Arnold Kling on the Economics of Health Care and the Crisis of Abundance
Nov 5 2007

Kling_bw.jpgArnold Kling of EconLog talks with EconTalk host Russ Roberts about the economics of health care and his book, A Crisis of Abundance: Rethinking How We Pay for Health Care. Kling discusses whether we get what we pay for when we spend money on health care, why health care isn't like cars, and why health care insurance isn't really insurance. The conversation closes with a discussion of innovation in America's health care system and why America is so unlike everywhere else.

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Explore audio transcript, further reading that will help you delve deeper into this week’s episode, and vigorous conversations in the form of our comments section below.


Nov 5 2007 at 10:18am

Just back from probably a record time on my morning run. When I heard the claim single payor will only add cost, adding people to the Titanic, I think I went into an unconscious sprint. And to hear pharmaceutical cost don’t even effecting the rounding of numbers?? WOW! Russ you know how reactionary I can be.

Drug company profits and Health plan administrative cost are not large!!!! I literally have to stop writing because I’m so infuriated by those claims.

Every other developed country spends far less and it’s not solely because they ration care.

Further people are already on the Titanic when they have NO health care and show up to the emergency department far more likely to have an extremely costly poor outcome then if we offered them preventative care.

OK..Now I really need to stop.

Nov 5 2007 at 10:38am

OK now on to Bayes’ Theorem. I enjoyed this part but ultimately found it also a good argument for a government run universal health plan. First you’re doctor was taken aback by your Bayesian analysis I’m guessing because subconsciously he realizes that almost none of his patients are capable of such calculations. As much as you’d like your doctor to treat you the fact s he treat populations.

Honestly I couldn’t have explained the theorem if you asked me outright before your show but indeed I think I use it regularly without regard to it’s namesake.

I’m a pediatrician. I regularly get sick babies that have positive test results. Almost always these are false positives. I literally tell my parents that the odds that your baby does have a blood infection are like 50:1. Well maybe I use 30:1 sometimes on gestalt. Then I tell them if this was Vegas and I were betting even money that your baby doesn’t have a blood infection I’d put $1000 or more dollars on the table without thinking twice. Then I tell them but here we are not betting money as I hold the babies hand and jester dad to look at the stakes. We treat all 50 babies cause I’ve seen the one when it goes untreated and because the dad doesn’t care much about theorems.

Nov 5 2007 at 10:54am

For an Insurance experiment, I would like to see very high deductibles for the rich and middle class. Like deductibles above $100,000/year. Maybe the carrot to get affluent people to use such a system would HSA’s where one could deposit any amount of money until the account balance reaches $1,000,000.

Russ Roberts
Nov 5 2007 at 11:18am


According to PubliC Citizen, a source I think you would trust, pharmaceutical industry profits in 2002 were 36 billion. If all pharmaceutical companies were forced to serve the public at zero profit, that would lower US health care expenditures from 1.3 trillion to 1.3 trillion. That’s a small change, I think. I’ll carry it out to a few more decimal places. In 2002, total health care expenditurea in the US were 1,342 billion. So taking out ALL pharmaceutical profits lowers that number to 1,306 trillion. I don’t think there’s any way you can argue that the profitability of the pharmaceutical industry is a large factor in US health care costs.

Arnold Kling
Nov 5 2007 at 1:45pm

I second Russ’ point about drug company profits. Insurance company overhead is a bigger number, but still only about 6 or 7 percent of total health care spending. And Medicare’s lower overhead is offset to some degree by higher fraud costs–one of the things that private insurance companies buy with their overhead expenditures is lower fraud.

My point is not to defend our current system. My point is to say that anger about drug companies, health insurance companies, and other capitalist villains does not move us close to a solution for putting the U.S. in line with other countries on health care spending. In order to do that, you have to reduce the amount of medical procedures that we undertake.

Bruce Boston
Nov 5 2007 at 4:04pm

So, quick question.

It seems to me that the $36 glass of Orange Juice is somewhat analogous to the $8 bucket of popcorn at the movie theater, or a $36 glass of wine in a high end bar that would cost you much less from your local winemart.

That said, in the case of the OJ, because the system is ‘not market driven’ we blame the higher cost on the inefficiencies of the system. In the case of the popcorn or the wine, both ‘market driven’ systems we go through a sort ‘robert frank’ economic naturalist exercise to justify the prices.

I guess my point is that it seems like our bias to the type of system could have very real effects on our calculations as to the efficiencies of the system.

How do we know that some number cruncher hasn’t determined that the ‘real cost’ of that OJ isn’t $36? Take into account that having someone that runs about $200-$400 an hour is playing waiter to get, pour and clean-up the Oj, coupled with the increased risk to desterilization of the environment that costs $2k ever once every 50 glasses when the organic substances is splashed across the room, as well as the increased purchase price of the OJ as surely a hospital couldn’t have the same OJ policy as your local Dennys (ie you’d have to have higher quality checks on the hospital OJ), as well as the higher cost of purchasing the OJ because a hospital doesn’t go through as much OJ as your local Denny’s purchasing group does, as well as the increased insurance costs/risks as one more organic variable is added to the overall packaged service equation etc, ect, ect…..

When a restaurant doesn’t allow customers to bring their own wine, or when a theater prohibits outside popcorn, we find market reasons, but when a hospital doesn’t encourage patients to bring their own OJ, are we to say there are ‘no reasons’?

While the simplicity of Orange Juice may seem like a good way to judge the inefficiencies of a system, I’d like to suggest that we really don’t have the data we need to measure the true inefficiencies, or perhaps conversely, the efficiencies of a system. And, as such I’d assume we’d be unable to give an authoritative conclusion as to the rate of efficiency of the system.

That said, there seems to be a very strong correlation between the perceived ‘market drivenness/lack thereof’ of a system and the perceived efficiencies we have a tendency to find/overlook in said systems.

I could be wrong, but just an observation…..


Nov 5 2007 at 10:30pm

“Insurance company overhead is a bigger number, but still only about 6 or 7 percent of total health care spending.”

Where are you getting these numbers? This is really infuriating. You wrote a book on this subject? This is a serious serious issue and misleading people on the facts is wrong.

From the CMA 13th Annual Knox Keene Health Plan Expenditures Report:

For the fifth year running, Blue Cross of California has spent less than 80 percent of premium dollars on patient care according to CMA’s 13th annual report examining annual health plan expenditures. Blue Cross, the state’s largest health insurer, spent 78.9 percent of its premium dollars on patient care in fiscal year 2004-2005, with 21 percent going to profits and administration.

Bruce Boston
Nov 6 2007 at 1:27am

Hi Muirgeo,

Blue Cross of California, or any one company, may very well have profits plus administration costs at a higher percentage than the average. That said, showing this doesn’t really invalidate the estimation of what the average is. Not saying I know the numbers, but I think if you want the math to match up, you’ll need to match the same denominators with the same numerators to do so.


Arnold Kling
Nov 6 2007 at 7:09am

My source on insurance administrative costs is the National Health Accounts, produced by the U.S. government.

When I began working on what became my book, I had a somewhat different view of health care than what emerged from looking at the literature and the data. I was willing to change my mind, based on the facts.

It is important not to get angry with facts. Take them as they are, and adjust accordingly.

Nov 6 2007 at 10:30am

Quote: “they spend less not because they’re more efficient but because they provide fewer services”

And still Europe’s more effective, looking at the difference in health outcomes between Europe and the U.S. (you know… basic outcomes such as health expectancy and infant mortality).

And also, while it’s all fun and games watching americans explain how the european healthcare system works, untill I meet an american who criticizes our system *and* understands the difference between the Canadian or British NHS, and the hybrid system employed in the rest of continental Europe, I’m afraid your arguments remain stuck in partisan mud.

Nov 6 2007 at 4:09pm


The average is not the point. The point is the big for profits have far higher administrative and profit numbers taken out of ever $100 dollars while government run programs in this country and in others have far lower administrative fees.

In California admin + profits

Aetna 21.3%
Blue Cross 21.0%
Health Net 14.2%
Pacific Care 13.8%
Kaiser 6.9%
(not for profit)

LA Care 5.5%
CalOptima 4.1%
Inland Empire 7.8%

Nov 6 2007 at 10:21pm


do your numbers for the public plans take into account the estimates for the deadweight cost of taxation?

Michael Ulm
Nov 8 2007 at 2:03am

I’d like to point out two factual errors in the Podcast.

First, the claim by Arnold Kling, that the four treatments mentioned (aggressive Cancer therapy, colonoscopy, screening for blood in urine, and MRI for back injury) would not be performed in socialized medicine. I do not know about cancer therapy, but the other three would be performed with no cost to the patient in the two socialized systems that I know (Austria and Germany). Some of them would need to be approved by a doctor, but getting that is usually easy.

The second error is more serious IMO. In your Bayes analysis, you claim, that a 5% false positive test would be unnecessary if the probability for the disease is only 1/1000. This is wrong. Testing positive in such a test, would indicate the need for more testing to weed out the false positives.

I agree, that the test may be unnecessary if there is no known treatment for the disease, but this is an unrelated point.

Nov 8 2007 at 1:28pm

It’s early here, so if my calculations are wrong, please set me straight…

If you crank through the Bayesian analysis on the ANA/Lupus example, don’t you arrive at an approximately 2% chance that a positive result on the test is significant?

Irrespective of complementary diagnostic criteria (responsive to immunosuppresants, musculoskeletal symptoms, etc.) a test that has absolute significance even 2% of the time hardly seems “irrelevant” to me. Granted, it’s not the 95% answer that most people would thoughtlessly offer, however, it is meaningful. Particularly when coupled with the expertise of a diagnostician who has seen the disease in question before…

On a side note, I loved this podcast as I do with all of them. I know the life of a prof is busy, so I appreciate that you take the time to do this each week.

Nov 8 2007 at 6:35pm

I just found this podcast and I am really enjoying it.

On Healthcare

I would really love to just hear more vetted statistical facts.

The claim is made that we are spending too much on unnecessary tests. What part of the 1.3 trillion do these amount to?

I have heard that a large percentage of health care spending is spent on a very small percentage of very sick patients. Is this true? Are these the same patients year-to-year?

I have also heard the a large percentage of health care costs occur in the last few months of life. Is this true?

If we want to reduce healthcare expenses we have to first determine where we are spending the money. Spending lots of time attacking some insignificant part of the spending, even if egregious, is ineffective.

On the comments about drug company (and healthcare company) profits. Perhaps I do not understand but are not these profits retained by the company and spent on further development? People that complain about profits always seem to assume that these are paid to the managers of a company but if this were the case these would not be profits but expenses. A not-for profit company can still easily overpay its managers.

Bruce Boston
Nov 8 2007 at 6:47pm

Hi Muirgeo,

Re: “The average is not the point. The point is the big for profits have far higher administrative and profit numbers taken out of ever $100 dollars while government run programs in this country and in others have far lower administrative fees.”

As a silicon valley high tech employee, my Family and I have access to a number of different plans at a number of cost points from my employer.

Blue Cross
Health Net
Pacific Care

I don’t remember every detail of the conversation that my wife and I had when we chose the ‘right plan for us’, but I’m pretty pretty sure we never asked
‘….but which one has the lowest admin and profit rates’
There are so many things that health care provides that are so much more important to the recipient of that care.

Additionally, in any industry, including health care, I don’t think I have ever seen a correlation between ‘lower profit margin’ and ‘higher quality’. More often its just the opposite, with the higher quality firms not only figuring out how to provide higher quality products, but also figuring out how to do so at a lower than average cost, thus creating a higher than average profit margin.

If Blue Cross has figured out how to decrease their real estate costs, or their utility costs, or their unneeded test rate, or their costs of training, or their record keeping costs, or their malpractice insurance costs, or their legal costs, or their advertising/marketing cost, or any number of other ‘costs’ that may not directly correlated to the quality of service, and thus have a higher profit margin at the end of the day as a result, then what? Should I consider switching to a provider that hasn’t figured these things out?

Clearly I have the option of a lower margin provider, with Kaiser at 6.9%, but if this lower rate doesn’t benefit the me with higher quality at the same price or similar quality at a lower price, why should I favor this?

As such, while I understand the informative value of the Admin+Profit Rate, I just don’t see any value in using it in making the health care provider decision, over more informative metrics like the ‘Quality/Price’ ratio, etc.

More importantly, on the public policy side, the last thing I want the government doing is mandating that my family get care from the low profit margin provider, or capping the profit rate of my health care provider, as this caps their incentive to increase internal productivity, something that would only slow the market’s ability to decrease prices.

Simply put, the incentive to increase one’s profit margin, is the same incentive to increase one’s productivity, which is the same mechanism that will increase market competition, which in turn lowers prices and/or increases innovation, depending on which has a higher demand in the current market.


Nov 9 2007 at 4:20am

Why are “maintenance” items (e.g., eyeglasses in your podcast) covered by employer-provided health insurance? While we humans are the consumers of health care, employers are the consumers of health insurance.

Usually, the details of employer-provided health insurance are frequently not known until the first day on the job. Consequently, employees don’t choose employers based on the details; they choose based on “rumors”, such as “company xyz has better coverage than company abc”. Providing eyeglasses would not have an influence on either attracting employees or holding onto employees (“I quit! You’re no longer providing eyeglasses!”).

Considering the number of employers providing either no or very limited insurance, and that even in a tight labor market employees are ignorant of coverage, the “fluffy” bits should be disappearing from employer provided insurance plans. Are they?

(As an aside, I’m currently purchasing individual coverage, a PPO with a _very_ large deductible. I’m also over 50. There are examinations I should get as a matter of course, but because I know that coverage can be revoked or priced beyond my ability to pay if early signs of disease are found, but that my insurance will cover catastrophic events, it is “better” for me to not have preventative physicals. My locally rational decision has the potential to raise global health costs in the future. And talking to others like myself, my choice is not unique).

Nov 12 2007 at 12:03pm

First an aside and then a longer post on an issue touched on in the podcast. The aside: Arnold Kling stated that health care costs appear to be excessive compared to health outcomes given that longevity in the United States is the same as in other countries that spend less. Longevity is not the only measure of health outcomes. Many other goods are purchased as well (e.g., time/convenience and the ability to remain active).

Now the main point. I have always thought that auto mechanics are a good analogy to doctors when thinking of solutions to one of the possible sources of market failure in health care: the suppliers of the goods (the doctors and auto mechanics) effectively demand the goods (by instructing the patients/car owners as to which tests and treatments should be provided). I was glad to hear the podcast discuss this issue, but don’t think it went far enough (although Russ Roberts almost came back to it at the end with a discussion of car insurance for oil changes).

Russ Roberts indicated that the way he solves this problem is to find a car mechanic he really trusts. The transaction costs to that solution are fairly high, and the market has found another (and I think better) solution. The car makers have internalized the cost of repairs, and the consumer pays for that cost in the price of the car. My experience is that vehicle warranties (on both new cars and used “certified” cars and used cars purchased through the national vendors) have become much more comprehensive and extended warranties are much cheaper and more comprehensive (I used to never purchase them, but have with my last two cars). At least one car maker I know of (BMW) has even internalized the routine maintenance (oil changes) given that the failure to obtain that maintenance may cause more costly warranty claims.

Perhaps the pervasiveness of third party payment systems is due to the high transaction costs of educating medical consumers or finding trustworthy doctors and providers. The internet may reduce some of those costs, but my guess is that most consumers only do the research after obtaining a diagnosis (and not research on whether or when to obtain tests and care in the absence of a diagnosis).

Ultimately this analogy would suggest that HMOs (providers who both provide care and take on the insurance risk) as being the best solution to the transaction costs of finding trustworthy providers. And yet, my experience (I am an attorney who works with employers on their benefit plans, including medical plans) is that HMOs have dramatically declined in popularity (to the point that many employers do not offer them as an option). What’s going on here? Is the analogy wrong? Interested in the thoughts of others on this point.

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Podcast Episode Highlights
0:36Intro. What is a "crisis of abundance?" Sounds like an oxymoron. We could pay for the health care we had in the 1970s, but with a lot of new equipment and training may be unnecessary, yet we have to pay for it. Compared to the 1970s, we have better diagnostics, etc., but is the improvement in line with the expenditures? We wouldn't have this criticism about cars, though. More cupholders, less likely to break down, better mileage, etc.--economists don't say, well, is it really worth the money? Consumers pay for them, so to those consumers it's worth it. But in health care, consumers directly pay for less than fifteen percent. The government (via taxes) and health insurers pay for the rest. Consumers themselves would not likely choose those procedures. People tend to think of health care in black and white--if you need it, you need it, if you don't, you don't. But many of these procedures are optional. Turn 50 and your birthday present is to get a colonoscopy. Screening for blood in urine. MRI for back injury. Expensive, risk of complications, and not absolutely necessary, nor is it absolutely unnecessary. In Sicko, Moore shows a woman whose husband had had kidney cancer, and doctor proposed a radical bone marrow transplant that was turned down by the insurer. Movie wants you to believe it was turned down for non-medical reasons, because the man was black and to be cheap. Turns out that medically, the transplant does not tend to save lives and is in some middle ground--neither absolutely necessary nor absolutely unnecessary.
9:36Countries that give people a right to health care probably wouldn't do any of these procedures. Not black and white, room for economics. For economists, e.g., Robert Frank, costs and benefits. People don't like to look at costs and benefits when it comes to health care. In market systems, cost-benefit decisions are made by consumers; but in non-market systems, political. In U.S. we do not have a market system for health care. On supply side, what a health care provider can do is tightly regulated, limits ability to make it efficient. On demand side, individuals typically do not pay for their own health care. You are supposed to show your insurance card, not pay cash. Consumer is insulated from the payment; and also often the employer pays for the insurance (though the consumer pays in the form of lower wages). Our system allows us to make extravagant use of medical costs and benefits. But worldwide people really love "free" health care. There is a ubiquitous benefit to not having to think about the costs. How about asking what something costs in the area of treatment? When having a child, many advance tests are done, anxiety-creating, some have health risks, but if you say to the doctor you may not want it, or what does it cost, doctors are surprised and may not even know the answer! Doctors don't sell it. Official cost of a glass of orange juice during delivery was high, could have brought own orange juice.
16:50Maggie Mahar's HealthBeat blog, post about having conversations with doctors being a potential solution. Arnold's question was: why doesn't that happen? Why not enough conversations with doctors? Bayes Theorem, 40 year old man with microscopic blood in urine, incidence of serious illness for that symptom at that age in a non-smoker is low, so more sensible to not have the extra test. Doctor didn't understand Bayes Theorem, was deeply offended and yelled at Arnold's wife. Opposite of Mahar's experience of just having a conversation. Illusion of the doctor knowing best. In a world where consumers paid for the cost, consumers would likely ask, and doctors would learn more about the answers. I like to trust my auto mechanic, but I don't have any illusions. Try to find a mechanic who would feel guilty to do more car procedures than are cost-efficient. But medical situations are affected by our fears about death.
20:45Only 15 cents out of every dollar is paid for out of our pocket today, but in 1960 it was at least 50 cents. Medicare, 1965, big driver of our expenditure in health care. Suggested institutional change is to push the direct consumer the means, the motive, and the opportunity to make better decisions. The doctors don't have a good sense of the costs and benefits. Ian Ayres had example of Bayes Theorem problem for doctors, 3/4 get it wrong. Could have commission to study of the costs and benefits, or a commission could emerge. Internet. Means. For motive, by having consumers pay directly they have incentive to consider procedures' costs and benefits. Bayes Theorem can be used to help evaluate costs and benefits of tests. Megan McArdle, suppose you have a blood screening for a rare disease, lupus, say 1 in 1000 people have it. Can have four outcomes to a screening test: true negative, true positive, false negative, false positive. Suppose there is a 0% false negative rate and a 5% false positive rate. Test means if it says you are okay, get a negative, you are really fine. But if you get a positive, what does that mean? It doesn't mean that you have a 95% chance of having the disease, though that is what many doctors interpret it to mean. Why doesn't it mean that? If you do the test on 1000 people, there will be 50 false positives, one true positive, so if you test positive, you have a 1/51 chance of not having this disease. It's because even though the test is pretty good, it's imperfect, and this disease is very rare. In real life, tests are imperfect even if there is no lab error. A 5% error rate sounds small but combined with the rarity of the disease it's very large. And with this particular disease there is no way to treat it till there are symptoms.
28:39Politically it's hard to make the argument that consumers should pay more for their own health care. People want to shuffle around the financing, but there are no large changes on the table. One might be for government to crack down on the procedures that get done. Another might be to give consumers more responsibility. Iron Trilemma: Suppose we want three things: 1. we like to be insulated from the costs of health care, 2. we like unlimited access to health care procedures, the best care now, and 3. we ultimately have to worry what it costs. Can't have all three. Single payer option: idea is that government runs the health care system, it would be more streamlined, less paperwork, we could take all these costs out of the system. Would it be more humane? Would it be less expensive? Evidence for expense seems to be that it would not be less expensive. Arithmetically the overheads by drug companies and insurers is not large. It's the spending on procedures that has been the big expense. Medicare, fiscal equivalent of the Titanic. What we've promised recipients is out of line with the taxes we are going to collect.
35:20Innovation. In the legal environment today there is a lot of defensive medicine done, tests run to fend off potential lawsuits. Puzzle: If you are an innovator, biotech or medical device company and you come up with a better imaging or diagnostic tool, what is different in today's environment compared to a more market-based system where consumers had to pay for it directly. There is an incentive to innovate with the current system. Amy Finkelstein paper. Wife's documentary of family at daughter's graduation was of a family saved by the health care system, survivors of breast cancer, heart problems, all taking medications that were not available years ago. Health care systems elsewhere in the world don't promote the kind of innovation we do. When developed elsewhere, they market it in the U.S. because we are receptive to it. Costs a lot but does create incentive for innovation
41:01Political world. What is your imaginary, ideal system? More experiments at state level, maybe a few states could experiment with single payer system. Hard to argue that if Arizona went to a single-payer route the problems Canada has experienced would not surface. More market. Government pays for the poor, most people have long-term catastrophic insurance, maybe augmented by government if it runs out. On supply side, more flexibility. Physical therapy will have to be with licenses. Sharon Brownlee, HMOs (not managed care), system with lots of different providers. Have to get rid of licensing requirements. Catastrophic health insurance: we have "insulation, not insurance." Purpose of insurance is to protect people from large financial risk. Home owners insurance, low premiums, rare claims, for very big amounts. Health insurance is the opposite, could be $12,000/year for a family; claims made all the time, even small dollars. Wasn't designed as insurance. Designed to insulate people from seeing the price of health care. Usage vs. price: you don't want to insure against common events is that it is very expensive. A government-run auto-insurance policy that lets you get oil changes whenever you need them would be very expensive. This is what we are doing with health care. Vision coverage and eyeglasses.
49:15Political economy, in some states there are mandated coverage requirements that you can't opt out of. Result is many uninsured people. Mandates are driven by suppliers, e.g., the opticians. Massachusetts, Romney. Health insurance crisis isn't always a health care crisis. Those who do have insurance drive up the price paid by those without. Few people are turned away for health care in the U.S., regardless of whether or not they have insurance. Top-down engineering focus as opposed to letting the system emerge. Evolution of markets. Markets are often sold as being efficient. Masonomist, George Mason's economics department: "lose the we." It's "our" health care system and we have to design it. Instead think of it as what I, the consumer, want. There will always be room for improvement. Where are you most likely to get that improvement? Government-run institutions that fail are more likely to be reinforced than market-based institutions. If you think you have to grope your way to a better system, markets are more likely to get rid of the failures and insure better incentives for success.

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