America Subsidizes European Welfare States

Late last week a hearty debate broke out in the blogosphere regarding whether Americans or Europeans have a higher standard of living. Paul Krugman started it, and Greg Mankiw, Dan Mitchell, and many others responded.

Krugman argued that European economies are no less dynamic than America's and standards of living are comparable even though social welfare spending is higher. Mitchell explodes the idea that Europeans and Americans are similarly wealthy--average American consumption is much higher--while Mankiw suggests a number of factors that may account for the differences in per capita consumption and unemployment.

My own humble contribution is merely to point out that the U.S. subsidizes Europe (and others) in at least two significant ways: defense spending and medical innovation.

In a recent paper on medical innovation published by the Cato Institute, Glen Whitman and Raymond Raad point out that America leads the world in three of four general categories of innovation--basic science, diagnostics, and therapeutics--while the fourth category of business model innovation lacks sufficient data to draw clear conclusions.

Politicians and pundits often argue that we'll fall behind if innovations don't take place here. Not so. Once an invention happens, those who have carried none of the burden of its development--the diversion of resources from production to research, the costs of many dead-ends, and the risks of failure--can take as much advantage of it as those who sacrificed for it. It's the classic free rider problem: most of the beneficiaries carry virtually none of the cost. Clearly, expanding the frontiers of knowledge and productivity is necessary for continued progress, but the costs and benefits are not evenly distributed.

And so it is with healthcare and other sectors where American innovation predominates. America's disturbing distorted health care system at least provides incentives for individuals and organizations to develop better ways of treating illnesses and promoting wellness. U.S. taxpayers and consumers foot the research bill, and Europeans and the rest of the world benefit from the disproportionately American advances.

U.S. subsidies to Europe (and Japan, South Korea, Australia, and many other places) also take the form of our picking up some of the tab for their defense. According to the CIA World Factbook, the U.S. significantly outspends most European nations in terms of percentage of GDP, and that's with a higher per capita GDP, as noted above.

For those that spend a greater share of domestic output--Macedonia, Turkey, Bosnia and Herzegovina, and Greece--I have three words by way of explanation: location, location, location.

Here are the big six: UK (2.40%), France (2.60%), Spain (1.20%), Italy (1.80%), Germany (1.50%), and Poland (1.71%). None of them are even close to the U.S.

If those are the levels that they think are appropriate given their threat environment, fine, but that seems unlikely. The United States are bordered by two gigantic oceans and two weak and friendly nations and haven't been invaded by a foreign power since the 19th century. Europe is proximate to the Middle East and Africa and has a history of continent-wide wars.

And one suspects that Europeans rightly view the 78,000 U.S troops stationed there and ongoing commitments to the NATO alliance as a signal that they don't need to fully fund their defense needs. The U.S. will be there to bail them out.

Needing to spend less on their defense permits them to spend more on social services. It's that simple.

Even if Krugman were correct about similar standards of living in Western Europe and the United States, the fact remains that the U.S. is massively subsidizing the European welfare state through our defense umbrella of that continent and by producing a disproportionately high share of the world's innovation (especially medical) here. Absent those subsidies, Europe's current 'generosity' would be unsustainable.

Health IT from the Bottom Up

Today I attended the event "Explaining International Health IT Leadership" at The Information Technology and Innovation Foundation to release an ITIF report by the same name. In addition to the ITIF scholar who authored the report, the panel included experts from the small, relatively homogenous nation-states of Finland and Denmark.

The panel discussion focused on government initiatives to spur development of electronic medical records, telemedicine, and other innovations that Information Age consumers expect in many other sectors of the economy. One got the impression that the primary impediment to broad penetration of these technological advances is a lack of political leadership.

But if health care consumers want these things, why doesn't the market provide them? Well, to a certain extent, it does, but probably not as much as people want.

The vast majority of private sector health plans are purchased through an employer. This has at least two effects with respect to health IT.

First, employment decisions are generally made based on total compensation, which includes wages, benefits (medical and otherwise), and intangibles like opportunities for advancement, prestige, enjoyability of work, and so forth. This bundling prevents workers from exploring alternatives and selecting something that fits them best, as we do when we choose universities, automobiles, and homes. Instead, employee demands on health care providers are mediated by insurance companies AND employers, neither of whom can efficiently communicate the individual preferences of workers. As a result, neither the insurance market nor the providers face sufficient competition to drive the rapid innovation seen in other sectors.

Second, the linkage of employment to health insurance means that insurance coverage is very likely to change every time a worker changes employment. Electronic medical records may be a worthwhile investment when long-term relationships exist, and perhaps less so in a market with contractual instability.

Medical records also raise concerns about privacy. What is the appropriate level of privacy protection? No 'correct' answer exists--demand for privacy varies subjectively with individuals. Any one-size-fits-all standard will in fact not fit all, but will leave many people unhappy--both those who want more privacy and those who are willing to trade off some privacy for other benefits (like individually tailored advertisements).

Concerns are also raised about interoperability and standards. This is an important point, but one that markets have resolved time and time again--railroad track gauges and PC operating systems, just to name a few. Far better to encourage experimentation that gets us to the medical records equivalent of modern operating systems instead of locking us into something like Windows 3.1--once state-of-the-art, now completely obsolete.

Giving individuals more control over their health care dollars ought to force insurance companies and medical providers to innovate and offer these products and invent others simply to attract and retain customers. It's not at all clear that government leadership is the only way to get there.

J. Craig Venter's Energy Confusion

In a recent interview with Popular Mechanics, geneticist J. Craig Venter offers his thoughts on energy and climate change. He displays an interesting contradiction.

On the one hand, he claims that "Had we followed intellectually where we were back in the Carter era, we wouldn't have a lot of the problems we do today. We've had a lot of short-term thinking from administrations that basically trades off the health of the planet for economic gain for the business community—and for their own re-election. We don't reward our leaders for making long-term beneficial decisions for society. It's like the stock market—all that matters is the next quarter, not where you are 10 years from now."

In practically the next breath when asked about a sort of "X-Prize" for advanced batteries, Venter responds, "Industry is very motivated to make new batteries. Whoever makes a better battery is going to make a fortune, and having a government incentive to do that doesn't necessarily move it along. In fact, if it's like the human genome project, it could just slow it down."

Indeed. But should policymakers incentivize alternative fuels? It would seem that researchers in the private sector and the academic community have every incentive to find and develop market-competitive alternatives, as an MIT team may have just done with solar.

The current energy situation is unlike the supply shocks of the 1970s. True, political forces unnaturally constrain supply and subsidize demand and monetary policy exacerbates the effects for Americans, but growing demand as the developing world exits poverty and the exhaustion of many low-cost sources of traditional fuels means that high prices are likely to persist.

When government action distracts intelligent, creative, productive people from their activities, it hinders progress and makes us all poorer.