What You Need To Know About Why Gov’t Programs Always Grow: Listen to Game Theory!

Health care reform is certainly one of the hottest policy questions around. Who wouldn’t want someone else’s help covering the costs of illness and accident? And who wouldn’t want to see less of our economy being spent on expensive treatments, doctor visits, and prescription drugs? But how can we add up to 15 percent of the population – 45 million people – to the roles of the insured and cut costs? Can there really be such huge economies of scale that by providing quality care to more people it will cost less. Seems like what people used to describe as voodoo economics back in 1980. That’s not to say cost should trump the people’s health but hey, let’s be frank about the costs as well as the benefits.

It could be true that there would be savings although the government’s independent assessors of costs don’t seem to think so. Probably that’s okay if we are all healthier but that may be a BIG IF. I am sure you have noticed that government programs often start off modestly and then swell to gigantic proportions. Let’s think a bit about this seemingly unintended consequence of legislators’ good intentions.

Often when people speak about the “unintended consequences” from government programs, for instance, what is really going on is that they didn’t work out the strategic reactions to those programs. Then, when those reactions happen, they are described as “unintended consequences.”  They may be unintended, but they are no product of happenstance. With some game theory reasoning lots of those “unintended consequences” turn out to be easily foreseen. Not to be too cynical, but I suspect that politicians sell this notion of “unintended consequences” to justify their narrow, self-interested motivations to get re-elected, even when doing so may come at great long-term social or economic costs to the rest of us. How else do we explain the fact that politicians just about always underestimate the actual costs of programs they promote? Let’s consider Medicare for a moment as illustrative of what might happen after we get some form of quasi-universal health coverage in America.

Medicare was introduced by Lyndon Johnson in 1965. It was supposed to be a small program. Today, however, it’s humungous. All the while that it grew, the cost of going to the doctor, buying medicine, and staying in a hospital has gone through the roof. Lots of folks see today’s high medical costs as the result of a loss of values by physicians, insurance companies and drug makers. While the old family doctor with his (doctors were almost always men back then) black leather case came to our homes and spent time talking to us, having a cup of coffee, and tending to our mending, today’s doctors seem to be just another breed of greedy businesspeople. And so greed becomes the explanation for the runaway costs of medical care. Few of us ever tie any part of the high cost of health care to popular programs like Medicare, let alone to ourselves.

Like with so many government programs, people quickly came to think of government-sponsored medical subsidies as something they were entitled to. They wanted more and more of it, so they demanded that Medicare cover more and more. Politicians obliged by expanding Medicare. They would have to want to commit political suicide to do otherwise. Meanwhile people keep complaining about the high cost of health care as if the two are unrelated. Somehow they think that subsidized care does not change the demand for medicine, increasing demand maybe even faster than the supply of doctors, hospitals, and pharmaceuticals can grow. The change in demand, of course, is an easily anticipated and calculated strategic response by most of us to reduced out-of-pocket costs. It’s not much different from what happens when the grocery store has a sale on steak or ice cream. Make something cheaper and more of it gets sold. The result in the case of a sale on medicine’s out-of-pocket cost is more people chasing an insufficient supply of quality medical care.

We know what happens when demand rises faster than supply: prices go up. So we have two potential sources of greater medical costs resulting from Medicare. Because of government subsidies more people can buy medical care than was true before Johnson’s program. That was the intended consequence. As planned, Medicare has encouraged greater consumption of medical care, undoubtedly a good result for us as individuals and for society as a whole. But we cannot escape the laws of economics. Higher demand, all else being equal, means higher costs. 45 million more insured Americans doesn’t seem to translate into reducing health care’s bite out of the national economy.

As Medicare’s good intended consequence kicked in, what could we expect if demand for doctors, drugs, and hospital space not only went up, but if it rose faster than their supply? Not only would the total spent on good health go up but so would the cost of individual doctor visits (along with their getting shorter to make room so that everyone could see the limited supply of physicians) and almost everything else associated with medicine. Certainly that was not Lyndon Johnson’s or the Congress’s intent, but anyone who has had Economics 101 (which, come to think of it, most of our lawyerly representatives in Congress probably have not) could work out that an out-of-pocket price reduction (via the government subsidy) would increase demand. Until supply catches up with demand, prices rise. As it is hard for supply to keep pace with demand when the range of things being subsidized continues to expand, it is hard for the growth in supply to overcome the price pressure created by more and more demand. (Does this remind you of oil prices? It should.)

Could the growth in the cost of medicine have been foreseen, even as in many instances the real – inflation-adjusted – earnings of physicians fell? Of course it could. When someone else – your neighbor, for example – pays the taxes to cover a big part of your own medical bills, you are more likely to go to the doctor, more likely to demand high-end tests, and more likely to want cutting-edge procedures to make sure you get the best care. Who, after all, doesn’t want the best care from the best doctors in the best medical facilities? None of us can be faulted for wanting good care and certainly one idea behind Medicare was to improve just such care – and it worked.

Patients may see the full cost of their care when they get their medical bill, especially if they read all the fine print, but then they also see the part that is deducted from that full cost because Medicare paid for it. Naturally, patients feel happy that they don’t have to pay the whole bill themselves. Indeed, they wonder how anyone could afford such a high bill and complain that the government must help out more. That, of course, is what creates the political pressure to expand government subsidies. Rarely do we think how much smaller the bill might be if no one were subsidized – not the patient, not the doctor, not the hospital, and not the pharmacy. Most us think the bill would be the same and thank our lucky stars that at least we are getting some help courtesy of our representatives in Congress. Each of us is right at the moment we pay our bills, but we are wrong about what the cost would look like if government subsidies didn’t exist. Would they be as low as their pre-Medicare or Medicaid prices? Surely not. There have been great strides in medical technology since the 1960s and the benefits that result are expensive, but not as expensive as the growth in medical costs.

Patients rarely stop to ask how much less their taxes would be if they didn’t pay Medicare taxes out of every paycheck, whether in sickness or in health. We forget that the average American spent about $143 on medical care in 1960 and more than $5,600 in 2003. Incomes only rose by about fifty percent (adjusted for inflation) over that same period. And few of us have an incentive to ask whether there are cheaper treatments for what ails us that are just as effective as the expensive stuff our physician – a beneficiary of Medicare spending – recommends. Even fewer of us think about all of the medical services that get provided needlessly because the direct, out of pocket cost to the consumer is relatively small. Even little things like taking ibuprofen instead of aspirin. For lots of purposes they work equally well and aspirin is generally much cheaper. Or how much fraud such a large, bureaucratic program engenders. The Government Accounting Office estimated in 1998, for example, that Medicare fraud and overcharges cost an extra $12.8 billion dollars that year. The upshot, because we think about benefits from subsidies without paying much attention to their costs, is that government programs grow rapidly as long as out-of-pocket costs are subsidized. We think about that out-of-pocket cost as all that we pay. Medical service doesn’t cost less because part of the payment is coming from a third party, it just means others are paying for you and me when we consume a service and – the part we tend easily to forget – we pay for everyone else too without being able to control how much they demand or whether they use the service prudently.

In game-theory terminology what this all means is that program growth is endogenous or, in plain English, it is a foreseeable strategic consequence of the situation that has been set up. Government offices are crowded, services are poor, and demand for programs keeps growing. All the while, our elected officials routinely grossly under-estimate what their programs will actually cost. They ignore the fact that these programs create new expectations and demands. As a result – and it is a result that could be anticipated – the programs inevitably grow, along with complaints that the service is inadequate and can be fixed only with ever more money and more growth. Meanwhile, no matter how much more effort goes in, the complaints keep on piling up; they do not diminish and no one ever seems convinced that the problems they were created to address have been fixed.

Health care seems to be a hotter political item today than it was when Lyndon Johnson gave us Medicare. Retirement benefits are a bigger issue today than when Franklin Roosevelt gave us Social Security. School policies today are a bigger issue than when public schools were being debated in the nineteenth century. Police services and prison services today seem less adequate than in the past even though we spend more, incarcerate more, and patrol the streets more than just about ever before. These are all easily anticipated – and maybe even good – consequences of public benefits. We want others to help make our lives better and we don’t mind asking them to pay more to do it – and as long as we see more benefit than cost from subsidies we will demand more of them.

Game theory compels us to try harder to foresee the consequences of our actions. It makes us think about what is endogenous – what is a strategic choice – and what is not. It draws out crystal clear differences between what we can control and what we cannot. Of course, we can think about these things without game theory, and many of us do, but we are compelled to think about such matters when we work through the strategic logic of any game situation. There’s no putting your head in the sand with game theory – you cannot ignore the strategic fallout of decisions because you simply cannot solve games without thinking through how others are expected to respond to your choices.