## Sunday, July 15, 2018

### Cross subsidies again -- hip replacement edition

From the Wall Street Journal, a familiar story of medical pricing mischief:
Michael Frank...had his left hip replaced in 2015. The Manhattan hospital charged roughly $140,000. The insurance company paid a discounted rate of about$76,000, and his share—a 10% copay, plus a couple of uncovered expenses—was a bit more than $8,000. The author, Steve Cohen I’d recently had two hips replaced, six months apart, at the same hospital that had treated him....the hospital had charged$175,000 for my right hip and $180,000 for the left. The insurance company had paid discounted rates of$75,000 and $77,000. The usual picture is a huge sticker price, an "insurance discount" and Medicare and Medicaid paying even less than that. I googled around a bit looking for the latter numbers, which I didn't find but I did find here a nice study of cost variation The average typical cost for a total knee replacement procedure was$31,124 in 64 markets that were studied. However, it could cost as little as $11,317 in Montgomery, Alabama, and as high as$69,654 in New York, New York. Within a market, extreme cost variation also exists. In Dallas, Texas, a knee replacement could cost between $16,772 and$61,585 (267 percent cost variation) depending on the hospital.
Similar trends also were seen for the average typical cost for a total hip replacement procedure, which averaged $30,124. However, it could cost as little as$11,327 in Birmingham, Alabama, and as much as $73,987 in Boston,5 Massachusetts, which had the greatest variance within a given market, with costs as low as$17,910 (313 percent cost variation).
These are, I think, insurance costs not the above sticker prices. Also from the LA times,
New Medicare data show that Inglewood's Centinela Hospital Medical Center billed the federal program $237,063, on average, for joint replacement surgery in 2013. That was the highest charge nationwide. And it's six times what Kaiser Permanente billed Medicare eight miles away at its West L.A. hospital. Kaiser billed$39,059, on average, and Medicare paid $12,457. The federal program also paid a fraction of Centinela's bill -- an average of$17,609 for these procedures.
That does give some sense that Medicare is paying even less than private insurers.

Economics

What's going on here? Observations:

1) This market is grotesquely uncompetitive. In any competitive market, suppliers bombard you with price information to get you to shop, and prices are driven to something like cost. Airlines don't need a government run nonprofit to disclose how much they charge. There is not just massive price-based competition for flights, there is massive competition for price-shopping services -- google flights vs. orbitz vs. kayay vs. priceline vs. expedia and so on.

2) The insane list price, the insurance discount of about half, and medicare paying about half that is telling. You would expect a cash discount. There are people with $30k to spend, insurance that doesn't cover hip surgery, and hospitals should be jumping to serve them, cash and carry, no paperwork. There are plenty of people with that kind of money to spend on cosmetic surgery. The clearest sign of pathology in US health care is that the cash market is dead. Even if you have the money, you must have an insurer to negotiate the "insurance discount." I suspect that in fact if you go to the hospital and say you're paying cash and negotiate, you can get a much better deal. So long as you don't let anyone else know what you're paying. But even that is no defense. You don't have to go visit airline offices and negotiate one on one for a ticket to New York. Competitive businesses chase after their cash customers. And people with$30k to spend on hip replacements don't want to spend weeks negotiating.

Why don't they advertise? Hospitals cannot publicly say what the cash price is. If they did, insurance would demand that price too and the cross subsidies would vanish.

The quoted price is a fiction. It allows hospitals to declare lots of charity care when they treat uninsured people with no money at all. But more importantly, it gives them a great starting point for a one-on-one ex-post negotiation for the unwary.

As in "cross subsidies," we have an immense scheme of cross-subsidies going on, in which private insurance at $70k overpays compared to Medicare, and the hospital is left free to fleece the unwary with outrageous$140k bills. Cross subsidies cannot withstand competition.

3) The huge price variation gives some sense how wasteful the system is. In addition to the obvious variation across hospitals in a given town, variation across cities is telling.

Google flights shows $591 for a first class ticket from New York to Birmingham Alabama, and the most expensive hotel I can find there is$177 per night. Why not fly to Alabama? Well, of course, insured patients are insured. And insurance is, per law, state based, so Alabama is out of network!

Regulations

In 2009, New York’s then-attorney general, Andrew Cuomo, announced the creation of a nonprofit organization called FAIR Health. Its mandate is to provide consumers accurate pricing information for all kinds of medical services.
I found the FAIR Health website and queried its database. It reported that the out-of-network price for a hip replacement in Manhattan was $72,656, close to what Mr. Frank’s and my insurance companies had paid. The problem: We were both in-network, and FAIR Health estimated that cost as only$29,162.
I never did figure out the reason for the difference in pricing—but somebody ought to.
The second natural response, which we hear over and over, is that the government needs to pass rules mandating price disclosure. But what happens when the government forces price disclosure and companies (evidently) don't want to tell customers what the price is? Well, there are rules mandating price disclosure for hotel rooms, which must be posted on the door of the hotel room.

Yet on the hotel's website,

Well, that regulation is working great isn't it.

It's easy to jump to the conclusion that people need more skin in the game, greater copays, greater incentive to shop. But the real problem is lack of supply competition. Incentive to shop is no good if you can't find out what things actually cost.

The problem is that hospitals don't want to tell you the price to attract your business. They don't want to because they don't have to, because they are protected from competition.

Hotels do want to tell you the real price. Until hospitals do too, they will find their way around disclosure regulations too. It's easy to post phony prices and wink that nobody actually pays that price.  Hospitals already do that when forced to disclose by stating huge prices and then offering insurers bundle discounts separated from the individual bill.

## Thursday, July 12, 2018

### Loss Aversion

A frequent email correspondent asked "I’d love to hear your take on “loss aversion.” I just finished listening to Kahneman’s book." My response seems worth sharing with blog readers.

Expected Utility

Let’s review expected utility first. The utility you get from consumption or wealth is a concave function of consumption or wealth. An extra dollar makes you more happy than it makes Bill Gates. So, compare either getting C for sure, or a 50/50 bet of getting C+Delta or C-Delta, i.e. having C or betting 50/50 on a coin flip. The expected utility of C for sure is just U(C). The expected utility of the bet is

EU = prob(loss) * U(consumption if loss) + prob(gain) * U(consumption if gain)

EU = 1/2 * U(C - Delta) + 1/2 * U(C + Delta).

As the graph shows, this is less than the expected utility of C for sure. So, people should decline fair value bets. They are “risk averse”.

Comments. Behavioral fans (New York times has done this often in its economics coverage) criticize “classical economics” by saying it ignores the fact that people fear losses more than they value gains. That’s absolutely false. Look at the utility function. People fear losses more than they value gains. That’s the whole point of expected utility. (You’ll see the confusion in a second).

A common mistake: EU( C) is not the same as U [ E(C )]. You do not find the utility of expected consumption, you find the expected utility of consumption. In my graph, C is equal to the expected value of C-Delta and C+Delta, and the whole point is that the utility of C is bigger than the expected utility of (C-Delta) or (C+Delta). You can take E inside a linear function, but you cannot take E inside a nonlinear function.

Loss aversion

OK, on to loss aversion. In the usual sort of experiments Kahneman found that people seem reluctant to lose money. They have a “reference point” and work  hard to avoid bets that might put them below that reference point. He models that as expected utility with a kink in it, as in the second drawing.

I was careful to draw the reference point as different than C. People do not necessarily place the reference point at the expected value of the bet. In fact, usually they don’t. If betting on stocks, the expected value of the bet is to gain 7% per year. The “don’t lose money” point would be do not go below 0, not do not go below the mean. Here people are especially afraid only of the very left part of the distribution.

Now, really, how are these models different? Expected utility can be any function, and nobody said it doesn’t have a kink in it. The key distinguishing feature of loss aversion – and its Achilles heel – is that the reference point shifts around. If you make some money, and play again, then your kink shifts up to the new amount of money you made. Expected utility is supposed to stay the same function of consumption or wealth. People might change behavior – most likely the utility curve is flatter at high levels of consumption, so rich people are less risk averse. But the curve itself does not shift. The key assumption that distinguishes loss aversion from expected utility is that the kink point shifts around as you gain and lose money.

That’s also the Achilles heel.  The first problem is how do you handle sequential bets. If I go to the casino, and know I will play twice, how do I think about my strategy? With expected utility this is easy, because the expected utility works backwards. Suppose you win the first bet, then figure out what you do in the second bet. For each of win or loss in the first bet, then, you have an expected utility from taking the second bet. The expected utility of the first bet is then the expected vaule of the expected utilities you would have if you won or lost.

## Thursday, June 14, 2018

### Different Planets

A friend, who reads an unusually diverse set of sources, passed on some interesting pictures suggesting that our media live on different planets.

On the Trump-Kim summit

On the investigations:

## Tuesday, June 12, 2018

### Cross-subsidies

Cross-subsidies are an under-appreciated original sin of economic stagnation. To transfer money from A to B, it would usually be better to raise taxes on A and to provide vouchers or otherwise pay competitive suppliers on behalf of B. But our political system doesn't like to admit the size of government-induced transfers, so instead we force businesses to undercharge B. Since they have to cover cost, they must overcharge A. It starts as the same thing as a tax on A to subsidize B. But a cross-subsidy cannot withstand competition. Someone else can give A a better price. So our government protects A from that competition. That ruins the underlying markets, and next thing you know everyone is paying more for less.

This was the story of airlines and telephones: The government wanted to subsidize airline service to small cities, and residential landlines, especially rural. It forced companies to provide those at a loss and to cross-subsidize those losses from other customers, big city connections and long distance. But then the government had to stop competitors from undercutting the overpriced services. And as those deregulations showed, the result was inefficiency and high prices for everyone.

Health care and insurance are the screaming example today. The government wants to provide health care to poor, old, and other groups. It does not want to forthrightly raise taxes and pay for their health care in competitive markets. So it forces providers to pay less to those groups, and make it up by overcharging the rest of us. But overcharging cannot stand competition, so gradually the whole system became bloated and inefficient.

A Bloomberg article "Air Ambulances Are Flying More Patients Than Ever, and Leaving Massive Bills Behind" by  John Tozzi offers a striking illustration of the phenomenon, and much of the mindset that keeps our country from fixing it.

The story starts with the usual human-interest tale, a $45,930 bill for a 70 mile flight for a kid with a 107 degree fever. At the heart of the dispute is a gap between what insurance will pay for the flight and what Air Methods says it must charge to keep flying. Michael Cox ... had health coverage through a plan for public employees. It paid$6,704—the amount, it says, Medicare would have paid for the trip.
The air-ambulance industry says reimbursements from U.S. government health programs, including Medicare and Medicaid, don’t cover their expenses. Operators say they thus must ask others to pay more—and when health plans balk, patients get stuck with the tab.
Seth Myers, president of Air Evac, said that his company loses money on patients covered by Medicaid and Medicare, as well as those with no insurance. That's about 75 percent of the people it flies.

 Source: Bloomberg.com

## Tuesday, May 15, 2018

### Meditation on a trip to the DMV

I arrived at the DMV yesterday at 9 AM. My number came up at 5:45 -- you have to wait anxiously all day as you have 10 seconds to respond to your number. At 6:05, 10 hours after arrival. I was informed it was too late to take my written test so I would have to come back. As usual the place was packed, no food, no drink, two filthy restrooms.

(California has an appointment system but it takes two months to get an appointment, so if you need something now or can't book a free day two months ahead of time, you wait. 10 hours. Then you still get an appointment to return two weeks later as they won't get to you.)

Despite 13.2% top income tax rate, 7.5-9.5% sales tax, gas taxed to $3.80 a gallon, California cannot operate a functional DMV. Even Illinois, good old corrupt, bankrupt, Illinois, can operate a vaguely functional DMV. (Direct election of the secretary of state may have something to do with that.) Estonia, this is not. Piles of paper flow around. Technology is about 1992 -- there is a number system, so you don't stand in line for 10 hours. But no indication where you are in the queue or when they might get to you. Rebellion was in the air. Most people do not have my time flexibility. The very nice lady next to me had taken the day off work and had to arrange child care, which was going to end at a finite time. This was her second day of waiting. She was ready to start the revolution. This is not unusual. It's just a completely normal day down at the DMV. The joke has been around a long time: Do you really want the people who run the DMV to operate your health care and insurance system? But it is a good joke. The DMV is the main interface most people have with the functioning or lack thereof of a bureaucracy. The irony is that the democratic candidates in California are falling all over themselves to be stronger on "single-payer" health -- which does not just mean one fallback, but that all others are banned. The amazing thing is that citizens of this noble state are all for it, though they must, like me, each take their turn in the 10 hour line at the DMV. (I suspect many high income progressives do not realize that "single payer" means them too. No concierge medicine.) Republicans: I suggest you set up tables outside the DMV. After all, there is motor voter registration and this might get people in a good frame of mind for your message. Second thought: Things could be worse. The DMV is good proxy for the quality of government institutions. In many countries in the world you must pay a bribe to get a driver's license. In many other countries you can pay a bribe to cut through swaths of paperwork. At least in the US you can't do that. But there are countries where government actually works. When our friends on the left dream of Scandinavian health care, perhaps they should visit a Scandinavian DMV first, and agree that let's see if our government can run a DMV before it tackles health care. And don't go after me with taxes -- the cost of a functional DMV is not that high. This one just needs to expand to match the growth in its population and the complexity of the various laws it has passed. ## Friday, May 11, 2018 ### Argentina update and IMF From Alejandro Rodriguez, my correspondent from the last post We are ***! People are withdrawing funds from fixed income mututal funds (which hold ARS 300 billion of CB short term debt). Yestedary alone people withdrew 4% from those funds and ran to the dollar today. Peso falls 5% to$24.00 ARS/USD. Next step is a ran against term deposits in banks. Next tuesday the CB has to roll over ARS 680 billion of short term debt. A conservative estimate is that ARS 150 billion will not be rolled over and will ran immediatelly to the dollar. No IMF bailout will stop the crisis but it will definitively help us in the aftermath.

PS: If you want to know what interest rates are now (like if anyone cares about them anmore)

maturity APR 5 days 81% 41 days 45%

If Basis is trading for less than $1, the blockchain creates and sells bond tokens in an open auction to take coins out of circulation. Bond tokens cost less than 1 Basis, and they have the potential to be redeemed for exactly 1 Basis when Basis is created to expand supply. Aha, basecoins get traded for ... claims to future basecoins? You should be able to see instantly how this will unwind. Suppose the algorithm wants to reduce basecoins. It then trades basecoins for "basecoin bonds" which are first-inline promises to receive future basecoin expansions. But those bonds will only have value during temporary drops of demand. If there is a permanent drop in demand, the bonds will never be redeemed and have no value. They are at best claims to future seignorage. Any peg collapses in a run, and the run threshold is mighty close here. But it gets worse. ## Thursday, April 19, 2018 ### Q is better than you think This lovely graph comes from "Learning and the Improving Relationship Between Investment and q" by Daniel Andrei, William Mann, and Nathalie Moyen. The careful investment and q measurement make it much better than similar figures I've made for example Figure 4 here. Their paper explores the puzzle, just why did q theory work worse before 1995? The graph also bears on the "monopoly" debate. Corporations are making huge profits, stocks are high, yet we don't see investment, the story goes -- marginal q must be much less than average q, indicating some sort of fixed factor or rent. Not in the graph. ## Wednesday, April 18, 2018 ### Buybacks redux Two more points occur to me regarding share buybacks. 1)When buybacks increase share prices, and management makes money on that, it's a good thing. The common complaint that buybacks are just a way for managers to enrich themselves is exactly wrong. 2) Maybe it's not so good that banks are buying back shares. 3) The tax bill actually gives incentives against buybacks. What's going on is despite, not because. Recall the example. A company has$100 in cash, and $100 profitable factory. It has two shares outstanding, each worth$100. The company uses the cash to buy back one share. Now it has one share outstanding, worth $100, and assets of one factory. The shareholders are no wealthier. They used to have$200 in stock. Now they have $100 in stock and$100 in cash. It's a wash.

Why do share prices sometimes go up when companies announce buybacks? Well, as before, suppose that management had some zany idea of what to do with the cash that would turn the $100 cash into$80 of value. ("Let's invest in a fleet of corporate Ferraris"). Then the stock would only be worth $180 total, or$90 per share. Buying one share back, even overpaying at $100, raises the other share value from$90 to \$100.

That was the big point. Share buybacks are a good way to get money out of firms with no ideas, into firms with good ideas. We want firms to invest, but we don't necessarily want every individual firm to invest. That's the classic fallacy that I think it turning Washington on its head. Best of all we want money going from cash rich old companies to cash starved new companies. Buybacks do that.

1) Management getting rich on buybacks is good.

OK, on to management. Management, buyback critics point out, often has compensation linked to the stock price. They might own stock or own stock options. So when the buyback boosts the stock price, then management gets rich too. Aha! The evil (or so they are portrayed) managers are just doing financial shenanigans to enrich themselves!

The fallacy here, is not stopping to think why the buyback raises the share price in the first place. If it is the main reason given in the finance literature, that this rescues cash that was otherwise going to be mal-invested, then you see the great wisdom of giving management stock options and encouraging them to get rich with buybacks.

## Friday, April 13, 2018

### Fiscal theory of monetary policy

Teaching a PhD class and preparing a few talks led me to a very simple example of an idea, which I'm calling the "fiscal theory of monetary policy." The project is to marry new-Keynesian models, i.e. DSGE models with price stickiness, with the fiscal theory of the price level. The example is simpler than the full analysis with price stickiness in the paper by that title.

It turns out that the FTPL can neatly solve the problems of standard new Keynesian models, and often make very little difference to the actual predictions for time series. This is great news. A new-Keynesian modeler wanting to match some impulse response functions, nervous at the less and less credible underpinnings of new-Keynesian models, can, it appears, just change footnotes about equilibrium selection and get back to work. He or she does not have to throw out a lifetime of work, and start afresh to look at inflation armed with debts and deficits. The interpretation of the model may, however, change a lot.

This is also an extremely conservative (in the non-political sense) approach to curing new-Keynesian model problems. You can keep the entire model, just change some parameter values and solution method, and problems vanish (forward guidance puzzle, frictionless limit puzzle, multiple equilibria at the zero bound, unbelievable off-equilibrium threats etc.) The current NK literature is instead embarked on deep surgery to cure these problems: removing rational expectations, adding constrained or heterogeneous agents, etc. I did not think I would find myself in the strange position trying to save the standard new-Keynesian model, while its developers are eviscerating it! But here we are.

The FTMP model

(From here on in, the post uses Mathjax. It looks great under Chrome, but Safari is iffy. I think I hacked it to work, but if it's mangled, try a different browser. If anyone knows why Safari mangles mathjax and how to fix it let me know.)

Here is the example. The model consists of the usual Fisher equation, $i_{t} = r+E_{t}\pi_{t+1}$ and a Taylor-type interest rate rule $i_{t} = r + \phi \pi_{t}+v_{t}$
$v_{t} =\rho v_{t-1}+\varepsilon_{t}^{i}$
Now we add the government debt valuation equation $\frac{B_{t-1}}{P_{t-1}}\left( E_{t}-E_{t-1}\right) \left( \frac{P_{t-1}% }{P_{t}}\right) =\left( E_{t}-E_{t-1}\right) \sum_{j=0}^{\infty}\frac {1}{R^{j}}s_{t+j}$
Linearizing $$\pi_{t+1}-E_{t}\pi_{t+1}=-\left( E_{t}-E_{t+1}\right) \sum_{j=0}^{\infty }\frac{1}{R^{j}}\frac{s_{t+j}}{b_{t}}=-\varepsilon_{t+1}^{s} \label{unexpi}$$ with $$b=B/P$$. Eliminating the interest rate $$i_{t}$$, the equilibrium of this model is now $$E_{t}\pi_{t+1} =\phi\pi_{t}+v_{t} \label{epi}$$
$\pi_{t+1}-E_{t}\pi_{t+1} =-\varepsilon_{t+1}^{s}$
or, most simply, just $$\pi_{t+1}=\phi\pi_{t}+v_{t}-\varepsilon_{t+1}^{s}. \label{equil_ftmp}$$

Here is a plot of the impulse response function: