This is What Bending the Cost Curve Looks Like

There are many scare stories coming out about how the Affordable Care Act is forcing health care providers to cut budgets (notably, the Cleveland Clinic). The Atlantic did an admirable job in setting the record straight about these budget cuts by (shock) actually talking to the Cleveland Clinic. A notable quote from the article:

Actually, much of what the Cleveland Clinic system is doing follows the recommendations of health-care analysts closely. For example, it has consolidated closely located neonatal intensive care units, because high volumes tend to lead to better results. It's working to reduce the number of procedures its staff performs, since in the current system "physicians are rewarded to do more, not to do the right thing for the patient," as Sheil put it. And there's a new focus on chronic diseases, which are an increasingly important and costly area for treatment.

Note: all of these changes mean less revenue for the Cleveland Clinic. Or, in other words, less money is being spent in health care than otherwise would have been. This is what bending the cost curve looks like.

When we talk about bending the cost curve in health care, we usually speak in unoffensive terms: stopping duplicative procedures, cutting administrative spending, and replacing brand name drugs with generic drugs. But the first two terms mean less revenue for health care providers (something that the Cleveland Clinic is preparing for in these stories) and the third term just isn't as significant as we'd like it to be. Here's a useful graphic from the CMS:

As you can see, prescription drug spending and private health administration costs (the two most unpopular forms of spending) are just not that significant in the grand scheme of things. What is significant is spending on hospitals and spending on physicians. Thus, if we're actually going to slow health care spending, it is going to be through the means of politically unpopular cuts to hospitals and physicians. This is what bending the cost curve looks like.

Deflate Your Enthusiasm

William Pesek argues in an opinion piece in Bloomberg that deflation in Japan is - contrary to popular belief among most economists - actually a good thing. Pesek's reasoning is that Japan's population is disproportionately composed of elderly pensioners living off of fixed income whom would benefit from falling prices. Furthermore, as prices in Japan rose too high during the 1980's, deflation "has acted like a stealth tax cut for households and restored some sobriety to costs." Lastly, the Japanese government has amassed mountains of debt, and deflation - "which lowers nominal bond yields" - "makes that burden easier to service."

This piece is a bit of a ridiculous #slatepitch. Deflation is not good. Deflation is very bad - and most every economist knows this. It is generally agreed upon by both conservative and liberal economists that deflation is one of the main culprits behind the severity of the Great Depression. This is because deflation reduced earnings and increased real debt burdens, leading to mass-scale defaults. We see the same forces at play in Japan (the depressed earnings - not the mass-scale defaults). The following graph shows private sector earnings in blue and the CPI in red. Falling earnings track pretty well with falling prices.

In other words: deflation does not occur in a vacuum - my falling costs are your falling earnings and vice versa.

But how does this affect elderly pensioners? 1) Falling earnings put pressure on private pension systems. If earnings are not sufficient enough to fully fund pensions, then pensions may need to cut their benefits; 2) Falling earnings put pressure on public pension systems. Falling earnings mean depressed tax revenue. If public funds can not sufficiently fund the pension system, then benefits may need to be cut; 3) Falling earnings mean falling stock prices. This reduces the wealth of stock holders (a group that contains a not insignificant number of pensioners). All of these negative effects will be especially felt by near-future and future pensioners.

The worst part of the article, however, is the claim that deflation makes the government's debt easier to service via lower nominal interest rates. Low nominal interest rates (and deflation) are generally a sign of an anemic economy which translates to lower tax revenue. Lower tax revenue means that the government will have a tougher time paying off debt. Furthermore, deflation not only does not ease the burden of debt, it actively increases the burden of debt by increasing the debt's real value.

But let's assume I'm wrong about all of this (which I'm not) and deflation really is a boon to elderly pensioners. Do you really want to use the well-being of pensioners (25% of the population now, projected 40% in 2060) as your benchmark of success for a national economy?