My co-blogger Bryan Caplan comments today on Paul Krugman's blog post on Arrow's famous 1963 article on health insurance. There is more to be said. Krugman writes:
Both George Will and Greg Mankiw basically argue that we don't need a government role because we can trust the market to work -- hey, we do it for groceries, right?
Um, economists have known for 45 years -- ever since Kenneth Arrow's seminal paper -- that the standard competitive market model just doesn't work for health care: adverse selection and moral hazard are so central to the enterprise that nobody, nobody expects free-market principles to be enough. To act all wide-eyed and innocent about these problems at this late date is either remarkably ignorant or simply disingenuous.
In a literal sense, Krugman is right about the standard competitive model. After all, at UCLA, Ben Klein and Armen Alchian taught us that the standard competitive model, if by "standard competitive model" you mean "perfect competition," doesn't work well even with gasoline stations and repair shops. When a company can invest in reputation, what Ben Klein called "brand name capital," the perfectly competitive model goes out the window. But if you read just Krugman's short post, you might think that Arrow is arguing for a government role in health care, as Krugman is, right? And I would bet that Krugman wants you to think that. Yet, nowhere in Arrow's article can I find such an argument. Rather, Arrow is saying that there are things peculiar to health care and health insurance that mean that we have to supplement our standard models. And, as for free-market principles, although Arrow might think that they are not enough, he doesn't say that in the article.
Unfortunately, many economists of various persuasions have said that Arrow's article makes a case for why competitive markets in health insurance will fail [which is different from saying that standard competitive models will fail] and why government regulation is needed. That's what I had remembered it saying. But, as I noted in January, when I went back and read the whole thing, I found no such thing. In fact, Arrow's article is much more careful and nuanced than I had remembered.
Also, and contrary to Bryan's claim, Arrow points out that optimality in health insurance requires that higher-risk people be charged higher premiums.
I won't be surprised if someone can find Arrow saying good things about socialized medicine or other government interventions in health care. What I am saying is that you can't find him saying those things in his seminal 1963 article.