Reinhardt on Arrow and efficiency Notes for September 16

Main points

Reinhardt inveighs against a kind of sleight of hand that occurs when we move from the technical definitions of “efficiency” and “optimality” to their common meanings. A more efficient distribution of something may usually be better than an inefficient one, but it is not necessarily so.

He thinks that considerations of efficiency are especially misguided in the case of health care. This produces what he regards as bad arguments against providing health care as a benefit in kind. It also led to what he regards as the hopeless attempt to use market mechanisms to lower costs through so-called “managed care” or “managed competition.” This was one of the big ideas behind the failed Clinton health reforms of the 1990s.

What’s inefficient?

Reinhardt is correct to say that we take a paternalistic attitude towards health care. We think that people should have it, even if there is something else that they would rather have more. Thus we’re willing to regard health care as a social obligation but we aren’t willing to give the recipients of public aid the cash equivalent of what we spend on health care. This is so even though we could spend less through cash transfers and the recipients could get more of what they really want.

Is this an inefficient result? It appears to be. Those who pay in to the social fund would rather pay less than more. And those who draw on the social fund would rather spend the money as they see fit than receiving a particular good. If they want health care, after all, they can buy health care. If they don’t, they can buy something else. So cash transfers appear to be a Pareto improvement over benefits in kind: everyone is better off and no one is worse off.

Reinhardt thinks this is misleading. It involves “recommending the maximization of the wrong maximand” (p. 979). It’s not easy to say what that means. I gather it has to do with the preferences people have for something other than money and the things it can buy. They want the members of their society to have health care, period. They want this for others and they want it for themselves, though they don’t always provide for themselves when left to their own devices. They also want money and the things it can buy, of course. But, I take it that Reinhardt is saying that’s not all they want. And, I think, he’s saying that this is what his fellow economists sometimes miss when discussing efficiency.

It seems to me that our paternalism may nonetheless be misguided. It depends on what we think of as health care and what the alternatives are. There are lots of things people can do to improve their health. Having health care provided by doctors and hospitals is only one. If the provision of health care comes at the expense of other steps to improve health, it may be a poor means to a desired goal.** I’ve been thinking about something Greg Evans said. Of course, as Jennifer pointed out last week, everything turns on what the alternatives to the provision of health care are.

For instance, consider all the social determinants of health that would not be covered by reforming the health insurance system.†† Added Sept. 22.

What explains the behavior of health care providers?

There is one point where Reinhardt seems to depart from Arrow’s analysis. His explanation of why health care providers hide prices on p. 987 seems much less sunny than Arrow’s. For Arrow, this sort of thing makes sense: it reflects our demands for professional standards. For Reinhardt, it is the product of the “vested interest” of the “enemies of transparency.” That sounds more like the claim that doctors and other health care providers hide prices as a way of charging more than they otherwise could.

But then Reinhardt adds that they do this “in part, no doubt, because American consumers have never really warmed up to the idea of a price-competitive, commercial health care system” (p. 987). That sounds more like Arrow’s original point.

I suppose that both explanations could be true at the same time. That’s a chilling thought.

This page was written by Michael Green for PPE Senior Seminar, PPE 190, Fall 2009. It was posted September 18, 2009.
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