Modernization Hub

Modernization and Improvement
Economics and Finance: Microeconomics and Regulation

Economics and Finance: Microeconomics and Regulation

ROSE: I’d like to
welcome everyone to the final panel of today. If you spend much
time around MIT, you all know that physics
has an uncertainty principle, and as you’ve discovered
today, so does economics. And indeed, in this panel,
the uncertainty principle we’re grappling with is
will our final panelist make it off the plane
that is supposed to be coming from Washington,
DC landing in Logan in time to join us at the very end
of our panel discussion? We’ll wait and see. So we started this morning with
a discussion of contributions that MIT faculty
and alumni have made to advance economic modeling
methodologies and science, particularly in the
microeconomic realm, but broadly. But MIT economists
have seldom been content with only these
objectives as laudable and as invaluable to academic
progress as those may be. Indeed, a hallmark of the
MIT economics department has been the firm insistence
on integrating economic science with applications. Economics faculty and alumni
have at least one foot on the ground at all times. Sometimes, as you’ve
heard from Esther Duflo, both feet on the
ground in entire teams in countries around the globe. So we’ve asked our current
panel to switch gears from a focus on
the macroeconomy, as uplifting as the last
panel’s discussion of that was, and shift attention to
discuss what microeconomists have contributed to
important policy questions and operations of government
policy, regulatory policy, and corporations. And this panel could, of
course, as the others, be an entire day of
discussion in and of itself, but Jim Poterba has told
me that we do have a firm stop, because people might
want to be able to eat at the end of the day. And so we will try
to limit our time to give you a bit of a teaser
to many of the important issues that we could
discuss but give you a sense for some of
the contributions. So I’d like to just briefly
introduce our panel, and then I’ll let
them weigh forth. Our first panelist
is Dennis Carlton. Dennis has an MIT
Ph.D. In economics and is the Katherine
Dusak Miller professor of economics at the
Booth School of Business at the University of Chicago. Dennis is going to
share his perspectives on economic contributions
to competition policy broadly– that’ll
be a theme of his– and is well-positioned
to do that, both through his experiences,
as been mentioned earlier, as deputy assistant attorney
general for economic analysis at the Department
of Justice, also as a member of the Antitrust
Modernization Commission. Policy roles, which greatly
complemented Dennis’s research expertise in this
area, as well as other broad areas of industrial
organization, anti-trust, and regulatory economics. Our second panelist,
Dick Schmalensee, is not quite an MIT lifer,
despite the dual bachelor and Ph.D. Degrees from MIT and
his role as the Howard Johnson professor of economics
and management, director of the MIT Center for
Energy and Environmental Policy Research, and dean emeritus
at the Sloan School. Now why do I say he’s
not quite a lifer? Well, Dick spent a
few years away from us at the University of California,
San Diego, which today looks particularly attractive to him. Dick has had a career
that has spanned a broad range of
research areas, ranging from industrial
organization, management, strategy to
antitrust, regulatory, and environmental policies. And I believe Dick
is going to weigh in, in particular,
to share with us some of the contributions of
microeconomics to solving some of the questions that Bob
Gordon raised in the last panel, namely how do we think about
intelligent energy policy and environmental policy given
the substantial challenges that we face not just as
a country, but as a world? Hal Varian, who is
an MIT undergraduate and has a Ph.D. in economics
from the University of California, Berkeley,
gives us a little bit of a change of pace. So how– well, he
has in his past life been a professor at Berkeley
in three departments there– business, economics, and
information management. Currently, he’s chief
economist at Google. And as you know,
economics undergraduates and even a healthy
fraction of economics Ph.Ds often choose to ply their
trade in the private sector. It’s a little less
common for faculty to make that transition
from academics to the business world,
although MIT alumni have done that consistently over time, and
some of our most distinguished alumni have done that in
very successful careers in both academics and the
corporate world, as well as sometimes the policy world. I think of people
like George Schultz, who moved from the University
of Chicago to Bechtel or Gary Loveman who leapt from Harvard
Business School to become CEO of Harrah’s. And today Hal is going
to share with us some of the contributions
that microeconomics have to understanding the operation
of firms in the information economy, the challenges that
are posed by some of the really dramatic technological
innovations that we’re grappling
with, and how we might make sense of that. And then finally, if
US Air is cooperative, and Logan snow crews
are doing their job, Mark McClellan, who has a Ph.D.
from MIT as well as an M.D. and MPA from Harvard,
is going to talk with us about health policy. And Mark, again, as you’re
catching this theme, has not only had a very
distinguished research career in this area, but has been
a very important policymaker in a number of health-related
policy positions. So without further
ado, I’m going to ask Dennis to kick
off this discussion. CARLTON: Thank you. I’m very pleased and honored to
be here to celebrate with MIT, and I want to really thank
MIT for the fine education they gave me in economics
and in operations research, and also thank them for how
nice all my professors were and the MIT administration
when I was a student. My topic today is regulation
with a special focus on antitrust, and I’m going
to talk about three things. I’m going to talk about
the enormous impact that economics, specifically
industrial organization, has had on antitrust, and
the very important effect that antitrust has had on
industrial organization. I’m then going to identify
a few key hot topic areas that are
emerging in antitrust, and finally, I’ll conclude by
drawing some lessons about how economics can best be used
to influence policy here and around the world. Before about 40
years ago, antitrust was abysmal in its
use of economics, both at the government
agencies, and in court decisions with rare exceptions. But industrial organization
in microeconomics provided a very simple
and powerful way to understand competitive
behavior amongst firms. And it really
produced a revolution in antitrust thinking,
and this revolution is often traced to
Aaron Director, who taught at the University
of Chicago Law School and co-taught,
actually, a course in antitrust with Edward Levy, who
was not only president of the University of
Chicago, but also an attorney general of the United States. By the 1960s, we
heard this morning, and certainly by
the 1970s, there was a growing economics group
at the Department of Justice. And in the 1980s, the
chief economist position was elevated to deputy
assistant attorney general, which put it on a par
with the other legal deputies. When I was there at the
Department of Justice about two years ago, I had
about 60 Ph.D. economists under my direction,
and they were doing very important
research, and moreover, they were listened to. On most cases,
the economists are asked to produce a memo that
goes to the front office, together with the
legal staff producing their own separate memo. And each are weighed in
terms of making the decision. The same is true
about the importance of economics at the
other government and antitrust agency, the
Federal Trade Commission. Let me talk briefly
now about some of the interactions between
antitrust and industrial organization and vice versa. Let’s start out with
one of the key areas in industrial organization
and antitrust– cartels. It’s a pretty simple theory. A bunch of firms get together. They collude to raise price. That’s bad. So what does the Department
of Justice want to do? They want to stop that. So what I’m going
to illustrate will be an example of how some
very simple ideas matter a tremendous amount. What we know is from
just very basic economics that your incentive
to engage in a cartel is going to depend
upon the penalties. So the Justice Department
looked and noticed that the fines were pretty low. So the fines were raised from
10 million to 100 million. And then they looked
about jail time, and they noticed
that they weren’t sending very many people
to jail for very long. So they raised the jail
penalty to 10 years. And then they did
something very clever. They introduced what’s
called a leniency program, and they said, if you’re
currently in a cartel, and you come to us and you
squeal on everybody else, we’ll give you leniency. You won’t go to jail. We’ll reduce your fine, and
when you get sued civilly by a private plaintiff,
and you’re guilty, because you’re telling
us you’re guilty, you’ll be subject to damages. Under the antitrust laws,
civil damages are trebled. But if you come to us,
and we give you leniency, we’re not going
to allow the court to multiply your
damages by three. So wow. Pretty powerful incentives. And by and large,
there weren’t a lot of cartels that were
being investigated. It was hard to find them. They put in place these three
programs that I just discussed. All of a sudden, people are
lining up around the block to say, I’m in a
cartel, I’m in a cartel, and I think economists were
pretty surprised by how many there were. Very simple idea,
very effective. Secondary are government
policy mergers. In the early 1980s, Bill Baxter,
a former Stanford professor, a law professor, was the
Assistant Attorney General, and he produced the
merger guidelines. Reissued merger guidelines
would be more accurate. But these merger guidelines
were based explicitly on economic reasoning,
heavily based on George Stigler’s
theory of oligopoly, and it gave economic
structure for the first time to merger review. And today, the latest
econometric techniques and industrial
organization theories are being used by the
staff of economists I referred to to analyze mergers. And they do very,
very good work. While I was at the Department
of Justice, I noticed something. I actually wrote
a paper about it, and I said, boy, you guys
are doing all this work about using fancy econometric
models, merger simulations to predict what’s going to
happen if a merger occurs, and you’re using that
to decide whether or not to challenge a merger. Why don’t you keep
following things? that way we can
test subsequently for those mergers
that go through. Which of our techniques,
which of our theories actually do a good
job at predicting, say, the pricing behavior? Unfortunately, we don’t do
enough of that at the agencies. Let me turn to the last
sort of important element in the antitrust cases
through our cartels, through our mergers. The last area is what
I’ll call section two cases or bad conduct cases. These are often the cases
that make big headlines. So there have been a number
over the last several years– the breakup of AT&T, the
government attack on IBM, a whole series of
Microsoft cases, and a whole series of litigation
involving credit cards. I’ve been involved in various
aspects of all these cases, and my point here
isn’t to discuss whether these cases were
decided rightly or wrongly. But what my point
is to illustrate that each of these
cases unleashed an enormous amount of research
among industrial organization economists about
practices that maybe they were vaguely aware of
but didn’t really appreciate their importance. So for example, there’s
now a huge literature on what I’ll call dynamic
strategic behavior in which a firm that has
some market power is able to engage in
various types of strategies against its rivals in order
to either preserve its market power or to swing its market
power from the product over which it has the market
power legitimately into areas where it wouldn’t otherwise have
market power but for its acts. What are some of the acts
that have been attacked? Bundling. You buy my product,
this product. Then you have to buy this
other product from me. You know, tie-in sales. Issues about how I
deal with my rivals who may depend upon me for certain
critical inputs and the like. Another area that
developed, a booming area, had to do with networks. Network effects occur
when, for example, my use of a word
processor program is influenced by how many
other people are using it, because I want to
communicate with them. Huge area that developed. Another area is this
recent area of what are called two-sided markets. What’s an example of
a two-sided market? Credit cards. How does that work? My usefulness as a customer
of having a credit card depends upon how many firms
accept that credit card, so there are two mechanisms of
payment by which a credit card company at least could get
paid either by the customer or by the firm, and there are
various types of revenue flows. The fact that antitrust cases
provide practical examples to industrial
organization economists is what is motivating, I think,
a lot of very good research into uncovering better
how current industry practices work. What are some common
features of these cases? Let me just mention two. Many of these industries
are undergoing rapid technological change. Now we know from a
lot of the panels and a lot of the work of
economists in this room how important
technological change is. What does that mean
for these cases? That means when you’re
intervening in a case, you want to make sure
you’re not preventing technical change by
what you’re doing, and you’re not impeding it. That’s a pretty hard
problem to figure out how firms compete when it’s
technological competition rather than price
competition that is emerging. We have much better models
of price competition than we do of
technological competition. And finally, the second common
element of a lot of these cases is a vertical aspect. In many of these
cases, the firm that’s being attacked under
the antitrust laws or what I’ll call
the dominant firm is providing an essential
input to its rivals who then compete against that
dominant firm in other aspects. And the question is,
what are the requirements one firm has with another about
duties to deal and on what terms? Let me just turn now to what
looked like the emerging hot topics in the field of
both antitrust and industrial organization. And I’ll mention just three. First one, I’ve
already alluded to. That’s bundling and tie-ins. When a firm sells a
product of which it may have some unique
power, market power, it can bundle that
product and say, you want to buy that
product from me? You also have to buy these
following other products from me. Or it might package the products
together as one product. Question is when is that an
antitrust violation versus when is it, for example, if I’m
bundling products together in one product, when is it
desirable technological change? How do you strike that balance? That’s been a problem,
a difficult problem to figure out in some
past antitrust cases, and I predict that’s
going to continue to be a difficult problem that
will dominate a lot of research that IO economists are doing. Second area, important
area, has to do with intellectual property. I’ll speak about patents. The patent system has
been widely studied, and a lot of people have
come to the conclusion that it’s broken. Why is it broken? A lot of what are called
weak patents are given. What’s a weak patent? You get something that really
isn’t that important, an idea. You get it patented
at the patent office, and then, perhaps, if
you go to litigation, the court says, eh,
it’s not so important. It’s not valid. How did this problem arise? An interesting way. In 1982, there was a
restructuring of the court system, and the normal
appellate court system was replaced by a
specialized patent court. And people thought
that would be good. We’ll get a lot of people who
have specialized knowledge, and patents will be
more accurately given when they’re deserved. But what happened was
a little different. Unexpectedly, there was
an enormous increase in the number of patents
that were granted, and this led to the
problem that I just alluded to of weak patents. And what kind of problems
did weak patents create? Well, if you’re an inventor, and
you come up with a new product, all of a sudden you might get
sued by 1,000 different people. And this is especially a
problem in high tech industries, where design of a
particular product can trigger literally hundreds
or even thousands of patents. In the antitrust
area, this problem has led to what’s called
the patent ambush problem, and this is a serious problem. In fact, I’m giving a
paper on this in two weeks. There’s a conference
in Europe specifically with one third of the day
devoted to the patent ambush problem in antitrust. What is that problem? That’s a problem where a patent
holder, in a sense, misleads, misuses the patent
system in order to induce firms to make a
technological investment that’s irreversible. Once they’ve made
it, the patent holder shows up and says, surprise. I have a patent. You owe me a lot of
money as a royalty. Creates ex post market power
where none might otherwise exist. The last hot topic
I’ll talk about has to do with information,
and this is a question as to who owns information. So think about the internet. I buy a lot of stuff
on the internet. Do I own that information? Does the seller own
the information? Does my credit card company,
if I pay by credit card, own the information? Does a search engine
own the information? Who can use it and how? When people start using
information, when there’s a lot of information
available, intermediaries are going to develop,
intermediaries that bunch together buyers who can
negotiate against sellers. Is that an antitrust violation? How about intermediaries
that put together a whole bunch of sellers who
then can gang up on one buyer? Is that an antitrust violation? When you start thinking about
putting together intermediaries or running auctions,
you’re getting very close to starting to study
or restudy how markets form. Economists have not really
paid as much attention as they should to the
fact that a market is a product that can be viewed as
a product that firms produce. What are the rules
that govern a market? Now if you look at something
like the Chicago Mercantile Exchange, they now own the
Chicago Board of Trade. There have been futures
exchanges around for a long, long, long time. They are in the business
of creating markets. We haven’t done enough
study of markets. We haven’t done
enough study of how the rules get created
to make a market work to generate liquidity. And this is going to get close
to not just antitrust, but SEC and CFTC regulation
of financial markets. And the final issue that’s
related to information has to do with privacy concerns. This is probably
less antitrust, but I know it’s something that, for
example, the Federal Trade Commission is very focused on. Well, let me just conclude by
asking what lessons, if any, about regulation
generally do I draw? Well, I think there are really
three points I want to make. The first is that simple
ideas have high value added. And that’s the thing where I
would stress regulatory policy could enjoy large payoffs. The example of the
leniency policy was a huge– the leniency
policy was an excellent example of showing how very simple
ideas about economic incentives can change things a lot. Second, a lot of regulation,
including antitrust, has an international dimension. And we have to cooperate
internationally. The difficulty
this raises is that many international
organizations, foreign organizations,
don’t quite have the same
staff of economists or the appreciation of economics
that a lot of US agencies have. So how do you convince
them what to do? Well, I think the
best way to do it– I mean MIT does it by
training Ph.D.s who then go to those countries– but
there’s another way of doing it, and that is the agencies
themselves can run training programs to bring people
to the United States and teach them economics. And I actually
started doing that at the Department
of Justice, and I think that was a very effective
way of teaching the staff, not the political
appointees, but the staff of international agencies
how they should think. And the final thing I’ll
mention may seem like a detail, and I used to think
it was a detail, but I’ve now come to
realize it’s really not. And that is if you
look domestically, the institutional structure
of the regulatory agency matters a lot. What do I mean by that? There are some government
agencies that have what I’ll call a public interest
standard in which their goal is to advance the public interest. There are other agencies–
for example, the Department of Justice– where their role
is to enforce the antitrust laws and make sure that there
is no harm to competition. So imagine a
telecommunications merger. It turns out that both agencies
review the telecommunications merger. The Justice Department
puts conditions on to make sure there’s
no harm to competition. The FCC can go much further. They can put on whatever
conditions they feel are important in order to
promote public interest. My own experience suggests that
the more carefully delineated the objectives are of
the regulatory agency, the more likely you
are to avoid what looked like arbitrary
imposition of conditions that might be used to promote
sort of the pet idea of one of the agency regulators. So thank you very much. [APPLAUSE] SCHMALENSEE: We
are fully staffed. As a near lifer, I’m
delighted to be here today, and I must say
what a privilege it has been to be here
these many years as part of this extraordinary,
extraordinary community. As I listened to
the previous panel, I was struck by the
notion that the difference between policymaking
in the macro sphere and in the micro
sphere is a little like the difference between
drivers and mechanics on a racing team. Everybody knows what drivers do. Everybody knows what
macro people do. They do inflation
and unemployment, and their stuff is on the
front page of the paper. The mechanic is kind of in
the garage late at night, dirt under the fingernails,
skinned knuckles, nobody watches, and nobody
has a clue what they’re doing until the car doesn’t go. It wasn’t macro policy
that got us into this mess, I think one can argue. And, of course, from
a micro point of view, the calls for more
regulation as a response, the undifferentiated calls for
more regulation that we heard in the aftermath of the
initial stages of the crisis are a lot like telling a
mechanic to use more wrenches. One does need to get
closer to the details. So my focus is to be on energy
and environmental policy, but I do want to say a few
words about micro or structural policy more broadly
that, to some extent, will echo what Dennis said. It’s a lot less fun to teach
antitrust and regulation than it was when I
started, because there are fewer really dumb policies. There are fewer of the
antitrust cases that came down in the ’50s and ’60s that
were really great fun to teach to an economics class,
because you could pick them apart. And you could say this
decision is pursuing– whatever it’s pursuing, it’s not
pursuing any single objective. It makes no sense. The economics is
bad and so forth. That has been transformed under
the influence of economics, and you get decisions
you disagree with, but you don’t get decisions
and arguments in cases that make no economic sense. They’re pretty rare and
insignificant cases. And we don’t regulate
airlines, and we don’t regulate
interstate trucking, and we don’t do a
lot of things that were fun to talk about
in class, because you could say, why
are we doing this, and get students to understand. There are still
some policies that fit the bonehead
description, and that’s because, I think,
like the mechanics, we tend to work not on the
front pages of the paper, but in the third page
of the business section. And the policies are
usually covered– the debates are
covered, if they’re covered at all– by
reporters who don’t actually understand the issues. The other point to make, and
I’ll come back to it briefly, is that there are still plenty
of analytically difficult problems, policy problems. There may be political problems
and administrative problems, but there are also difficult
technical problems. Dennis mentioned two-sided
markets and credit cards as a classic example. Well, the Federal Reserve was
taxed by the Dodd-Frank bill with regulating an
aspect– let me not get into it– of the
pricing of debit cards. And while there is a
literature on this, which I’ve contributed,
Dennis has contributed, others have contributed
going back at least a decade, about the only consensus in
that literature is that what the Fed did was wrong. We don’t have the right answer. We don’t have a
prescription that says, marginal cost pricing. Well, we know that’s
wrong in this case. We don’t have that answer. So let me tell some good news
before I tell some bad news. So there has been
a lot of progress beyond antitrust in the
general area of energy and environmental regulation. We used to regulate the
wellhead price of natural gas. That was another one
of those great policies to talk about in class, because
it served no useful purpose and had a very high cost. We moved away in large parts
of the country in the 1990s from the traditional model of
regulating electric utilities. We found ways, following
models in Chile and England, of bringing competition
into the system, of reducing the
scope of regulation, and increasing the
scope of competition. Economists played
a significant role. You even now see some regulators
thinking about incentives, about the incentives
given to regulated firms. One would not read that in
the ’40s and ’50s too often. Since the Reagan administration,
cost-benefit analysis has been required in
the process of making federal environmental rules,
as well as other rules. Sometimes this is even
an aid to decision rather than a defense of
a decision already made. But this is now a
bipartisan thing. The guidelines for doing
cost-benefit analysis don’t get torn up every time
an administration changes. It begins to look a
little bit like antitrust. It’s something you do as
part of good government, and that is economics. And finally, at least until
the recent demonization of cap and trade,
policymakers had come to appreciate the ability
of market-based mechanisms to achieve environmental
goals at reduced cost. The high watermark,
at least so far, is the European Union’s
emission trading system for reducing carbon dioxide
emissions– ironically, a system sold to them by the
first Bush administration and then the Clinton
administration based on our experience
with the acid rain program enacted in 1990. There are other elements of
good news, other elements where other areas, where economics
has had an impact on the way decisions are made and on the
policies that have resulted. But frankly, it is
amazing when you look across energy and
environmental policy, the extent to which policy is
still inefficiently pursuing goals that don’t
make much sense. And I think the hard problems
really are political, not technical, and really
do come from the fact that this stuff tends to be on
the second page of the business section. Let me give you an example
that infuriates me, but I’ll try to control myself. It’s outside this area. It’s Massachusetts
auto insurance. Now we’re the only
state in the union that regulates the prices of auto
insurance, the only state in the union. You will occasionally see
third page discussions of the business section
about, could competition work? This is not an open question. But in Massachusetts, it is. So why doesn’t it just
get answered correctly? A, there isn’t really
intelligent public debate, because it’s kind of
an obscure question, and not that many
people really realize that in the rest of the country,
you could have the gecko if you want the gecko, but not here. And they don’t
quite realize there is an agency that has
an interest in continued regulation, and there
are a set of companies that don’t operate
outside Massachusetts that have an interest in the
continuation of this regime. That kind of– it
happens in a small room not on the floor of Congress,
not in front of the press. It happens in a small room with
a few people taking minutes that decisions are
made is a reason why bad policies persist. People don’t watch the mechanic. People don’t understand the
mechanic much of the time. So let me give you a few
examples of bad policies that have persisted
for awhile, and then just to give us a
depressing conclusion that tries to echo the
macro panel, I’ll talk a little bit
about renewable energy. So since 1970, the
Environmental Protection Agency has been required to
regulate local air pollution under the demonstrably
false assumptions that perfect safety is possible
and that damage functions are discontinuous. It is sometimes required
by law to disregard cost. Second example– despite the
partial success of the 1990s, much of the US electric
power sector– and I should give Paul Joskow
credit for pushing a lot of the change
that did occur, and Paul being frustrated
by the fact that it stalled. And a large fraction
of the country didn’t move to restructure. About a third of the
country didn’t move. Unlike telecommunications,
unlike electric power in the European Union, there is
no overall effective national policy. There is, in a continent
spanning system, a dominance by state regulators. There is an extraordinary
heterogeneity in legal regimes,
organizational forms, even though the
electrons whiz around. It is a system that
has been in place more or less since the
1930s and is dead stuck. Huge barriers to
reform– not technical. Not technical. Lots of great
economic work has been done in bringing market forces
to bear in electric power, but politically, there
are awesome obstacles. Finally, since the 1970s, with
all due respect to Bob Gordon, I think discussion of
energy independence has driven out much intelligent
debate about energy policy. Except for oil, which we don’t
use to generate electricity, we’re self-sufficient. And despite the
subsequent discovery of huge oil fields in Alaska,
great advances in technology, and ongoing subsidies, US oil
production peaked in 1970. Full stop. Peaked in 1970. Has declined since. We will not drill our
way to independence. If you listened to the
last presidential debates, you would never get
that impression. You would get the impression,
if we just drilled a little more– well,
that is technically nuts. So it is frustrating when
one works in these areas that level of debate
on important questions about energy policy. So finally, let me talk
about the whole issue of renewable energy
and climate change. I’m glad Bob Gordon
mentioned a climate tax. I’ve worked the climate change
issue in one fashion or another since I was at CEA,
and it is, to my mind, the most complex
public policy problem I’ve ever seen, in part because
of its international dimension, in part because of its
inner temporal dimension, in part because of all the
uncertainties involved, in part because of all
the mechanism design problems involved, but many
of the incoming members of this Congress don’t
believe there’s a problem. That’s step one. And step two, we’re not
going to deal with it. The state of public debate is
we’re not dealing with climate. I’m sorry. That was yesterday’s question. Well it goes on. The substitute
seems to have been, we will do renewable energy. I love the sun, and
I love the wind. Just let me be
very clear on this. How could you be opposed
to the sun and the wind? But let’s just for a
moment get serious. 29 states and the
District of Columbia have requirements that certain
fractions of electricity be generated from
renewable energy. The president of the State
of the Union talked about 80T of electricity generated
by clean sources by 2035. However, it has been made
clear that almost everything is clean, so we seem
to be OK there. But let’s be clear what all of
this focus on renewable energy is. It is not a responsible
reaction to climate change. It deals only with one
sector, provides no incentives in transportation, no
incentives for energy efficiency in heating and cooling
and industrial processes, transportation, provides
no direct incentive to back off coal, which
is the main way you reduce carbon dioxide emissions. It’s not a good
way to create jobs. I mean Detroit learned that
having a big domestic market doesn’t necessarily give you
a healthy domestic industry, and switching from one
capital intensive way of generating electricity to
another capital intensive way to generate electricity
is probably not the recipe to cure mass unemployment. It is industrial policy. It is industrial policy. It is the government
picking a winner and saying the Chinese
think solar is a big deal, so we’re going to think
solar is a big deal. Now if you work in the energy
and environmental policy field, and you see industrial
policy coming up again, despite the
governments– and that’s a plural governments– despite
governments’ terrible record at picking winners, and even
worse record at developing national champions that can
compete internationally, it’s a little bit depressing. This has enormous
political momentum. The level of debate is very low. Those people who know the
issue and have thought about these things are drowned–
their voices are drowned out by the voices of
special interests operating like the mechanics
in the garage where it’s quiet, not on Sunday afternoon in front
of the audience like the macro people. We all have envy of
the macro people. They get the attention. But I think the
fact that they get the attention means that the
debates are at a higher level. The fact that it’s
economy-wide issues means there’s less scope
for special interest. A lot of micro
policy is frustrated. Even though there’s good
economics and progress to be made, it’s
frustrated by the fact that it is very hard to
get past special interests when there isn’t
widespread attention. So I’m trying to
match the earlier panels that dealt with the macro
economy for being negative. This is about as
well as I can do it. There has been progress. There’s been a lot
of work done here. Antitrust in particular has been
revolutionized by economics, but if you look in energy
and environmental policy or broadly in areas
of regulation, there is much to
be depressed about. There are plenty of
areas where economists are unanimous and unable
to move the needle. But there’s always tomorrow. Thank you. [APPLAUSE] VARIAN: So I grew up on
a small farm in Ohio, and when I was in junior
high, a momentous event took place in my life. The Russians shot off Sputnik. That was a satellite. And Congress got very
upset about falling behind in the space race and
all of this stuff. They passed something called the
National Defense Education Act, and it was because of that
act and the scholarships that they provided
that I was subsequently able to attend MIT. And that’s had a huge
intellectual impact on my life, so thanks to
Sputnik and thanks to MIT. Now I’m going to
be more optimistic. I think I’ll be the most
optimistic person that you’ve heard today,
because after all, I do come from California, where
it was 63 degrees when I left, and I’m counting the
minutes until I get back. But we live in a period
of great innovation, and I refer to this as a time
of combinatorial innovation, and by that I mean,
every now and then you get a set of component
parts become available that innovators can
combine and recombine to create new inventions. Now this is an old idea. Marty Weitzman, also an MIT
grad, has written about it. Joseph Schumpeter
has written about it. He wasn’t an MIT grad,
but hey, nobody’s perfect. Think of something like
in the 19th century, there were standardized
mechanical parts became available. Beginning in the
20th century, you electrification,
motors, electric motors, gasoline engines. In World War II, we
saw radar, electronics. In the ’20s and after,
microelectronics, integrated circuits,
software, and now the web. So the nice thing is you’ve
got these components. You can create all
sorts of innovations by combining them in novel ways. And I think exploring this
idea might help address what Bob Solow talked about
this morning of trying to make that connection between
investment and technology and how it actually
turns into products. So you get a very rapid
pace of innovation. I’ll just give you
a recent example. Back in 2005, Google
released Google Maps, where you could display
maps in a convenient way, and a computer engineer named
Paul Rademacher looked at this, and he dumped the JavaScript
from the web browser that we used to
call Google Maps, and he hacked it
for awhile, and he was able to combine Craigslist
house rentals with the Google Maps and put these two
pieces of software together. So what did Google do when we
saw this egregious violation of our intellectual property? We did the obvious thing. We hired the guy. We put him to work
building an API so that anybody could do this. And so Google Maps then
a few months later, under Paul’s guidance,
released this API, and there was a huge
growth of innovation as people found
all sorts of ways to combine this particular
component, a geocomponent, a map with all sorts of
interesting capabilities. Now this kind of
combinatorial innovation is a global phenomenon. It’s particularly
global, because the costs of communication
have really collapsed in the last 10 or 15 years. So even a very, very small
company, 10 or 15 people, can now be born
global and has access to communications and a
computation infrastructure that even the largest
multinationals could not afford just 10 or 15 years ago. So small firms can use Skype
and chat and wikis, docs, source code repositories,
email, video, et cetera to work around the globe and
around the clock, because you don’t have to worry
about everybody going to bed at the same time. You’re able to
continue production in other parts of the
world, and there’s a whole host of these what I
would call micro multinationals that are springing
up in various places, mostly connected to
universities, where you can see this kind of
innovation take place in a very vibrant environment. And not only do you have this
efficiency in development, you can also host
your software products at data centers run by
Amazon, Google, Microsoft, and other vendors
of cloud computing so that they’ve
essentially changed what was a fixed cost
and a barrier to entry into variable cost, so
you can get firms entering at much smaller scale,
and so you can get much more innovation going on. I think this is also leading to
a big improvement in business processes. So I think there’s an area
that we haven’t really gotten into much. That’s what you might call
the nanoeconomics of the firm. I know we’re talking about
microeconomics, which is taking the firm as given,
but withinside the firm, there are business processes
and communication patterns that go on. And the fact that we have
these highly networked, highly computerized organizations
makes life much more efficient. As a little example,
Yan Chan, who’s a professor at
University of Michigan, did a study where she took
students and gave them questions from Google. One team of students went off
to answer the questions using the library, and the other
team used a search engine, and you could compare
the time to answer these different questions. Turns out it’s
about seven minutes using a search engine and 21
minutes using the library. So you’re saving about 15
minutes a day on a question, and if you take some average
numbers for how often you ask a question on Google, that
adds up to about $200 billion of savings and lost time. Now there are some
subtleties here, because it used to be asking
questions was expensive, or maybe I should say getting
answers was expensive. So we didn’t ask
very many questions, or we only asked really
important questions. But now getting questions
answered is very cheap, so we ask a lot of
them, so there’s a bit of a consumer
surplus calculation that has to be gone
through to do this right. But no matter how
you cut it, you get a pretty big increase in
productivity in knowledge work. Now think about the way
we do knowledge work. So everybody in this audience
is a knowledge worker, I’m quite sure, and one
of the things you do is you produce documents. And in most cases,
those documents are reviewed by other people. So you get input
into what you do. And traditionally, we
had technological devices like typewriters and carbon
paper, and you would shorthand. People would transcribe
your document. It was sent around
for commentary, and people scribbled
notes on it, and it was all combined
into a new document. It went around again. Then we had great
innovations like white out– that was a great innovation–
and post-it notes, and that made it much easier
to do this kind of process of revision. When we went to email, we
mirrored that same process of creating and
circulating a document and getting comments on it
just using a software for. So it’s very inefficient when
you stop and think about it, because you could do so much
better by having a master copy up in the cloud and
having the computer do all the revision tracking and
keeping track of who did what, and be able to
restore the document to its stage at any point. And you end up with a huge
productivity improvement, and hopefully, you get
not only better documents, but better ideas
and better decisions by removing a lot of
the transactions cost from this process. And by the way, I
think it is tricky, because a lot of those
transactions costs don’t show up in GDP,
so it’s a little hard to talk about the
productivity increase. I think there’s definitely
a productivity increase, but there’s a challenge
in terms of measuring it. Now along with this
improvement in computation and communication, the cost of
experimentation and exploration has dropped rather dramatically. So I talked about
combinatorial innovation, where you have lots
of innovators trying different things, but any single
innovator or any single firm can also try lots
of different things. That’s called
experimentation, and we heard Esther Duflo talk
about that this morning. We saw experimentation
in the age of agriculture with the huge
productivity improvements that came from agricultural
research stations. You look at the age
of manufacturing. David Hounshell has written
a wonderful book called From an American
System a Manufacturer to Mass Production,
and you can see these technological
improvements that went place because of tinkering of
trying to work on improvement in the production process
through assembly lines and time and motion studies. Remember in the ’80s, the
Japanese system of manufacture, Kaizen, which was the idea
of continuous improvement in the production process. And so all of these
things dramatically improved productivity
by experimenting and trying to find
better ways to do things. Now in the internet
age, the fantastic thing is that experimentation
and continuous improvement is just dramatically
cheaper, because you can design software, so it
allows all the parameters to be variable, and then you
can implement a system, try out different
configurations in real time, and really get a continuous
improvement in the processing of your system. So for example, at Google,
we are firmly committed to experimentation. Last year, we ran
5,000 experiments in the search engine
side of the business. That resulted in 400
improvements in search quality, and on the ad side, we ran
about the same number, 4,000 to 5,000, with, again,
several improvements, and at any one time, there’s
about 500 experiments running on both the ad side
and the search side, so 1,000 all together. And anytime you
use Google, you’re probably in a dozen experiments
or a half dozen experiments at least. So this is a system
that is continuously improving, because
we’re continuously running experiments and
trying to improve the system to make it function better. And it’s far, far easier to
do that in the web environment than it is to do it
in Africa for sure, but we know the value
of experimentation really pays off. I’ll give you an example there. Back in 2006, Google wanted
to get into voice recognition. Now we had no data
and no expertise, so the first thing we did
is we hired some expertise. We got some of the world
experts in this area, and then we created a system
called GOOG-411, which was an automated information
system, where you could call GOOG-411 and say,
pizza, Mountain View, and it would come
back and say, do you mean Joe’s Pizza
on 123 Main Street? And you could say yes,
or you could say no. And that allowed you to
find what you wanted. Now the great thing
about it is it was a light client on the phone. In fact, it was
virtually no client. And all the calculation
took place in the cloud. It took place on
the Google servers. So this system could
learn in real time. When it said
something and thought it recognized what you
said, it said yes or no, and you answered yes or no. And that was a data point
for it to learn from. And so in the
space of a year, we had an absolutely fantastic
state of the art data system, and even now, if any of you
are using Android phones, it works exactly the same way. When you talk to
your Android phone, it is learning
from your response whether it’s got the
right voice recognition, and this system is
continuously improving to recognize a
variety of accents, a variety of languages, and
you can do this in a real time. And by the way, you
can do the same thing with optical
character recognition, so you can get a much,
much better system there by doing the same thing. So the old systems, you
ran the learning part as a batch process, and
then every time there was a new release of the
system a couple times a year, it got a little better,
but now the model is you have continuous
learning, so you’re learning all the
time, and the system is evolving in real time. Now I want to spend
just a minute talking about the role of modeling
in business and economics, because this was one
of my assignments. When I went to work at Google,
I started as a consultant back in 2002, and I
asked Eric Schmidt what I should work on,
and he said, oh, why don’t you work
on this ad auction? I think it might make
us a little money. Well, he turned out to be right. I mean, it is a funny thing. Even in 2002, Google did
not have a clear idea of how it was going
to make money, and the ad auction was
one choice among several. So I built a model
of the ad auction using game theory,
the kind of game theory I was taught at MIT. It was a very simple model
you could do using high school algebra, and it turned out
to be a pretty accurate and a pretty useful way to
understand the dynamics of what was going on in that auction. And kind of the surprising
thing in retrospect is that other companies who were
built around auctions like eBay and Yahoo never really
bothered to hire people who are experts in
this area until much, much later, but not
until 2005, 2006. Nowadays, everybody wants
to have a chief economist. Yahoo, Microsoft, Intel, Amazon
have all hired chief economists in the last few years. So economics is really on
a roll in Silicon Valley. Now the good news is, I think,
that standard techniques from economics really work very,
very well on business problems. And I mean the kind of
modeling and econometrics you get from an undergraduate or
maybe an introductory graduate education in economics. And it’s important
to realize this, because it’s a
little discouraging working as an
academic economist, because the problems that
you work on are so hard. They’re so difficult. And there
are much, much easier problems in industry. I think that’s
because in industry we have better data and
easier to access data. We have pretty much
a closed system, so you don’t have worry about
lots of other things going on. It’s inherently
less complicated, and we have this capability
of experimenting, which you typically
don’t have in economics, or if you do have it, as
we heard this morning, it tends to be something that’s
quite costly to implement. So one kind of nice
example is auctions, where those of you who
are aware of what’s been going on in academic
and business research, in this area, there’s been
really some fantastic ways in which the theory and the
empirical analysis of the data have fed on each other. We have a much, much
better understanding of how auctions work
for privatization, for IPOs, for ads, and
all sorts of other things. So it’s a great
example of how you can have very practical
outcomes from something that started as a kind of
esoteric area of research. And finally, I want to
say one word about policy, because I was on
my prescription. If you look at most
businesses now, pretty much everyone has
a real time database, a database of what’s going
on in their business, a data warehouse or database. And you look at these. They’re extremely powerful. Google, of course,
has a lot of data. But it’s not just Google. You could look at UPS or
FedEx or Walmart or Amazon or MasterCard, and
they can actually query what’s happening in the
last day and in some cases, even what’s been happening
in the last hour. Now this is actually
much, much better data than the federal
government has, and I think that one of the
advances that we’re going to see in
the next decade is we’re going to figure out ways
for the federal government to get access to some of
this real time data that’s being produced in
the private sector, and that’s going
to allow us to have a much better handle on what’s
going on in the economy. So I think that the real
time economics, real time econometrics is going
to be something that’s very important from
the viewpoint of policy in the next few years. Thanks. [APPLAUSE] MCCLELLAN: Well, good afternoon. I’m really glad to join you
all, and I’m sorry it was late. I’m coming from Washington,
DC, not the happy, sunny land that Hal just
described, where there’s transformative
information technology, and people are hiring
and presumably listening to economists, but the land
where whether you’re describing last night’s traffic
during the storm or just about any
political issue these days, including
environmental economics, the word is gridlock. But despite that,
I still want to try to convey a sense
of some optimism, and I gather from
some of the comments earlier that not
all of the speakers have been that optimistic
about the impact of economics on policymaking. I think there is, in
health care at least, which is what I’m going to focus
on, some reason for hope, but also some reasons
for skepticism. And it all kind of reminds me
of one of my first briefings when I went to
Washington and started working in economic
policy, and I’m not going to even say which
administration this was in. I worked in more than one. But at that White
House briefing, we were debating the
administration’s position on a very important policy
initiative related to Medicare. And I started off
my presentation as part of this debate
by saying that this is an idea that virtually
every economist in the country thinks should be done now. And without missing a beat,
one of the senior White House advisers who was there, who
shall remain nameless, said, is that a pro or a con? And they get– and so I think
there’s still this sense that a lot of these good
ideas that economists have are missing
something, are missing a connection to the public. They’re missing paying
attention to those nano details that we’ve heard about from
some of the earlier speakers, or something that’s standing
in the way of having a bigger impact. And I think that’s
really not a challenge for the rest of the world. I think that’s a
challenge for us, who are doing applied economics to
find ways to make our work more practically relevant. The good news here is I think
that some of that is happening, and I want to take the
recent health care reform law and the health
care reform debate, and we’re just continuing to
provide some examples of that. Leading up to the implementation
of the law, virtually all of the major decisions
about what kinds of subsidies would be provided and how
insurance choices would be set up in these new
exchanges and the fact that an individual
mandate might be needed to get broad participation
and prevent adverse selection, all of those are a
reflection of empirical work by applied economists
here and elsewhere. People like John
Gruber here at MIT had a fundamental impact
on the economic modeling that went into and that
had a tremendous influence on the legislation that
was put together on scoring by the Congressional
Budget Office, on the debates around
which kinds of policies might practically work or not. You can still debate,
and many economists have, about whether some
of the conclusions built into those models
are the right ones. But you can’t say that
they weren’t influenced by the applied
economic research that has been done in decisions
about insurance choice, decisions about labor supply,
decisions in microeconomics that have been applied to
health care in recent years. But I want to make a
distinction between that kind of microeconomic analysis,
which is having some impact, and a big area that I think is
still missing in health care and probably in other fields
like education as well, where the impact of
empirical economics is much more limited,
I think, in part, because of how compelling
the evidence is is also missing as well. And in that respect, I want to
talk about health care costs, health care quality,
the kinds of decisions that go into determining
health care costs and quality at an even more micro level. Decisions like what
kinds of services, what kind of treatments
does a doctor decide to provide for
a particular patient? There’s a good deal
of economic evidence that those decisions
are influenced by a range of economic
and policy factors. Similarly, what kinds
of behavioral choices are made by consumers, both
about which doctor to go to, which treatments to
use, how to use them, and even more
fundamental treatments about their own health, their
own diet, their lifestyles, whether they smoke,
whether they engage in other kinds of behaviors
that have health implications. And here, the impact
of economics on policy has been more
limited, and I think it’s at least in
part because of some of the limitations
of the evidence. And this is very important
for policymaking. Aside from the fact
that we have been able to come up with
some estimates of what the impact of
coverage expansions would be and things like
that, that’s all done on top of this much more
micro level of health care delivery in
the United States, where there’s a tremendous
amount of variation that continues to occur
that we haven’t done a good job of explaining or
at least describing policy solutions to address. Around the country,
Medicare costs vary more than
two-fold from region to region from places like Miami
to places like Minneapolis. There also are big variations
in health care costs. Going along with that
are some big variations in how health care is
delivered that seem to persist year after year. Some people have said
that, well, maybe it’s just a difference in preferences
or some hard to measure differences in health status
that account for this. But also true is the
fact that variations exist in health care
cost growth from area to area around the
country and in changes in medical technology use that
are equally as big– growth rates ranging from one to two
percentage points per person higher than GDP to four or
five percentage points higher than GDP over the
last decade or more. And we haven’t done much
during this whole time period to address whether there
are any consequences of those variations
for health and what kinds of policy changes could
have a more fundamental impact on our health care costs. A lot of people have
looked at these kinds of descriptive
statistics and said, gosh, if we could get the
growth rate down a little bit, if we could deliver
care in what looked like more efficient
ways, we could easily pay for making health insurance
more widely available. We could easily address the
long-term fiscal challenges facing the country,
but we haven’t figured out policies that help
us get from here to there. There is suggestive
evidence, but it’s not yet compelling evidence. And I want to give examples
of that in three areas before I finish my remarks. One of them is in
the incentives facing health care providers,
physicians, hospitals, other providers. A second set involves
consumers and the demand side of health care, so
supply and demand side. So let me start with providers,
because this actually was a big part of the recent
health care reform debate. Some of you may
remember President Obama saying at one point that if
there was a good idea out there for reforming health care
from the provider side, for paying doctors differently,
paying hospitals differently, it’s in the law. And he’s right. There are a broad
range of proposals in terms of changing the way
that health care payments work designed to address some of
those apparent inefficiencies in our health care system
by promoting more high value decisions by providers. The basic idea here
is to move away from a traditional way of
payment in health care based on fee for service, where
insurance plans, Medicare, and other plans
typically pay based on the volume and intensity
of services provided. So reimbursement goes up
with the volume and intensity of treatment. I got some firsthand experience
with the practical side of these reforms,
which people have been talking about
in health care and applied economics
for some time, with one of my first meetings
with the CEO and the leaders from a number of health
care organizations around the country
after I became administrator of the Medicare
and Medicaid programs. They came in and
said, look, Mark. We’re trying to do
a number of things to improve care, which we
think are the right things to do from the
standpoint of patients, from a standpoint of delivering
care more effectively. We’re trying to do things
like use health information technology so that we have
something like real time data on patients. I noticed, Hal, none of your
examples were from health care. And we’re trying to do things
like have nurse practitioners and allied health
professionals work with our patients
with chronic diseases to give them some more education
support that our physicians just don’t have time to do
in terms of understanding why they’re on the
medications that they’re on, the nutrition changes
that might make the most difference for their health,
other lifestyle changes. We’re trying to coordinate
care in new ways, so when patients
leave the hospital, there’s actually a
plan in place that’s shared with the post-acute
care providers and the family to prevent the very high
rate of readmissions. In Medicare, still today,
about one in five patients are readmitted to the
hospital within 30 days after they’re discharged. And the problem is we think
all these things are actually working. Here’s the data showing it. We’ve gone to some extra
effort to show these impacts on quality of care, and
we think it’s saving money for the Medicare
program, because we’re using fewer services and
billing Medicare less. But for every single one of
these things that we’re doing, we’re getting killed. We’re getting
killed in two ways. First of all, traditional
health care payment systems don’t pay for any of those
things that I just described, and second, to the extent that
they actually work and lead to fewer duplicative lab tests
or imaging procedures or fewer readmissions or fewer
visits back to the doctor, because patients
are doing better, we lose again, because
we’re not reimbursed for any of those steps. So the basic idea behind a lot
of these reforms on the supply side is to move away from those
traditional ways of paying based on fee for service. What we came up with in
the Medicare program based on some microeconomic theory and
applications on the supply side was to start a second
track of payment. We didn’t get rid of Medicare’s
traditional payments overnight. That wouldn’t have been
acceptable to beneficiaries or providers, but
the providers who are participating in
this pilot program started tracking how
their patients were doing in terms of some
important health outcomes and results like for their
overall population of patients. Could they
significantly increase their use of evidence-based
preventive services? For their patients
with diabetes, could they get improvements in
important proximate outcomes for the disease like the
level of blood sugar control, and could they reduce
important complications that led to hospital
admissions or premature death? They started tracking
all these things. Not traditionally part of
health care payment or policy, but they started doing
it for this program, because they now had a
reimbursement path based on it. And what Medicare did was
we took in the information that they provided
on performance, on the outcomes that their
patient population was actually getting. We also started tracking
the overall spending in the Medicare program for
these beneficiaries, not just physician cost, but everything–
hospital cost, rehab cost, post-acute care cost,
drug cost, all of it. And the deal was if they could
show significant improvements in most of these
dimensions of outcomes for their patient
population, and if we saw reduction and the
overall trend in spending, they could keep most
of the difference. They were now accountable
for the first time for the results of care
for their patients, both in terms of health and
in terms of overall spending. And that program,
now five years in, has shown some impact
on health care costs and on health outcomes. Of the 10 medical practice
groups that participated, all of them showed significant
improvements in outcome. Nine out of 10 showed
significant reductions in cost trends. Five out of 10 showed reductions
in cost trends of more than two percentage points
per year, which would be enough to pay for the
expansion of health insurance in the recent legislation. And so that’s some relevant
evidence of this question. But it’s only one study. It’s only one pilot
program, and there have been a lot of other studies
on similar kinds of reforms, which have found mixed
results depending on the context in which
they’re implemented and depending on how
widely and in conjunction with what other reforms these
changes are implemented. So the upshot of all that is
in the bottom line for at least Washington-based
policy analysis, what does the
Congressional Budget Office think of this kind of evidence
for all of these reforms, this long list? And I just gave you one example
of reforming provider payment. The sum total of savings
estimated by the Congressional Budget Office in the health
care reform legislation was around $5 billion out
of a $1 trillion bill. And that’s not because
of not paying attention to these reform
issues, but because of the limited evidence
that exists on them. Now over the next
few years, Medicare and the private insurers
they’re working with it in the states now have some
very broad authority to try out more of these kinds of reforms. And a big challenge and
a key unanswered question for economists is,
can we find a way to use this very broad authority
and this very good multibillion dollar opportunity
to show whether some of these kinds of reforms
can really be implemented in a truly compelling
way, one that could be extended more widely
in our health care system? But it is very slow going
and very limited evidence right now. So that’s the supply side. That’s where a lot of the focus
was in the recent health care legislation. What about the demand side? Well, there’s also
a lot of evidence from microeconomic
studies that what people pay for their health care
does influence their choices. Randomized studies
and other studies showing that higher co-payments,
higher out of pocket payments reduce use, that there is
an elasticity of demand for healthcare just like
for any other services. The challenge with this evidence
from a public health standpoint is that it looks like the
services that are affected are mixed. Both services that seem to
be of high value and services that seem not to be of high
value, you might say, well, what does it matter what you
experts say about how consumers are responding? It’s consumer choice,
and they’re presumably making some rational decisions. But even if you say
that, even if you say that consumers know best,
the estimated demand elasticity here is not that large
in studies that have just looked at incremental
changes in co-payments and incremental
insurance reforms. And not only that. There’s considerable
evidence that people are very risk
averse when it comes to high out of pocket expenses
with respect to their health. People don’t want to
face an out of pocket risk of many thousands
of dollars in cost if they or their loved
one has a serious illness, and they need to have access
to very valuable treatments. So here, too, there’s
an economics answer. Ken Arrow decades ago showed
that the optimal policy in this kind of setting where
you need insurance because of risk aversion is a policy
with a high deductible upfront and catastrophic
protection on the back end. And we’ve actually
tried to implement some of those with HSAs and
other high deductible health plans. But the problem is that, still,
something like 90% or more, even if you have a deductible of
as high as $10,000, 90% or more of health care spending
occurs when you’re past that out of pocket limit. And once again, you’re then
kind of out of the realm where demand side
incentives, at least on our traditional insurance
plans, would make a difference. Applied microeconomics
in health care started to affect this as well
with some innovative insurance design, where the consumers
can be more sensitive to cost. In particular, consumers with
high expected health care costs can get more of an
opportunity to save money when they use less
expensive care, but not through that kind of
traditional insurance design. I’ll give you a
couple of examples. Safeway had recently
implemented a program for doing colonoscopies through what’s
called a tiered benefit design, where they looked at what
they were actually spending on– this is a procedure
that everybody over 50, including everybody in this
room, should be getting, but many people don’t. And if you look at the actual
cost of the procedure out in California, it
varies something like five-fold ranging
from around $2,000, $3,000 from some providers
who seem to be doing it well, high volume practices,
things like that, to upwards of $25,000. So what Safeway did was try to
look at some of the evidence, and then group providers into
tiers based on this cost. And the idea was that they
would pay something close to the full cost for what they
regarded as a good quality colonoscopy, and a patient
would have– their beneficiaries would have a choice of whichever
provider they wanted to go to. But they would pay for the
difference at the margin. They would pay for the marginal
cost difference between, say, the $20,000 provider and the
$3,000 or $4,000 providers. Now the Pacific
Business Group on Health is doing something
similar with knee surgery. Same thing– fivefold
variation in cost. No clear relationship
to outcomes, and they’re implementing
the same kind of reform and payments. They’re moving away from a
traditional insurance design, where if you have a
serious enough illness– cancer, serious heart
disease, something like that– to where you’re
hospitalized once or twice in the year, any kind
of traditional insurance plan, you’re going to be at
your out of pocket maximum no matter what you do–
$15,000, $20,000 a year. Under these plans,
those patients can still have
differences in their costs of $10,000, $20,000,
$30,000 or more, which is enough, it looks like,
to start changing behavior. Now these are hard to implement. The examples that I gave
you took a lot of work by the employers,
the payers involved working with their
beneficiaries, explaining the changes,
working with the providers, and getting enough acceptance,
enough political acceptance from all the stakeholders
to move them through. And even if they have
an effect, we’re only talking about each
of these procedures, even though they’re common,
is only a small part of overall health care cost. So the effect overall that
we’ve seen from the evidence so far seems to be
pretty incremental, like not enough to really
alter those overall health care spending trends that
I alluded to before. So the question is, is there
a faster way to get there? And that brings me to one
final demand side issue, and that’s around the
choice of insurance plans. If people had better incentives
for their insurance plan choice, economic efficiency
might become more prominently observed in behavior
and might lead to a faster impact of
these kinds of reforms both on the demand side and
on the supply side in the way that care is paid for, and
therefore, perhaps, in the way that care is delivered. And if you look at the
incentives facing Americans today for health insurance,
economic theory and evidence tells us that we’re not
doing a very good job. So perhaps that’s some
reason for depression. Today if you have coverage
through your employer, you have an
open-ended tax subsidy that’s proportional to
your marginal tax rate since it’s regarded as
an employer benefit. That means that you don’t pay
the full out of pocket cost for your insurance plan. If you’re in a moderate to
high income tax bracket, that means you’re paying
something like only 30, 40. You’re paying– the
tax break is 30%, 40%, 50% of the cost
of your insurance plan. And there’s a tremendous
amount of evidence that increasing those
costs at the margin would lead people
to choose plans that have lower
premiums that tend to drive more efficient care. And yet we persist in keeping
this kind of subsidy in place. Well, one of the things that
the health care reform law did was change that incentive. It doesn’t do it until
2018, so there’s still plenty of room for people
to come back and modify this politically difficult
step, and it only affects plans at a very
high level of spending, something like the top 7%. It gradually might
affect more over time. But the point is
that today we’re a long way from that
efficient kind of choice system for insurance for people
who have employer coverage. It’s the most common way
to get coverage today. Same thing is true for different
reasons in the Medicare program, where there is one
dominant government-run plan that relies heavily
on price regulation. There are some other
private plan choices, but there’s not the same kind of
paying the marginal difference in premiums that would drive
more efficient choices. There are a lot of
subsidies built in. There are even
subsidies in effect for supplemental coverage to
wrap around efficient plan designs in Medicare
and shield people from paying out of pocket costs,
from paying even limited out of pocket costs,
without making them face the full marginal cost,
marginal spending consequences of those decisions. One exception to that in
the Medicare program today, and I think it’s instructive,
is Medicare Part D. That’s the prescription
drug benefit that was added to Medicare in 2006,
which I had the privilege or curse of
implementing in my time in the last administration. But it was set up differently. It was set up with a flat
subsidy for beneficiaries that was based on your income
and your health status, but it was a fixed
amount of money. And the deal was
you could choose from a range of
competing plans that were allowed to vary their
plan design, in some cases quite significantly,
as long as they met an actuarial
minimum value test. And if you chose a
more expensive plan, if your plan costs $2.00
more than an alternative, your payment for the plan
would be $2.00 higher, paying the full
cost at the margin. And interestingly, what happened
when this system was set up was that people
migrated– first of all, seniors were very
frustrated or very annoyed. And I heard from many of them. I heard from thousands of
them around the country that they didn’t want to
see all these choices. In some cases, 30,
40, 50 or more. Lots of different choices. It was very confusing. It was taking a lot of
their time to sort this out. They were worried that they
didn’t even fully understand it in spite all of our efforts
to provide information, objective information
on the premiums and the out of pocket
costs that people would face based on their
drug use in each of the plans. So they were very frustrated
by having to take all the time. Now why couldn’t
the government just come up with one simple
clear plan design and just give it to us and
make it much easier for us? But the flip side of that
was that people ended up choosing plans that were
very different from the model envisioned in the law. There was a standard
benefit design, a sort of traditional
insurance with a deductible, a co-payment, and catastrophic
protection on the back end. Between, there was
that famous donut hole, because the expected
cost of the benefit was more than the Congress
thought they could subsidize. But basically, it’s a
traditional insurance design. Today no one in the
Medicare program is in a plan with that kind of
traditional insurance feature. People have
overwhelmingly signed up for plans that have a tiered
benefit design, going back to the demand changes that
I was talking about earlier. What that means is if
there’s a generic drug, which those drugs work just as
well as the brand name drug, and they’re available after
patents expire for drugs for many common illnesses. Those drugs are basically
free under these plans. You might pay $1 for it. And virtually all other
drugs are available, but people pay much more
of the cost difference out of their own pocket. So if there’s a
generic available that the brand name
version of that drug will typically be much
more expensive, close to the full price, so
people would get letters from their plans. Mrs. Smith, you’re on
the brand name version of this beta blocker drug. It’s costing you $72 a month. You could switch to this generic
version, which the doctors say, which the FDA says
works just as well. It’ll cost you $1. You’ll save $71 a month if
you switch to that drug. In cases where generics
weren’t available, the plans would typically
negotiate a lower price for a preferred drug within a
category of similarly acting medications. Those might cost $30 a
month, and again, you could take the more
expensive non-preferred one, but you would pay the
difference in cost. And the plans had to
meet an actuarial value test of the same value as a
traditional insurance plan. But the difference is instead
of saving just 20% or 25% of the cost like you would with
traditional co-insurance, you save almost the full
differential in cost. Well, people
overwhelmingly chose those plans, because
they had higher premiums, and then they switched
the drugs they were using. The Medicare drug
benefit is still– it’s a significant
government cost– no question about it– because
of the subsidies involved. But it’s currently
running about 40% below the actuarial
in the CBO projections at the beginning of 2006. And there are a number
of reasons for that, but one important reason is
that seniors have overwhelmingly switched which drugs they
use from brands to generics, where they’re available. The use of generics
among seniors is running around
80% of prescriptions. And they switched
from non-preferred to preferred brand name drugs. There was a lot of complaining
about the drug benefit. I thought there was going
to be a lot more complaining about switching drugs based on
these tiered benefit features, but that really hasn’t
been as big of a problem. And so this program, even though
Congress had a chance to come in and change it and reform
it in the last round of health care reform legislation,
they didn’t. They made it more generous. I guess that’s probably
not good for the long term fiscal outlook, but
no fundamental changes in the structure of the
program was my point. So the upshot is that
there may be a way to move towards more
efficient health care through implementing insurance
choice with full cost payment at the margin,
and that, by the way, is what the exchanges in the
new health care reform law may be able to do in principle. There is still a big unanswered
question for economists and for the policymakers who
may listen to them about how these insurance exchanges
for people who aren’t buying coverage through
their job and who aren’t on Medicare or Medicaid,
how they will actually work. And we’ll see how that plays out
over the next couple of years, but the law itself sets
up a flat subsidy, very much like the one I just
described in Medicare Part D. It depends on your income. It depends on your
health status. But if you choose a
less expensive plan, you may be able
to save, depending on how it’s implemented,
the full difference in cost at the margin. And this is why, I think,
that even though there are many states,
especially states with Republican governors, given
the strong political opposition on the Republican side for
some understandable reasons to the law. If you look at states
with Republican governors, they are moving forward on
implementing the exchanges, and they’re trying
to do it in ways that would meet those kinds
of competitive design features that I just described with a
lot of support from economists. So those are areas where there
is some impact of health care, of economic analysis
on decision-making, but still a lot of very
important questions ahead in the next few years that
may determine our overall cost. I see Jim getting up. I just want to make
one final point here about economics in health care. The most important
thing in economics, and the reason why
it’s so hard, I think, to reform these
policies without and why it’s so hard to get public
confidence in making changes just because economists think
they’re good without even more compelling empirical
evidence behind them, is because health
care is so valuable. Kevin Murphy and Bob Topel,
Bill Nordhaus, David Cutler, some of my work
with David– what all has shown over the last 30,
40, 50 years– name your time period– medical
innovation on average has been extremely valuable,
more value creation than in all other sectors
of the economy combined. I mean it’s great to have jet
travel and iPads and 3-D TV and Google Maps, but what
people really seem to like is the time to
enjoy it, the time to spend with it,
living longer, living better, plus the sunsets,
plus time with family, and all of that. So there is a potential
for doing much better here, but we have to find
better ways to bring the microeconomic evidence
to bear showing that we can improve the margin
without taking away from that average, that
tremendous average value of innovation. Thank you all very much. [APPLAUSE] PRESENTER: OK. I’m afraid given the
hour that we are not going to have time for questions
at the end of this session, but let me thank all
of the panelists here. I want to just say a couple
of things before we close. I mentioned this morning that
economics has, in fact, played a central role in MIT’S
intellectual history for nearly 150 years. And I think that as you’ve
seen from the enormous range of presentations today, that’s
in part because economics, just like the science and
technology and other areas that MIT is so
fundamentally committed to, has an enormous opportunity
and potential and reality to improve the human
state of existence. I would point to two
illustrations of that based on what we’ve heard. In the macro area,
the last two years have not been a good time for
the public view of economics and economists. But I think that rather
than pointing to the crisis and saying, why wasn’t it noted
in advance, one could also look and say, this
has dramatized the cost of getting
off the right path in terms of economic
outcomes and economic policy. And it underscores
the importance. It underscores the social
return to getting the policy mix right and the value to the
research and the policy advice that comes as one
tries to implement and to use the tools of economic analysis. In the micro area, where we
just heard the last panel talk about some of
these applications, one example that I
love to cite– it’s not a great moment
for MIT, because it’s an example from Kenneth Arrow–
Nobel laureate at Stanford University, but someone who was
rejected from our Ph.D. program when he applied–
can’t win them all. But Ken Arrow working in the
White House in the early 1960s said as a staffer at the Council
of Economic Advisers, one day he got a proposal,
which suggested using nuclear
explosives to build a second canal– in this
case, through the Yucatan. And it’s just a simple
application, the kind of thing that Hal Varian was
pointing to, of diminishing marginal utility. He wrote back on the top
of it like the credit card ad, first canal, priceless,
second canal, worthless. He cites it has one of the
highest social value activities that he was ever
associated with to dissuade whoever was proposing this
from actually undertaking it. But I think it
does illustrate how on a whole host of
these places, that’s a perfect example of
the mechanics working through the night to
keep things going. But there’s an enormous
range of places in which the use of
applied microeconomics and microeconomic
theory has really improved the way in
which we do a whole range of different things. I want to close this
afternoon on behalf of Andrew Lowe
and Bob Solow, who have worked with me as the
organizers of this panel, by thanking an enormous team of
people who have helped to make this event go so
smoothly and who have assisted us on a whole
different set of dimensions. You don’t manage to get
1,045 people registered for an event at Kresge
without an enormous group that supports the undertaking. And I would particularly
point first, of course, to our speakers and
our panel chairs who have added the excitement
of this program and really kept us riveted
from quantitative easing to cell phone pricing to air
conditioners from CO2 to QE2 to ZLB. We’ve run the gamut today
of different activities and different places
where economics fits in. But then there’s
the support team, and that’s Ted Johnson
and Rebecca Tyler and Lilly [? Munet ?], who
have been at the MIT 150 office and for over two years
have been working on planning the set of
symposia and other activities. Kathy Levine and Nicole
Silva and Eva Carbone at the MIT conference
services team, Gail Gallagher and Joe Cohen and
Lee Corbett, who are part of Institute events
and were key in making this all come together. And then in the Sloan School,
Jana Cummins and Jessica Cologne and Lisa de Forge
and the Economics Department, who have been the key teams in
terms of making this all work. One of the many decisions
that Bob and Andrew and I had to make in planning this was,
did we thank them all today, or did we thank
them all tomorrow? And we managed on a 3-0
decision to decide we just thank them both
days in case anybody came one day but not the other. So on that note, thank you
all for coming and joining us. We are adjourned. We will gather again
tomorrow morning. The program begins.

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