Longtime readers of this blog will be pleased to learn that this month sees its migration into book form. Uncommon Sense: Economic Insights, from Marriage to Terrorism, which collects what we believe are the best, most interesting, and most lasting posts from this blog. The posts selected for the book are representative of the wide range of topics we cover here, and, where appropriate, they've been updated to take account of subsequent events.
The book is available at all good bookstores, on- and offline, as well as directly from the University of Chicago Press: http://www.press.uchicago.edu/presssite/metadata.epl?mode=synopsis&bookkey=1606474.
I sympathize with all the people who are upset by the very large bonuses, stock options, and other compensation received by heads of some financial institutions that ran their companies into the ground through bad investments. However, I also believe it is a big mistake to have a pay czar, Kenneth Feinberg, impose sharp cuts over the salaries and other compensation of the seven financial institutions, like Citibank, that received the most government bailout money. The Fed has made matters even worse by proposing to implement pay controls over thousands of banks as part of its regular review of their performance.
General controls over wages have frequently been tried in different countries. The usual motivation for wage controls is to reduce inflation by keeping labor costs, and therefore prices, from rising rapidly, although wage controls are invariably combined with general controls over prices as well. Inflationary fears were certainly behind the wage and price controls in almost all countries during World War II, and in the US under President Nixon from 1971-1973. These measures sometimes succeeded in suppressing inflation temporarily, but they also led to rationing of various consumer and producer goods because of weak incentive to produce or work when prices and wages are kept below their market values.
Companies can still compete for employees when higher pay cannot be offered as inducements by increasing fringe benefits to employees, such as longer vacations and subsidized lunches and other meals. US companies began to offer free health insurance to employees during World War II as a way to get around the wartime control over wages. The American health care system has suffered badly since then from this artificially induced connection between employment and subsidized health care.
In some respects, the effects of controls over pay are even more harmful when they apply only to a small subset of all employees, such as the proposed sharp ceilings on management compensation at the seven companies that received the largest amount of government assistance, or the scrutiny of pay of top executives at the thousands of financial institutions under the Fed's supervision. The most talented individuals at these firms will tend to leave because they will receive much higher compensation packages by financial and other companies that do not have their pay set in Washington. So the financial companies that received much government assistance and other banks would lose many of their best people just when they need talented management to help put their companies under a more solid financial foundations. Without the requisite talent, many of these companies may either go under, perhaps not a bad idea, or more likely the government will bail them out once again-not a pleasant prospect.
o prevent an exodus of whatever talent is left and to attract new talent, Feinberg and the Fed may try to differentiate between more and less able executives, and allow much higher pay for the best of them. But can a czar or the Fed perform that task better than the forces of market competition for talent? History indicates that is highly unlikely.
These controls over pay not only will cap salaries, but they would also reduce bonuses and stock options, and prevent the executives affected to cash in options for several years. The reasoning is that this will force executives to take a longer-term view of the risks and other decisions that they take. One irony is that, as pointed out by Yale's Jonathan Macey in a recent Wall Street Journal op-ed piece, Congress in a 1992 Act prevented corporations from deducting as a normal business expense any salaries that exceeded $1 million. As a result, corporations were encouraged to shift their pay to stock options, which received more favorable tax treatment.
I have not seen convincing evidence that either the level or structure of the pay of top financial executives were important causes of this worldwide financial crash. These executives bought large quantities of mortgage-backed securities and other securitized assets because they expected this to increase the average return on their assets without taking on much additional risk through the better risk management offered by derivatives, credit default swaps, and other newer types of securities. They turned out to be badly wrong, but so too were the many financial economists who had no sizable financial stake in these assets, but supported this approach to risk management.
The experience of other financial crashes also does not indicate that either the level or form of compensation of top financial executives were major factors in precipitating these crashes. Thousands of banks failed during the Great Depression, as did hundreds of American savings and loans institutions during the 1980s, without heads of these institutions in either case getting particularly high pay, or pay that was mainly in the form of bonuses and stock options. My impression is that this same conclusion applies to the Mexican bank crisis of the mid 1990s, and the Asian financial crisis at the end of the 1990s.
The generous bonuses and stock options received by financial executives may often have been unwarranted, but they are being used as a scapegoat for other more crucial factors. Financial institutions underrated the systemic risks of the more exotic assets, and apparently so too did the Fed and other regulators of financial institutions. In addition, large financial institutions may have recognized that they were "too big to fail", and that they would be rescued by taxpayer monies if they were on the verge of bankruptcy because they took on excessively risky assets.
Limiting the compensation of a handful of employees at a handful of firms can't have any effect except to benefit the firms' competitors by making them more attractive places to work. The limitations are a form of scapegoating designed to appease public anger over the high incomes of financiers who precipitated an economic collapse that has caused widespread suffering, much of it to people who, unlike financiers, bumbling or inattentive government regulators, macroeconomists, members of Congress, and improvident homebuyers and home-equity borrowers, bear no share of blame for the collapse.
There is a slightly better, though still unconvincing, case for regulating (2) compensation structure, as distinct from the level of compensation, of (2) all financial institutions. Since the market for financiers is global (in part because even a very small country can become a major banking center, given the mobility of capital and of financial personnel and the absence of any need for elaborate infrastructure, physical resources, or a large domestic market), effective regulation of compensation structures would require agreement among all major and many minor nations. If that obstacle to effective regulation could be surmounted, the case for regulation would come down to the fact that front-loaded compensation of financial executives can increase macroeconomic risk.
To explain, the risk of the kind of financial collapse that occurred in 2008 was reasonably perceived as small; had it been perceived as large, the banking industry would have reduced its leverage and other sources of risk. The risk of the kind of financial collapse that occurred in 2008 was reasonably perceived as small; had it been perceived as large, the banking industry would have reduced its leverage and other sources of risk. That small-seeming risk was produced by individual risky transactions, and the object of compensation reform is to discourage such transactions. Suppose the transactions were the purchase of triple-A tranches of mortgage-backed securities at an attractive price, but carried a correlated annual risk of 1 percent that the investments would turn out to be worthless and bring down the firm. A financial executive paid salary or bonus based on the expected profit of such a deal would have an incentive to make it despite the slight chance that it would blow up eventually. Merely requiring, say, that a portion of his salary or bonus be placed in escrow for a few years would not deter him; the reduction in his expected compensation would be too small. Suppose 50 percent of the bonus he received on the deal was placed in escrow and the duration of the escrow was five years. Then he would face a 5 percent chance of losing half his bonus. That would be too small an expected penalty to dissuade him from making the deal. The penalty could not be made sufficiently heavy to disuade him without depriving him of most of his current income.
So I think regulating financial compensation is a mistake. At the same time I think financial executives probably are overpaid from a social perspective. The reason is that their high incomes are generated mainly by speculative trading of stocks and bonds and other financial assets. Speculative profits are not net additions to economic welfare, because they are offset by the losses of the speculators on the other side of successful speculators' trades. That is not to say that speculation has no social value. It generates great social value by bringing about improved matching of prices to values, which encourages investment in productive activities. But the amount of profit that a speculator makes is not the measure of the social value of a successfl speculation. The increase in social value is probably only a small fraction of the speculator's profits.
If financial speculation involved a lot of career risk, in the same way that becoming an actor does, then the high incomes of successful speculators, like those of successful film actors, would be compensation for the risk of failure. But financial executives, while they do sometimes lose their jobs because of bad trades, generally experience a soft landing because their training and experience equip them for a variety of good jobs in business, government, or academia.
Recipients of Harvard Ph.D.'s in physics are said to have two career tracks open to them: academia and Wall Street. No doubt many are attracted to Wall Street by the much higher incomes they can expect there. Yet their social value might well be greater in academia.
Higher marginal income-tax rates, or a stiff tax on financial transactions, might go a slight distance toward correcting the financial brain drain, but probably it is a problem that we shall just have to live with.
Oliver Williamson's influential contributions to the theory of firms were the stimulus for our discussion topic this week of the analysis of organizations. Posner gives an excellent discussion of various factors that determine organizational structure and efficiency, such as conflicts between principles, like stockholders, and agents, like employees and managers, the ease of communicating information and knowledge from the bottom to the top of the organization, and the number of "layers" in the command structure. I will concentrate my comments on the environment that organizations face, and especially on the degree of competition they have to deal with.
One of the most compelling observations from highly competitive environments is that many different organizational structures sometimes survive in the same industry. For example, in the retail grocery sector, large "warehouse" types of stores exist alongside small specialized grocery stores. Chains that own many supermarkets, such as Safeway and Whole Foods, compete against small mom and pop stores with few paid employees.
George Stigler argued many years ago in a classic article ("The Economies of Scale", reprinted in his collection of essays called The Organization of Industry) that different types of firms that survive in the competition for profits in very competitive environments must be of rather equal efficiency at producing profits. A corollary is that if a competitive industry were trending over time toward a narrower set of organizational types, this would imply that these types must have become relatively more efficient as the economic and political environments changed over time.
The fact that small supermarkets and large warehouse markets survive the tough competitive pressure of the retail grocery market suggest that both types must be of about the same efficiency in their respective niches of the grocery sector, although the trend seems to be toward larger supermarkets. That steel mills are much larger than textile factories suggest that economies of scale in steel production must be sufficiently larger than the scale economies in the production of textiles to overcome the larger number of command layers and other inefficiencies of a larger production scale in steel but not in textiles.
Also of relevance to understanding the efficiency of different organizational types is that very different types of firms survive in different countries, often even when they are in the same or similar industries. For example, Japan and South Korea (occupied by Japan for about 40 years in the 20th century) have large conglomerates that are active in many different industries, such as Korea's SK company whose products range from an oil refinery to cell phones, whereas Taiwan tends toward smaller firms that are more concentrated in particular sectors (although Taiwan was also occupied by Japan).
Both the inter country and within country evidence indicate that no single organizational form is always the most profitable even in a particular sector of the economy. Different combinations of scale economies, principle-agent problems, compensation practices, thickness of the span of control, and many other variables highlighted in the organizational literature often produce outcomes that are about equally efficient and profitable. The outcome of strong competition is the only really decisive way to determine which are the possibly quite different but about equally efficient combinations of all these different variables.
The major difficulty in evaluating many governmental organizations is that they often do not face such strong competition and they have no simple measure of success, such as profits. These two factors make it difficult to use Stigler's survival test. To take Posner's example, can the criminal catching activities of say the FBI be efficiently combined with a terrorist deterrent function? If this were a competitive industry with many different organizations and good observable measures of success, one could then look at whether such combinations compete successfully in the longer run against more specialized agencies. Lacking either much competition or such measures of success, one has to rely in good part on the insights of analyses of these issues. Similarly, the organization and efficiency of armies is only rarely tested against competition on the battlefield. When so tested, losing armies often try to reorganize so that they can look more like the successful armies, although generals are often accused of reorganizing to fight the last war.
Perhaps then it is best to try to create competition among governmental agencies, such as both the CIA and FBI trying to deter terrorism, and then provide greater resources to the more successful agency. This, however, runs into the difficulty that agencies may withhold information from each other in order to gain an advantage in such competition.
The worldwide recession has slowed the growth in the demand for cereals and other foods as many countries have experienced stagnation or contraction in their GDPs. Now that the recession appears to be over, world GDP will start growing again. Many are forecasting that this growth in world output, especially the growth in developing nations, will put sharp upward pressure on food prices and that of oil, natural gas, and other commodities. Even the Malthusian specter has been raised again that the growth in world population will exceed the capacity of the world to produce the food demanded to improve living standards in the developing world.
The sharp increases in food and other commodity prices during the period from 2002 to 2008 when world GDP was growing rapidly tends to support these fears. The World Bank's index of world food prices increased by 140 percent from 2002 to the beginning of 2008, and by 75 percent after September 2006. The price of oil went up more than fourfold from the beginning of 2002 to its peak at over $145 a barrel during mid 2008. At that time there were many predictions of oil going to $200 a barrel rather quickly, and also of food prices continuing to rise rapidly. The world recession clearly made these predictions obsolete, at least until world GDP begins to grow again.
Rapid growth in world GDP will put strong upward pressure on some commodity prices. However, the supply responses of exhaustible resources, like oil and natural gas, should be distinguished from the supply response of food production. The supply of fossil fuels is obviously ultimately limited by the amounts in the ground. Outputs of oil, coal, and other fossil fuels can be increased by new discoveries, such as the recent discovery of oil off of Brazil, by extracting more of these fuels out of existing fields, and by squeezing oil and other fuels out of shale and other rock formations. Yet, all these ways combined have rather limited effects on total output. This is why, along with OPEC's restrictions on oil output, long run supply responses of oil, gas, and coal to changes in their prices are usually estimated to be quite modest. The long run elasticities of supply in response to rises in the prices of fuels are about +0.4 to +0.5.
The short run response of world food production to increases in food prices may not be large either, although farmers can shift rather quickly among the production of corn, soybeans, wheat, and other crops. In the long run, however, world production of food is quite sensitive to the world price of food. Given time to adjust, farmers can substantially increase the production from given amounts of land devoted to farming by greater use of fertilizers and capital equipment. Higher prices encourage investments in discovering mew methods of improving farm productivity, such as corn and other hybrids, the green revolution, and genetically modified foods. Productivity advances in agricultural output were very rapid at many times during the past century, often outstripping advances in manufacturing and other sectors.
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The amount of land devoted to farming in most countries declined drastically during the past century as urban sprawl, highways, and other land uses took over much of the land formerly used to farm. In the United States, farmers comprising less than 2% of the labor force and using well under half the available land, produce enough farm goods not only to contribute most of the food that feeds the huge American population, but these farmers also export corn, soybeans, wheat, and other farm goods all over the world. With high enough food prices, financial incentives will encourage farmers to take some land back from suburban, ethanol production, and other non-food uses.
World prices of food generally declined during the 20th century when world population and world GDP per capita grew enormously. The reason for these diverse trends is that productivity in the production of food expanded at a more rapid rate than did the demand for food. The advances in production were due to the use of new and more effective fertilizers, better farm machines, and many applications of scientific knowledge to improving the productivity of agriculture. Developed countries spent considerable resources on subsidies to farmers to help keep their prices up, not down. Even though it may not be possible to predict the exact nature of future agricultural innovations, one can reasonably expect similar growth in world farm output during the next several decades, especially if food prices rise by a significant amount.
Rapid growth in future world GDP is likely to greatly raise the prices of oil and other fossil fuels, unless concerns about global warming induce major steps to reduce the demand for these fuels. Rapid growth in world output is also likely to sharply raise the demand for cereals, meat, and other foods in developing countries. However, I have tried to show why food is different from fossil fuels and minerals, like copper, in that the supply of food is not limited by natural bounds on overall quantity. Rather, the efforts and ingenuity of farmers and researchers are able to greatly increase world food supply to meet even very large increases in the world demand for food.
Becker is right to point out the difference in supply conditions between oil (and other minerals, but I will limit my discussion to oil) and agricultural products: it is cheaper to expand output of the latter than of the former. Hence as demand for oil and for food rise as a function of population growth (an important qualification, as I'll explain--population growth is not the only driver of increased demand for food), oil prices will rise faster than food prices. This is fortunate because while there are substitutes for oil, there are no substitutes for food.
A continued increase in world population will increase the demand for both oil and food, and historical experience suggests, as Becker explains, that the increased demand for food can be met at only modestly increased cost even if the world's population expands greatly, though this depends in part on how rapid the expansion is--the more rapid it is and hence the steeper the increase in the demand for food, the higher the cost of meeting that demand will be, as it is easier to increase production in the long run than in the short run. Moreover, a sizable expansion in population would raise the price of farmland by increasing its opportunity cost.
As the world grows wealthier, the rate of expansion of population should, if historical experience is a guide, slow. But even if population stopped growing altogether, the demand for food would continue to rise because more people (perhaps billions more) would be able to afford the rich diet that people in wealthy countries consume. Supplying that rich diet is very costly in agricultural resources, for one of the major components of the diet is meat and the production of meat requires more agricultural output than the production of cereals and vegetables, since the animals that people eat are big consumers of food.
Technological innovations may hold down increases in the price of food that are due to the increased demand for a rich diet as multiplied by increase in population. But those innovations may create substantial externalities even if they do not push up prices (indeed, the less the increase in prices, the greater the output of agricultural commodities and hence the greater the externalities). As more and more countries adopt the most efficient methods of agricultural production, and thus for example converge on the optimally genetically modified variants of crops, genetic diversity will decline, which will increase the potential damage from blights. (It is not only stock portfolios that benefit from diversification.) Agriculture is a heavy user of water, moreover, and global warming appears to be reducing the supply of water usable for irrigation by reducing the size of glaciers. The run off from the seasonal melting of glaciers provides a more usable supply of water than rainfall, because the water from a melting glacier is channeled, while rain that falls outside a river or other body of water is difficult to store for use in irrigation.
I am one of those timid souls who worry about the downside of technological advance and economic growth. I find the prospect of continued increases in population and income, and of the technological innovations necessary to cope with those trends, unsettling.
The New York Times published an article last Thursday on the Swiss health care system, which can be viewed here: www.nytimes.com/2009/10/01/health/policy/01swiss.html?_r=1&em. The system is simple. There is no "public option," that is, there is no government health insurance program, such as Medicare or Medicaid. There is very little employer-provided health insurance, presumably because employee health benefits are not tax exempt; almost all health insurance is therefore bought by the insured. Everyone is required to buy a health insurance policy that provides a specified minimum of benefits (they can buy more expensive policies if they want), but there are subsidies for people for whom the expense would be a hardship; about 30 percent of the population receives a subsidy. Because of the heavy subsidization, the prices charged by the insurance companies are limited by government, but at a high level. (The limits therefore limit doctors' fees and incomes, and doctors are less well paid in Switzerland, relative to average wages, than in the United States.) There are many insurance companies, and people can switch freely among them. Copayments or deductibles are larger, and as a result the average out-of-pocket cost of health care is higher in Switzerland than the United States--an average of $1,350 per year, versus $890 in the United States. But the aggregate cost of health care is much lower in Switzerland--11 percent of GDP versus our 16 percent--though higher than in any other country besides the United States.
There is, as I said, no special program for the elderly, corresponding to Medicare--which may be why male life expectancy at age 65 is higher in the United States than in Switzerland, although female life expectancy at age 65 is higher in Switzerland and life expectancy at birth is substantially higher in Switzerland, in part because infant mortality is only about half as great as here. The quality of medical care does not appear to be inferior in Switzerland to that in the United States, and there appears to be no problem of queuing, as in Britain and Canada. Indeed the Swiss have significantly more doctors, nurses, and hospital beds per capita than the United States, which suggests that there may be less queuing there than here; and there is general satisfaction among the Swiss with their system, although there is some grumbling over the high cost of medical care.
Of course one must not put too much weight on a single article, but the information in the Times piece appears to be corroborated, at least the statistical data; and some of my description of the Swiss system is drawn from other sources.
If the United States could reduce its medical costs from 16 percent of GDP to 11 percent, the savings would be $700 billion a year; and if the reduction did not reduce the health or longevity of the American population or create queuing costs, there would be no offsetting cost; the $700 billion in savings would be net.
But while the Swiss health-care system may be great for the Swiss, comparing the health-care systems of two countries, even if they are broadly similar (both the United States and Switzerland are wealthy, modern, Western, democratic, capitalist nations), is treacherous, because beneath the broad similarities are potentially important relevant differences. Two of particular importance in the present context are, first, that the Swiss are probably healthier than Americans, on average, apart from any superiority of Swiss health care, and, second, that the Swiss probably have lower expectations of health care than Americans.
The Swiss do not have a large "underclass" (corresponding to the residents of our inner cities) that is poor and has a very high murder rate and high infant mortality and a high incidence of AIDS and other diseases. In addition, the Swiss do not have America's obesity problem, which is a source of abnormally high medical costs because of the treatment costs of diabetes and other diseases to which obese people are disproportionately prone.
And the Swiss people in all likelihood do not expect as much medical intervention as Americans too. Europeans tend to be more fatalistic than Americans. They do not share our preoccupation with extending the longevity of very old people, or our exaggerated faith in medical science that leads some of us to describe the death even of a nonagenerian relative as a "medical failure." Nor do they have as great a propensity as we to insist (after researching a disease on the Internet) on receiving medical care beyond what a doctor's professional judgment thinks warranted.
Our expectations regarding medical treatment are connected to our poor health: Americans want both to indulge in an unhealthy but enjoyable life style and live forever, and they try to square the circle by demanding extravagant (by international standards) health care. (I am exaggerating, of course; some of our poor health is due to ignorance rather than to a deliberate choice to substitute medical treatment for healthful living.)
So we might adopt the Swiss system and discover that our aggregate costs of health care had declined little from their current 16 percent of GDP. Indeed, because of increased coverage, it might increase (see below).
The proper use to be made of the experiences of other nations with health care is not advocacy for our adopting the health-care system of a nation broadly comparable to ours that spends a lower fraction of GDP on health care than we do. It is to note the methods used by foreign countries whose health-care systems are well regarded by the local population and see whether any of them could work well here, bearing in mind the dangers of piecemeal adoption of foreign methods. (An example of those dangers is the adoption by the Detroit auto companies some years ago of the "quality circles" used by Japanese auto companies to increase productivity by encouraging their workers to suggest productivity-enhancing innovations. The quality circles failed in Detroit because the auto companies did not realize that what made the quality circles work in Japan was the practice of lifetime employment; our workers were reluctant to suggest productivity improvements because they knew it might well result in a smaller workforce and therefore in layoffs.)
The features of the Swiss health-care system that seem well adapted to American conditions (though whether their adoption would be politically feasible is a separate question--to which the answer is "no," at least at present) are, first, repealing the tax exemption for employer-furnished health benefits, since the exemption both creates an artificial incentive for employers rather than employees to buy health insurance and disguises the cost of the benefits to the employees (in lower wages); second, making everyone buy health insurance, in order to prevent adverse selection (that is, excess demand by the unhealthy), the problem to which group (normally employer-group) insurance is a second-best solution; third, requiring significant copayments or deductibles so that the marginal cost of health care to the insured is not so low as to induce the overuse of medical resources; and fourth, providing no special program for the elderly, but instead requiring them to buy insurance like everyone else, with the cost subsidized only if they cannot afford the cost of the insurance rather than just because they are old.
Such reforms would probably produce a net savings in aggregate U.S. health-care costs, though this is not certain, because of the subsidies and because any extension of coverage--which would be considerable because everyone would be required to have health insurance and the number of uninsured in the United States exceeds 40 million persons--is likely to increase the demand for health care. The subsidies are transfer payments rather than costs in the sense of consuming real resources, but worrisome nevertheless because of the potential long-term harm to the economy from our soaring public debt. But the aggregate transfers and (real) costs would probably be less under a version of the Swiss approach than under the approach urged by the Administration, which does not have credible cost-saving measures build into it.
The Swiss health care system has several important properties that I (and many others) have been advocating should be incorporated into any reform of the US health care system. One major advantage of the Swiss system is that employer-provided health care does not receive any special tax breaks, whereas the US system is built on these tax breaks. As a result, only a rather a small fraction of Swiss health care is obtained through employment. Mainly, Swiss families buy health care on their own, so that, unlike in the US, their health insurance does not reduce their incentives to change jobs because job changes do not endanger their health coverage. Unfortunately, probably due to union pressure, Congress is not planning to eliminate this tax break for employer-provided health care. Indeed, many Congressmen want to increase the pressure on employers to provide health care to their employees.
The Swiss system includes a mandate that everyone buys a minimum amount of health care coverage. This solves the American problem where over 40 million persons have no health care coverage. If uninsured persons get sick-fortunately this is not frequent since they are mainly young-that raises the cost to everyone else since the uninsured typically seek treatment for any illnesses at hospital emergency rooms. The health care reform bills in Congress do include various coverage mandates, although they are not as straightforward or as desirable as the Swiss mandates.
The Swiss system typically has much larger co-payment rates than the US does for anyone seeking medical care or buying drugs. By shifting more of the cost to individuals and away from insurance companies, the Swiss give individuals greater incentives to economize on their health care spending since health care is more expensive to them. On the other hand, the Swiss system does not seem to have the equivalent of health savings accounts (HSAs) that allow consumers to carry over from one year to the next any balances in their health accounts that are not spent. These HSA accounts should become a more important part of the American system.
The Swiss do not give any special medical advantage to older persons, for they have access to the same health subsidies and same private health insurance system, as does everyone else. The US could approach the Swiss way by making Medicare much more means tested, so that higher income older persons would pay a much larger share of the costs of their medical care than they do now. Unfortunately, neither President Obama nor either political party is willing to tamper much with the Medicare system as presently constituted.
The Swiss system has no public insurance option, and relies on competition among private health insurance companies. I have argued strongly against a public option (see my post on August 17th of this year), and while it appears that this option is being dropped from most Congressional bills, liberal Democrats are still lobbying to have such an option included in any reform package.
Although I do not know the details of the Swiss system, it appears to provide good health care while spending only about 11% of its GDP on health care compared to the US' 16%. I say " appears" because previously the British and then the Canadian heath care systems were held up as models for the US to emulate until further evidence revealed that these systems had serious flaws, such as long queues for many types of treatments. In fact, the Swiss system does have some unattractive features that should not be emulated when reforming the American system.
For one thing, the Swiss impose sharp price controls on drugs, lab tests, and other medical procedures. To take drugs as one important example, Swiss price controls reduce prices of top selling US patented prescription drugs to about 40-50% below their American prices. In particular, the cost of lipitor in Switzerland is about 1/3 of its American price. In reality, what the Swiss (and other countries) do is free ride off of the incentive provided by American drug prices for pharmaceutical companies to invest the huge amounts of resources required to produce blockbuster drugs like lipitor.
Very small countries like Switzerland can get away with this free riding since their demand for drugs is so much smaller than that of the US. However, were the US to emulate the Swiss system, and there is a call from some Congressmen for greater control over drug prices, the incentives biotech and pharmaceutical companies have to innovate would be greatly reduced. It is precisely the greater price freedom in the US that induced many drugs companies to relocate their research labs out of Europe and into the United States.
Even though the Swiss spend a much lower fraction of their incomes on health care, their life expectancies at age 50 are about 1.5 years better than those in the US. However, as I argued in earlier posts (see, for example, July 28 of this year), life expectancies depend on many other factors than medical care, and the United States does not look good on most of these factors, such as obesity. More relevant comparisons are access to various tests, such as mammograms and PSA tests, and survival rates from major diseases, such as cancers and cardiovascular disease. The US does much better than other countries, including Switzerland, on both sets of criteria.
So despite the obvious conclusion that various reforms of the American health care delivery system are desirable, Americans are getting some important advantages for their large spending on health care. It is crucial that these advantages not be forgotten when evaluating how much better other countries health delivery systems, including the Swiss system, are than the American system, and in deciding how to improve the American system.
