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Identifying Sources of Cost Disease (kurtsp.com)
66 points by kespindler on June 26, 2017 | hide | past | web | favorite | 37 comments



Here's a major one the article missed: short-sightedness.

In industry and commerce, that may be optimizing for short-term cost-cutting over long-term efficiency.

In education, that might be standards and incentives that lead schools to "teach the test" so the teacher/school gets a positive evaluation this semester - rather than investing in teaching how to learn or instilling a love of learning.

In healthcare, that might be high costs and bureaucratic obstacles that deter people from seeking evaluative and preventative care - at the cost of much more expensive later-stage treatments down the line.

In real estate, it could be crappy building materials and lower standards of craftsmanship that help build faster and cheaper but result in more problems and higher utility and eventually maintenance costs down the line.

In infrastructure, it can be deferring maintenance so you can cut taxes - resulting in more expensive repairs when things fall apart completely for want of a bit of paint or grease.

And so on ad nauseum.


In quality circles this is known as cost of poor quality. We might need Deming type thinking again to counter the short term thinking.

* Deming's chain reaction: *

http://www.transformationforum.org/Chain_Reaction.html


I think the problem is that the neoclassical theory of perfect competition is just flatly wrong, and markets actually tend to monopoly (oligopoly) pricing over time. (So the "perfect competition" is more an exception than a rule in the real world.) There is plenty evidence for this, see e.g. Keen & Standish: http://www.albany.edu/~gs149266/Keen%20&%20Standish%20(2006)...

One simple way to see this, really, is to consider a simple example (curiously omitted from economic textbooks) of a supply chain: You have two markets and three entities - producers, distributors and consumers, where producers sell to distributors and distributors sell to consumers. Now consider, in the case of competition, what should be the margin of the distributor in the equilibrium? That is, why should all the cost decrease be propagated to the consumers?

In reality, "equilibrium" prices are probably oligopolistic determined by some "relative market power", which is really about how much you can "screw" your customers. And health care and education are matter of life and death for most people, so yeah, high prices, unless there is a big factor that will put an end to that (which happens outside the U.S. through regulation and government price negotiation).


>And health care and education are matter of life and death for most people, so yeah, high prices

Food is also a matter of life and death.

The difference between food and healthcare/education is that the former is not as heavily subsidised as the latter.

>And health care and education are matter of life and death for most people, so yeah, high prices, unless there is a big factor that will put an end to that (which happens outside the U.S. through regulation and government price negotiation).

This is incorrect. The cost disease is a global phenomenon affecting most advanced economies.


> Food is also a matter of life and death.

And we have a pretty well established cultural understanding that you don't let people starve, no matter how poor they are. And yet somehow the equivalent understanding that you don't let people die of preventable diseases, no matter how poor they are, is somehow controversial.


It's not the preventable diseases that are the most costly to treat. But regardless of semantics, I know what you mean. The reason is that the consequences of guaranteeing everyone enough food are different than the consequences of guaranteeing everyone top-of-the-line (i.e. doing everything we can to keep sick people alive) healthcare.

Food has become so cheap that almost everyone can afford enough to eat without direct subsidies (e.g. indirect subsidies, like welfare payments, are enough). So such an understanding doesn't result in the creation of pervasive government programs that utterly dominate the market for food and inflict it with the cost disease.


> Food is also a matter of life and death.

I think that's because you can grow your own food, and you can also buy it from abroad. Not so much with health care or education (because it's a service, not a physical product).

So you can be (at least in the U.S.) screwed less over food than over health care.

I agree that I don't have a complete picture, but at least, people should consider evidence for this theory.

> The cost disease is a global phenomenon affecting most advanced economies.

The problem is, the economies that have strong government actor working on behalf of consumers (either in the form of regulation, or a public corporation that competes in the market too) are actually affected less.


>The problem is, the economies that have strong government actor working on behalf of consumers (either in the form of regulation, or a public corporation that competes in the market too) are actually affected less.

I don't see any evidence for that. A couple counter-examples: Singapore and developing countries like India and China have more market based healthcare systems than Western Europe and the US, and spend far less on healthcare as a percentage of GDP. India and China are making significant gains in life expectancy, but that may be explained away by the fact that they're starting from a lower level. Singapore however has a higher life expectancy than European countries.

The US is the outlier, with approximately half of healthcare spending being private, yet spending a very high percentage of GDP on healthcare. But I would argue that much of this 'private' is quasi public, as it's a manufactured outcome as a result of significant intervention by state and federal governments, like tax incentives for employers to provide healthcare through large insurance companies, and state mandates requiring health insurance to be comprehensive.

The fields of medicine in the US less subsidized via these kinds of interventions; cosmetic and laser eye surgery, have seen prices increase at below the rate of inflation.

The key is that people pay out of pocket for cosmetic and laser eye surgery:

http://healthblog.ncpa.org/why-cant-the-market-for-medical-c...

The government intervention in the private US healthcare system encourages exactly the opposite.

Also with respect to US healthcare spending, it's worth mentioning the US is a higher income country than other OECD countries, and there seems to be a trend toward healthcare spending as a percentage of GDP increasing with level of wealth, independent of all other factors. The US does have a more capitalised healthcare system, with more diagnostic equipment and advanced treatment centres for things like neonatal care. Often not mentioned is that the US has some of the best cancer survival rates in the world.

Mind you, the US is definitely suffering from the cost disease in healthcare, but the relatively higher wealth level of the US may explain the difference with Europe.


It's also worth noting Singapore is certainly not a market-based system. Singapore's healtcare efficiency is completely the result of mandatory saving programs, a government funded insurance scheme for the poor and strict price controls[1].

As for China frankly I don't think anybody would seriously want to replicate what passed for healthcare in China. It's disturbingly common for patients to die because they cannot afford even routine surgeries in China.

[1] https://en.wikipedia.org/wiki/Healthcare_in_Singapore#Fundin...


Singapore's healthcare system is more market based than the EU's, and other than the guarantee of government coverage (despite spending much less per capita on its public healthcare program than the US), than the US's.

The mandatory health savings accounts are not redistributive. Each account is funded by the individual that makes use of it. And the individual decides how much to spend out of it, and with which provider, so it turns the individual into a price-conscious consumer. In the US, leftists would call such a program 'regressive' and a form of privatisation.

So for the reasons mentioned, I think it's reasonable to suspect that the relative efficiency of Singapore's healthcare system is due to the greater role that market forces play in it.


I am not all that familiar with Singapore's health care, but just a cursory look at Wikipedia reveals that it's not really that much market-based, it looks quite similar to most European countries, really.

> there seems to be a trend toward healthcare spending as a percentage of GDP increasing with level of wealth

This can be expected under my model, too. The monopolistic prices depend on the demand curve, which depends on the level of wealth.


Private spending constitutes a larger portion of healthcare spending in Singapore than in the US. Also, much of that private spending is out of pocket:

https://thehearttruths.files.wordpress.com/2013/10/slide4-1....

Which is very unlike the US, where, as a result of government intervention, spending through insurance companies is the norm.


> A couple counter-examples: Singapore and developing countries like India and China have more market based healthcare systems than Western Europe and the US, and spend far less on healthcare as a percentage of GDP.

I think this is far more to do with the fact that they're developing countries than the economic structure of their healthcare systems.


I mention that possibility in the very next sentence and also point out that Singapore has a higher life expectancy than EU countries.


"Cost disease" has affected some large sectors in the US economy for the last 5 or so decades, but not most other countries, and not the US before that.

Your general assertion about competition not working proves too much. If true, it would affect all market economies all the time.


The claim is not about "competition not working", the claim is about the price. It's actually quite tricky to determine whether the price level corresponds to monopolistic or marginal cost price, because it depends (in neoclassical theory, at least) on supply and demand and these are often not known. So people can easily mistake the (actual) monopolistic price for the (expected by neoclassicals) price at marginal cost, and I would argue they often do.

And there are other mechanisms, in play, too. For example, if there is friction in the market, and it often is, then the prices can be lower due to competition for market share.


I still don't see anything in this argument that is specific to the affected sectors of the economy in the last half century US.

If you're right, you might win a Nobel Prize in Economics, but I don't see how you've explained Cost Disease.


IMHO, the affected sectors are specific because they are very hard to substitute. Ordinarily, when prices start to grow towards monopolistic price, the demand curve will shift (due to substitution) to counter this effect. But these sectors have demand curves that cannot be shifted easily, and so they seem as a special case, but in fact they are not.

Speaking of Nobel prize, I think Steve Keen deserves one (and maybe two), but he will never get one, unfortunately.


Very interesting observations and a very complex subject with many factors.

One theory of economics is that it only actually works if very few of the market participants act like rational economic actors.

In the example of higher education, for instance, universities used to be a great value for students. Now they are approaching break-even on average in terms of cost-benefit for students, with some students losing and some winning.

That is a market based outcome and is exactly what a market should do but people don't like it.

In the past maybe professors and administers thought in non-market ways, such as that they should impart knowledge for the good of society, etc, etc, as opposed to rationally optimizing their income.


> That is a market based outcome and is exactly what a market should do but people don't like it.

Maybe... whispers maybe not everything is best determined by the free market?


A break-even cost-benefit is not a market based outcome.


Serious question: do any reputable economists besides Tyler Cowen believe in cost disease?


Cost disease is definitely a real thing but you should be very wary of the diagnoses proposed by these amateur (libertarian) bloggers. Even a cursory analysis reveals that attempts to blame regulation, utilization, or government spending do not hold water -- all you have to do is compare the US to France, Germany and Japan.

A more plausible theory is that cost disease is largely due to (1) regulatory capture and weak institutions, (2) coordination costs between various institutions and (3) what ultimately boils down to corruption (public officials acting with private interests). If you really want to understand rising costs in health-care, military, and construction you should pay close attention to the rise in outsourcing and pseudo-government agencies (eg US defense contractors, supposedly "private" corporations where 70%+ of revenue comes from the government).

France, Japan, China -- these are in fact highly centralized economies which means that they are able to operate national, robust healthcare and military systems with surprising efficiency. UK, Brazil, India and of course the USA (par excellence) -- these are highly decentralized and federalized economies which means large scale initiatives are very prone to succumbing to the dangers referenced above.


> attempts to blame regulation, utilization, or government spending do not hold water

Agreed. These amateur ideologues latch onto anything that seems to support their beliefs with very little hard thinking.

> ultimately boils down to corruption ... highly decentralized and federalized economies

Maybe, but Western nations are arguably more centralized today compared to 50 years ago.

70 years ago the US won a world war and rebuilt Europe and Japan. 60 years ago the US built the interstate highway system. 50 years ago the US put people on the moon.

Can you imagine the US doing any of these things today? Today we can't win a war in one country (not to mention fighting in the Pacific and Atlantic simultaneously).

The space shuttle is gone with no replacement.

And we can't even maintain the roads and bridges that our grandparents built from nothing.

These were years with great decentralization and with no computers. Organized crime played a much larger role in the economy.

What's changed in the last 5 or 6 decades?


> 60 years ago the US built the interstate highway system.

I think this is the point. The US spent roughly half a trillion dollars to build ~40,000 miles of road. There was a great deal of corruption as well as massive political conflict between federal, state and city agencies. Compare this to what the Nazis did in 1935 when the government hired 150,000 men and put them to work and finished construction five years later.

The point here isn't that decentralization is bad. But it's not difficult to see why these large federalized states like the US, India, Brazil do infrastructure so poorly.

> What's changed in the last 5 or 6 decades?

The rise of highly sophisticated private actors that are, in fact, very, very good at extracting public monies. This is most visible in the military where the cost of outsourcing is so obscene that even Congress cannot deny it and now "in-sourcing" is a thing -- but really it afflicts almost everything the government does. This combination of decentralized, unsophisticated, weak government actors trying to match wits with highly sophisticated, numerate private actors is, in the end, a recipe for pillaging of the public treasury. (In fact one could argue that the 2008 global financial crisis is ultimately the best example of such pillaging.)

Another way to look at this is to understand that what people call "cost disease" is the other side of the growing pricing power of private firms. And, ultimately, these firms can charge such high prices because they have worked very hard to guarantee that governments will pay them. (See eg Medicare where by law the program cannot negotiate prices.)


>France, Japan, China -- these are in fact highly centralized economies which means that they are able to operate national, robust healthcare and military systems with surprising efficiency.

France and Japan are suffering from the cost disease. China's healthcare system is more private than the US system. It's also pretty primitive at the moment so not a great point of comparison.

I think your cursory analysis is sloppy.

>amateur (libertarian) bloggers

Ah the irony..


I think most do... Can you point to some that don't?


It is, unfortunately, impossible to prove a negative, not that that's ever stopped anyone from trying. For example, though, a cursory Google turns up no instances of Paul Krugman or Larry Summers mentioning it, which I would expect for something which "most economists" understood to exist.


When I read Scott Alexander's post I couldn't shake the notion that he could have saved himself a lot of writing if he simply read up on how CPI is calculated and noticed that it's a very limited measure of real inflation.


I don't think saving himself writing is high on the list of that dude's motivations. :P


What real inflation measure should he have used?


What writing exactly could he save himself? I'm confused.


The main concept this is completely neglecting is economic rent.


Here is an example: School district budget: 11.3m

Salaries: 4.5m

Benefits: 3m

That's for ~220 students and ~30 full time teachers...

http://www.edline.net/files/stream/5D3207F7E11684C4-0000015B...


Request URL is not accessible. Try logging in to access the resource.

$51K is being spent per student per year? And $150K salary and $100K benefits per teacher? Even if there is a school district with that budget, it is hardly representative of most school districts.


http://www.edline.net/pages/Shelter_Island_UFSD/Board_of_Edu...

they have some part time teachers - but that is about the gist of it...and the outcomes not super impressive for the money...


The cost disease can't be cured gracefully, for too many people have a vested interest in maintaining the delusion that government is not inefficient.

The source of the cost disease is the growing control of government over sectors of the economy.

In education:

https://academic.oup.com/qje/article-abstract/111/3/671/1839...

In healthcare, the cost disease began when Medicare programs began being created around the world.

Even within sectors, we see the pattern. For example, the two fields of medicine which have seen the least cost growth are cosmetic [1] and laser eye surgery. Not only have costs risen the least, but the quality of some procedures in these fields has improved tremendously over the last two decades. Both are electives, so there are fewer mandates requiring that they be covered by insurance and fewer redistributive programs to subsidise them.

[1] http://healthblog.ncpa.org/wp-content/uploads/2013/06/HA1-06...




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