It should be no surprise that Krugman considers me a nobody

Posted by Marc Hodak on July 1, 2009 under Collectivist instinct, Regulation without regulators | 10 Comments to Read

In this case, though, I appear to be in good company:

The standard competitive market model just doesn’t work for health care: adverse selection and moral hazard are so central to the enterprise that nobody, nobody expects free-market principles to be enough.

Whenever I see such nonsense, I have to keep reminding myself that the trade theories for which Krugman won his Nobel Prize were explanatory and predictive. Krugman did not win a prize for mechanism design; he could not have predicted E-bay.

The idea of people bidding for stuff they can’t really see from people that they’ve never met is fraught with asymmetrical information. Honest sellers could not hope to compete with liars selling competitive products. Honest bidders could not hope to compete with fraudulent bids that may not be honored. Such a market, failing as it does the test of a “standard competitive market model” could never exist.

Except that it does.

E-bay exists because they managed to attach a credibility mechanism to their bidding process. This mechanism rewards people for neither understating nor overstating the qualities of the items they have put up for bid. It encourages honest bidding.

Krugman, like many Nobel-prize winning economists, won his fame by debunking a “standard competitive market model” of trade. “Standard models” often have a way of becoming obsolete by advances in theory or practice. Adam Smith took it for granted that roads and bridges would have to exist as “public works.” Half a century later, many regions of the United States were laced with private roads and bridges. Markets have evolved competitive models for postal service and telephone, once thought to be public goods.

Krugman pretends that insurance plans are doomed by the existence of adverse selection and moral hazard. Yet we see thriving markets in insurance products of all sorts, including our huge private market in health insurance. One can argue their imperfections, and perhaps blame them on the “free market,” although a free market does not exist for most insurance products, least of all health insurance. But widely-used, competitive insurance products can clearly exist without government–something that ordinary people might one day forget some decades after our health care has become socialized.

To the extent that insurance companies earn a competitive return on selling insurance, everyone is paying a little extra for adverse selection. Krugman might have a problem with that, but I suspect that his real problem regards those people who cannot take advantage of adverse selection, rather than adverse selection per se. Such people with obviously preexisting conditions would simply be prepaying for treatment of those conditions in any kind of market-based insurance plan. I can see how someone might consider that a problem, but it’s not necessarily an insurance problem.

Even real-world markets, unlike the straw man “free market” that Krugman attacks, deal with adverse selection and moral hazard in insuring for every conceivable risk. Mechanisms like deductibles or co-insurance go a long way toward rationalizing insurance economics. Other mechanisms could certainly be developed if the insurance markets weren’t so regulated as to severely curtail such innovation. Why does Krugman suppose that “free markets” cannot evolve more elaborate mechanisms? More importantly, why does he suppose that the government mechanisms will be any more efficient?

The real answer is that Krugman doesn’t have to answer these questions. He can, instead, get away with engaging in name-calling and attacking straw men in advocating for his collectivist vision of a world where the moral hazards of government-run systems are invisible to him.

KipEsquire said,

In real-world markets, the customer is usually the consumer. In health care, the tax code (i.e., not the market) has made employers the customers but employees the consumers. The choices of one cohort do not maximize the utility of the other? Go figure…

In every other (i.e., truly private) insurance market — life, home, auto, etc. — none of these “intractable” problems even exist.

Stated differently, Krugman’s an ass.
Kat said,

One of the biggest problems with what we currently call “health insurance” is that it isn’t insurance at all. It’s simply a third party payer system. Real insurance would only kick in when an illness is diagnosed. Government then magnifies every single problem of insurance and then blames it on the “free market”. Typical.
Daniel Kuehn said,

I don’t understand the argument in your post… that if you accept that asymmetric information can make markets inefficient, you can’t conceive of markets operating in any context where there might be some asymmetric information or that you can’t conceive of emergent institutions to handle asymmetric information?

That seems like an odd way to frame the asymmetric information case… but I must admit – it’s a framework that provides you with a very catchy article title.
Daniel Kuehn said,

RE: “In every other (i.e., truly private) insurance market — life, home, auto, etc. — none of these “intractable” problems even exist.”

Sure they do! They’re just overcome by management by the insurance provider.
Marc Hodak said,

Daniel,

I’m afraid I don’t understand what you don’t understand about what I wrote. I certainly can conceive of emergent institutions to handle asymmetrical information. In fact, I make my living creating such things: http://hodakvalue.com/blog/?p=133

Also, I think “overcome by management” counts as eliminating a problem, if I’m reading you right.
Paul Krugman Could Not Have Predicted Ebay | Economist Blog said,

[…] Hodak Value: Whenever I see such nonsense, I have to keep reminding myself that the trade theories for which Krugman won his Nobel Prize were explanatory and predictive. Krugman did not win a prize for mechanism design; he could not have predicted E-bay. The idea of people bidding for stuff they can’t really see from people that they’ve never met is fraught with asymmetrical information. Honest sellers could not hope to compete with liars selling competitive products. Honest bidders could not hope to compete with fraudulent bids that may not be honored. Such a market, failing as it does the test of a “standard competitive market model” could never exist. Except that it does. E-bay exists because they managed to attach a credibility mechanism to their bidding process. This mechanism rewards people for neither understating nor overstating the qualities of the items they have put up for bid. It encourages honest bidding. HT: Marc’n’NY […]
Daniel Kuehn said,

I know you can conceive of those things – it’s what your whole post is about.

I find it troubling that you assume Krugman can’t conceive of these things – that anyone who raises the issue that there may be a problem with asymmetric information somehow assumes that it can’t be fixed with emergent institutions.

In other words, you seem to automatically assume that you’re smarter than Krugman is if you think that his very identification of the problem of asymmetric information and the value of a government role is a statement that the market is “doomed” in your words.

And that’s really what it comes down to. All Krugman said is that “the market isn’t enough”. You read that as the market is “doomed”. Doesn’t seem like a very fair reading to me.
Marc Hodak said,

Thanks for the clarification, Daniel.

I don’t view this as a “whose smarter” question. I don’t know Krugman, but I know a lot of smart academics, including a few Nobel Prize winners (I teach at NYU), and, trust me, their brilliance has a very specific grain. In fact, being at the top of your field almost assures that you will be incompetent at just about anything outside of it.

It bothers me how much credibility famous people have outside of their specific area of expertise. Having a Nobel in economics does not make you an expert in every area of economics, any more than a Nobel in biology makes you an expert in every area of biology. A well-trained medical resident knows more about drug interactions in the human body than someone who won the Nobel Prize for breakthroughs in genetics.

My specialty happens to be mechanism design. I assure you that I know more about that than Krugman does. I have read more about it than he has, and have seen far more practical applications of it in the real world than he ever could. It’s not a question of smarts so much as particular training and experience.

So, with regards to your proximate point, I don’t really see the distinction between a market failure because the “market isn’t enough” and the market being “doomed” absent some intervention by government. I think he was rather clear on that point. But even granting that there may be a distinction, I am confidently asserting that I can come up with more ideas for market mechanisms to get around the ‘market failure’ than he can because that is what I’m trained to do and he’s not. I also believe that my mechanisms are far more likely to work than the political interventions he is advocating because I have far more experience than he does in implementing mechanisms or interventions. This may be my hubris against his, but I think mine is actually much milder.
Incentives in health care » Hodak Value said,

[…] will argue that asymmetrical information and market imperfections will doom any private system, but they will always lose that argument against someone who can conceive of a mechanism to get […]
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