Bryan Caplan  

Health Insurance, Fairness Norms, and Unemployment

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Nominal wages rarely fall - even when there's high unemployment.  Part of the reason is regulation, of course.  But even under laissez-faire, employers have to cope with human psychology.  Almost all workers think that nominal wages cuts are unfair.  And while employers might be tempted to say, "Fairness be damned," they have to face the fact that hurting worker morale hurts productivity and profits.  (See here for lots of supporting evidence). [Broken link fixed.]

So how can the market get back to equilibrium?  The simplest solution is to freeze nominal wages and wait for inflation to bring the real wage back to realistic levels.  A more proactive solution, though, is to cut benefits, and hope workers don't mind.

Cutting benefits sounds crafty.  But on reflection, it might be even worse than cutting wages.  Consider: Most workers' main benefit is health insurance.  If employers curtailed this benefit, would workers find it unfair?  I don't know of any survey research on this point, but I'll bet that most workers would react viscerally to cuts in health insurance.  Higher co-payments?  Unfair!  Tighter coverage?  Unfair!  Cheaper plan?  Unfair, unfair, unfair!

It gets worse.  Unlike wages, health insurance costs go up automatically - at a rate well above inflation.  So even in the midst of severe unemployment, total nominal labor costs keep rising - unless employers choose to risk severe morale problems.

In past recessions, this was probably a small effect.  Back in 1980, health care was only 9.2% of GDP.  By 2009, this percentage had nearly doubled to 17.6%.  To get a feel for the numbers, consider George Mason.  My total Kaiser premium is $1448 per month.  If this rises 5% per year, labor costs soar $2700 in just three years.  Relative to an econ professors' salary, that's not much.  But for lower-paid workers, it's huge.  Even if there were a "total pay freeze," a worker who cost $30k in 2008 would cost 9% more in 2011.

My speculation: The high and rising cost of health insurance, combined with health insurance fairness norms, is a major reason why employment is recovering so slowly.  If I'm right, we've got a serious problem with no easy solution.  As always, though, we should start with the low-hanging fruit: Don't mandate coverage, don't punish firms for trying to control costs, and above all, don't amplify workers' dysfunctional beliefs about fairness with demagoguery.  Sigh.

COMMENTS (20 to date)
Nathan Smith writes:

If you can't cut wages, why can't you just keep paying the old wages to legacy workers and hire new workers at a lower wage?

ed writes:

Yes, and here is a real-world example in the looming Southern California grocery workers strike:

A solution would be to make "total compensation" figures more prominent. The concept of "total compensation" never even appears in any of the news stories I looked at about the strike. If it did, the whole story would have a very different flavor.

Unions should negotiate about total compensation, and then they could decide separately how to divide it between wages and benefits.

jim Ancona writes:

Sounds like another good argument for the Fed to target NGDP.

J Oxman writes:

@ Nathan,

I believe that is what Ford did. No reason that couldn't work in general. But I think you'd still be buying a boatload of health plan trouble.

Joshua writes:

Outside of unions, where specific levels of both benefits and other compensation are locked in for a fixed number of years by contract, my impression (as somebody who's been programming H&W and pension benefits for almost two decades) is that workers have been experiencing cuts in health benefits for years now. Or, more precisely, failure of health benefits to grow as fast as costs...most employers can probably claim that their costs have risen every year, while at the same time the employee contribution and co-pays have also risen. Employees, though, don't care how much it's costing their employer... they see their take-home pay go down and regard it as a pay-cut.
So I don't think there are any special health insurance fairness norms that prevent employers from risking morale by cutting benefits. Rather, they've been chipping away at those benefits, and living with the morale problems, for a long time now. If they're constrained it's that they already take away as much as they think morale can stand every year.

OneEyedMan writes:

My corporate experience was that I paid for my health insurance (but not the whole thing). I got pretty much the same benefits form year to year but as health insurance prices increased what I paid went up. I recall little grumbling about it.

I think Ed's example of the Southern California grocery strike is a bit unrepresentative because those are very low skilled workers. They are much less able to absorb their growing insurance premiums out of wages because their wages are already low.

Another bit of low hanging fruit is to gradually eliminate the tax deduct-ability of health care. This would lower benefits in an artificially rigid form of compensation.

Kyle writes:

$1400 is a crazy group premium, even for a family policy. A typical worker costs $350 (conservative, high estimate). Even the 65+ group averages more like $850-$950 per person, and they are (unsuprisingly) exceptionally high cost. A typical *expensive* family policy should barely cross the $1000 mark.

The benefit design must be straight up stupid. The only place I ever see costs that high is in self insured city & state plans.

Oh, wait. . .

JFA writes:

I'll have to agree with Joshua on this one. Given that I haven't read a study on it, my evidence is anecdotal. From what I observe of the experiences of my friends, acquaintances, and the occasional news, it seems that employers seem to cut health benefits much more readily than cutting wages. This can come in the form of switching from a more comprehensive to a less comprehensive plan or increasing the workers contribution to health insurance (real wage cuts can also come from reducing or eliminating the employers contribution to employees' 401k plans). My sense is that employees more readily accept a decrease in health compensation rather than wage compensation because there is enough information out there in the cultural/societal ether that knowledge of rising health insurance costs are well understood by most people (even the people paying very little attention). This gives employers the story. They can come into the conference room and say, "So as I am sure everyone knows, the cost of health insurance is rising..." etc. What is not in the cultural/societal ether are stories of out of control labor costs being driven by increasing wages. An employer cannot come into the conference room and say, "As everyone knows, wages are rising..." Because employees see (or hear) that the cost of health insurance is rising, they can buy the reasoning employers give for increasing employee contribution to health insurance. The only story for cutting wages is that profitability is down, and employees don't have sympathy for having their wages cut so that someone else's compensation (profit is compensation to someone) doesn't decrease.

David R. Henderson writes:

Your first link isn't to supporting evidence. It's to Hoover and his claims.

mark writes:

Well my experience is that the company cuts the 401k contribution. Not that much bitching about the cut actually among the rank and file as far as I heard but every time the CEO spoke to us he brought it up to assure us that it would come back. It bothered him more then it bothered the rank and file. The 401k did come back but they reduced it by 25 percent. Frankly, my health care costs are around 350 dollars a month-single, Bingo Kyle, with about 80 dollars a month being my share. Where I work the company is much more focused on reducing conpensation by proactive hiring and reducing overtime then going after benefits which are only about a fourth(not including vacation, why I don't know) of my compensation anyway. Dysfunctional beliefs about fairness, I am going to have to investigate that phrase.

Floccina writes:

The PBS News Hours did a little expose on "Open Books Management". It seemed to allow companies to lower compensation, in fact employees chose lower compensation over layoffs.

Other methods: Using more temporary contact employment, making more employees independent contractors (1099).

Lord writes:

The bigger problem is sticky prices though. I haven't seen a breakdown between household and business change in net financial position but businesses seem to be doing much much better.

As far as benefits, many companies have already dollarized them and do not increase them with rising costs leaving employees to face the brunt of higher prices, and they do cut pension matches, company cars, coffee, and others. This doesn't help though when prices don't fall and tends to make the situation worse.

mark writes:

It's incredible that there is no official data on the dollar amount of health benefits paid by employers annually. There are estimates that are backed into but no true, hard data, as there are regarding wages. I assume this is because they are untaxed. It's such a huge part of the labor market and also of managing a business but the government fails to track it.

Evan writes:

Ever since I've read Bryan's posts on this topic I've had this fantasy of someday attaining a managerial position, getting all my employees together, and asking them to vote by show of hands on whether they want pay/benefits cuts, or for some of them to be laid off. And if they vote for layoffs, then make them collectively recommend which workers they want laid off. To their face. With an open, nonsecret ballot. But that's just a fantasy, I'm sure that would cause more problems than it would solve.

Chris Koresko writes:

It seems to me that the only way out of our health-care cost fiasco is to drastically improve the efficiency of health care delivery.

And the only way I know of to do that is to fundamentally reform the regulatory environment in a way that promotes innovation and cost-competition, and punishes rent-seeking.

Start by reforming the FDA: revert it to its original mandate to regulate for the safety, and not the efficacy, of drugs and treatments.

Require FDA to approve any drug or treatment that's approved by its peers in other countries. For example, make a list of 20 nations with advanced medical systems, and if any three of them approve something then require FDA to follow suit.

Expose health-care consumers more directly to costs, e.g., by using a voucher program for government-funded care.

Use the Commerce Clause the way it was intended: require states to allow interstate commerce in medical insurance. Force them to drop the maze of mandated coverages that give near-monopoly status to local companies and make it hard to tune coverage to customer preferences.

Allow consumers to supplement Medicare and Medicaid payments with their own funds if they want to. I believe that was banned in 1990 or so.

Weaken or eliminate the current legal monopoly for producing medical professionals. Allow private for-profit or non-profit companies to issue credentials to doctors, nurses, and other practitioners. Let consumers decide how much trust they have in those credentials.

Establish a system of medical courts with the expertise to consistently evaluate malpractice cases. Give them guidelines which specify or at least suggest damage amounts for particular types of malpractice. Give them the authority to fine legal firms which bring frivolous suits, and establish a loser-pays system for legal costs.

Make it easier to break into the medical field. The big efficiency gains are probably going to come from computerized databases, expert diagnostic systems, and sensor tech. The potential market is huge, and lots of companies out there have those skills, but new entrants are strongly restrained by high regulatory barriers and the risk of lawsuits. Get the regulators and the lawyers out of the way.

There is no sensible reason why medicine should defy the normal trend of rapidly decreasing cost with improving technology. Fix the regulatory and legal environment, make the delivery system freer and more market-oriented, and we should see a huge gain in the quality and cost of medicine.

Rafal Smigrodzki writes:

"So how can the market get back to equilibrium?"

While it is true that at the individual level, human psychological quirks (loss aversion) lead to sticky wages, this does not need to significantly impair the functioning of the market. Customers and firms interacting commercially do not have the long term psychological commitments present within firms. If conditions change, increasing the number of job seekers, and necessitating a wage cut, customers can immediately switch to other providers. If the other providers are new entrants who started out with lower wages (and, given the unemployment level, they could), then such new entrants (or newly created branches of older firms) will soak up the unemployed pool, and gain market share at the cost of older, high-wage firms.

Thus, I would claim that a market system with no barriers to entry, completely unregulated corporate structures, and no employment regulations of any kind, will promptly and effectively solve most unemployment problems an economy may encounter, by allowing selection at the firm level to overcome the psychological limitations present at the individual human level.

The corollary is that the pathologies we see in our economies are due to government regulations that slow down the functioning of markets. Unemployment is a feature of the bureaucratic economy, and would not happen in capitalist, free market economies (if such existed).

Mr. Econotarian writes:

I agree with OneEyedMan.

The major market distortion is tax policy that links health insurance with your job.

It is an insane situation, but clearly difficult to get out of. I suggest a 10-year gradual reduction in health insurance deductibility to zero.

This would allow an entirely new market for health insurance products to launch, and effectively decouple health insurance and job.

mark writes:

I agree 100% with Mr Econotarian's reform proposal.

Chris Koresko writes:

Rafal Smigrodzki: Customers and firms interacting commercially do not have the long term psychological commitments present within firms. If conditions change, increasing the number of job seekers, and necessitating a wage cut, customers can immediately switch to other providers.

This strikes me as a really important point, and one I've never seen before. Have Keynes et al. considered it?

Of course the mechanism you propose essentially involves workers being laid off at high-wage firms and taking jobs at lower-wage firms. But psychological stickiness should affect that process as well, in the sense that people will be reluctant to take jobs that pay less than the ones they lost, especially if unemployment insurance is available to help stretch the job search. The exception would be very low-specialization jobs in which the laid-off workers would be replaced by different (younger, poorer) people.

If this is right, it suggests a mechanism by which unemployment insurance may increase wage stickiness. Fascinating.

George writes:

I'm confused, this may be good for the individual firm, but would it actually be beneficial to the macro economy? Demand is a function of variables including income. So, a reduction in income would reduce demand. Fine policy for a firm, but it wouldn't actually solve any macro problem, it would only worsen it, no?

I mean, let's say a firm does this, now they have more cash, but will they invest it if there is no demand? I wouldn't.

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