Brad DeLong attempts a Theory of Mind task:
Tyler Cowan [Cowen] would probably say: tough. If you were born with a tendency toward high cholesterol you ought to have known that by age 20 and been busily saving all your life in order to pay the extra expected costs of treating your heart diseases. But I don’t think the rest of us are willing to say that a bad dice roll in the genetic lottery plus an absence of foresight should doom you to an early, untreated death.
Since I believe none of that, I will offer no grade. Nor do I believe in privatizing Medicare, as another part of Brad’s post (“In Tyler Cowen’s world, those who want to buy Medicare almost surely cannot. The market to sell and buy medical risk is unlikely to exist.”) seems to suggest and it was only last week that I distinguished my view from this, endorsing the Yglesias-Krugman argument that privatized vouchers bring higher costs.
I do believe in a core set of Medicare services, topped off with the ability to choose how much of your extra benefit comes in the form of either Medicare or Social Security benefits (cash). It is nonetheless an interesting question whether that system would encounter adverse selection as a major financial problem. A few points:
1. When it comes to the elderly, adverse selection as a problem is overstated. The real problem is usually a high degree of information about many conditions, so often insurance is difficult per se. It’s not the asymmetry of information that is the core issue, it is the existence of lots of information, and that is one of Arrow’s subtler points. That distinction matters a good deal for mechanism design.
2. An old person might know better his health care condition, but not know better his expected health care costs. That is a critical distinction. You can’t reach age 60 and credibly say: “I’ve been healthy so far, I guess my lifetime health care costs will be low.” It’s not even clear whether the healthy or the unhealthy will have lower health care costs in their later years; the unhealthy might die rather quickly and decisively. Adverse selection on the grounds of health care costs need not be high and arguably actuaries can estimate those as well as the individual himself.
3. Perhaps most importantly, adverse selection in this context doesn’t have to be a problem; if low cost people take some cash it could be that the system is working well (if only on grounds of equity), not badly, and remember this is all tax-financed.
4. You can imagine patients visiting a combined doctor/financial analyst service at age sixty and asking for the best information and whether they should take the cash or the fuller Medicare package, possibly leading to adverse selection in terms of program finances. But a lot of people don’t listen to their retirement planners either.
5. When choosing a future benefits package, if impatience for cash (one cognitive bias) outweighs overestimation of the value of medical care (another cognitive bias), my preferred system will work not so well. If the net bias is runs the other way, the system will capture some but not all available gains from trade.
6. The general approach of “give everyone some basic benefits for free, and then allow everyone to top off at some opportunity cost” applies to food (food stamps), education (free K-12), housing, and now, with ACA, to health coverage for the non-elderly, among other areas. And yet many people think the approach is morally outrageous. The correct way to proceed is not to lash out, but to start by admitting in which spheres the approach makes sense, and then seeing how far outwards those arguments can radiate.