Thursday, December 22, 2016

What Is the Nairu and Why Does it Matter?

In December 2016, after a year-long pause, the Fed resumed its tightening of monetary policy. As usual, the action took the form of a quarter point increase in the target range for the federal funds rate (a key rate that banks charge  on short-term loans to one another).

Is still more tightening in store?  Most observers think the answer is “yes,” but the Fed is leaving its options open. Its most recent projections, released immediately after its December meeting, hint at the possibility of as many as ten more quarter-point increases over the next three years—or perhaps none at all. So what will actually happen?

The wonkiest number in all of economics

What actually happens will depend , in large part, on what may be the wonkiest number in all of economics—the Nairu. Nairu stands for Non-Accelerating Inflation Rate of Unemployment—such a mouthful that no one ever says it out loud. Often, it is spelled out as an acronym, NAIRU, but increasingly, it is written as an actual word, with only the first letter capitalized. In the 1960s, Milton Friedman used the more civilized term, natural rate of unemployment. Today, many economists treat “Nairu” and “natural rate” as synonyms.

The basic idea behind the Nairu is simple. It is widely accepted that as the economy moves through the business cycle from recession to expansion to boom, shortages develop in labor and product markets that put upward pressure on prices and wages. The Nairu is supposed to capture the sweet spot—the lowest level to which the unemployment rate can safely fall before inflation starts to accelerate.

The Nairu is a natural fit with the Fed’s statutory objectives for the conduct of monetary policy. Under its so-called dual mandate, the Fed is supposed to aim for “maximum employment and stable prices.” The Nairu captures both parts of the dual mandate, being the maximum employment (or minimum unemployment) that is consistent with prices that are stable in the sense that the inflation rate does not accelerate from month to month.

In order actually to implement its dual mandate, the Fed needs to fill in some numbers. In recent years, it has maintained an inflation target of 2 percent per year, as measured by the personal consumption expenditure (PCE) index published quarterly by the Bureau of Economic Analysis. Putting a number on the Nairu, however, has posed more of a challenge.

Why the Nairu is so hard to pin down

Back in the 1960s, things seemed simpler. Consider the following chart, which shows the pattern of unemployment and inflation that prevailed during the Kennedy-Johnson years, 1960-1969:

The points in this chart fit closely around a trendline that economists call a Phillips curve—a curve that shows an inverse relationship between inflation and unemployment over the course of the business cycle. Taken literally, the value of the Nairu would be 6.7 percent, the level at which inflation started to accelerate after reaching its low of 0.6 percent in the fourth quarter of 1961. If, instead, we interpret the Nairu as the value of unemployment beyond which inflation begins to rise above  the 2 percent target, then the chart suggests an unemployment target of about 4.3 percent.

Sunday, December 18, 2016

Does Paul Krugman Really Want to Say Hillary Could Have Won Only by Keeping the Truth from Voters?

Paul Krugman says the election was hacked. He thinks Hillary Clinton would have won the presidency, but for two problems:

I’m talking about the obvious effect of two factors on voting: the steady drumbeat of Russia-contrived leaks about Democrats, and only Democrats, and the dramatic, totally unjustified last-minute intervention by the F.B.I. . .
Does anyone really doubt that these factors moved swing-state ballots by at least 1 percent? If they did, they made the difference in Michigan, Wisconsin and Pennsylvania — and therefore handed Mr. Trump the election, even though he received almost three million fewer total votes. Yes, the election was hacked.
I’m not sure Krugman has any hard statistical evidence to back this up, but he may very well be right. Is so, what is the implication? 

Krugman wants us to focus on the fact that the people who did the hacking were “bad guys.” Vladimir Putin is a devious authoritarian who arguably had no business trying to tilt the US election to his favored candidate. The FBI may really, as he says, “have  become a highly partisan institution, with distinct alt-right sympathies” (although I find that a bit of an overstatement.) 

In my view, though, we should not allow the fact that “bad guys did it” to distract our focus from one key fact: What we learned from the Russian hackers and the FBI was true.

Yes, Clinton really did have a private email server. At a minimum, by her own admission, that showed bad judgement. It seems to have been at least a technical violation of State Department rules, even if the FBI was right to recommend against criminal prosecution. The server, and Clinton’s handling of the issue, really did turn off some voters.

Yes, the DNC, as revealed by Wikileaks, really did put its thumb on the scale in the primaries, contrary to its professed neutrality. Without the DNC’s covert aid—or with a more timely revelation of that aid—a fairer primary process might well have resulted in the nomination of Bernie Sanders.

Yes, Clinton’s paid speeches to banks really did contain material that could have swayed undecided primary voters, had it come out earlier in the year — her embrace of free trade and open borders, her offer to give Wall Street executives a larger role in crafting regulations, her casual willingness to say one thing behind closed doors and another in public.

None of this was false news. It was true news. I agree, it would have been more  palatable if it had been revealed by an earnest, all-American whistle blower within the DNC campaign rather than by the Russians, but that does not change the fact that the material released was true.

So here is my question: When Krugman says that Clinton would have won the presidency of only the election had not been hacked, isn’t that exactly the same as to say that she could have won only if she had been able to keep the truth safely under wraps?

If it is, then the blame for Clinton’s defeat lies with the message, no matter how much effort Krugman makes to shift our focus to the messengers.

Wednesday, December 14, 2016

Just About Managing: How the "Jams" Elected Donald Trump

Hillary Clinton famously characterized Donald Trump’s voters as a “basket of deplorables,” but she was wrong. Our friends, the British, have figured it out: Trump was elected not by deplorables, but by jams.

“Jams,” short for “Just About Managing,” is the new term has swept British political discourse. They are defined as a social class consisting of people who have jobs and a home, but little by way of savings or discretionary income; people who see themselves as precariously comfortable at best, with nothing to fall back on if adversity strikes.

The instant popularity of the term may have something to do with the way it echoes another typically British political expression, “jam tomorrow,” meaning an often made but never fulfilled promise.

James Frayne of the British think tank Policy Exchange has written a thorough and thoroughly wonky report on jams. For statistical purposes, he equates jams with the middle half of the British class structure, sandwiched between professional and managerial classes above, and unskilled workers and those who live on social benefits, below.

What Frayne says about jams certainly makes them sound a lot like Trump voters. They work hard, pay their taxes, and play by the rules. What they want is to see “society run in a fair way.” American translation: They want to see that the system is not rigged.

Monday, December 5, 2016

This Chart Shows Why the Fed Will Be Tightening Monetary Policy Soon

Will policymakers at the Fed raise interest rates at their December meeting? Wall Street  oddsmakers increasingly think they will. One simple chart shows why.

The chart tracks the economy’s progress toward the central  bank’s target of “stable prices and maximum employment.”  The Fed’s rate-setting Federal Open Market Committee (FOMC) has operated under this so-called  dual mandate since Congress amended the Federal Reserve Act in 1977. In recent years, the Fed has interpreted “stable prices” to mean a rate of inflation close to 2 percent per year, as measured by the annual change in the price index for personal consumption expenditures (PCE). It interprets “maximum employment” to mean the highest level that is consistent with its 2 percent inflation goal, currently thought to be an unemployment rate of about 4.8 percent.

We can use the two components of the dual mandate to draw a bullseye that the Fed is aiming for.  Here is how things are going, seven years into the recovery from the Great Recession. (All data shown in the chart are quarterly, except for the last point, which shows the latest, still-incomplete data for the fourth quarter of 2016—unemployment of 4.6 percent for November 2016 and PCE inflation of 1.5 percent for October.)

As recently as the fourth quarter of last year, the Fed was missing the inflation target by a wide margin on the downside and the unemployment target by a smaller margin on the upside. Small wonder, then, that when the FOMC raised interest rates at its December 2015 meeting, many critics saw such an action as premature. That was especially true for those who hold the orthodox view that 2 percent inflation is a not an unconditional ceiling, but rather, a target that may acceptably be exceeded for a time after a long period of below-normal price increases.

Sunday, December 4, 2016

Why a Protectionist Shock Would Do More to Harm Than to Help the Job Market

Dramatic promises to restrict international trade were a signature element of Donald Trump’s presidential campaign. So far, he seems to be following through, with an early reaffirmation of his intent to withdraw US participation in the Trans-Pacific Partnership (TPP).

An aggressive stance on trade played a key role in gaining the support of working class voters in Midwestern manufacturing states, where upset wins swept him into the White House.  What is more, trade is one area in which Trump, as President, will have the power to act on his own without action by Congress. As Gary Clyde Hufbauer of the Peterson Institute has explained, both the US Constitution and past acts of Congress give the President ample authority to do things like withdraw from the TPP or NAFTA, label China a currency manipulator, or impose retaliatory tariffs on any country he sees as a threat to US economic security.

But how would American workers actually fare under a protectionist regime, especially older workers, and those with few skills and little education, who voted for Trump by wide margins? Not well. Here is why a protectionist shock could do more to harm than to help the US job market.

Friday, November 18, 2016

Free Trade Under Fire

The recent presidential election was characterized by attacks on free trade from leading candidates in both parties. As I detailed in my earlier post, "The Bipartisan War on Free Trade," eventual winner Donald Trump broke sharply with the traditional free trade position of the Republican party. Populist Democrat Bernie Sanders drove his rival Hillary Clinton to abandon her earlier embrace of trade. Cracks have even appeared in the formerly almost monolithic support of trade among economists.

I have now pulled together the key points from several earlier posts and articles for a new slideshow, "Free Trade under Fire," available for viewing or free download on my Slideshare page. The slideshow is suitable for classroom presentation or for discussion by community groups. Contact me if you would like me to present the slideshow to your class or community group.

Highlights of the slideshow:

Four flawed arguments against free trade:
  • Deficits mean we are losers
  • Blame it on currency manipulation
  • Protectionism will bring back manufacturing jobs
  • Don't trade with the poor 
Why the real problem with trade is slow adjustment to trade shocks

Five factors that slow adjustment to trade shocks, with discussion of reforms that could speed adjustment:
  • Work disincentives in the social safety net
  • Insufficiently portable healthcare
  • Ownership bias in housing policy
  • Spread of occupational licensing
  • Too many people with criminal records
Why protectionism is not the answer

Follow this link to view or download the slideshow

Thursday, September 22, 2016

Why Does Big Business Fear Trump?

It is not surprising that there is little love for Donald Trump’s presidential candidacy among the leaders of top US multinational corporations. Why then, asks Andrew Ross Sorkin of the New York Times, do they not speak out? Why do they quickly follow up their private comments with, “I could never say that on the record”? I find some of the views reflected in Sorkin’s article disturbing.

The attitudes of top executives would be more understandable if they centered on the issue of free trade, but they do not. Yes, big business has profited from past trade deals and backs new ones like the TPP and TTIP, which Trump promises to cancel. But Trump’s Democratic opponent and a majority of Congressional candidates from both parties have also joined the anti-trade bandwagon, so trade policy is in for a change no matter who wins this election. As Trump himself would say, there’s something else going on.

Trump the bully is one broader fear of the executive class. Sorkin quotes Reid Hoffman, co-founder of LinkedIn, who was one of the few willing to speak to him on the record:
People are fearful that, especially in a circumstance where he might be in a position of extreme power as a potential presidential candidate, that would be used in a retaliatory way, that would be used in vengeful way. Everyone gets worried about being attacked, and part of the logic and mechanics of bullies is that they cause people to be fearful that they’ll be singled out and attacked.
It’s the same thing like on school grounds, when people won’t go help the kid who is being bullied because they’re worried that the bully will focus on them.
Yes, it is frightening to think about the ways a thin-skinned and vengeful President might misuse the office. The entanglement of corporations with government is such that there would be many opportunities to punish enemies. Taxes, regulations, and government contracts would be some of the most direct, but backdoor methods like planting rumors or leaking documents might be easier, and just as damaging. A President Trump might install a compliant security chief who would give him access to a company’s internal phone and email communications, encrypted or not. The tools at the disposal of a spiteful president would make something like closing a bridge look like a playground prank.

Friday, September 9, 2016

How Hillary Clinton's Social Policies Could Raise Effective Marginal Tax Rates for the Middle Class

Hillary Clinton is often said to be a policy wonk, deeply enmeshed in specifics and details, but that may be a mischaracterization. In some ways, her approach seems disturbingly superficial, skipping one perceived problem to another with little attention to their underlying causes. In some cases, Clinton seems to have paid little attention to the unintended consequences of her proposals, as a real policy expert would do. A look at the tax implications of some of her social policy proposals will illustrate these shortcomings.

How progressive? Nominal vs. effective tax rates

Discussions of by both supporters and critics have characterized Hillary Clinton’s tax policies as progressive. The appearance of progressivity arises from her pledge to raise tax rates and close loopholes for the wealthiest Americans, while leaving nominal tax rates for middle-class families largely unchanged. According to an analysis by the Tax Policy Center, her proposals would increase revenue by $1.1 trillion over the next decade, with nearly all of the tax increases falling on the top 1 percent.

However, the conclusion that Clinton’s policies would have little effect on middle-class families is based on a narrow view of taxes—one that takes into account only the money that taxpayers hand over to the IRS. Economists have long favored a broader concept called the effective marginal tax rate (EMTR), which includes reductions in government benefits that occur as income rises as well as increases in taxes paid. Some little-noticed features of Clinton’s education and healthcare policies would have the unintended consequence of raising effective marginal tax rates on middle-class families to levels far above those that top earners would face.

Wednesday, August 31, 2016

How Occupational Licensing Undermines Labor Fluidity, and Who is to Blame

A healthy economy requires a fluid labor market. Even when total employment and output are stable, the labor market is in constant motion. Jobs disappear when firms close or downsize. Other jobs appear when new firms open or old ones expand. People move freely from one job to another in search of career advancement or better fit between their work and their personal lives.

Unfortunately, the US labor market is becoming less fluid. We can trace part of the decrease in fluidity to outside factors like an aging labor force and changing business practices, but much of it stems from ill-considered labor market policies. Of these, one of the most damaging is the spread of occupational licensing over recent decades. As we will see, Democrats and Republicans share the blame.

How can we measure labor fluidity and why do we care?

A paper by Stephen J. Davis of the University of Chicago and John Haltiwanger of the University of Maryland  charts the decline in US labor market fluidity. Using data on quits, layoffs, and job openings from the Bureau of Labor Statistics, supplemented by other data sources, the authors construct three fluidity indicators:
  • The job reallocation rate is the sum of the number of jobs created at new and expanding firms each calendar quarter and jobs destroyed at firms that close or downsize. Newly created jobs include both those that are immediately filled and job openings that become newly available but not yet filled.
  • The worker reallocation rate is the sum of the number of hires, quits, and layoffs. It includes people who move directly from one job to another; those who move from a job into unemployment or out of unemployment into a job; those who leave a job and, at the same time, leave the labor force; and those who enter the labor force and immediately take a job.
  • Churning is the amount by which the worker reallocation rate exceeds the job reallocation rate. If people changed jobs only when their current job disappeared and took only newly created jobs, the rate of churning would be zero. The rate of churning, then, represents job changes that are motivated by career advancement opportunities or personal choices, rather than forced by job creation or destruction.
The following chart from Davis and Haltiwanger shows that all three measures of fluidity have been decreasing in the United States. Their paper includes many more charts showing decreases in other measures of fluidity, decreases in underlying indicators like quits and hires, and decreases by state and demographic group. The decreases in fluidity have been widespread, but they appear to have affected men more than women and less educated workers more than those with college educations. Key aspects of the decline in labor fluidity appear to be unique to the United States, or at least more pronounced here than in other advanced economies.

Monday, May 23, 2016

What Does the Unemployment Rate Measure? Labor Market Slack or the Social Stress of Joblessness? Why Does it Matter?

The unemployment rate published monthly by the Bureau of Labor Statistics is one of the most widely watched of all economic indicators. But why? What does it really measure?

The news media, politicians, and voters tend to see the unemployment rate as an index of the social stress of joblessness. There is ample evidence to support that view. Researchers have linked high unemployment rates to increased mortality and impaired mental health. A recent cross-sectional analysis shows a strong relationship between unemployment  and suicide. There is evidence that unemployment undermines personal relationships, although the impact on divorce rates is ambiguous: A weak job market can break up some couples while leaving others stuck in bad marriages because they can’t afford divorce. Rising unemployment is also associated with higher crime rates, for both violent and property crimes. There is even something called the misery index, which is the sum of the unemployment rate and the inflation rate.

Economists, on the other hand, more often view the unemployment rate as an indicator of economic slack. People who want to work but are not working are a wasted resource. Finding jobs for them would add to GDP. Monetary and fiscal policymakers watch employment indicators closely because the more slack there is in the labor market, the more room there is for economic stimulus without risk of inflation.
The questions we need to address, then, are, first, can the standard unemployment rate do double duty as an indicator of both macroeconomic slack and social stress? And if not, what might be better?

Thursday, April 28, 2016

The Social Safety Net and Work Incentives: Conservative and Progressive Views

One of the most common criticisms of social safety net programs is that they discourage work. As House Speaker Paul Ryan has put it, they risk becoming a “hammock that lulls able-bodied people to lives of dependency and complacency,  that drains them of their will and their incentive to make the most of their lives.”

It is not hard to find examples in which the threat to work incentives is real. Not long ago, in a post on labor market adjustments to trade shocks, I cited a recent report from the Congressional Budget Office, according to which taxes and benefit reductions can claw back as much as 80 percent of each dollar of additional income earned by households whose income is just above the poverty level.

A few days later, however, a reader called my attention to a paper, “It Pays to Work: Work Incentives and the Safety Net,” by Isaac Schapiro and colleagues at the Center on Budget and Policy Priorities. The CBPP team uses the very same CBO data to support the opposite conclusion:
Some critics of various low-income assistance programs argue that the safety net discourages work.  In particular, they contend that people receiving assistance from these programs can receive more, or nearly as much, from not working — and receiving government aid — than from working. Or they argue that low-paid workers have little incentive to work more hours or seek higher wages because losses in government aid will cancel out the earnings gains.
Careful analysis of the data and research demonstrates, however, that such charges are largely incorrect and that it pays to work.
What is going on here? How can it be that the same data support both the view that the social safety net discourages work, and that it does not?

Monday, April 11, 2016

Inversions Strengthen the Progressive Case for Abolishing the Corporate Income Tax

The Obama administration has taken off the gloves in its war on runaway corporations. On April 4, theTreasury released a new set of rules designed to curb “inversions,” a strategy in which a US company cuts its corporate tax burden by merging with a foreign company and moving its official tax residence out of the United States. The pharmaceutical giants Pfizer and Allergan immediately announced that they would abandon their pending mega-billion inversion deal.

The new rules are a change in policy for the administration. At one time, President Obama saw the US corporate tax code as needing deep reform, not stronger enforcement. In his 2011 State of the Union Address, he said:
Over the years, a parade of lobbyists has rigged the tax code to benefit particular companies and industries.  Those with accountants or lawyers to work the system can end up paying no taxes at all.  But all the rest are hit with one of the highest corporate tax rates in the world.  It makes no sense, and it has to change.
So tonight, I’m asking Democrats and Republicans to simplify the system.  Get rid of the loopholes.  Level the playing field.  And use the savings to lower the corporate tax rate for the first time in twenty-five years—without adding to our deficit.  It can be done.
It could have been done, but it wasn’t. Now, instead, Obama seems have adopted the views of progressive icon Senator Elizabeth Warren, as expressed in a speech last November, reported on the progressive website Common Dreams. Warren disagreed with the contention that corporate taxes are too high. She urged Treasury Secretary Jack Lew, who was already working on the new rules, to be sure they were written in a way that increased the amount of taxes that corporations pay:
When I look at the details, I see the same rigged game, a game where Congress hands out billions in benefits to well-connected corporations, while people who really could use a break. . . are left holding the bag.
Only one problem with the over-taxation story: It’s not true. There is a problem with the corporate tax code, but that isn't it. It's not that taxes are far too high for giant corporations, as the lobbyists claim. No, the problem is that the revenue generated from corporate taxes is far too low.
In my opinion, the Obama of 2011 was right, while Warren, and the Obama of 2016, are wrong. Here is why real corporate tax reform—preferably the complete abolition of the corporate income tax—is a cause that progressives should embrace as enthusiastically as do conservatives.

Monday, April 4, 2016

How Reform of the Social Safety Net Could Mitigate the High Costs of Trade Adjustment: A Response to Autor et al.

The two most watched candidates of this presidential election season, Donald Trump and Bernie Sanders, have put anger over the effects of free trade at the center of their campaigns. In doing so, they have won millions of votes.

Many of the arguments they use in their stump speeches are overly simplistic, but the anger is real. And, as Eduardo Porter noted recently, angry voters have a point: New research suggests that economists have long understated the costs of trade and underestimated the time required for the economy to adjust to the trade shocks that rapid growth of both US imports and exports have produced.

If that research is correct, if free trade really causes more pain than we thought, what is the right policy response? Not protectionism, in my opinion, but there are measures we could and should take to ease the pain. Read on.

What the New Research Seems to Show

Jared Bernstein, a Senior Fellow at the Center for Budget and Policy Priorities, points out that how we assess the balance between the costs and benefits of trade depends on whether we view people as consumers or as workers.

Consumers benefit from free trade through lower prices and access to a wider variety of products. The impact on workers is more complex. Some lose jobs at factories that can no longer compete with imports. Waiters at local restaurants lose income when unemployed factory workers stop taking their families out to dinner. At the same time, new jobs open up as trade expands employment in export industries, and as lower prices of imported goods leave consumers with extra money to spend on local goods and services.

The impact on workers depends to a large extent on whether those who lose their jobs to import competition can find their way to the new jobs created elsewhere. To take an example from my last post, suppose consumers save $1.1 billion from cheaper imported tires at the cost of 1,200 jobs lost in the tire industry. At more than $800,000 in gains to consumers per job lost, that sounds like a huge net gain for the economy as a whole. But is it a net gain for Joe, the tire worker? Not unless he quickly finds a new job as good, or nearly as good, as the one he lost.

Monday, March 14, 2016

The Trump-Sanders Bipartisan War on Free Trade

Like most economists, I am strongly inclined toward free trade. I cringe to see the way free trade is under attack, from both parties, during this primary season.

The two populist candidates are the worst offenders. Bernie Sanders, whom I support on many other issues [1] [2] [3], goes off the rails when it comes to trade. Donald Trump, whose policy views are sometimes too vague to pin down, has made clear-cut opposition to “horrible trade deals” a centerpiece of his campaign.

Nor is the pushback from the rest of the field as strong as one might hope. Hillary Clinton has changed her position on the Trans-Pacific Partnership (TPP), which she supported as Secretary of State, and runs away from her previous support for the North American Free Trade Agreement (NAFTA), which she liked well enough when her husband signed it into law. On the Republican side, Ted Cruz, Marco Rubio, and John Kasich all profess to favor free trade in principle, but when pushed, as they were during last week’s Republican debate in Miami, they quickly go on defense, hedging their support for trade with numerous “ifs” and “buts”.

Let’s take a look at some of the candidates’ least defensible arguments against free trade, starting with Trump and moving on to Sanders.

Friday, March 4, 2016

Why the US Needs a Healthcare System More Like Europe

The presidential election of 2016 reopened the healthcare debate in the United States. Republicans were unanimous in urging repeal of the Affordable Care Act (ACA), or "Obamacare," but were vague on a replacement. Senator Bernie Sanders, the most creative of the Democratic candidates, wanted to turn in the other directions. Rather than simply tinker with the ACA, he urged America to abandon it in favor of a healthcare system more like that of other wealthy countries. “The United States is the only major country on earth that doesn't guarantee health care to all people,” Sanders said, “And we end up spending far, far more per capita on health care as do the people of any other country: Canada, U.K., France, whatever.”

Here is why Sanders was right.

What to call it?

Sanders said he wants a healthcare system like those of other wealthy countries—one that provides better results at a lower cost than the one we have. Unfortunately, there is no generally accepted term for all such systems as a class.

Both critics and supporters often call them as “single-payer systems,” but that is not strictly accurate. Other wealthy countries do not all have a single agency would make directly pay healthcare providers with funds from the government budget.  Their plans are surprisingly diverse. Some, like those of Germany and France, funnel payments through multiple independent insurance funds. Others, including those of the UK and Canada, are more decentralized than the “single payer” label suggests even when the government budget is the ultimate source of funds. And, as shown in the following chart from an OECD report, private funding plays a substantial roll in all OECD healthcare systems. Government funds account for just 78 percent of total health expenditures on average, more than in the United States, but far short of “single payer.”

Conservatives describe the healthcare systems of Scandinavia, Germany, France and other wealthy countries as “socialized medicine,” but that term doesn’t uniformly fit, either. Socialized medicine suggests something like Veterans Administration healthcare in the US—a system that not only features a single payer, but one in which doctors are salaried government employees and hospitals are government owned. That description, too, fails to capture the diversity of foreign healthcare systems, where we find a kaleidoscopic mix of salaried and fee-for-service doctors; for-profit, private not-for-profit, and state-owned clinics and hospitals; and both unified and decentralized payment mechanisms.

We could stick with “high performing healthcare systems of other wealthy countries,” but that is too long winded. For this post, I will shorten that to Euro style healthcare, despite the obvious problem that non-European countries like Canada, Australia, New Zealand and Japan also fit the pattern.

Turning from terminology to substance, anyone who favors a Euro-style healthcare for for the United States faces critics both from the left and from the right. Let’s look at what some of them have to say.

Conservative Argument No. 1: The US already has the world’s best healthcare system

Many conservatives think, or at least pretend to think, that the United States already has the best healthcare system in the world, or at least that it did before the advent of Obamacare. Senate leader Mitch McConnell and former House Speaker John Boehner are both on record as having said so. A survey from Harvard University, taken not long before passage of the Affordable Care Act (ACA), found that 68 percent of Republicans (but only 32 percent of Democrats) thought the US healthcare system was the world’s best. To support that belief, conservatives often note that world leaders like former Italian Prime Minister Silvio Berlusconi, Jordan’s late King Hussein, and the Shah of Iran have all sought healthcare in the United States.

Unfortunately, hard data do not support that optimistic view. One of the most detailed recent comparative studies of healthcare systems in wealthy countries comes from the Commonwealth Fund. The following figure shows its ranking of eleven healthcare systems along with data on expenditures per capita (evaluated at purchasing power parity to avoid exchange rate distortions):

The United States ranks last in the fund’s overall evaluation of health care, despite having by far the largest per capita expenditures. The Commonwealth study is not the only one to have reached that conclusion. This earlier post discussed other rankings that agree. (We will return to some of the more detailed findings of the Commonwealth Fund report shortly, but the whole report is worth reading.)

Conservative Argument No. 2: European healthcare saves costs only by severely rationing care

The second conservative myth is that Euro-style healthcare achieves lower costs only by employing a degree of rationing that would be unacceptable to Americans. Here, for example, is David Brooks, writing the The New York Times: 

Sanders would create a centralized and streamlined system. His approach would also, as in Europe, reduce the rate of medical progress, increase the rationing of care, increase the wait times for patients, induce many doctors to retire, and centralize decision-making.

In a recent televised debate, Presidential candidate Ted Cruz put it even more bluntly:

Socialized medicine is a disaster. It does not work. If you look at the countries that have imposed socialized medicine, that have put the government in charge of providing medicine, what inevitably happens is rationing.

Canada is Exhibit A for many who make the rationing argument. Consider, for example, this “explainer video” from Vox, titled “What is Single-Payer Healthcare?” After noting that such a system could save administrative costs, the narrator says, “But there’s a catch.” The catch is said to be longer waiting times and other limits on services, illustrated by a graphic showing that waiting times for health services are longer in Canada than in the United States.

Detailed data from the Commonwealth Fund report show how unfair the charge of rationing is, especially when based on a comparison with Canada. Of the eleven countries covered in the survey, the US ranks last overall, but Canada is next to last. One of the main reasons for Canada’s poor performance is its poor record on measures of rationing, where it has the lowest ratings of the countries surveyed.
  • 48 percent of Canadians reported an emergency room waiting time of over two hours (11th place) compared with 28 percent in the US (7th place) and 14 percent in New Zealand (1st place).
  • 38 percent of Canadian doctors reported that patients had difficulty getting specialized tests like MRIs (10th place) compared to 23 percent in the US (7th place) and 3 percent in Switzerland (1st place).
  • 18 percent of Canadian doctors reported a wait of four months of more for elective surgery (9th place) compared to 7 percent in the US (6th place) and 1 percent in The Netherlands (1st place).
To compare the US with Canada in terms of rationing by waiting, then, is to make a sub-par system look better by comparing it with one that is truly terrible. Most wealthy European countries do better than either of their North American peers when it comes to rationing by waiting, and still manage to spend less.

Instead of rationing by waiting, the American system practices rationing by cost. Relatively few private plans, whether employer-provided or individual, give free access to a full range of providers, drugs, and services. Most middle-class insurance plans steer their members toward hospitals and doctors who are in a preferred provider network and drugs that are on the company’s preferred list. The uninsured often find themselves rationed out of anything but emergency services by high prices.

The burden of rationing by cost shows up clearly in the Commonwealth study:
  • 37 percent of Americans reported that they did not fill a prescription, skipped a test or treatment, or failed to visit a doctor when ill—the worst of all countries. In Canada, the figure was 13 percent, a respectable 4th
  • 28 percent of Americans reported that their insurance company denied payment or paid less than expected for treatments they received, the worst of all countries. In the top ranked countries, Norway and Sweden, the figure was 3 percent.
What is more, the pressure toward rationing by cost is intensifying. A recent New York Times article describes the situation in these terms:

Once emblematic of everything wrong with health insurance, the health maintenance organization is making a grudging, if somewhat successful, comeback. But its reputation for skimping on care has so tainted the plans that the insurers and companies resurrecting them have gone through innumerable steps to try to avoid using the term H.M.O. . . . Despite the stigma and many failed efforts, insurers say they are eager to push a revamped version that revives many of the same features that restrict choices as a way of lowering costs

In short, far from achieving their cost savings through rationing, European systems provide more timely care with fewer people skipping needed services for economic reasons.

Liberal critics also focus on cost

Unlike their conservative counterparts, Liberal critics approve of Euro-style healthcare in the United States, yet many of them seem to have bought into the idea that such a system would be unaffordable. That attitude was on display during the 2016 campaign when supporters of Hillary Clinton turned their fire on Sanders own healthcare plan, which he called Medicare for All.

The most widely publicized critique came from Kenneth Thorpe of Emory University. In this critique, he estimates that Sanders’ plan would be almost twice as expensive as the candidate claims. Instead of leaving most middle class households better off, Thorpe claims the Sanders plan would make 71 percent of households worse off, when the taxes needed to fund it fully are set against savings in healthcare costs.

I find Thorpe’s analysis disingenuous. The problem is that he construes Sanders’ plan in a naively literal way that makes it very different from the healthcare systems of Europe as they actually operate.

The first difference concerns just who pays for what under high quality, low cost Euro style systems. When many Americans think of European healthcare, they assume that the government pays for everything, providing a broad range of services at no charge to the consumer. That is not strictly true, as the chart given above showed. Instead,  the government share of total healthcare expenditures ranges from nearly 90 percent in Sweden and the UK to around 75 percent in Switzerland, compared with a little under 50 percent in the US.

The reasons for the substantial private healthcare expenditures vary from one country to another. Most countries expect copayments for some, if not all, services and medications. In many, people purchase private insurance to cover services not provided in the government’s basic package, for example, private hospital rooms. Some countries do not fully cover dental and vision services. However, it is worth noting that most Euro-style systems have special mechanisms in place to shield low income families from some of these cost-saving measures.

One of the reasons that critics like Thorpe come up with such high cost estimates is that they take at face value the version of the Sanders plan posted on his campaign website. That version promised to “cover the entire continuum of health care, from inpatient to outpatient care; preventive to emergency care; primary care to specialty care, including long-term and palliative care; vision, hearing and oral health care; mental health and substance abuse services; as well as prescription medications, medical equipment, supplies, diagnostics and treatments.”

I do not think we have to take that language literally in estimating the cost of translating Sanders’ political aspirations into a specific program for implementation in the real world. The very fact that Sanders describes his plan as “Medicare for All” suggests that a final version is likely to include deductibles and co-payments similar to those in Medicare as it now exists for seniors. Nor would we need all of the features of the website version of the plan in order to meet Sanders’ often-repeated goal of equaling the quality and cost performance of other countries.

The hard part lies ahead

It is easy to criticize a campaign slogan and to inflate the cost of ambitious aspirations. Liberal critics, who ostensibly share Sanders’ aspirations, ought to put their energies into the hard part—filling in the details that would allow the US to equal the cost performance of the best Euro style healthcare systems without loss of quality.

Including Medicare-style deductibles and co-payments would go a long way toward closing the gap between Thorpe’s estimates of the costs of Sanders’ healthcare plan and the candidate’s own estimates, but it would not entirely close it. There are many other problems to deal with.

Administrative costs are one. The Sanders campaign estimated that administrative savings from his plan would reduce total healthcare spending by 13 percent. Thorpe says it would save 4.7 percent. If we split the difference, the savings would be a little under 9 percent. But reducing per capita healthcare spending to the level of The Netherlands (the most expensive after the US among the eleven covered in the Commonwealth study) would require US spending to fall by 33 percent. To get to the level of the UK (the least expensive of the eleven) would require a 60 percent cut. So, even viewed optimistically, administrative savings are just a start.

A second major saving claimed by the Sanders team comes from lowering the price of prescription drugs. The US currently spends about $300 billion per year, or 10 percent of total healthcare costs, on prescription drugs. Cutting that in half—a truly heroic accomplishment—would save another 5 percent of total healthcare costs.

Beyond prescription drugs and administrative costs, where would the additional 20 to 40 percent saving come from that would be needed to bring US healthcare costs down to the level of the best performing Euro style systems? There are only two possible sources: Cuts in quantity of services or cuts in prices.

Cutting quantities is not as easy as it sounds. To be sure, there are some areas where the US does seem to provide excessive services or procedures. For example, the US rate for Caesarian sections is more than 30 percent, compared to around 7 percent in The Netherlands and Scandinavia. On the whole, however, as healthcare economists like Princeton’s Uwe Reinhart note, the quantity of healthcare services provided in the US is actually lower than in other advanced countries. It does not seem realistically possible to cut service quantities further while extending healthcare coverage to the 13 percent of Americans who remain uninsured, even under the Affordable Care Act, and to do so without any loss in quality of care.

Prices, says Reinhart, are the elephant in the room. US Prices for common medical procedures like appendectomies or normal deliveries average three or four times the levels in Europe. What is more, the prices for such services, or for tests like an MRI or colonoscopy, can vary by a factor of two, three, or more even with in a city. Worst of all, says Reinhart, “Fees in the private health care sector have been jealously guarded trade secrets among insurers and providers of health care.” That makes it impossible for consumers to shop around for the best price, as they would do if they wanted a new set of snow tires.

Liberal critics don’t even pretend to address the problem of healthcare prices. The widely cited Thorpe study simply assumes that prices under the Sanders’ plan would be an average of the prices now paid by private insurers and the modestly lower prices now paid by Medicare.

Any serious healthcare reform, whether it comes from the left or the right, will have to face up to the problem of prices. Unfortunately, there is no single solution. Instead, the problem would have to be approached one piece at a time. Coordinated bargaining for lower prescription drug prices is just a start.

Lowering the prices charged by the most expensive hospitals to those charged by the most effective ones would help—and no, they are not necessarily the same hospitals. A single government payer would have more bargaining power. Greater transparency in pricing would help, too. So would greater competition among hospitals. The present trend toward mergers and consolidations demonstrably pushes up prices.

Another reason for the higher cost of US healthcare services are higher earnings of physicians. US doctors earn considerably more than their European counterparts do, even when we adjust fees for differences in expenses and cost of living. But changing compensation practices for American doctors would not be easy without reforming other pieces of the healthcare complex. European doctors typically receive free education, so they don’t begin practice with tens or hundreds of thousands of dollars in student debt. Entry into medical schools is not as tightly restricted in Europe as in the United States. And less adversarial systems to deal with malpractice claims free European doctors from a major cost item while giving them less incentive to practice unproductive defensive medicine.

The bottom line

It is hard not to conclude that Sanders is right to think that America needs a healthcare system more like those in Europe. True, the campaign version of his Medicare for All plan was more aspirational than operational, but what did other candidates offer? Hillary Clinton proposed building on Obamacare, but there is nothing in the byzantine complexity of the Affordable Care Act that makes it easier to solve any of the cost and price problems we have discussed, and many things that make it harder. Republicans have a field day enumerating the problems of the ACA, but are still struggling to define what they would offer in its place.

This is a substantially revised version of a post from March 4, 2016. The original version is archived here.