Health-care reform in America

This is going to hurt

Barack Obama was elected in part to fix America’s health-care system. Now is the time for him to keep his word

DIAGNOSING what is wrong with America’s health-care system is the easy part. Even though one dollar in every six generated by the world’s richest economy is spent on health—almost twice the average for rich countries—infant mortality, life expectancy and survival-rates for heart attacks are all worse than the OECD average. Meanwhile, because health insurance is so expensive, nearly 50m Americans, an obscene number in such a rich place, have none; those that are insured pay through the nose for their cover, and often find it bankruptingly inadequate if they get seriously ill or injured.

The costs of health care hurt America in three other ways. First, since half the population (most children, the very poor, the old, public-sector workers) get their health care via the government, the burden on the taxpayer is heavier than it needs to be, and is slowly but surely eating up federal and state budgets. Second, private insurance schemes are a huge problem for employers: the cost of health insurance helped bring down GM, and many smaller firms are giving up covering employees. Third, expensive premiums depress workers’ wages.

Every rich country faces some of these problems (see article), but nobody suffers worse from them than America. This summer’s debate about health care may determine the success of Barack Obama’s presidency. What should he do?

Uncomfortably numb

If he were starting from scratch, there would be a strong case (even to a newspaper as economically liberal as this one) for a system based mostly around publicly funded health care. But America is not starting from scratch, and none of the plans in Congress shows an appetite for such a European solution. America wants to keep a mostly private system—but one that brings in the uninsured and cuts costs. That will be painful, and require more audacity than Mr Obama has shown so far.

The uninsured are the relatively straightforward bit. All you need do is “mandate” everyone to take out health insurance, much as drivers are legally required to have car insurance. Poorer Americans would get subsidies, and (as with car insurance) insurance-providers would be forced to offer affordable plans and not exclude the sick or the old. This has already happened in Massachusetts as well as in a raft of countries, including the Netherlands, Israel and Singapore. All the main proposals now working their way through Congress include some version of a mandate. Mr Obama opposed a mandate on the campaign trail, but since he has not come up with any plausible alternative, he should quietly swallow one.

The snag is that all these subsidies are expensive. Those congressional plans might cost $1.2 trillion to $1.6 trillion over ten years: the White House is feverishly trying to massage the estimates downward, as well as working out how to plug the hole through various savings and tax increases. But the sticker-shock for the mandate is really just a reflection of the second big problem: the overall cost structure of American health care. Indeed, one of the worst things about Mr Obama’s oddly hands-off approach to health reform (see article) is that he is concentrating on a symptom, not the underlying disease.

A bolder president would start by attacking two huge distortions that make American health care more expensive than it needs to be. The first is that employer-provided health-care packages are tax-deductible. This is unfair to those without such insurance, who still have to subsidise it via their taxes. It also encourages gold-plated insurance schemes, since their full cost is not transparent. This tax break costs the government at least $250 billion a year. Mr Obama still shies away from axing it, as do the main congressional plans on offer; but it ought to go (albeit perhaps in stages).

Perversity on stilts, or crutches

The second big distortion is that most doctors in America work on a fee-for-service basis; the more pills they prescribe, or tests they order, or procedures they perform, the more money they get—even though there is abundant clinical evidence that more spending does not reliably lead to better outcomes. Private providers everywhere are vulnerable to this perverse incentive, but in America, where most health care is delivered by the private sector rather than by salaried public-sector staff, the problem is worse than anywhere else.

The trouble is that many Americans are understandably happy with all-you-can-eat health care, which allows them to see any doctor they like and get any test that they are talked into thinking they need. Forcing people into “managed” health schemes, where some species of bureaucrat decides which treatments are cost-effective, is politically toxic; it was the central tenet of Hillary Clinton’s disastrous failed reform in 1994.

But to some extent it will have to be done. There is solid evidence to suggest that by cutting back on unnecessarily expensive procedures and prescriptions, anything from 10% to 30% of health costs could be saved: a gigantic sum. The Mayo Clinic in Minnesota and the California-based Kaiser Permanente system have shown that it is possible to save money and produce better outcomes at the same time. So reform must aim to encourage more use of managed health care, provided by doctors who are salaried, or paid by results rather than for every catheter they insert. Medicare, the government-run insurance scheme for those over 65, could show the way, by making much more use of results-based schemes and encouraging more competition among its various providers and insurers.

But in the end it will be up to the private health-care system. One thing that should be unleashed immediately is antitrust: on a local level many hospitals and doctors work as price-fixing cabals. Another option, favoured by many Democrats and the president, is for the government to step in with a results-based plan of its own, to compete against the private industry. That could harm innovation and distort the market further. Mr Obama should use it as a threat, rather than implement it now. If the private sector does not meet certain cost-cutting targets in, say, five years, a public-sector plan should automatically kick in. Such a prospect would encourage hospitals and doctors to accept a painful but necessary reform now.

Central banks' exit strategies

This way out

The Federal Reserve weighs plans to unwind its unconventional stimulus

A FIREFIGHTER’S first rule of survival is “know your way out”. The same can be said of financial firefighting. Though it has no intention of exiting soon, the Federal Reserve is planning its path out from the extraordinary measures it has taken to free credit markets and boost demand.

With other central banks, the Fed is under growing pressure to explain its exit strategy in order to allay fears that its policies will produce inflation. On June 2nd Angela Merkel, the German chancellor, launched an astonishing attack on the Fed, the Bank of England and the European Central Bank (ECB) for their loose monetary policies. Mrs Merkel’s outburst, which trampled on a German political tradition of not commenting on the actions of independent central banks, makes life awkward for the ECB, which was due on June 4th to announce details of a plan to buy €60 billion ($86 billion) of covered bonds. But her most pointed barbs were aimed elsewhere. “I am very sceptical about the extent of the Fed’s actions and the way the Bank of England has carved its own little line in Europe,” she said.

The Fed did most to unsettle Mrs Merkel and its other critics when it said on March 18th that it would buy $300 billion in Treasuries by September, plus $200 billion in bonds issued by Fannie Mae and Freddie Mac, America’s two housing-finance giants, as well as $1.25 trillion of their mortgage-backed securities by December. The purchases are meant to drive down long-term interest rates, and at first they did. Ten-year Treasury yields fell to 2.5% from 3%. But by June 3rd they were back up to 3.5%.

Some of this increase is indeed down to higher inflationary expectations. Inflation-protected bonds now imply future inflation of 2%, up from close to zero late last year, according to Barclays. On June 3rd Ben Bernanke, the Fed chairman, put some of the increase in yields down to concern about surging government borrowing.

But the Fed attributes most of the increase in yields to investors abandoning the safety of Treasuries for riskier investments as economic optimism rises. By itself, that is not a reason for the Fed to step up bond purchases, an option it has kept open. “The aim of the programme was mostly to bring down mortgage rates and generate another wave of refinancing, which it did,” says William Dudley, president of the Federal Reserve Bank of New York*. “That said, if the choice were to keep mortgage rates lower for longer or have a recovery, I’d pick the latter.” But there may be a case for the Fed to schedule extra, smaller purchases to avoid a sharp rise in yields when the current programme ends.

The Fed has financed its loans and securities purchases in the past year by creating new reserves for the banking system (in effect, printing money). Reserves have rocketed, to almost $900 billion now from an average of $11 billion in the year to September. Many analysts see these excess reserves as a pool of inflationary fuel just waiting for the match of credit demand.

The Fed considers this analysis flawed. It sees excess reserves as a problem only if they overwhelm its ability to raise the federal funds rate when need arises. That risk has shrunk since the Fed received authority in September to pay interest on reserves, as other major central banks have long been able to. That in theory should put a floor under the Fed funds rate. Banks should not lend excess reserves at, say, 1%, if they can earn 2% from the Fed.

That said, the Fed cannot be certain that paying interest will work as planned, so it would also like to be able to soak up some reserves. Some were created by the Fed’s myriad loans to banks, issuers of commercial paper and others to unfreeze the credit markets. Those liquidity facilities charge borrowers a penalty rate which makes them less attractive as private credit returns. That is now happening, and the liquidity facilities have begun to shrink (see chart). The Fed could hurry that process up by raising the penalties.

Managing its growing securities holdings will be tougher. The Fed could simply sell them but that would create waves. “The day you sell will be a big market event,” says Mr Dudley. “Historically, the Fed has been buy and hold.” Since the average maturity of the Fed’s bond holdings is five to ten years, the Fed will have to find a way to mop up, or “sterilise”, the related bank reserves for a long time. The usual approach is to conduct reverse-repurchase agreements, borrowing from one of its 16 primary dealers for short periods of time in order to finance the assets on its balance-sheet. But dealers may not have the necessary capacity for the task.

The Fed is currently absorbing reserves by having the Treasury issue more debt than it needs. When dealers purchase the debt, cash shifts from their reserves accounts to Treasury deposits at the Fed, where they remain, unspent. But the Treasury itself is constrained by the debt ceiling set by Congress, and an independent central bank should not rely on the fiscal authority for one of its tools.

A better solution would be for the Fed to issue its own bills, as other central banks do. It could rely on a wider variety of investors, not just primary dealers, to manage its balance-sheet. It would restrict the maturity of such bills to less than 30 days to avoid interfering with Treasury’s longer-dated issuance. The hitch is that Congress has to authorise it. It may come to that. “As long as people are worried about whether we have adequate tools, it makes sense for us to get more tools even if we don’t think we need them,” says Mr Dudley.

This Tax Is for You

A levy on Joe Six Pack.

Today is the dreaded April 15, but at least in Oregon it's even going to cost you more to drown in your tax sorrows. In their sober unwisdom, the state's pols plan to raise taxes by 1,900% on . . . beer. The tax would catapult to $52.21 from $2.60 a barrel. The money is intended to reduce Oregon's $3 billion budget deficit and, ostensibly, to pay for drug treatment.

If it passes, Oregon will overnight become the most taxing state for suds, one-third higher than the next highest beer tax state, Alaska. The state may do this even though Oregon is the second largest microbrewery producer in the U.S. The beer industry and its 96 breweries contribute 5,000 jobs and $2.25 billion to state GDP. Kurt Widmer of Widmer Brewing Co. says the tax would "devastate our company and small breweries throughout the state." Adds Joe Henchman, director of state projects at the Tax Foundation, "This microbrewery industry has gravitated to Oregon in part due to low beer taxes."

For Oregon to enact punitive taxes on its homegrown beer industry makes as much sense as Idaho slapping an excise tax on potatoes or for New York to tax stock trading. Even without the tax increase, taxes are the single most expensive ingredient in a glass of beer, according to the Oregon Brewers Guild.

But Democrats who run the legislature are desperate for the revenues to help pay for Oregon's 27.9% increase in the general fund budget last year. If they have their way, every time a worker steps up to the bar and orders a cold one, his tab will rise by an extra $1.25 to $1.50 a pint. Half of these taxes will be paid by Oregonians with an income below $45,000 a year. Voters might want to remember this the next time Democrats in Salem profess to be the party of Joe Six Pack.

Co-operatives

All in this together

How is the co-operative model coping with the recession?

THESE are difficult times for the Fagor appliance factory in Mondragón, in northern Spain. Sales have seized up, as at many other white-goods companies. Workers had four weeks’ pay docked at Christmas. Some have been laid off. Now salaries are about to be cut by 8%. Time for Spain’s mighty unions to call a strike? Not at Fagor—for here the decisions are taken by the workers themselves.

Fagor is a workers’ co-operative, one of dozens that dot the valleys of Spain’s hilly northern Basque country. Most belong to the world’s biggest group of co-operatives, the Mondragón Corporation. It is Spain’s seventh-largest industrial group, with interests ranging from supermarkets and finance to white goods and car parts. It accounts for 4% of GDP in the Basque country, a region of 2m people. All this has made Mondragón a model for co-operatives from California to Queensland. How will co-ops, with their ideals of equity and democracy, cope in the recession?

Workers’ co-ops are often seen as hotbeds of radical, anti-capitalist thought. Images of hippies, earnest vegetarians or executives in blue overalls could not, however, be further from reality. “We are private companies that work in the same market as everybody else,” says Mikel Zabala, Mondragón’s human-resources chief. “We are exposed to the same conditions as our competitors.”

Problems may be shared with competitors, but solutions are not. A workers’ co-op has its hands tied. It cannot make members redundant or, in Mondragón’s case, sell companies or divisions. Losses in one unit are covered by the others. “It can be painful at times, when you are earning, to give to the rest,” Mr Zabala admits. Lossmaking co-ops can be closed, but members must be re-employed within a 50km (30-mile) radius. That may sound like a nightmare for managers battling recession. But co-ops also have their advantages. Lay-offs, short hours and wage cuts can be achieved without strikes, and agreements are reached faster than in companies that must negotiate with unions and government bodies under Spanish labour law.

The 13,000 members of Eroski, another co-operative in the Mondragón group and Spain’s second-largest retailer, have not just frozen their salaries this year. They have also given up their annual dividend on their individual stakes in the company. A constant flow of information to worker-owners, says Mr Zabala, makes them ready to take painful decisions.

It sounds conflict-free, but that is misleading. One of Mondragón’s many paradoxes is that worker-owners are also the bosses of other workers. People have been hired in far-flung places, from America to China, as the group has expanded. It now has more subsidiary companies than co-operatives. Mondragón has two employees for every co-op member. The result is a two-tier system. And when recession bites, non-member employees suffer most. They are already losing jobs as temporary contracts are not renewed. Like capitalist bosses, the Mondragón co-operativists must, indeed, occasionally handle strikes and trade-union trouble.

Some worry that Mondragón-style success kills the idealism on which most co-ops are based. Those within the Mondragón group are aware of the danger. Eroski wants to offer co-op membership to its 38,500 salaried employees.

The most successful co-ops, however, are those least shackled by ideology. Mondragón used to cap managers’ pay at three times that of the lowest-paid co-operativist, for example. But it realised it was losing its best managers, and that some non-member managers were earning more than member managers. The cap was raised to eight times. But this is still 30% below market rates, and some managers are still tempted away. “Frankly, it would be a bad sign if nobody was,” says Adrián Celaya, Mondragón’s general secretary.

Lately Mondragón has had trouble keeping successful co-operatives locked in. Irizar, a maker of luxury coaches, split off last year, reportedly because it no longer wanted to support lossmaking co-ops elsewhere in the group.

Henry Hansmann, a professor at Yale Law School, says co-ops often fall apart when worker-owners become too diverse. He points to United Airlines—not a co-operative, but once mainly owned by workers from competing trade unions—as an example of how clashing interests can kill worker ownership. By bringing in tens of thousands of new members at Eroski, many far from the Basque country, Mondragón risks falling into that trap. The group’s bosses believe, however, that the way forward is to promote the idea that co-operativism brings advantages. The global downturn may strengthen the group internally. As unemployment sweeps the globe, after all, there is no greater social glue than the fight to keep jobs.