Monday, April 27, 2009


Education and Health Care: Connecting the Dots

An alert reader sent me a link to this post (and presentation) by Peter Orszag, Director of the Office of Management and Budget. It gives a synopsis of a talk he gave to the Association of American Universities suggesting important links between the difficult economics of higher education and the difficult economics of health care.

As longtime readers know, I've been linking the two for years. (For example, see here.) The fact that folks in a position to matter are starting to make the connection gives me hope. They haven't really cracked it yet, but the fact that they're at least connecting the two suggests the possibility of eventual progress.

Orszag's argument, which is true as far as it goes, is severalfold. First, education is a key driver of economic productivity, and of economic equality. When access to quality education becomes the province of the elite, we should expect to see economic polarization accelerate. Second, education competes for tax dollars with other expenditures, notably health care. As the costs of health care have increased relentlessly, government support for higher education has been squeezed to make up some of the difference. Finally, the Obama administration is committed to 'bending the curve' (love that!) of cost increase in health care, specifically to free up resources for higher ed. Since a healthy and educated population is more productive than a sick and ignorant one, these policies are both 'hard headed and soft hearted.'

Okay, cool. But even though I'm sympathetic, Orszag is only scratching the surface. To make real and lasting progress, you have to go deeper.

Both health care and higher ed have been subject to incessant cost spirals, and for many of the same reasons. And our current political debate gets those reasons almost completely wrong. Leaning on one to feed the other is a defensible short-term political choice, but it doesn't get at the underlying drivers of cost increase. It doesn't solve the long term problem.

First, and most basically, health care and education are exceptions to the rule that industries only spend money on innovations that are likely to pay off. (Law enforcement is another exception; the cost spiral there is also incessant.) In most industries, a given firm will spend money only on those experiments or innovations that seem likely to generate more money (in either increased revenue or decreased costs) than they cost. That's why local auto repair shops often have ten-year-old computers with dot matrix printers. They don't see the payoff to getting something cutting-edge, so they don't.

In health care, innovations typically add cost; they're justified instead by their results. We've made a judgment as a society – and I'm on board with this, by the way – that extending good life is worth serious money. That's true even when extending that life involves both expensive treatments now and additional treatments later for the afflictions that the patient now lives long enough to get. In olden times, fatal heart attacks at 50 were common. Now, many people who would have died from those live long enough to get cancer, too. That's not to deny for a moment that this is a net gain for humanity. It's just to say that the cost spiral is a direct and predictable consequence of medical success.

In higher ed, similarly, we adopt innovations not because they pay off for us, but because they pay off for other industries. We prepare students to work in the current economy, at jobs as they're currently configured. That means not just professors and libraries, but human patient simulators, multimedia labs, imposing IT infrastructures, and the lab technicians to tend to it all. We don't capture any of the economic gains from these investments. Our students do, and the economy as a whole does, but we don't (at least not directly). We upgrade even when it isn't 'efficient,' because we couldn't do our job otherwise. So we have the normal inflationary cost increases, plus the cost of backfilling decreased public support, plus the cost of health insurance in a labor-intensive sector, plus the cost of keeping up with industries that keep changing. That adds up. We take the edge off by exploiting the hell out of adjunct faculty, but there are limits to that.

(We also have an ever-increasing number of unfunded mandates for which we have to hire, and pay, staff. It's our version of 'defensive medicine' – unproductive spending made necessary by arbitrary external interventions. I shudder involuntarily whenever I hear the phrase “reporting requirements.”)

Second, both industries are paid by their input. Hospitals and doctors are paid by the procedure. Colleges are paid by the course. A cynical view would suggest that procedures and course requirements would multiply. A more nuanced view would suggest that from the institution's point of view, innovations that might save money by getting away from input-based payment will get strangled in the crib. (In my darker moments, I imagine that this is part of the subtext of the opposition to outcomes assessment.) When you're paid by time – whether seat time or bed time – the only way to increase productivity (I said productivity, not quality) in economic terms is to raise prices. There is no other way. So we do.

Third, in both industries it's extraordinarily difficult for the novice consumer to judge the quality of one institution against another. To compete for students or patients, both have to spend money in ways that novices will notice. That may or may not correlate with the core function. To the extent that it doesn't, it's yet another cost item. In a competitive environment, expect those to increase continually.

Fourth, and predictably, both sectors are beset with parasites. In health care, they're called “HMO's.” In education, they're called “private student loan providers.” These parasites crawl into the interstices of the system and suck the lifeblood, growing fat on diverted nutrients. They must be expunged. By replacing profit-seeking middlemen with, say, single-payer systems, tremendous recurring savings can be realized. For proof, compare the administrative costs of Social Security to the average administrative costs of 401(k)'s. The math is irrefutable.

'Bending the curve' of cost increase in these two sectors without just watering down the product won't be easy. It will involve upending some longstanding arrangements, and tackling head-on the 'productivity' problem without which no progress can stand. (Interestingly, public support through progressive taxation solves the 'capturing the gains' problem elegantly. If a given institution's public support were correlated, say, to the taxes paid by its graduates...) I'm happy to see a commitment to increased Pell grants, but over the long term, that doesn't bend the curve. The problem is far deeper than a mere moral commitment will solve, as welcome as that commitment is. The political debate, up to this point, has elided the productivity point completely, but it's key to the entire enterprise.

Still, I'm glad to see that folks in the halls of power are finally starting to connect the dots, even if only in a basic way. After so many years of darkness, a glimmer of light is remarkably refreshing.

For proof, compare the administrative costs of Social Security to the average administrative costs of 401(k)'s. The math is irrefutable.Yes, but comparing the earnings on SS to the earnings on my 401(k), even after the beating of last year, is pretty damn irrefutable, too.
I don't have anything substantive to add, I just wanted to say that I enjoyed this post. I know you've mentioned this idea before, and it made sense then, but this post really lays out a clear and convincing case for the concept.
I wish more people outside the academy understood DD's point about how colleges/universities provide gains for students that they don't recoup, which makes them different from businesses.

For proof, compare the administrative costs of Social Security to the average administrative costs of 401(k)'s. The math is irrefutable.I had never heard this before, but it seems like big news. Inspired, I did a little checking around.

At the Social Security web page, they have a helpful table of administrative costs, and it has hovered around 1% since the mid-1980s. At the Vanguard website (where I do my investing, at least), I found this:

In 2008, the average expense ratio for Vanguard funds was 0.20%, or $20 deducted annually for every $10,000 invested. The industry's average was almost six times that, at 1.19%, or $119 for every $10,000 invested, according to independent research company Lipper Inc. looks like some private firms have significantly lower costs, some have higher. YMMV, but I pay lower administrative costs on my private 401 than I do on my social security contributions. I don't think that invalidates the single-payer plan, but the claim that the math is "irrefutable" is, well, refutable.
@Anonymous: Maybe I'm naive, but I still expect my 401k to be there when I retire in 40 years. (But then I also have to contend with the possibility of being forced out of the labor market before that...) I can't say that I believe SS will be there.

@Rubashov: Vanguard's expense ratios are likely as low as they are because they have a lot of investments in index funds, which typically have lower costs than actively managed funds. FWIW.

@Dean Dad: Can you do a piece on Obama's plan to use the DOE as a single payer system? Can you give an analysis for both sides of the argument?
Let's see if we can follow this. Dean Dad writes:

"First, and most basically, health care and education are exceptions to the rule that industries only spend money on innovations that are likely to pay off.Then writes:
In health care, innovations typically add cost; they're justified instead by their resultsFollowed by:
We've made a judgment as a society – and I'm on board with this, by the way – that extending good life is worth serious money. The 2nd and 3rd phrases really refute the first one, at least as it relates directly to health care. Let's put it a different way. How about:

"Because we, as a society, place such great value on extending our useful lives, the healthcare industry has been able to justify the increased costs of research because the pay-off is there. We will pay!Healthcare researchers, providers, and insurers are in their business because they do see a pay-off. The prices ("costs" for consumers) are increasing because we are willing to pay them.

The price is directly related to the amount people are willing to pay. If the costs (to the providers) become greater than the price customers are willing to pay (the "cost" to consumer) then the healthcare providers will have to respond by cutting costs.

Dean Dad seems to have confused the payoff to the company with the amount the consumer has to pay. An understandable mistake, but alas one that I am not sure we want our leaders to be making.

Also, the analogy to the mechanic is flawed on the face. The Mechanic invests in computers that attach to the car, and to the computers that read the digital tech manuals, because they do directly improve efficiencies and their ability to repair cars (their "core competency.") They may not invest in other technologies that only support their operation, but then again, if they need to remain competitive in their particular market by offering wifi while you wait, then they are adding that too.

Interesting: this is somewhat like providing a peer review for a journal article. Anyone else feel that way? recently launched an early version of its drug price comparison Web site. Consumers type in their drug name, dosage and ZIP code, and can find prescription drugs available on discount generic programs and where they can find them in their neighborhoods. The site will eventually offer users information on scheduled immunizations, health screenings and mini-clinics in their area; recalls and warnings; an "Ask the Pharmacist" feature; and an online community in which individuals can share information.
I find DD's arguments much more persuasive than pseudonymous' critique. DD uses the word 'pay off' to express non-monetary gains (better health, better education) as well as monetary gains.

I am quite sure that one way to have a cheaper and more efficient health care system would be to withhold all 'heroic' measures (transplants, radiation treatments, chemotherapy, etc.). It is certainly true that many of us are willing to pay higher health care costs in order to have access to these measures, but the fact remains that they introduce 'inefficiency' into the system.

Likewise, we all know how to have a cheaper and more efficient education system: giant lecture halls, reduced access to technology and fewer high-cost programs. Again, education consumers are commonly willing to pay the higher cost, but the fact remains quality education is more expensive.

They key here is that while I am willing to pay higher health insurance premiums and higher tuition to a SLAC, the government bears a substantial portion of the cost of providing health care and education to many of our residents. That is the crux of DD's arguments. Colleges, hospitals and the government in general, do not directly benefit financially from increased quality in medicine or education.

As for computers in mechanics' shops, the point was that mechanics continue to use obsolete technology for printing bills because there is no financial benefit to moving to newer technology. They do invest in analytical computers because it helps them do their jobs faster and better, yielding a direct financial benefit (Actually, I'm thinking they use dot matrix printers because they have 3-part forms that require impact printers).
"To compete for students or patients, both have to spend money in ways that novices will notice."

Indeed... If your high school wants to be a doctor, you'll be looking at premed programs. If University A has a bright, shiny, new science building and University B has a 40+ year old hulk that's had some upgrades in the lab areas, but generally looks like it was built in the 1960s... because it was.... Well, ask yourself why so many SLACs built massive science building around the late 1990s. (I noticed this because I worked for one and my wife had graduated from another.)

I'm convinced this need to pay for facilities and services necessary to keep up with the competition (and every school knows who it's competing with for students) has done more to drive up the cost of higher ed than people realize.

Compare and contrast with health care.. where I live there are two big hospital conglomerates. They aren't sitting back and waiting for people to come to them.

Another question to consider: If you're trying to win customers, you first have to decide who the customer is. It's not always students and patients respectively.
It is interesting that DD's "irrefutable" math statement,though clearly proven wrong, has not been corrected in his original blog entry. I guess this why facts generally have a conservative bias. Liberals tend not to let reality get in the way of their belief that anything private industry can do, government can do better and cheapr.
@Rubashov: You might want to look at the numbers for just the retirement part of social security. Disability and medical portions have understandably higher expenses. Also, the SS Trustees report that I looked up lists expenses as % of expenditures, which is less than 1/3 of the size of the fund. Typically, mutual funds charge expenses as a % of the total funds under management. I think you'll find that SS beats your Vanguard index fund.
Also, SS is insurance and Vanguard is savings.

That's why SS includes the word "security" and Vanguard includes the word "fund."
Folks, you are dancing around the point:

Social Security isn't designed to actually manage money. It's designed to collect it--and pay it out. The "irrefutable fact" is really that it takes more money to manage funds designed to MAKE more money.

Quite honestly, I am very happy to be paying in to TIAA/CREF right now. I am young enough that I know that through the "magic" of dollar cost averaging, the quantity of shares I am buying now will be worth a "significant amount" of money when I am ready to retire. (And I also know that, as I get older, I should be moving the money from a more risky portfolio to a more secure savings, and money market, portfolio.)

Let's look at another "irrefutable" fact: in the years since the SS Administration was created, the rate of return (interest earned) on funds put into Social Security is significantly less than the rate of return on money put into nearly any fund in the same period of time, even with this recent "downturn."

So--I reluctantly agree with DD--it is cheaper to administer someone else's money when you aren't expected to be "smart" about it, and actually earn them a rate of return.

You get what you pay for.

"Plain and simple."
Social Security is still insurance, so it's still kind of absurd to talk about "rate of return." You don't talk about your rate of return on your life insurance, you figure you're going to break about even on average.
Punditus: Agreed. Social Security is "insurance" and thus should not be compared to a 401K which is an investment. The requirements for administering them are very different, and thus the ways of measuring the costs of administering would be very different as well. Apples to Oranges comparison.

But I didn't make the comparison--DD did.

That said, SS is a poorly run insurance plan. Most insurance companies maintain large reserves enabling them to pay out as required. Most insurance companies are able to set the rates based on actuarial tables so that they can ensure that the risk they assume is balanced by the premiums they collect.

So, perhaps the lesson learned is that while SS is an insurance fund, not an investment fund, it is a poorly managed one compared to most. (AIG being a glaring exception since they used their cash reserves for risky practices.)

Since you brought it up...

I have been pondering this whole notion of SS being insurance. Generally speaking, when insurance companies talk about "insurance" they are placing a bet.

Life Insurance: They bet that you won't die. You bet that you will.

Auto Insurance: They bet you won't have an accident, you are betting you will.

Homeowners Ins: You are betting that you WILL be robbed/have a fire, etc, and they are betting that you won't.

It's that "bet" that enables them to stay in business. The insurance companies all build actuarial tables looking at the probabilities (or the likelihood) of having to pay out for certain events, and then they figure what rates they can charge to pay out against those events which in the (very) long run with large groups will pay out at (slightly less than) the same rate.

Health insurance: Well, if it were really "insurance" then the above would be true, and we would pay in more than we use. Instead,most people I know complain if they get less out of the healthcare than they put into it, so they are more likely to visit the doctor any time their kid gets the sniffles. (Seriously--if you haven't met these parents, then you need to get out more.)

Now, on to Social Security "Insurance." If it was there simply to protect against the unlikely event we would lose a source of income (death of a parent, dismemberment, etc), then we could see how it is insuring us against the "unlikely" event that those might occur. But once the SSA became our "retirement" account, they became an investment. Now, we all know better than to "just" trust in SS for our retirement. The government has been telling us that for years. The best spin is "it is a safety net for retirement." Regardless, people have it in their heads now that they have made contributions into their "Social Security accounts" and that they will get it back when they get their retirement.

So, once we started relying on SS to be our retirement fund, we then have an expectation that they are a "fund" not simply "insurance." The funds will be payable to all.
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