July 11, 2014 by Roger McCain
I should begin by saying that I am not opposed to public provision of health care — quite the contrary. My wife and I had an experience with socialized medicine when we were in Wales. An injury cut our vacation short, but the medical care was first-rate, cheap and much less stressful than it would have been in the U.S. If we had been British residents, it would have been free.
For that reason and many others, I would support a single-payer plan if it were up for a vote. Nevertheless, no system is perfect. Like any other institution, public provision of service, including medical service, has predictable problems. For public provision of services, the predictable problem is that they will be underfunded.
The reason for this is not just politics as usual. If public provision of services is popular, but tax cuts are also popular, we might expect cynical politicians to vote for both, resulting in insufficient money to provide the services. And while that probably does happen, there is a nastier problem. It is economics as usual, not politics as usual. It has to do with what we hotshot economists call “monopsony” and “the elasticity of supply.”
The current presidential administration calls it “clout.” One of the expressed objectives of the Affordable Care Act is to use the “clout” of government purchasing to slow the increase of medical care costs. What the government calls “clout,” economists call “monopsony power.” Monopsony means “only one buyer,” as, for example, only one hirer of a category of labor. If the employer has a monopsony, then he can force the wage down by reducing his demand for labor of that category.
This is very uncommon in the private sector in a literal sense, but we can find examples that approximate it pretty closely. In Seattle, for example, an aircraft company used to hire most of the qualified aluminum welders, but not quite all — a few worked for shipwrights instead. Nevertheless, the aircraft company had what we call monopsony power: by cutting back on the number of welders it hired, it could push the market wage for aluminum welders down. Similarly, when the government purchases the service, the government has monopsony power, or “clout,” to hold down the wages and salaries the providers receive.
But “clout” is not a simple constant. The elasticity of supply is a number that tells us how much the employer has to cut back on hiring to push the wage down by one percent. The bigger the elasticity of supply is, the less “clout” the employer has. And the elasticity of supply depends on some other things, including the time we allow for the suppliers of the service to change their decisions. If we measure the elasticity of supply over a period of a few years — say the term of a Congress or a parliament — then the elasticity of supply will be relatively small.
Most of the providers of the service — doctors, nurses, surgeons, technicians — will have already completed their education, or most of it, and gone in debt to do so, and will have few alternative jobs to switch to, so they will (rationally) continue in their professions despite reduced lifetime pay. This means the elasticity of supply is small. On the other hand, if we measure the elasticity of supply over a period of a few decades, many of the providers of the service will retire, some will die, and they will need to be replaced. But younger people who might replace them, anticipating lower pay and huge debt, will choose instead to study engineering or open a pub. Thus, over decades, the supply of medical providers will drop by a much larger margin while demand increases, and shortage is the predictable result.
But won’t the employees use their lobbying power to influence the vote for higher salaries or union protection? No doubt they will try. But the fact remains that, in a conflict, public employees have a boss that has far more power to use against them than any private employer could have. Again, I will call on my own experience, for what it is worth: I have been employed by both public and private (nonprofit) universities and have found the public ones are the more oppressive employers.
I don’t mean to suggest that our government is evil. It is, however, ignorant of the economics of supply and it is also subject to many pressures in the short run. And I do think that there is hope that they will do better. We should never underestimate human creativity. In the past, governments have used central banks and paper currencies to pursue their short-run objectives, but it has come to be understood that this is unwise and that the central bank needs to be independent of politics.
We may hope for a similar evolution of institutions that can supply public health care on a sustainable and economically sound basis. However, that will not happen if we do not see the problem and monopsony power has not gotten the attention it should, even among economists.
Roger McCain is a professor of economics at Drexel University. He can be contacted at firstname.lastname@example.org.