Posted by Joseph Y. Calhoun, III

President Obama has said that health care reform should include a public option in the menu of choices available to healthcare consumers. Greg Mankiw asks, what’s the point?

Would the public plan have access to taxpayer funds unavailable to private plans?

If the answer is yes, then the public plan would not offer honest competition to private plans. The taxpayer subsidies would tilt the playing field in favor of the public plan. In this case, the whole idea of a public option seems to be a disingenuous route toward a single-payer system, which many on the left favor but recognize is a political nonstarter.

If the answer is no, then the public plan would need to stand on its own financially and, in essence, would be a private nonprofit plan. But then what’s the point? If advocates of a public plan want to start a nonprofit company offering health insurance on better terms than existing insurance companies, nothing is stopping them from doing so right now. There is free entry into the market for health insurance. If a public plan without taxpayer support would succeed, so would a nonprofit insurance company. The fundamental viability of the enterprise does not depend on whether the employees are called “nonprofit administrators” or “civil servants.”

The bottom line: If the goal is honest competition in the provision of health insurance, the public option cannot do much good but can potentially do much harm.

That’s a darn good question and the answer is that the “public option” will have access to the public purse because the Obama administration sees that as a way to bludgeon health insurance costs lower. They will offer a public plan with more benefits and a lower price than the private options and the taxpayer will pick up the losses. If the private companies match the benefits and price, health insurance prices will be reduced and the public option won’t get much business. If the private companies don’t match the public option, then President Obama will say, “See, the government can do this cheaper and better”. Of course, we won’t know the true cost until much later, but if the public option works like every other  government program it will cost a lot more than initially thought. But that is in the future and in the meantime, the administration will be able to claim a victory on healthcare.

The problem with this plan is that over time it will tend to increase the utilization of healthcare services and absent any action to increase the supply of those services, the price will rise. If the public option becomes the default for most Americans over time, the government will be forced, as they have in other countries, to ration services and/or impose price controls. And those actions will just further exacerbate the problem by further reducing the supply of healthcare services. Or at least that has been the experience of every other country that has tried to take over the administration of healthcare. Does economics work differently here?

The problem with all the healthcare reform plans I’ve seen is that they concentrate almost exclusively on the demand side of the problem. Even worse, the reforms will increase the demand for healthcare services while the stated goal is to reduce the cost. If reform doesn’t also address the supply side of the problem there is no way we can accomplish the twin goals of increased access and decreased costs. The plans that are being debated in Congress only address the imbalance by attempting to reduce the long term demand per capita by encouraging more efficient use of healthcare (and not in very effective ways in my opinion). Why not do something to increase the supply at the same time?