Labor Economics Medicaid/Medicare

Obama’s Economic Case for Health Reform

Health Reform is at the top of President Obama’s list of reform efforts. Mr. Obama claims that not only will health reform improve the physical health of the nation, it will also improve its economic health. In a Council of Economic Advisers Report, President Obama lists three reasons why slowing health care costs and expanding health care coverage will increase economic growth. Let us look at each of these arguments in turn.


  1. It would raise standards of living by improving efficiency. Decreasing health care costs while maintaining the same quality of health care would certainly improve efficiency. However, simply decreasing costs will not necessarily improve efficiency since the quality of medical care could deteriorate. Many researchers believe that Americans receive too much specialist care and not enough primary care. Cutting costs in the primary care sector may actually decrease efficiency. Further, decreasing reimbursement for groundbreaking technologies may slow the growth of longevity rates. Thus, cutting cost by reducing reimbursement for inefficient medical care would improve efficiency, but cutting cost by reducing payment for cost-effective method would actually decrease efficiency.
  2. It would prevent disastrous budgetary consequences and raise national saving. The first part is certainly true while the second is not. The Medicare Trust Fund is will run out of funds in less than ten years. As the baby boomers continue to progress into retirement, the promised health care benefits will need to be financed by a higher tax rate on workers. Thus, the government must take some action to bolster its fiscal solvency. Cutting health care costs, however, may not increase national savings. Let us assume overall spending on medical care health care spending is too high right now. This may be the case because employers–not employees–choose the set of health plans offered and the moral hazard problem has lead to overconsumption. In this case, decreasing spending would increase savings, because individuals are spending too much on health insurance. But why are people spending “too much”? It could be the case that they are spending (on average) exactly what they want to given the expensive nature of medical care. If this were the case, reducing government health care expenses would be offset by an increase in private health expenditures. For instance, a government cut in reimbursement rates to doctors would decrease spending and increase savings. Patients faced with the possibility of lower quality care may opt to spend more money on more personalize health care (e.g., flat-rate no limit primary care doctors) which would decrease savings. The net effect on savings is ambiguous.
  3. It would lower unemployment and raise employment in the short and medium runs. The most important point to mention here is “Who cares about the short/medium runs?” If you are going to implement new huge government program to reduce unemployment in the next 3 year, this is a huge mistake. Any large health reform effort should be made not for it’s short run impact, but for its long run impact. Nevertheless, cutting costs may create a small short-run increase in employment. The reason is that firms can will pay less for health insurance (or pay lower taxes for Medicare) and can hire more employees. However in the medium to long run, total worker compensation is set in a competitive market. Thus, a drop in health insurance premiums will likely be offset by higher wages and employment will remain at the same level as if no cost-cutting occurred. As evidence of this, the cost of health care has increased monotonically for the last 30 years. On the other hand, unemployment looks like a sine wave, displaying no strong long-term trend.  If medical costs caused unemployment, one would expect unemployment to be increasing over the long run just as medical costs have done.


  1. It would increase the economic well-being of the uninsured by substantially more than the costs of insuring them. It is likely that the economic of the uninsured would increase. It is likely that the economic well-being of the currently insured would decrease (through higher taxes). The net effect in the short run is likely to positive. To restate, in the short run, expanding coverage is almost certainly worthwhile. The question is whether or not expanding coverage be detrimental in the long run. Would an increase in the proportion of individuals with government-run health care lead to a stifling of innovation? Would lobbying by interest groups (e.g., PhARMA, AMA) lead to distorted reimbursement patterns? Would costs cutting measures lead to longer wait times to see doctors? While the short run benefits of expanding health insurance coverage are clear, the long run effects on both economic and health sector efficiency is ambiguous.
  2. It would likely increase labor supply. The CEA claims that “reducing disability and absenteeism in the work place” will increase the labor supply. This is true, but may be offset by a reduced number of people who are employed in the first place. Many people take second jobs just for the health insurance. If individuals can get health insurance without working, this could decrease the labor supply. Overall, I believe the net effect will be small. The more important economic impact is (3) below.
  3. It would improve the functioning of the labor market. This is definitely true. Individuals often keep job below their skill level simply because they fear losing health insurance. Other high-skilled individuals will take low-paying second jobs (e.g., Starbucks) just to have some insurance coverage. These two problems are named Job Lock and Job Stretch. If workers can choose employers based on wages, their own skills, and the overall work environment, this will lead to more efficiency labor market than if individuals would need to choose jobs based on the health plans offered. Further, it would increase small business innovation. Workers would be more attracted to small business if they knew they could receive insurance from the government.

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