Paul Krugman is something an unusual: a brilliant economist who can be relied upon to throw economic reasoning out the window whenever it gets in the way of toeing the Democratic party line. Here, in an attack on the Blue Dogs, he supports a key argument for the public option:
Finally, there would be a public option: a government-run insurance plan competing with private insurers, which would help hold down costs...
There has been a lot of publicity about Blue Dog opposition to the public option, and rightly so: a plan without a public option to hold down insurance premiums would cost taxpayers more than a plan with such an option.
This argument is framed in terms that mimic the appeal of standard free market arguments. Competition is good, right? You can't hurt people by giving them more choices.
But there already is competition in the health insurance industry: Aetna, Blue Cross Blue Shield, CIGNA, UnitedHealth Group, and WellPoint, to name the top five. It is an abuse of the theory of competition to treat the entry of a new supplier into an industry that is already competitive as necessarily a good thing. If there are increasing returns to scale, as there typically are in insurance, it may be more efficient to have a small number of firms rather than a large number. If the health insurance industry is competitive already, which the number of suppliers suggests that it is, premiums are already held down to marginal cost, and the entry of a new supplier could not force current suppliers to lower premiums.
If the health insurance industry is not competitive, one of the following situations must obtain: (a) health insurance is a natural monopoly, or (b) there is some kind of collusion going on. The idea that health insurance is a natural monopoly is hard to reconcile with the existence of multiple suppliers. In any case, it would be absurd, under that supposition, to introduce another supplier, because the definition of a natural monopoly (think of an electricity distribution network) is that it is inefficient to have more than one supplier (to have two sets of power lines running to the same house). If health insurance is a natural monopoly, the government should either take over or regulate the premiums for the entire industry. If there is collusion, the Department of Justice should break it up. Under no set of assumptions is it a reasonable policy for the government itself to enter the industry as a supplier and compete with private insurers.
The silliness of this argument becomes immediately evident if we think about some other industry, say, restaurants. Suppose people are complaining that restaurant prices are too high, and a politician proposes to start a government restaurant chain that will compete with the private sector restaurants and bring down prices. I think it's obvious enough what's wrong with that. If the government restaurant chain somehow has completely separate finances from the government-- in which case it's not clear in what sense it is a government restaurant chain-- then perhaps there is no objection to the policy except that it is very odd. But presumably the government restaurant chain will get some kind of taxpayer subsidy or other privilege (e.g., an implicit guarantee of its debts, or favorable treatment by regulators) that gives it an unfair advantage over the private sector restaurants. It will then become a means of redistribution, from the general taxpayer to the patrons of the government restaurants. Presumably state eateries will be less efficient, as theory and practice tell us (theory tells us that the absence of market discipline takes away the incentive to exert effort and make sound decisions). So there will be losses to society as a whole, as well as redistribution. Non-patrons of state restaurants, and private restaurateurs, will suffer, while frequent patrons of state restaurants may benefit, although their gains may not be enough to offset losses from higher taxes and crowding out of private restaurant options. The objections to a "public option" in health care are exactly the same.
But isn't health care different? Doesn't free-market economics somehow fail to apply to health care? Maybe so, in some ways. The reasons to think health care is different are basically three. (1) The high degree of uncertainty about health care needs means that payment systems, to be efficient, probably need to involve insurance, and insurance markets create special kinds of agency problems. In this respect, health care resembles auto repairs or disaster relief. (2) Patients are unusually ignorant, relative to doctors, about their needs in health care markets: my stomach pain (say) might, for all I know, require treatment by a $1 box of pills or a $100,000 surgery. In this respect, health care might resemble any kind of consulting service or, again, auto repair. (3) Health care is considered by some to be a merit good, which everyone "deserves" (whatever that means) regardless of ability to pay. Few would object if poor people don't have access to jet skis or Hawaiian shirts or iPods or pineapples, but some feel it is wrong for anyone to die just because they cannot pay the doctor's bill. None of these peculiarities of health care have any bearing on the market structure of the industry or give the argument for the public option as competition any of the validity that it so obviously lacks in the case of the restaurant industry.
There are many questions in economics that are to a large extent unresolved or mysterious, where there is large scope for valid differences of opinion. If I were to ask why some countries are so much richer than others, you could give many different and contrasting, to some extent even contradictory answers, and it would count as good economics. The validity of the Krugman/Obama argument for the public option is not one of those questions. It IS WRONG. The argument is a simple fallacy. An attempt to clarify its logic with a model would have laughable results. If a student were to make this argument on an exam it would be a professor's duty to mark him down, on the grounds that he doesn't understand the basics of how markets work. It is the kind of argument the absence of which defines the writings of a great economist, at least when he is not degrading his intellect to peddle propaganda.
What is especially sinister about this argument is that it mimics free-market language in order to appeal to people who are vaguely sympathetic to the free market without understanding it. There are sensible grounds for supporting a public option. One might want it as a means to subsidize cheap, low-quality health care for the poor and indigent while leaving the existing system in place for the middle class. Or, one might want to subsidize the state system in order to drive private health insurance companies out of business and move to socialized medicine. To state those reasons, though, would make enemies. The Krugman/Obama argument is a way to trick people who don't want a health welfare program or socialized medicine into thinking of the public option as a way to improve efficiency and lower costs while leaving the current system in place. Krugman at least is surely aware that the argument is spurious.
How long will the public tolerate the economics profession when our Nobel laureates choose not to avoid the most elementary fallacies?