grants and subsidize student loans. As a result, people can go to the doctor, get cared for and get some help with the bill. Or they can apply for assistance and loans, go to college and graduate, usually with tens of thousands of dollars in loans. If only a handful of people got these benefits and there were no effect on the market for the goods, the only inefficiency would be the time and effort spent applying to these great programs. But millions benefit and there is a pronounced upward impact on price and a very positive effect on supply. In response to the dollars, we make and sell some great stuff to customers with a lot of dollars to spend, albeit dollars designated for these particular goods. Our education system is top-heavy with Cadillacs; tuition at top private colleges comes with a price tag of $50,000 or more, and we have the finest health care in the world, as long as we focus just on the quality of the product. Americans have access to MRIs, Viagra, arthroscopic surgery, plus all the research from MD Anderson, the Harvard Medical School, the Mayo Clinic, and so on.

The supply response to the increased buying power of patients and students is a great thing and a pernicious thing. It’s great because health care and education are unalloyed goods for our society. We all benefit when these goods are broadly distributed. But the high cost of medical care has become a disadvantage for American business and a big hit on the wallet of individuals paying for their own insurance or for health care directly. In addition, health insurers have become so cost-conscious, their greatest focus is on selection, having become extremely choosey about who they are willing to insure, making life very hard for unlucky people with pre-existing medical conditions and creating an adverse selection bias for the governmental entities that sometimes pick up those left behind.

On education, here’s an odd fact: the majority of students at most private college are on financial aid. Most come from relatively privileged families, but who can afford to spend $200,000 on tuition? The system is hardly fair for the lucky few who can afford it, and it’s not much fun for the majority, who are stuck with a decade of paying off debt. Many view top private colleges as an investment, and consider whether the additional earning power after graduation will offset the debt burden. Somehow it’s not supposed to work this way.