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November 13, 2014

A Closer Look at Employment and Social Insurance

The Atlanta Fed's Center for Human Capital Studies hosted its annual employment conference on October 2–3, 2014, organized once again by Richard Rogerson of Princeton University, Robert Shimer of the University of Chicago, and the Atlanta Fed's Melinda Pitts. This macroblog post summarizes some of the discussions.

Social insurance programs in the United States and other developed countries represent a large and growing share of expenditures relative to gross domestic product (GDP). Assessing the costs and benefits of the diverse programs that make up the U.S. social insurance system is a key input into the design and implementation of effective programs. This conference featured seven papers that dealt with various aspects of this assessment. Although each program is designed to address specific issues and hence needs to be studied in the context of those issues, many of the same basic economic questions arise in each context. For example, what is the rationale for social insurance programs? Do they address inefficiencies, or are they mainly designed to redistribute from one group to another? Who benefits from specific programs? How do programs designed to achieve specific objectives distort economic outcomes? These are the questions that featured prominently in the conference.

A classic question in economics concerns the extent to which markets cannot achieve efficient outcomes without government intervention. It is well known that the so-called "invisible hand" can achieve efficient outcomes in a wide range of standard settings, but do these results extend to situations in which information asymmetries exist? In 1976, Michael Rothschild and Joseph Stiglitz's article "Equilibrium in Competitive Insurance Markets" suggested that in the presence of certain kinds of private information, insurance markets could not achieve efficient allocations. In fact, they argued that competitive equilibrium might not even exist in these settings. In "Adverse Selection Is Not a Justification for Social Insurance," Ed Prescott challenges this result and shows that competitive equilibrium exists and achieves efficient allocations in settings that include information problems such as Rothschild and Stiglitz's adverse selection problem. Key to this result is the presence of mutual insurance companies, and how this presence influences the contracts offered by insurance companies in equilibrium. In the Rothschild and Stiglitz environment, insurance companies were effectively agents with deep pockets that were outside the model.

Providing insurance to individuals in situations in which they face bad outcomes may distort individual behavior and lead to negative outcomes that outweigh the benefits of the insurance. This basic issue was addressed by three of the papers at the conference in three separate contexts. Jason Abaluck, Jonathan Gruber, and Ashley Swanson examined how prescription drug coverage through Medicare influences prescription drug usage; Hamish Low and Luigi Pistaferri studied the disability insurance (DI) system; and Bradley Heim, Ithai Lurie, and Kosali Simon examined whether the extension of health benefits to young adults as mandated by the Affordable Care Act (ACA) influenced the behavior of young adults.

In "Prescription Drug Use Under Medicare Part D: A Linear Model of Non-linear Budget Sets," Jason Abaluck, Jonathan Gruber, and Ashley Swanson study how prescription drug use responds to price changes associated with social insurance through Medicare. At the conference, Gruber discussed one key objective of their analysis: uncovering the elasticity of prescription drug use with respect to price. A large elasticity implies that providing insurance in the form of lower prices will distort behavior and lead to much higher drug use, and some recent papers have argued that this elasticity may be quite large. Their basic strategy is to study how changes in the details of Medicare coverage over time influenced individual choices. A novel feature of the estimation strategy is to take advantage of the fact that the marginal price people face depends on their overall annual expenditure on prescriptions, so that individuals can be sorted into groups based on histories of usage, interacted with changes in the details of coverage. A first key finding of this paper is that the elasticity is relatively small. A second key set of findings concerns the extent to which individual choices (in terms of plan selection and yearly expenditure conditional on plan choice) reflect departures from rationality, such as myopia or salience. The paper finds an important role for both of these effects.

Disability insurance (DI) represents a clear and classic example of the tension between insurance provision and insurance. While one would like to provide insurance to individuals who are unable to work, it can be difficult to assess the true ability of an individual to work, thereby creating the opportunity for people who are not disabled to also collect. Luigi Pistaferri addressed this issue in the paper he coauthored with Hamish Low, "Disability Insurance and the Dynamics of the Incentive-Insurance Tradeoff." This paper builds and estimates a structural model that incorporates labor supply, health shocks, earnings shocks, and the key details of the DI application process. The authors conduct various counterfactuals and assess the tension between insurance and incentives in the context of the U.S. DI program. Several results emerge. First, making the review process less strict would enhance welfare despite worsening incentives for people to misreport their health status. This is because the current system denies too many truly disabled individuals from collecting. But decreasing generosity would also increase overall welfare by decreasing the incentives for false collection.

One of the first measures of the Affordable Care Act (ACA) to be enacted was the provision that allowed dependent individuals to remain covered by their parents' healthcare plans until the age of 26. The paper by Bradley Heim, Ithai Lurie, and Kosali Simon, "The Impact of the Affordable Care Act Young Adult Mandate: Evidence from Tax Data," aims to assess the extent to which this provision has affected outcomes for young adults in terms of employment, wages, schooling, and marriage. As Simon described it at the conference, the novel aspect of this analysis is that it tracks outcomes using administrative IRS data, which affords a large sample size. The main empirical strategy is to compare the change in outcomes from before and after the provision was enacted for individuals below the age threshold with the change in outcomes for individuals just above the age threshold. The paper also reports estimates based on triple differencing that uses information on parental health insurance status. The main message from the analysis is that one cannot find robust, statistically significant effects of this ACA provision on outcomes for young individuals. One important qualification is that despite the large sample size, standard errors are still quite large, so that the analysis cannot rule out the possibility of economically significant effects.

Naoki Aizawa and Hanming Fang also considered the effects of the ACA in their paper "Equilibrium Labor Market Search and Health Insurance Reform." However, in contrast to the above papers that focus on how a particular program feature might influence individual choices, this paper focuses on how the creation of health insurance exchanges and the individual insurance mandate would affect the overall equilibrium in the labor market, taking into account the firms' decisions on whether to offer insurance and the wages that they offer to workers. In his presentation, Fang discussed building a structural equilibrium model of the labor market and estimating it using a variety of data sets. The authors find that the ACA will reduce the uninsured rate from about 20 percent to about 7 percent. But interestingly, the paper finds that the uninsured rate would drop even further if the employer mandate were dropped from the ACA. General equilibrium responses are key to understanding this result, illustrating the importance of studying these effects.

One of the rapidly growing social insurance programs is Medicaid. Mariacristina De Nardi, Eric French, and John Bailey Jones assess the benefits of this program in their paper "Medicaid Insurance in Old Age." As French described at the conference, this paper uses a structural approach to assess the extent to which households with different income and health status benefit from Medicaid. The analysis focuses on individuals from age 70 and forward using data from the Health and Retirement Study, emphasizing the risks that individuals face as a result of health shocks. Medicaid offers partial insurance against these shocks, particularly the large expenditures associated with nursing home care, and the paper assesses the value of this insurance for individuals in different positions in the wealth distribution at age 70. The paper has two main findings. First, the insurance value of Medicaid is substantial, and decreasing the size of the program would entail large welfare costs in excess of one dollar for every dollar of reduced spending. Second, expanding the size of the program would offer significant insurance value only to wealthy households. The authors conclude that in terms of managing the risks of the elderly, the current scope of Medicaid seems appropriate.

As the above discussion emphasizes, a critical input into the design and assessment of social insurance programs are data that allow us to reliably document the outcomes and groups that the insurance program wishes to help, as well as measure the efficacy of existing programs in achieving desirable outcomes. In the paper "Welfare Programs and Survey Misreporting: Implications for Income, Poverty and Disconnectedness," Bruce Meyer and Nikolas Mittag documented the serious shortcomings of several standard publicly available data sets when it comes to measuring the resources available to the poorer segments of the population. Meyer presented the paper at the conference, and it uses administrative data from New York State that allow them to link income and transfer data, both cash and in-kind, and compare the measures obtained using these administrative data with the measures obtained using data from the Current Population Survey (CPS), which is a standard source for publicly available data on the income distribution. The results are striking. Relative to analysis based on data from the CPS, analysis using administrative data shows better outcomes in terms of inequality and disconnectedness and yield larger effects from existing programs in terms of their ability to affect these outcomes.

Full papers or presentations for most of these papers are available on the Atlanta Fed's website.

By Melinda Pitts, director of the Atlanta Fed's Center for Human Capital Studies, Richard Rogerson of Princeton University, and Robert Shimer of the University of Chicago