The late Kenneth J. Arrow, Nobel-winning economist and one of the most brilliant minds of the 20th century, would be dismayed at action being taken by Republicans in Congress to repeal the individual mandate provision in the Affordable Care Act (ACA) that requires every American citizen to obtain health insurance or pay an annual financial penalty.
The ACA Times ran this post in March 2017 just after Arrow passed away, and we thought it appropriate to run it again based on recent and expected actions in Congress.
Kenneth J. Arrow was known for, among other things, laying the intellectual foundation that eventually gave rise to the Affordable Care Act. Born in 1921 in New York City, the son of Romanian Jewish immigrants, Arrow made groundbreaking contributions in economics and the social sciences and is arguably the father of modern political science. He was the youngest economist to ever win a Nobel.
His contributions to the theory behind the ACA came as a result of his earlier work in social choice theory, particularly his 1951 monograph, “Social Choice and Individual Values,” which includes his namesake theorem, “Arrow’s Impossibility Theorem,” wherein he demonstrates the inherent flaw in all voting systems.
Also of importance is his 1954 work with Gerard Debreu, the “Arrow-Debreu Model,” where he offers the first formal representation of Adam Smith’s famous “invisible hand.” He goes further by specifying the exact conditions necessary to achieve market-clearing prices.
These foundational works culminated in Arrow’s 1963 paper, “Uncertainty and the Welfare Economics of Medical Care.” In it, he demonstrates ways in which healthcare markets are a special case which do not follow the usual rules. The conclusions drawn from this landmark paper led policymakers to look for alternatives to the free market for healthcare, while giving them the theory behind what would and wouldn’t work. The ACA is a result of their efforts.
Readers may be familiar with the term “moral hazard,” loosely defined as the increase in risk-taking when shielded from consequences. For example, if a bank is deemed “too big to fail” and knows that the government will bail it out, perverse incentives arise which encourage excessive risk-taking, constituting a moral hazard. Insurance policy deductibles are intended to prevent moral hazard because they impose a real cost to taking risky action that would otherwise adversely impact the insurance pool or society at large.
It was Arrow’s 1963 analysis of moral hazard that arguably led to its prominence in healthcare policy today. He notes that “it is frequently observed that widespread medical insurance increases the demand for medical care,” and that “the physicians themselves are not under any control and it may be convenient for them to prescribe more expensive medication, private nurses, more frequent treatments, and other marginal variations of care.”
On the subject of third-party control of health insurance, he remarks, “insurance removes the incentive on the part of individuals, patients, and physicians to shop around for better prices for hospitalization and surgical care. The market forces, therefore, tend to be replaced by direct institutional control.”
Regarding the pooling of unequal risks in health insurance, he states, “If a plan guarantees to everybody a premium that corresponds to total experience but not to experience as it might be segregated by smaller subgroups, everybody is, in effect, insured against a change in his basic state of health,” and that “this may be thought of as insurance with a longer time perspective.”
The individual mandate in the ACA is, in part, an intended solution to these moral hazard-induced problems outlined by Arrow. For example, it attempts to dissuade healthy people from taking advantage of the system by not getting insurance until they have a preexisting condition.
During a 2012 correspondence with Arrow, this writer inquired as to which of his works he thought would improve the world the most, were they more well-known. The late economist replied that he found it difficult to choose between his two most original works, “Social Choice and Individual Values,” and “Uncertainty and the Welfare Economics of Medical Care.” Indeed, today, with the future of the ACA in limbo, perhaps more than ever, it is critical that we do not forget the lessons of this humble polymath.
In 2013, Arrow joined other economists in signing a letter to Congress, written by a small group of health policy experts. The letter stresses that the individual mandate “is essential to address two key features of current health insurance markets,” that the mandate “is one of three pillars that together support ACA’s private market approach,” and that “without the mandate, some people will choose to gamble or to free-ride, undermining the fairness and financial stability of the health insurance system.” It also mentions that “insurance reform without subsidies and mandates has consistently failed.”
The individual mandate is central to the entire system, and without it, the ACA would fail to function as intended. In one of his final years, Professor Arrow joined with others to defend the individual mandate. It would be foolish to consider removing the individual mandate from the ACA without addressing his conclusions. We have been warned.
