Bernie Sanders, Diminishing Returns, and the Challenge of American Socialism

Or, In Which I Agree with Ben Studebaker in a Qualified Way

This gets to Ben Studebaker and I significantly agreeing, though we have to meander through a pretty big disagreement first.

Ben puts forward that to get the health care results of Denmark, we just have to scale Denmark’s bureaucracy up. This argument, I will show, is economically naive. But he leaves himself an escape hatch: if we substantially change Sanders’ plan, the many states can probably do what Europe has done. This raises questions about what exactly that would look like, but I am genuinely all ears. This may be the “missing ingredient” in Sanders’ run.

Diminishing Returns

Ben raises the issue of scale this way:

Why would the size of the United States be a meaningful obstacle to the adoption of any social program? I have yet to read a convincing account of why a program that can work for 5 million people cannot work for 50 million or 500 million. The size of the bureaucracy needs to be scaled up, but if we live in a more populous society we have more people available to work in such a bureaucracy.

The answer can be found in any introductory economics textbook. The concept that he forgets is diminishing returns, and there is very little that it does not effect. Now, diminishing returns are often poorly explained in introductory texts and this is because we do not have a foundational model of diminishing returns in the literature. (Wikipedia has a serviceable introduction.) Indeed, most models—from the standard cubic cost equations to the macroeconomic assumptions in the Solow Model—are chosen for mathematical rather than economic reasons.

At any rate, the idea is intuitive enough. As an operation (private or public) grows larger, it must spend more energy and resources managing itself. The difference between providing insurance to 6 million people and to providing insurance to 300 million people is not just 50 fold. As the operation scales, one must hire more managers to coordinate different departments, more specialists to make decisions, and devote more time to lateral coordination.

There are significant advantages to this scaling. Division of labor, specialization, and the resources to make very precise decisions are all major benefits to economies of scale. There is a constant balancing act between accessing the benefits while trying to stave off the inefficiencies. Grow too large, and you pay for it in management costs. Stay too small, and you cannot access the benefits of specialization.

Health Care in the United States

Where health care sits in the USA is not easily discerned. The evidence Ben puts forward is, at face, against his proposition. Medicare is smaller than the major insurance companies, both in scope and number of patients. The expectation has long been that you will have private insurance to chip in for the numerous things Medicare does not cover. This sort of passing the buck is not what I think Sanders has in mind when he proposes socializing health insurance. (I am much more sure it is not what his supporters largely think he means.) Further, Medicare is smaller than the leading firms in the market, who are driving national costs.

It is a bit exuberant to reason from there that Medicare will be past the point of diminishing returns if we extend it up past the levels of those national firms. This evidence is only so much innuendo. My point is much more that Medicare’s effectiveness plausibly lies in its lack of ambition. Diminishing returns offer a good reason to proceed with caution, though not an airtight argument against Sanders’ proposal.

I offer a last piece of innuendo against Ben’s interpretation, but again stress it is little more than that. If economies of scale existed to the magnitude Ben hopes, the market would tend towards monopoly. The largest firm serves, round figures, about one in five people in the United States, or about 13 Denmarks. This is not insignificant, but the has no shortage of competition and is known to have efficiency problems. That gets us to about a fifth of what we need—and diminishing returns implies that the last four-fifths will be even steeper.

Errata

A quick word about the Federal exchanges: they are not insurance. They are a marketplace for buying and selling insurance contracts. It is a bit like trying to make an argument about socializing corn farming by talking about supermarket regulation. While changes in how insurance is sold can (and evidently did!) change the insurance market, that is different in virtually every way from having the government run the insurance being sold on those exchanges. It is proof that regulated capitalism can be effective and not an example of any kind of socialism.

Much of the remainder of the evidence in the piece concerns itself with showing that the status quo is stable and is predicated on the idea that there are no diminishing returns. If there are diminishing returns, this too is the argument for the kind of regulated capitalism we have expanded under Obama. It deeply undercuts Sanders’ argument.

States’ Rights

Where Ben and I agree emphatically is that this may well be something the many states should handle. The irony that two liberals would agree on a Federal solution tickles me, but here we are. Europe has arrived at a de facto Federal solution that has worked quite well. I am game for trying it in the States.

But that too undercuts Sanders’ wider project. Pay attention to semantics as I’m about to split a hair: Europe has never tried Democratic Socialism. The many states of Europe certainly have, and it has worked reasonably well. But Federal-level Democratic Socialism has never been attempted, never mind succeeded. (Shots fired: the only European attempt at socialism on the scale Sanders proposes was the USSR.) We have arrived at the case for Sanders to run for Governor of Vermont, preferably with 49 other candidates in other states.

For the sake of space, I must give short shrift to the argument of President Sanders and a favorable Congress creating a mandate for the many states. To deal with it only briefly, to go down that road is to concede that Sanders’ Federal-level approach is flawed. We are then dealing in shades of Federal involvement, which opens up a host of legal, constitutional, and political questions that I do not think get us any closer to dealing with the problems of diminishing returns at the Federal level.

Ben is onto Something

To review, there is a convincing argument for giving diminishing returns a wide berth. In the particular case of health care, the preliminary evidence suggests Medicare’s strength may be in its limited scope, though the issue is far from settled either way. The experience from Europe suggests Sanders’ plan is out of line with the evidence and suggests a state-level plan instead.

And yet, Democratic Socialism survives the diminishing returns critique on the very argument Ben put forward. I throw the ball back in his court in a very different way than I usually do. I am genuinely excited that we may be on the cusp of agreeing on a sort of Federal socialism. Long experience tells me that we may not agree—but we will see.

The obvious question that presents itself is this: What does a Sanders revolution look like if we accept diminishing returns effect some of his proposals? (Also: what are Ben’s thoughts on diminishing returns?)

I have some thoughts, but I’d genuinely like to hear from Ben. He has changed my mind already to think the states are much more capable of socialism than I thought prior to reading his piece, and I would like to see where he traces the thoughts that changed my mind.

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8 thoughts on “Bernie Sanders, Diminishing Returns, and the Challenge of American Socialism

  1. By replacing the many private insurance companies with one big single payer system, Sanders would eliminate lots of duplicate bureaucracy. It stands to reason then that the bureaucratic costs would be smaller under his proposed system than they currently are under the privatized system. They might still be larger per capita than the bureaucratic costs of Denmark, but our system could be substantially more expensive per capita than Denmark and still come in at much cheaper than the private system. When I was a first year undergrad, one of my professors made this point to us and showed us why diminishing returns is not relevant to the question of single payer in the US–we already have a large and bloated bureaucracy, and because it is privatized and duplicated over and over, it is substantially more costly than the equivalent bureaucracy under single payer.

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    1. I will freely admit this is a possibility! “There are significant advantages to this scaling. Division of labor, specialization, and the resources to make very precise decisions are all major benefits to economies of scale.” Eliminating redundancies is definitely part of the equation as well, even if I did not mention it explicitly

      But what your response lacks is something to clinch it. It is certainly theoretically possible that getting rid of the duplicated bureaucracy would allow firms to access returns to scale. But then we must contend with this: “I offer a last piece of innuendo against Ben’s interpretation, but again stress it is little more than that. If economies of scale existed to the magnitude Ben hopes, the market would tend towards monopoly. The largest firm serves, round figures, about one in five people in the United States, or about 13 Denmarks. This is not insignificant, but the has no shortage of competition and is known to have efficiency problems. That gets us to about a fifth of what we need—and diminishing returns implies that the last four-fifths will be even steeper.”

      Contrast this with your next comment: “For an argument against single payer to be convincing, it would need to show that it’s worse for a health insurance company to be big rather than small, that smaller health insurance companies have some kind of competitive advantage over larger ones. This is clearly not the case, so all such arguments fail.”

      I would not characterize your conclusion as “clear”. It passes the relatively low bar of being possible to envision a set of trade-offs where the policy works favorably. What you have emphatically not shown is that such a trade-off exists. Defining “smaller” as “smaller than Medicare for All”, the correct margin as it is the one you are arguing in favor of, literally every existing firm and government program is “smaller” by a factor of at least 5. If a monopoly had a comparative advantage, these smaller firms would likely have joined up. American health care firms remain small (in terms of the sector), and that tells us a good deal.

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      1. The government has not allowed a private sector health insurance monopoly to form because a private sector monopoly cannot be relied upon to minimize costs for patients–without competition from other insurance companies, it can charge exorbitant premiums. A state-run insurance company’s primary goal is to minimize costs, not to make a profit off of patients, which makes a state-run monopoly much more feasible.

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      2. That seems dubious to me. Until 2010, health insurers were exempt from antitrust regulation. More, antitrust regulation kicks in well above 50% of market share; the largest insurer has 20% of market share. In theory, antitrust regulation could become the limiting factor, but I do not see a lot of evidence that it is. This pretty strongly implies, if nothing else, that private firms are facing rising average /costs/ to scale.

        Costs are not the same as prices in this case; costs are what firms or agencies pay, while prices are what consumers pay. You are correct that an unusually large percentage goes to profits and equity payments to top brass. Choosing a number that favors your analysis, The Economist gets about 20% of revenue, meaning that about 80% of prices are actually costs. (http://www.economist.com/blogs/democracyinamerica/2010/03/insurance_costs_and_health-care_reform) This is all a bit sketchy, but you’l see in a second that it does not take a particularly fine grained analysis to throw up the problem.

        The big unknown here is the elasticity of inputs to outputs for health care. (To a point, it is unknowable since we are talking about a margin that has never been attempted in the US, but we can work around that.) If firms are facing rising costs, then the elasticity is somewhere between 0 and 1. An elasticity of 0.5 implies that quintupling the largest firm requires inputs to increase by 2500%. The good news is that it is also now spread over 5 times the people, meaning costs “only” increase by 500% per person.

        These are not the same order of magnitude. Even the most profitable firms defined for the broadest conception of profit cannot absorb this difference by eliminating profit (and becoming public.) Dis-economies of scale are brutal at the level of millions of people and trillions of dollars, and that fact has never been controversial among economists.

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  2. Or to make the same point in a different way, a single payer system is essentially a monopoly health insurance company. A monopoly health insurance company is going to necessarily have lower costs than a bunch smaller health insurance companies, because a monopoly health insurance company pays 1 CEO instead of dozens or hundreds of them (and there are many other duplicate administrative functions it need not replicate). Additionally, because it has a much larger patient pool, it can use its leverage to drive down costs far more effectively than a smaller insurance company with a smaller pool. This is why a larger health insurance company is generally able to outcompete a smaller one. So while it’s true that a single payer program in a large country will cost more than a single payer program in a small country, in any given country the single payer program will always be much cheaper than a private system. For an argument against single payer to be convincing, it would need to show that it’s worse for a health insurance company to be big rather than small, that smaller health insurance companies have some kind of competitive advantage over larger ones. This is clearly not the case, so all such arguments fail.

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  3. One last thing–while I certainly think the states could individually operate their own universal healthcare programs and that this would be a significant improvement over the status quo, we should also remember that in the EU there are huge inequalities in the quality of care among the various member states and this is due to the fact that the EU does not have a centralized system. It is clearly much better to get healthcare in Britain than in Poland, and so on. So in the US, we would expect states that are wealthy to have better systems than states that are not and for states that have smaller populations to have more efficient systems than states with larger populations. These inequities could only be eliminated with a centralized system.

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    1. While inequality could by a large measure be eliminated by shuffling funds between the various states, that does not establish that it would make the pie larger. In the first instance, it would create in average, arguably the one we have.

      Also: “we would expect states…that have smaller populations to have more efficient systems than states with larger populations.” This is literally the opposite of the argument you make about economies of scale? Unless you accidentally reversed your point or I misunderstand something drastic?

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      1. I don’t expect single payer to improve the quality of care for people who already have access to health insurance. I expect it to grant additional people access to this care and to lower costs relative to the current private system.

        There is no inconsistency–as I said, a single payer system will be more expensive in a larger society than in a smaller one, but for any given society, a single payer system will always be cheaper than a private sector alternative. California and Wyoming will both have lower costs than they currently do, but Wyoming’s possible financial gains are larger.

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