Aggregate Demand vs. Structural Unemployment

October 26, 2010 by

The U.S. unemployment rate has been stuck in the range of 9.5% to 10% since the beginning of the year, with many uncounted discouraged workers and many underemployed part-time workers.  Does this mean that we have structural unemployment?  Brad DeLong published a short paper today[i] arguing that our unemployment problem is currently due to inadequate aggregate demand, not structural unemployment.

DeLong explains that if we suffered from structural unemployment, then some sector such as construction would have high unemployment but another sector such as manufacturing would be booming and employers would be seeking qualified workers without success.  The actual situation, DeLong argues, is that almost all sectors of the economy have seen significant declines in employment, which is a symptom of inadequate aggregate demand.

Paul Krugman argued as usual yesterday that the $800 Billion American Recovery and Reinvestment Act of 2009 was wholly inadequate, providing mainly tax cuts, unemployment extensions and meager aid to state and local governments that was barely enough to offset declining state tax collections in the short term and not nearly enough to compensate for the precipitous decline in demand in the private sector in 2008-2009.[ii]

This does not mean that we are not in danger of falling into the trap of structural unemployment.  If the current high rate of unemployment persists for two or three more years, the long-term unemployed will lose their skills and become unemployable.  Then we will be in a worse economic mess than we are in now.  That is the danger of electing a Republican majority in Congress, which will block any further proposals by President Obama to stimulate the economy.

I reiterate the reasons for high unemployment in the U.S.[iii]

  1. Inadequate aggregate demand.
  2. Migration of jobs to other countries, especially China.
  3. Increased productivity of employed workers.
  4. Inadequate credit for small businesses.
  5. Uncertainty about future taxes and regulations.

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Trade Friction with China

October 20, 2010 by

There have been several developments since I posted two weeks ago about jobs and industries being shipped overseas.  (“Causes of High Unemployment in the U.S.”)

The United States has ramped up the pressure on China to revalue its currency. Yesterday, Treasury Secretary Tim Geithner reiterated to a gathering in Palo Alto that the Chinese renminbi is significantly undervalued (despite a 3% revaluation over the past month or so).  He said that he is postponing the scheduled report on whether a major trading partner has been unfairly manipulating its currency value; he wants to coordinate his strategy with other aggrieved countries at the coming G-20 meeting in South Korea.

This is not first excuse Geithner has had for not publishing an accusation that China has been manipulating its currency.  Is he afraid of Chinese retaliation?  In the past, there has been speculation that the Chinese could retaliate by selling U.S. bonds, driving down the dollar.  Indeed, the dollar has declined about 7% against the euro and other currencies in the last two months, but not against the renminbi.  Is makes little sense to fear a potential Chinese action that would make the U.S. companies more competitive in international markets.  However, the Chinese have a more effective means of retaliation.

Last Friday, American trade officials announced that they would investigate whether China was violating international trade rules by subsidizing its clean energy industries. The inquiry includes whether China’s steady reductions in rare earth export quotas since 2005, along with steep export taxes on rare earths, constitute illegal (under WTO rules) efforts to force multinational companies to produce more of their high-technology goods in China.  The Chinese did not like that announcement, and they did not wait for the outcome of that investigation.

On Sunday evening, in an extremely rare move for a senior Chinese official, the country’s top energy policy maker, Zhang Guobao, called in reporters from international media organizations and objected to the American announcement.  Hours later, according to the New York Times[i], Chinese customs officials began singling out and delaying rare earth shipments to the West.  Today China denied that it had halted sales of rare earth shipments[ii], but the threat of a future cutoff has been duly noted.

Rare earth production is another example of the failure of American laissez faire economic policy in the face of competition from Asian managed economies.  Rare earths are important in the production of many high technology products, from advanced fighter avionics to high temperature superconductors to windmill blades.  China has about 30 percent of global rare earths deposits but accounts for about 97 percent of production. The U.S., Canada and Australia have rare earths but stopped mining them in the 1990s.

Just as consumer electronic industries moved to Asia, rare earth production moved to China over the last two decades because of lower costs.  Congress is considering legislation to provide loan guarantees for the re-establishment of rare earth mining and manufacturing in the United States, but new mines will probably take three to five years to reach full production.  Meanwhile, China will have an advantage in the production of high technology products, including clean energy products.

In his Palo Alto discussion, Secretary Geithner said he opposed the import tax on Chinese products advocated by Andy Grove (and that would be enabled by legislation that passed the House of Representatives recently) because that would provide subsidies to inefficient American companies as well as raising prices for consumers.  Geithner did not discuss Grove’s analysis of the need to rebuild a manufacturing infrastructure in order to compete in the development and production of new high technology products.

Our trade imbalance with China, largely due to the undervalued renminbi, remains a factor in the high unemployment in the United States.


Causes of High Unemployment in the U.S.

October 4, 2010 by

There has been an extensive and prolonged discussion in the media about the high unemployment in the United States since 2009.  Some commentators have focused on one cause, some on another.  This article discusses five causes of the current high unemployment, in the order of their importance:

  1. Inadequate aggregate demand.
  2. Migration of jobs to other countries, especially China.
  3. Increased productivity of employed workers.
  4. Inadequate credit for small businesses.
  5. Uncertainty about future taxes and regulations.

Aggregate Demand

Aggregate demand is the demand for goods and services from both the private sector and the public sector.  Demand in the private sector declined precipitously in the Fall and Winter of 2008-2009.

During the period from 2001 to 2007, average household income was stagnant, but there was a housing bubble, with housing prices in some areas doubling.  Homeowners felt wealthier and were able to refinance their homes or take home equity loans to maintain and improve their standard of living.  Banks created complex financial instruments based on mortgage loans, which were widely distributed in the belief that spreading the risk would somehow reduce the risk.  When the housing prices started falling, demand fell and the recession started, officially in the fourth quarter of 2007.

Falling housing prices led to financial crisis, epitomized by the bankruptcy of Lehman Brothers in September 2008.  Financial institutions no longer trusted each other, and the shadow banking system collapsed.  Households and businesses could not get loans.  The decline of housing prices and the tightening of loan standards meant that home equity loans became much more difficult to obtain.  Private-sector borrowing plunged from 28% of GDP in 2007 to minus 17% of GDP in 2009.  Layoffs began.   As unemployment increased, people did not have money to spend, and the economy spiraled downward.

The federal government acted to prevent a depression.  The Federal Reserve stepped in as the lender of last resort and provider of liquidity for many types of credit markets, increasing its assets from $900 billion to $2.3 trillion.

At the request of President George W. Bush and his treasury secretary, Hank Paulson, the Congress approved the $700 billion TARP program.  Treasury used the TARP funds to buy preferred shares in major banks, some of which were threatened with insolvency, as well as to rescue AIG, General Motors and Chrysler.   Most of the TARP funds has been or will be repaid to the Treasury.

At the request of President Barack Obama, the Congress passed the American Recovery and Reinvestment Act of 2009.  This act included $288 billion in tax cuts, primarily for the middle class.  The Congressional Budget Office originally scored the cost at $787 billion, but the tax cuts, unemployment insurance and Medicaid cost sharing with states have pushed the anticipated expenditures above $800 billion, of which about $533 billion has already been spent.  The Recovery Act has created or saved 2.5 to 3.6 million jobs.  However, 8 million jobs were lost in the recession that started in 2007, and the federal stimulus from the Recovery Act was not enough to reduce unemployment below its current level of 9.6%.

The national recession and weak recovery have produced both declines in state and local revenues and increased need for public programs as residents lose jobs, income, and health insurance. In the 2009 and 2010 fiscal years, the imbalance between available revenues and what was needed for services opened up budget gaps in most states. The Recovery Act gave states roughly $140 billion over a two-and-a-half year period to help fund ongoing programs, including K-12 education, higher education, and health care. However, the federal assistance will run out soon.  Most states have now addressed significant budget shortfalls in enacting their 2011 budgets and even more budget gaps are projected for fiscal year 2012. Total shortfalls for 2011 and 2012 (both those that have been addressed and that have yet to be closed) are likely to reach some $260 billion.  The shortfalls would be even higher in the absence of federal Recovery Act aid and the $24 billion state-aid bill to extend support for education and Medicaid for six more months.  Without additional federal aid and if states continue to cut spending as they have in the current fiscal year, the national economy is projected to lose up to 900,000 public- and private-sector jobs.[i]

To get the economy growing again, four out of five economists interviewed by Bloomberg Business Week agree the federal government should increase infrastructure spending.   There are thousands of unsafe bridges thousands of miles of railroad tracks that urgently need repair or replacement.  Our ports are vulnerable to terrorist attack.  Our national electricity distribution grid is a hodgepodge of outdated equipment, vulnerable to both natural and manmade disasters and urgently in need of redesign and upgrade.  The private sector is not going to take the initiative to do it, but the private sector will benefit greatly if the federal government funds and contracts with private companies to fix the national infrastructure.  Now is the time to do it.  It will provide jobs in the near term, but the benefit will continue.  Like the construction of the Interstate Highway System started by President Eisenhower, rebuilding the national infrastructure will lower costs for the private sector long after the federally contracted work has ended.

In addition, because states are required by their constitutions to balance their budgets even during recessions, the federal government should resume federal-state revenue sharing (first proposed and implemented by the President Nixon and ended by President Reagan).  This could save almost a million jobs.

Migration of Jobs to Other Countries

In 1992, erstwhile presidential candidate Ross Perot warned of a “giant sucking sound” of jobs going to Mexico if we ratified NAFTA.  We now know that the “giant sucking sound” did not come from Mexico, it came from Asia.

While the U.S. trade deficit in goods and services declined from $696 Billion in 2008 to $381 Billion in 2009[ii] because of the worldwide recession, it is rising again at an alarming rate.  For June 2010, the U.S. trade deficit was $49.9 billion, up from $42 billion in May, as exports dropped by the most in a year.[iii] Our trade deficit with China is rising and may reach $290 billon this year.  China accounts for more than half the non-petroleum trade deficit.  According to the Economic Policy Institute, the trade deficit with China has resulted in the loss of 2.4 million jobs over 2001-2008.[iv] An additional one-half million jobs could be lost to China this year.

Some economists say that China benefits from an undervalued currency, which it depresses by buying dollars and euros.  Indeed, China has foreign currency reserves of over $2.5 trillion.  The Chinese Renminbi is estimated to be undervalued by 35% to 40%.  This makes Chinese goods cheaper than they should be on the world market, and makes foreign goods, including American goods, more expensive in the Chinese market.  An exchange rate adjustment would make American goods less expensive in China, which would benefit American exporting companies, but would also benefit Chinese consumers, who have been complaining lately about inflation in China.  The Chinese government promised earlier this year to adjust the exchange rate, but there has been little change.  The Economic Policy Institute estimated that ending China’s currency manipulation could add as much 1.4 percent to economic growth in the U.S., based on calculations made by Nobel laureate Paul Krugman. That would lead to $500 billion in additional federal government revenue–or deficit reduction.  Krugman suggests we threaten a 25% tariff on all Chinese goods if China refuses to revalue its currency.[v] We also need to demand the end to illegal subsidies and other unfair trade practices by China and other countries.  While we should not repeat the mistake of broad Smoot-Hawley-style tariffs, a targeted approach may be in order, so long as it is done within WTO rules.

It is hard not to notice that so many goods we buy are made in Asia – clothing, toys, cell phones, television sets, personal and laptop computers, iPods, iPhones, iPads, and even the internet routers that link all these devices.  One company, Foxconn, employs 920,000 workers in China to manufacture the gadgets that are conceived and largely designed in the United States.  To a large extent, this situation is a result of Chinese mercantilist policies taking advantage of naïve American laissez-faire policies.  However, it also results from American investor pressure to lower costs for their own individual profit without regard to the consequences for American society as a whole.

Andy Grove, former chairman and CEO of Intel, published an excellent article in Bloomberg Business Week in July titled “How to Make an American Job”.  He writes cogently that America needs to reinvigorate its manufacturing base that has eroded so dramatically over the past thirty years.  It is only partially true that small businesses generate more jobs.  Our problem is that small businesses do not grow jobs as they used to, because successful small businesses are expanding overseas, building their manufacturing plants in Asia.  Many companies like Apple have generated ten times as many jobs in Asia as in the United States.  This happens not only because of low wages in Asia, but also because Asian countries like China have policies to encourage certain kinds of industries, especially manufacturing.  When American companies build their manufacturing plants overseas, engineering and management jobs go overseas as well.  The manufacturing experience grows in Asia, not the U.S., making it more likely that new technologies will be developed in Asia rather than the U.S.  Grove makes the point that laissez faire works better than communism, but the Asian model of government encouragement for manufacturing is working better than U.S. laissez faire policies in encouraging job growth.  U.S. government intervention is necessary to stop and reverse the hollowing out of American industry.

In the old days, the U.S. manufactured radios, television sets, hi-fi music systems, and personal computers.  However, production of all these products has shifted to Asia under the laissez faire economic policies of the past thirty years.  Some economists welcome the transfer of the production of these “commodity” products to “less developed” countries.  However, we have lost manufacturing skills that have made it difficult to compete in newer technologies.  Flat panel LCD display technology was invented in the United States, but the manufacturing base to support production was not here, so production of flat PC and TV displays scaled up in Asia.  Touch screen display technology was invented in the United States, but American companies went to Asia for mass production.  When Apple developed the iPhone, the production facilities for the main components were in Asia, so it was logical to give the production contract to Foxconn in China.  Semiconductor solar cells were invented in the United States, but now China is dominating the production of lower-cost solar power panels.  As the manufacturing skill shifts to Asia, engineering jobs go to Asia as well.

The United States cannot hope to maintain the American dream of full employment and a vibrant middle class without manufacturing.  Andy Grove says we need to stop the venture capitalist practice of encouraging every new technology startup to plan for production in China.  The government needs to offer financial incentives to keep new product manufacturing in the United States.  “The first task is to rebuild our industrial commons… Tax the product of off-shore labor.”  Use the resulting tax revenues to fund companies that will scale up their new product manufacturing operations in the United States.  We should encourage businesses to consider it their duty to support our industrial base as well as the American Society that made their business possible.

Increased Worker Productivity

Companies are investing in manufacturing equipment and information systems to increase the productivity of the workers they already employ, rather than investing in more employees.  Equipment and software sales increased 24.9 percent in 2Q10 after an increase of 20.4 percent in the first quarter.[vi] Many workers also report that, after deep cuts in their workforces, companies have not been hiring after their business started improving, leaving the existing employees with more work to do for the same salaries.

We don’t want to discourage greater efficiency, as long as it does not come from employee exploitation, because increased worker productivity should lead to improved living standards in future.

Inadequate credit for small businesses.

Small businesses are often said to be the engines of our economy.  In mid-2010, 45% of small businesses reported inadequate credit to support their needs.  The unavailability of credit constrains these small businesses from hiring new employees, and may jeopardize the jobs of existing employees.  The recently-enacted Small Business Jobs and Credit Act establishes a new $30 billion fund for community banks, which will leverage up to $300 billion in new private sector lending to small businesses.  The new legislation provides more than $12 billion in tax relief provisions and creates eight new small business tax incentives aimed to encourage expanded business planning for investments in operations and hiring additional workers.[vii]

On Business Uncertainty Constraining Hiring

Verizon CEO Ivan Seidenberg has said that uncertainty about future taxes and regulation is constraining hiring.[viii] While we have heard this assertion repeated by Republican leaders, we find little compelling evidence to support it.  Uncertainty about the economic expansion is a credible constraint on hiring.  Companies may not feel the need to hire if their markets are only expanding 1% or 2% annually.  However, business leaders are accustomed to making decisions in the face of uncertainty.  Launching satellites or drilling for oil in a new area involves uncertainty, but businesses make those decisions.  Anytime a new product is introduced, there is uncertainty about the size of the market and whether customers will buy it.  Remember New Coke?  How about the Edsel?  Who knew Google would be so successful selling online advertisements?  On April Fools Day 2009, what would the reaction have been if you had said that Susan Boyle’s recording sales were about to make a dramatic change?  When Apple was looking for a wireless carrier partner, there was uncertainty as to the market for the new iPhone.  It might have been a money loser for the carrier who partnered with Apple.  Mr. Seidenberg did not know that AT&T would gain market share and profit from the deal.  (AT&T had to hire many people to sell iPhones and expand its network to keep up with the demand for its services.)  Business leaders who don’t like to make decisions under uncertainty will always have difficulty competing.


[i] http://www.cbpp.org/cms/?fa=view&id=1214

[ii] http://www.census.gov/foreign-trade/statistics/highlights/annual.html

[iii] http://www.bloomberg.com/news/2010-08-11/u-s-trade-deficit-unexpectedly-widens-to-49-9-billion-as-exports-decline.html

[iv] http://www.epi.org/publications/entry/bp260/

[v] http://www.nytimes.com/2010/03/15/opinion/15krugman.html?_r=2

[vi] http://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.html

[vii] http://www.suite101.com/content/nuts-and-bolts-of-the-small-business-jobs-and-credit-act-of-2010-a289622

[viii] http://www.washingtonpost.com/wp-dyn/content/article/2010/06/22/AR2010062205279.html (Mr. Seidenberg was more reticent to talk about Verizon charging its wireless customers for services they had not contracted for and were not using.)

Causes of Current Federal Deficit

October 3, 2010 by

An article in the June 24 issue of the Westport Minuteman described Dan Debicella as saying “Jim Himes voting record has led to the $1.4 trillion [federal budget] deficit.”  Debicella also said the $800 billion stimulus package (American Recovery and Reinvestment Act) enacted in February 2009 was both unnecessary and ineffective, and Congressman Himes committed a grave error in voting for it.  Mr. Debicella proposes to repeal the act.  In blaming President Obama and Mr. Himes for the current deficit, Mr. Debicella apparently has a poor memory and a poor understanding of economics.

The article did not mention that President George W. Bush handed Barack Obama a federal budget deficit of $1.2 trillion in January 2009 as well as an economy declining more rapidly that at any time since the 1930s.  Economic stimulus was needed to stop the downward spiral caused by the impending collapse of the financial sector as well as the housing sector, which had not been adequately regulated during Republican control of all three branches of government, as well as the Federal Reserve.

The Great Recession started in December 2007, more than a year before Barack Obama and Jim Himes took office.  This recession was caused by failed Republican policies of deregulation and unfunded war.  (Remember how Bush saved us from Iraq’s weapons of mass destruction that did not exist?)  Congress funded TARP at the request of President Bush.  Hank Paulson, Treasury Secretary until 2009, has said that if Bush had not reversed course and funded the bank bailout and initiated the bailout of the auto industry, we would have had 20% unemployment.  President Obama and Jim Himes have been working tirelessly to fix the mess left by the Republicans.

It should be noted that it was a Democratic Administration that produced the only balanced federal budgets in a generation.  President Clinton inherited a large (for those days) budget deficit from President George H.W. Bush.  Proper Democratic Administration fiscal policy and Congressional Paygo rules produced budget surpluses during the last three years of Clinton’s second term, and there was serious talk of paying down the national debt to very low levels in preparation for the retirement of the baby boomer generation.  Although the recession of 2002-2003 would probably have led to a temporary budget deficit, we should have had a federal budget surplus again by 2005 if President George W. Bush had followed equally sound fiscal policies.  However, he was influenced by V.P. Dick Cheney, who said deficits did not matter.

Republican deregulatory policies wrecked the U.S. economy.  Alan Greenspan, appointed to the chairmanship of the Federal Reserve by President Reagan, followed the Republican deregulatory philosophy and urged people to take adjustable rate mortgages instead of fixed-rate mortgages with payments they could be sure they could afford.  When no down payment mortgages and liar loans were offered by mortgage brokers, Greenspan looked the other way and the Bush Administration asserted federal jurisdiction to prevent five state attorneys general from investigating the use of fraudulent and deceptive sales tactics by mortgage brokers.  This fueled the pipeline to Wall Street firms that created collateralized debt obligations and sold the CDOs to foreign banks, pension funds, etc., obscuring the risk involved in the inevitable downturn of the housing market.

In a June 2008 speech, President and CEO of the NY Federal Reserve Bank Timothy Geithner — who in 2009 became Secretary of the United States Treasury — placed significant blame for the freezing of credit markets on a “run” on the entities in the shadow banking system. These entities became critical to the credit markets underpinning the financial system, but were not subject to the same regulatory controls as banks. Further, these entities were vulnerable because of maturity mismatch, meaning that they borrowed short-term in liquid markets to purchase long-term, illiquid and risky assets. This meant that disruptions in credit markets would make them subject to rapid deleveraging, selling their long-term assets at depressed prices.

Paul Krugman, winner of the 1999 Nobel Prize in Economics, described the run on the shadow banking system as the “core of what happened” to cause the crisis.  A sudden drop in liquidity led to a sharp downward spiral in aggregate demand, and we started seeing 700,000 jobs lost every month.  It is well documented that the $800 billion stimulus package has created or saved between 2 million to 3 million jobs.  However, Prof. Krugman said in February 2009 that an $800 billion stimulus was not enough, and recent developments indicate that he may have been right.

In testimony to a Congressional committee investigating the causes of the financial crisis, Alan Greenspan admitted that there had been a flaw in his philosophy of financial market deregulation.  Essentially, the flaw was that financial markets do not regulate themselves as efficiently as he had assumed.

One of the lessons that we should have learned from the Great Depression is that early attempts to balance the budget will not work.  In general, premature attempts to balance a national budget will lead to an economic downturn.  The resulting downturn will reduce tax revenues, making it harder to balance the budget.  This is what happened in 1937, when political pressure forced President Roosevelt to reduce federal spending.  The net federal deficit was reduced almost 90% from 1936 to 1937.  The result was another severe recession.  In 1938, the deficit rebounded to 60% of its 1936 peak, not because of increased spending but because of reduced tax revenues.  Other countries have had similar experiences.

Joseph Stiglitz, another Nobel Prize-winning economist, has said that one of the many ironies that have marked the crisis is that Greenspan’s and Bush’s attempt to reduce the role of government has resulted in a large temporary increase in the government’s role in the economy.  Barack Obama and Jim Himes, like the main stream of the Democratic Party, are in favor of a well-regulated market economy.  As the economy recovers, the government will sell its stakes in CitiGroup, AIG, and General Motors.  Indeed, this has already started.  The Government will get most of its money back.

What we will not get back is the trillions of dollars of lost output from the idle capacity and millions of unemployed people.  That lost output is the result of the failed Republican policies, and a return to those laissez faire policies of the past 25 years would be a tragic mistake leading to even more lost output and misery for people who are out of work due to no fault of their own.  This tragic situation can only be remedied by increasing aggregate demand, and government will have to do its part.

Healthcare Public Option and Costs

July 4, 2009 by

Let me start by saying that for more than 50 years, I have favored universal healthcare.  The question is how do we get it?

I have been receiving solicitations for support of the Healthcare Public Option.  They say, please send a fax to your senators, or sign a petition to Congress urging them not to abandon the Public Option so that everyone will have a choice of private healthcare insurance or the Public Option.  Here are four Healthcare Reform criteria recommended by one of the emails I received:

  • Available to all of us: A strong public health insurance option should be available to anyone who chooses to participate. If you like your current plan, you can keep it; if you want to participate in the public health insurance plan, you can choose that.
  • A national plan with real bargaining clout: In order to truly control costs and compete with private health insurance plans, a strong public health insurance option must be available nationwide.
  • Ready on day one: Every day we wait on real reform, health care costs continue to rise. A strong public health insurance option with a broad network of providers right out of the gate is key to building a competitive program that will help control costs.
  • A truly public plan: To ensure it’s held to the highest standards of accountability, a public health insurance option must be truly publicly run—accountable and transparent to Congress and to voters.

This sounds like Medicare for everyone

There seems to be an assumption that a national public healthcare insurance organization can use its bargaining power to reduce healthcare costs.  This point of view may be a little naïve.  Nancy-Ann DeParle and her staff at the White House have been holding weekly seminars on healthcare reform, and serious discussion of controlling costs usually leads to a consensus that we need a different model of healthcare delivery to control healthcare costs.

Medicare is certainly better than being old with no health insurance.  However, Medicare is a fee-for-service health insurance plan whose costs have been rising rapidly, at a rate far exceeding the rate of inflation.  The only way that Congress has agreed to fix the escalating costs of Medicare is to cap payments to doctors and hospitals, and threaten to actually reduce the fee schedule.

Medicare needs reform.  Medicare does not pay for preventive care; it should, even if it does not substantially reduce overall healthcare costs.  Medicare does not pay for immunization; it should.  Medicare does not pay physicians for telephone or email consultations.

In my opinion, the Medicare fee schedule pays primary care physicians too little, and in many cases pays specialists too much.  We need a healthcare system that allows people to go to the physician of their choice, including both primary care physicians and specialists, but encourages people to use their primary care physicians to coordinate their care when they have complex conditions or chronic diseases.

We need a healthcare system that pays for treatment of a disease or condition, rather for each procedure performed.

We all want to control healthcare costs; who does not?  It would be nice to have a list of major healthcare cost categories, so that we could focus on the major cost categories.

Here is my list of major healthcare cost categories:

  • Care during last year of life.
  • Treatment of chronic diseases such as diabetes, Parkinson’s disease, Cerebral Palsy.
  • Lifestyle issues such as obesity, smoking, nutrition, and lack of regular exercise.
  • Mental health problems such as depression.
  • Emergency room visits by the uninsured
  • Insurance administrative costs (healthcare providers and insurers)

The Public Option may reduce the last two costs, but what about the first four cost categories?  It is difficult to find credible data on what these costs are in the U.S. Nevertheless, I assert that these categories need to be addressed by healthcare reform.  How is the Public Option going to reduce costs for these categories better than a system of non-profit healthcare cooperatives?

Dr. J. Deane Waldman, MD, gives the following list[i] of what drives up healthcare costs:

There are nine reasons for escalating health care costs.
1. New value (new medical capabilities) resulting in
2. More people who live longer.
3. Inefficiency, Reconciliation and Disconnection
4. Regulatory compliance and unfunded mandates
5. Perverse incentives
6. Defensive medicine
7. Adverse outcomes and errors
8. Profits taken out of healthcare (insurance and medical malpractice)
9. Fraud and embezzlement

As Dr. Waldman writes, we want to preserve the first two items while reducing the others.  Again, it is difficult to find credible data quantifying these reasons for health care costs.  Nevertheless, any comparison of the Public Option versus the Non-Profit Healthcare Cooperatives Option should address these causes of rising healthcare costs.

I hasten to explain that I support President Obama’s overall objectives and guiding principles for healthcare reform, whereas Dr. Waldman has been very negative about President Obama’s program.  Remember, however, that the President has stated that he would like to achieve a bipartisan agreement on healthcare reform.  Therefore, I call on Dr. Waldman to tell us what program he would propose in place of the Public Option proposed by the Obama Administration.  How would Dr. Waldman design legislation to reduce the factors driving up healthcare costs?

There seems to be a consensus on the creation of a healthcare insurance exchange from which people could choose a healthcare plan if they don’t get one from their employers.  The debate is over whether the choices offered through the healthcare insurance exchange should include a publicly managed option in addition to private insurance plans.

Senator Kent Conrad (D, ND) has proposed a national network of healthcare cooperatives as an alternative to the public health insurance option favored by the Obama Administration.  Rather than being dismayed by this proposal, I am reminded of the Japanese healthcare system.

Japan spends 8% of GDP on healthcare, versus 16% for the United States, but Japan has lower infant mortality and the Japanese live longer than we Americans.  Although genetics and diet may play small roles, Japan must be doing something right with their universal healthcare system.  The Japanese government requires everyone to have health insurance.  Many Japanese get their healthcare insurance through their employer, but if not, they can get healthcare insurance through a nonprofit community-based insurer.  These insurers are not allowed to deny anyone coverage, or charge extra, because of pre-existing conditions.  Only the poor get a government subsidy for their healthcare insurance.

The Japanese healthcare system is highly competitive.  There is no gatekeeper requirement.  Anyone can go to their internist, or directly to a specialist of his/her own choosing.  Unlike the British National Health System, 80% of Japanese hospitals are privately owned and managed by doctors.

To hold down costs, Japan regulates the prices of healthcare procedures in great detail.[ii] The Japanese regulators hold biannual meetings with doctors and hospitals to negotiate prices.  There is constant pressure to increase efficiency and reduce prices for healthcare procedures such as MRIs and quadruple coronary bypass surgery.

The argument for a public option is that it will provide competitive pressure to hold down healthcare costs.  The tacit assumption is that Japanese-style price regulation is not possible in the United States, so we must rely on artificial market forces to control healthcare costs. Of course, you can imagine the Republicans howling about the giant government bureaucracy that would be required to regulate healthcare prices in the United States, despite the fact that the Japanese Health Ministry is not so large.  The rest of us should howl about the high cost of our current healthcare system.

Fundamentally, we must make a commitment that everyone in the country is entitled to good quality healthcare.  We need to end a system that provides incentives to insurance companies to drop sick people and deny coverage to people with pre-existing conditions, or make premiums for those people so expensive that they cannot afford their healthcare insurance.  I think we should take the profit out of healthcare insurance, crack down on fraud and abuse, pay doctors well but not exorbitantly, and relieve new doctors of the huge debts that they now face by public financing of accredited medical schools.   Germany has competitive healthcare insurance companies, even though they are not allowed to make a profit.  Just the prospect of higher executive salaries for growing insurance companies is enough to keep the companies competitive [ii]. If we made all U.S. healthcare insurance companies nonprofit, we would not need a “public option”.


[i] http://thesystemmd.com/?p=248

[ii] http://www.pbs.org/wgbh/pages/frontline/sickaroundtheworld/

Brits are Healthier than (White) Americans

January 25, 2009 by

Benefits of single-payer vs. fee-for-service medicine

Similar longitudinal surveys in different countries are beginning to reveal the institutional and cultural variations in these life cycle dynamics. A new investment in international longitudinal surveys on aging may eventually unravel the changing dynamics at the end of the life cycle across time and countries. One recent comparison showed that health improved with socio-economic status in both England and the United States. It also showed, however, that English health status is better than in the United States at each socio-economic level.

J. Banks, M. Marmot, Z. Oldfield, J. P. Smith, JAMA 295, 2037 (2006).

http://jama.ama-assn.org/cgi/content/abstract/295/17/2037

http://jama.ama-assn.org/cgi/reprint/295/17/2037

Thanks to John Wirt.

New Financial Services Industry Regulation

January 24, 2009 by

Today the New York Times reported that the Obama Administration will soon adopt this blog’s recommendations concerning regulation of the financial services industry, including stricter federal rules for hedge funds, credit rating agencies and mortgage brokers, and greater oversight of the complex financial instruments, such as CDOs, that contributed to the economic crisis.

Soon Paul Volker and Timothy Geithner will propose new federal standards for mortgage brokers who issued many unsuitable loans and are largely regulated by state officials. They are considering proposals to have the S.E.C. become more involved in supervising the underwriting standards of securities that are backed by mortgages.

“The administration is also preparing to require that derivatives like credit default swaps, a type of insurance against loan defaults that were at the center of the financial meltdown last year, be traded through a central clearinghouse and possibly on one or more exchanges. That would make it significantly easier for regulators to supervise their use.”[i]


[i] http://www.nytimes.com/2009/01/25/us/politics/25regulate.html?hp

FDA and Prescription Drug Reform

January 4, 2009 by

The FDA budget needs to be doubled to deal with the safety of the food supply and the crisis in the integrity of the pharmaceutical industry.  Many articles have been written about the pharmaceutical industry promoting their proprietary drugs despite questionable efficacy.  There are many documented cases of drug companies suppressing test results that might question the efficacy of their proprietary drugs.  The FDA should be more vigilant in dealing with issues of drug efficacy.

There is another, less widely discussed problem with prescription drugs.  Americans expect their pharmacies to dispense the drugs prescribed by their doctors, with the correct dosage on the label.  However, there is a growing problem of prescription drugs from unregulated factories not meeting quality standards.

American and European drug plants are closing as Chinese and Indian plants undercut them in price.  The Chinese and Indian drugs are purportedly pharmaceutically identical to the American and European drugs they replace, but is that assertion really true and are they safe?  No-one really knows, because the FDA rarely inspects drug manufacturing plants outside the United States.  Any company importing drugs or pharmaceutical ingredients into the United States is supposed to test the supplies before using them.  However, Chinese manufacturers are notorious for giving samples that pass tests and then changing the ingredients or the manufacturing process after passing the sample test.  In 2008, Chinese manufacturers substituted a cheap fake for dried pig intestines used to make heparin, which is used to prevent clotting during surgery and dialysis.  81 people died of allergic reactions and tens of thousands of people around the world were exposed to danger before the FDA got the situation under control.  This is not an isolated case.  It is estimated that 8% of over-the-counter drugs in China are counterfeit.[i]

One often-mentioned way to reduce medical expenses is to encourage the use of generic drugs.  The asserted reason is that generic drugs are not only much less expensive, but also pharmacologically equivalent to brand name drugs.  However, the healthcare reform discussion often neglects the lack of FDA regulation of generic drug manufacturers, especially the lack of inspection of the increasing number of drug manufacturing plants outside the United States.  Not only are generic drugs often different from their supposed brand-name equivalents, but drug potency varies from manufacturer to manufacturer.

For example, practicing pharmacists are aware that warfarin, the generic version of coumadin, is not actually equivalent to coumadin.  Coumadin (and warfarin) is an anticoagulant drug, and the wrong dosage of this drug can lead to internal bleeding, including hemorrhage, with serious consequences.  Hungarian warfarin has been found to be 20% higher effective dosage than Indian warfarin of the same nominal dosage, with brand-name Coumadin falling in between.  (I found this out when I refilled a warfarin prescription that was randomly dispensed with warfarin manufactured in a different country, and my INR changed by 30% at the next weekly test.)

Another example is the recent (September 24, 2008) FDA list of 32 finished drugs and 7 active pharmaceutical ingredients manufactured by Dewas and Paonta Sahib facilities of Ranbaxy Laboratories, banned because those sites failed to pass FDA inspections.  We do not know how long those drugs were on the market in the United States before the inspections.

The FDA budget should be doubled.  The FDA should promulgate a rule that neither drugs (whether prescription or over-the-counter) nor their ingredients may be imported into the United States unless the FDA has inspected the manufacturing plant within a year of importation.  The inspection costs should be recovered by fees imposed on the drug manufacturers.  Improve the FDA drug manufacturing plant database.  Also develop a source database system for all produce sold in the United States.


[i] http://www.nytimes.com/2008/11/02/magazine/02fda-t.html?scp=1&sq=The%20Safety%20Gap%20Gardiner%20Harris&st=cse

Obama Healthcare Forum — December 2008

December 11, 2008 by

President-elect Obama is inviting Americans to spend part of the holiday season talking about health care — and report back to him.  As he gears up for major health reform legislation next year, Obama is encouraging average Americans to host informal gatherings to brainstorm about how to improve the U.S. system.  “In order for us to reform our health care system, we must first begin reforming how government communicates with the American people,” Obama said in a statement last week. “These Health Care Community Discussions are a great way for the American people to have a direct say in our health reform efforts.”[ii] 

From December 15 through December 31, 2008, this blog will focus on healthcare, with the objective of collecting healthcare stories and polishing recommendations to be submitted to the Obama Transition Team.  You can find healthcare pages listed to the right of this post.  Click on Obama HealthCare Forum as well as topics of interest under it, and comment on the contributions you see on the page focussing on that topic.

Background

President-elect Barack Obama has begun preparing to change the U.S. healthcare system, reaching out to his supporters and interest groups to build grass-roots support for the huge undertaking.  “Every American is feeling the pressure of high health costs and lack of quality care, and we feel it’s important to engage them in the process of reform,” said Obama transition team spokeswoman Stephanie Cutter.

U.S. healthcare costs now account for about 16 percent of U.S. gross domestic product — or $2.3 trillion — a proportion projected to grow to 20 percent or $4 trillion by 2015.[i] 

The United States now spends more on healthcare than any other developed nation, yet has some 47 million people without health insurance. Most insured people receive coverage through their employers but businesses complain that exploding costs threaten their competitiveness in a global market.  High worker healthcare costs have been cited as a major reason why U.S. automakers are in such trouble.

At the press conference today when he introduced Tom Daschle as his nominee for Secretary of Health and Human Services, President-elect Obama said “What we want to make sure is that any plan that we have starts with the premise that rising costs are unsustainable.  We can’t insure everybody under the current program without bankrupting the government, business or states. We are going to spend a lot of time figuring out how to streamline the system,” He added. “We are also going to examine programs that aren’t giving us a good bang for our buck.”

Many health reform advocates believe Obama will need broad public support to overhaul an industry that has become among the most intractable of U.S. political problems.  Remembering what happened to the healthcare reform proposal led by Hillary Clinton in 1993, the Obama camp wants to gain broad public input early, before the insurance companies and drug companies start an intensive lobbying  and advertising campaign to defend their interest in the current system, which almost all experts and the majority of voters recognize is broken.  Daschle has already launched an effort to create political momentum last week in a conference call with 1,000 invited supporters culled from 10,000 who had expressed interest in health issues, promising it would be the first of many opportunities for Americans to weigh in.

Note the Editorial in the December 14th New York Times:

http://www.nytimes.com/2008/12/14/weekinreview/14sack.html?ref=weekinreview


[i] http://www.reuters.com/article/vcCandidateFeed2/idUSN04420785

[ii] http://www.washingtonpost.com/wp-dyn/content/article/2008/12/05/AR2008120503322.html

Financial Industry Regulatory Framework Pending

December 4, 2008 by

The Congressional Financial Industry Rescue Panel led by Harvard Law Professor Elizabeth Warren is supposed to monitor the disbursement of the $700 billion in bailout money, but it is also required by law to provide Congress with recommendations for reforms to the financial regulatory structure, a report that she said it would deliver by Jan. 20.[i]  What kind of regulatory structure should be considered?

To prevent a recurrence of the problems that led to this current financial crisis, the United States and indeed the entire world need a new rigorously enforced regulatory structure for the financial services industry.  In the United States, legislation is needed to establish a streamlined framework for regulating the equity, debt, commodity and derivatives markets.  The functions of the SEC and CFTC, as well as functions undertaken by the Fed and the Treasury on an ad hoc basis, should be transferred to this new regulatory agency.[ii]

The federal government needs to regulate all aspects of the financial services industry.  As Barack Obama said in his speech on March 27, 2008, “We need to regulate financial institutions for what they do, not what they are.”[iii] The basic principles should be based on asking what role the financial institution plays in the economy.  If it is accepting and keeping retail and commercial deposits, with FDIC insurance, it should be regulated as a commercial bank.  If it invests the shareholder capital in risky assets, using leverage to increase its returns, it should be regulated as an investment bank.  Some 21st Century version of Glass-Steagall is necessary to protect taxpayers from the need to bail out investment banks.

With Elizabeth Warren as chairman of the Financial Industry Rescue Panel, we can expect a strong consumer protection element in the recommendations.  She has recently proposed that mortgage products should be examined and tested for safety.    She and her daughter Amelia Warren Tyagi wrote “Of all the borrowers who were sold subprime mortgages in the past five years, nearly 60 percent would have qualified for prime mortgages if brokers had offered them; the subprime mortgages carried so many rate escalators, prepayment penalties, and other traps that even would-be prime borrowers defaulted.”[iv]  When actual costs and unfavorable terms are regularly concealed, the regulatory authority should order those products removed from the market.  Warren and Tyagi have proposed a Financial Product Safety Commission, which would require that companies reveal the true cost of credit.  This is a good idea, and should be included in the recommendations, but it is a small part of the reforms needed to protect the 21st Century economy from another financial meltdown.

Leverage needs to be controlled for all financial institutions, whether they are called banks or insurance companies or hedge funds or commodity futures trading companies.  No company should be allowed to operate with so much leverage that its failure could threaten the entire global financial system, a situation in which we have found ourselves during the past two years.  To be more specific, leverage of 30:1 is outrageously too high.  Fines are not a sufficient deterrent to the greed of some people who will use high leverage whenever they think they have a chance to make a large fortune risking other people’s money.  Legislation needs to specify significant prison time for people who violate the rules of the new financial system. 

Now that we have mentioned hedge funds, the question is whether they have any redeeming social value.  Banks keep depositors money safe and put money to work by lending to households and businesses based on the lender’s assessment of their ability to pay the loans back.  Insurance companies spread risk among large groups of customers, sparing the focus of hardship on the unlucky few.  Financial advisers help people and businesses save and invest wisely.  Venture capitalists raise funds for entrepreneurs who create innovative products and services.  Hedge funds should not be allowed to exist just to gamble on giant returns by using greater leverage than is allowed of regulated financial institutions.  As a minimum, hedge funds should be regulated with regard to leverage and the transparency of their operations.  If hedge funds cannot find a contributing role in the real economy, they should be shut down.

The new financial order must ensure the independence of the financial rating companies.  We need to separate the funding of financial rating companies (like Moodys, Standard & Poors, and Fitch) from the financial engineers who came to them for ratings.  We have suffered from a system under which bond issuers paid the ratings companies to rate their bonds, and the ratings companies sold consulting services to tell the issuers how to tweak the composition of their Collateralized Debt Obligations to get AAA ratings. The federal government needs to police conflicts of interest like that.

Transparency is a key issue.  New Deal legislation sought to increase transparency in the interstate offering and sale of securities.  The Securities Act of 1933 requires every U.S. public company to register new securities (with the SEC after 1934) and to offer (interstate) securities only through a truthful prospectus giving basic financial information as well as stating the risk involved in investing in the offered securities.  Corporations were also required to issue audited annual reports on the status of the business.  The Securities Exchange Act of 1934 focused on the sale of securities in secondary markets, creating the Securities and Exchange Commission (SEC) to monitor and enforce corporate reporting, ensure conformance with regulations, as well as to detect and punish accounting fraud, false information distribution, insider trading or other violations of the securities law.[v]  Unfortunately, despite additional legislation (e.g., the Investment Company Act of 1940, the Investment Advisors Act of 1940, and the Sarbanes-Oxley of 2002), federal laws have not kept up with the pace of financial chicanery (described in the industry as innovation).

There needs to be more transparency of all kinds of financial instruments, including the kind of mortgage-backed securities, collateralized debt obligations and credit default swaps that have created the multi-trillion dollar financial meltdown we have experienced over the past eighteen months.  For example, standardized credit default swaps should be traded through a CDS clearinghouse (something that Tim Geithner has been encouraging in recent months). Legislation is needed to establish a streamlined framework for regulating the equity, debt, commodity and derivatives markets.  The functions of the SEC and CFTC, as well as functions undertaken by the Fed and the Treasury on an ad hoc basis, should be transferred to this new regulatory agency.[vi]

Size is also an issue.  No financial institution should be allowed to grow into a company that it is too big to fail.  Sandy Weill was right when he predicted the repeal of the Glass-Steagall Act after he created Citigroup, but he was also right in what he implied, which was that he had created an institution that had an inherent advantage over its rivals because it was too big to fail.  Citigroup must be broken up.  If the Citigroup management does not spin off parts of its business voluntarily, then antitrust litigation should be used to break up the company.  Furthermore, we need to reverse the trend during the Paulson era of turning to the biggest banks to absorb other big banks that get into trouble.  We must ensure that there are no more Citigroups in the future.

We hope that that the Warren Panel will lay out a framework by January 20 and then work with the new Economic Recovery Advisory Board to be chaired by Paul Volker to address in more detail the proposed financial system regulatory framework.

 


 

[i] http://www.nytimes.com/2008/12/02/business/02tarp.html?_r=1

[ii] https://westonpolicy.wordpress.com

[iii]http://www.prospect.org/cs/articles?article=seven_deadly_sins_of_deregulation_and_three_necessary_reforms

[iv] http://www.law.harvard.edu/news/2008/10/23_warren.html

[v] http://en.wikipedia.org/wiki/U.S._Securities_and_Exchange_Commission

[vi] https://westonpolicy.wordpress.com