Individual Mandate 101

The Washington Post has a piece that explains the individual mandate.  Unfortunately, I think the explanation must be incorrect.  Here is the reason given for the mandate: 

Where the policy came from: The individual insurance mandate was the brainchild of conservative economists, as a way to address “free-riding” in healthcare without going all the way to a single-payer system.

The conceptual problem here is the assertion that the mandate is about fixing the problems associated with free-riding behavior.

The reason I think this must be incorrect is because free-rider behavior is one of the reasons for concluding that a public good is a source of market failure.  A public good has two characteristics: (1) nonrivalry in consumption and (2) nonexcludability.  Health care is both rival (we each consume our own units of health care) and excludable (a person can be physically excluded).  Health care goods and services are private goods, not public goods.  Private goods do not have the free-rider problem.

The problem of adverse selection with respect to insurance is really what the mandate is supposed to be about.  The problem of adverse selection is seen in recognizing that individuals at greatest risk will be more likely to seek to purchase insurance than will individuals at least risk.  A business trying to earn a profit by supplying the ability of others to pool risk may find that it is difficult to do this without having a risk pool with both high risk and low risk individuals.  The consequence may be that insurance businesses offer insurance at premiums that many of the people facing higher risks find too expensive, and perhaps the market will fail to supply efficient risk pooling.  This also suggests a sort of vicious circle.  When the insurance businesses discover the need to increase premiums this will also decrease the incentives for low risk individuals to think insurance is worth the price.  If so, then even fewer low risk individuals will choose to pool risk by purchasing the insurance.  The policy answer that is typically suggested is to force both low risk and high risk individuals to be in the insurance risk pool.

I suspect the idea that adverse selection is a market failure is incorrect.  The reason is that I suspect the conceptual analysis of adverse selection assumes knowledge that no one can know.  We cannot know, given that people differ with respect to their preferences to accept risk, which people would be willing to pay for insurance at the efficient price.  Surely it cannot be efficient to force everyone into the risk pool.  For efficiency we would have to be able to identify which individuals would choose to join the efficient risk pool. This we cannot know in practice, even though we can certainly do conceptual analysis assuming we actually know all the relevant information.

This also suggests, it seems to me, that the insurance mandate in the ACA does not fit the conceptual efficiency concerns found in the model of adverse selection.  After all, this mandate compels all individuals to purchase insurance, and there is no effort to discover the efficient risk pool.

My last comment on the quotation above is about the idea of a "conservative economist."  I wonder what the definition of "conservative economist" is?  Most of the economic analysis of public policy these days relies on the normative framework of pareto optimality, a.k.a. efficiency.  It seems to me that economists of all political stripes do efficiency analysis.  Both free rider behavior and adverse selection come from efficiency analysis, and thus I'm thinking an economist is an economist.  If it makes sense to refer to a "conservative" or a "liberal" economist, then I think it is likely that economist is acting politically and not as an economist.