Wellness, again

Austin Frakt and Aaron Carrol had a nice column in Bloomberg on Wellness programs and the PSU program in particular. They point out that, 

Whether wellness programs work as intended or not, let’s recognize what they also do: They increase the cost of coverage for some employees. That saves employers money but by shifting costs to workers. Those who bear the brunt of this increase are the less healthy employees, who also tend to be those of lower socioeconomic status. 

Now let’s consider what wellness programs might do: reduce health-care spending and improve health. In general, the evidence is weak that they will. Why? Conceptually, factors within workers’ control make only a small contribution to rising health-care costs, so there’s only so much such a program can do, even if it works perfectly. Empirically, the track record of wellness programs’ efficacy is mixed at best.

They do not point to the irony of our self-financing system directly. But they note the fact that the research shows that they are ineffective. And they answer the question of why they are so popular with employers.

More rigorous studies find that wellness programs in general don’t save money. With few exceptions, they often don’t improve health, either. The additional screenings that such programs encourage can lead to overuse of care, pushing spending higher without improving health. 

Given all of this, why are wellness programs so pervasive? Our hypothesis is that it’s a form of supplier-induced demand: The wellness industry is doing a good job of pushing its product. Understanding research is challenging, and it’s relatively easy for a marketing representative to cite glorious-sounding results.

Clearly the suppliers of these programs benefit, as PSU employees could see when we took our biometric testing and saw how many people the wellness program hired. I think that PSU is just counting on a lot of dropped spousal coverage. As they conclude, 

Penn State’s plan would hardly be the first time Americans bought something that may not work as well as advertised. Companies should reconsider the reasons that they are so eager to have them and whether they’re really worth the investment.

So Much for Energy Independence

With all the talk about US shale production there is a lot of talk about the US becoming energy independent. But as this report from the FT makes clear, the whole world is still highly dependent on Saudi Arabia, Kuwait, and the UAE. 

The US might be drowning in oil, but the world is still dependent on Saudi Arabia.

Indeed, Saudi Arabia is pumping out more crude than at any time since at least the 1970s. In neighbouring Kuwait and the United Arab Emirates meanwhile, oil production levels hit record highs. 

These numbers reflect a profound but easily overlooked trend in the global oil market. In spite of the shale oil revolution in the US, the world has become, if anything, more dependent on a handful of Gulf producers to fill supply shortfalls elsewhere. 

This  is of course great news for Russia. In July, Russian output reached 10.4 million barrels per day, a post-Soviet high. 

The problem is uncertainty of supplies elsewhere. Libyan production is down almost 1 million barrels per day due to turmoil. Iran still faces sanctions, and Nigeria has its own problems. As the world oil market is like a bathtub these are shocks we cannot escape, so Saudi behavior still matters.

Hard to disagree with this conclusion.

The consequences for the global economy – and the world’s biggest oil consuming nations – are significant. Saudi Arabia is already the single largest supplier to many of the large importing countries, including China. But it only sells crude to existing customers, and does not allow buyers to sell on their cargoes. 

For all the talk about the shale boom, then, it is business as usual for the rest of the world in terms of supply. The market will be watching those output data closely.

Wellness Programs

Not being a health economist I had not thought much about wellness programs until Penn State instituted one. I thought only our program was ill-conceived. But it turns out that there has been research on wellness programs, and the main conclusion is that they do not save money. This is discussed at the blog Incidental Economist, which is a great health economics blog.

The main point is that the only way these programs can save money is through cost shifting. But the obese and tobacco users do not expend enough on health care to make the savings significant. Especially with laws that bar health-based discrimination at the workplace. 

This recent study by Horwitz, Kelly and DiNardo in Health Affairs is indicative. The bottom line:

We reviewed results of randomized controlled trials and identified challenges for workplace wellness programs to function as the act intends. For example, research results raise doubts that employees with health risk factors, such as obesity and tobacco use, spend more on medical care than others. Such groups may not be especially promising targets for financial incentives meant to save costs through health improvement. Although there may be other valid reasons, beyond lowering costs, to institute workplace wellness programs, we found little evidence that such programs can easily save costs through health improvement without being discriminatory. Our evidence suggests that savings to employers may come from cost shifting, with the most vulnerable employees—those from lower socioeconomic strata with the most health risks—probably bearing greater costs that in effect subsidize their healthier colleagues.

I wonder why nobody involved with designing our program bothered to speak with a health economist?

On the Economics of the New PSU Health Plan

Thinking About the New Health Plan

Penn State University has adopted a new health initiative. The wellness program requires employees to take a wellness test, schedule a biometric exam, and promise to take a physical or else see their insurance rates go up by $1200 per year. Smokers will see their health care costs rise by $75 per month. The idea, as explained by University President Rodney A. Erickson, is to cut growing health costs. According to Erickson,

“We are implementing a significant set of changes that will help us turn the tide on unmanageable increases in health care costs for our faculty and staff…Higher education is at the crossroads with respect to our responsibilities for greater cost control, and now is the time for decisive action. I have challenged our leadership in human resources to hold annual health care cost increases to the Consumer Price Index plus 2 percent, a goal that will help us to sustain the existing quality of employee health care options while easing pressures on tuition increases that face our students and their families.”

There are many questions about this plan. I am interested in the economics of it, however. Suppose that these wellness initiatives work. How can this plan result in any short-term cuts in health care costs? Penn State is self insured so the only way it saves on health care costs is if the population becomes healthier so fast that expenditures fall in the near term. As Erickson points out:

“Since Penn State is self-insured, we are providing health care benefits to eligible employees with our own funds. This is very different from fully insured plans where an employer contracts with an insurance company to cover employees and their dependents. Because of this self-insured arrangement, we assume the direct risk, but we also can reap substantial rewards when our medical and pharmacy bills (claims) are low. "

If Penn State purchased insurance then one can see how imposing restrictions may make us a better potential client and give the university leverage to reduce premiums. But if we are self-insured then this channel is not available.

Moreover, Erickson claims that this program is being initiated to cut expenditures by roughly 10%. How is this possible, given that the program relies on behavioral changes, aside from the smokers tax? At $900 per year, this would require 24,000 employees to admit to smoking to earn the required savings. With only 8,800 full and part time faculty this will be a hard target to reach.

It is not even clear that cost will fall at all in the near term. Suppose that I did not see my physician twice a year for physicals and take appropriate medicine and lab tests. Then this plan could lead to new information about my health that could seriously impact my long-term health trajectory. If I began to see a physician and take appropriate medicine now expenditures would rise, they would not fall. How then do we achieve the 10% savings? In the near term expenditures should rise as more health care is consumed due to learning about how sick we are. Moreover, even if wellness plans improve health in the long term it is not clear how much of those benefits PSU will even realize. If it improves health outcomes after age 65 it may be great for Medicare expenditures but its not clear how it helps PSU. At a minimum we would need to have a clearer picture of which segment of the employee population is generating the largest increases and then ask if wellness programs will affect them in the near term.

The only way the plan can cut expenditures in the near term is to induce people to leave the plan. If enough employees are annoyed, and if their spouses have competitive plans, perhaps they will leave our plan. This would reduce total health expenditures for PSU by reducing the size of the employee pool that is covered. This could reduce health expenditures.

Given that we are self-insured an obvious policy to reduce expenditures would be to increase co-pays. Presumably health care costs are rising because we are consuming too much health care. Make us pay a bit more. Then we will be more careful at the margin. This would lead to direct savings for a self-insured group. Why they did not choose this idea is not exactly clear.

Hedging and Thin Markets

The Financial Times had an interesting article about the problems plaguing independent shale oil producers trying to hedge price risk. Rising production of shale oil has led to a huge increase in US oil production. As producers invest in new production they typically sell oil forward to lock in prices so that they can obtain credit. But as they do this the price for future delivery declines. As high prices are the basis on which unconventional oil production makes sense, this is problematic:

Since the start of 2011 crude production from the Bakken field in North Dakota, the most prolific US shale oil field, has nearly tripled. During the same period the price of benchmark West Texas Intermediate three years ahead has tumbled from more than $105 a barrel in April and May 2011 to as low as $81.51 by June this year.

That is a worry for the independent companies that dominate US shale production. To attract the credit they need to keep drilling, most of these companies sell futures contracts to show lenders they have locked in an oil price that is higher than their cost of production.

...The principal reason for the downward drift in prices, say analysts and traders, is the hedging activities of shale oil producers themselves. As the volume of production in the hands of independent producers grows – EOG, a bellwether independent oil producer, doubled crude and condensate production between 2010 and 2012 – so does their hedging activity. 

The problem is that the futures markets tend to be quite thin as you move out into the future. Users of oil do not engage in significant amounts of hedging three years and further out into the future. So the actions of producers tend to have large effects on price. 

Hence, we have the situation where the markets signal a large future decline in the price of oil, based on a boom caused by high prices of oil. Hence, we have a situation where the markets signal a large future decline in the price of oil, based on a boom caused by current high prices. The increase in supply has been caused by high oil prices. Clearly, if oil prices were really expected to fall by $20 a barrel in the next couple of years, many shale plays would no longer be profitable.

Two points seem important here. First, the futures market may not be giving us the best signal of what prices may be no matter how efficient it is, simply because it is too thin. Second, oil producers cannot use futures markets to significantly hedge price risk. 

This point is all the more important if we think of conventional oil producers who also must make huge investments on a very large scale. When we talk about the implications of price risk for investment in East Siberia economists often ask why Russia does not hedge the risk in the futures market. Now ask yourself: if the actions of independent shale producers can depress futures market prices, what would happen if Russia tried to hedge its production? Ten percent of Russian oil production is about the size of the entire annual production from the Bakken shale!

With markets so thin producers cannot hedge price risk with futures or options. Risk sharing must take other forms. I will talk about this in future posts.

Russia's Growth Crisis: It's not the middle-income trap that Russians should fear. It's the Bear Traps

Russians and observers are concerned that Russia is in a growth crisis.  A recent article in Russia Today is typical:

The Russian economy will not be able to grow faster than 2 percent per year in the coming decade and might become another Greece, says one of Russia’s leading investment banking firms Renaissance Capital.

An underlying theme is that Russia is entering the Middle Income Growth Trap. The idea is that when countries reach an annual per-capita income of $15,000 in PPP dollars that growth significantly slows down. 

Fear of the middle income growth trap misses the point, however. Russian growth has slowed down not because the period of catch-up growth is over but because oil prices have stabilized. The reason why Russia grew so fast from 2000 to 2008 was the growth in oil prices. As oil prices grew Russia became much wealthier. Now that oil prices have stabilized this source of growth has receded. The slowdown we observe today is simply the expected outcome of the stabilization of oil prices. Growth rates have declined because the period of rising oil prices has ended. Russian growth rates have settled down to levels that are consistent with the non-oil fundamentals of the economy. It is only now that oil prices have stabilized that we can see how anomalous the high growth rates of the last decade were.

To the extent that the middle income growth trap is a real phenomenon, it is because that level of income reflects a certain degree of convergence to the technological frontier and therefore the steady-state growth rate. Absent the oil effect, Russia is not really at the middle income level. Its per capita GDP grew from $7,700 in 1999 to $15,100 in 2008. If we say the economy would have grown at 2% a year at a flat oil price, then it would have grown to $9,200 by 2008. So Russia is a $9,000 economy, that only resembles a $15,000 economy because of oil The middle income rule doesn't apply.

Now the fact that Russia's 2000-2008 growth was due to oil and not catch-up means there is more room for catch-up growth than one might otherwise think. That is good news, in one sense.

But the more fundamental point is that all during this period Russia's growth process has been hampered by the structural legacies it has inherited from the Soviet period, what Clifford Gaddy and I refer to (in our new book that has just appeared) as Bear Traps. These are primarily a spatial misallocation that imposes excess costs on production and investment; distortions to human capital; an excessively high relative price of investment that serves as a tax on physical capital accumulation; and an economic mechanism that inhibits adjustments that would correct the misallocation.

Because of the Bear Traps Russia cannot experience the same catch-up growth that a similar economy not so burdened would display. Russia must always invest more to get the same catch-up effect as other countries. Also, the existence of the Bear Traps keeps it from being able to implement the necessary institutional reforms it needs for effective catch-up. 

The emphasis on the middle income growth trap, and the reluctance to notice the impact of oil prices on Russian growth distorts analysis of Russia's growth crisis. It pushes attention away from dealing with the Bear Traps which is the only way to fundamentally alter Russia's growth trajectory.

But it should also be noted that oil has been good for Russia. Russians are much richer than they otherwise would have been. Yesterday's oil may have been a key enabling factor in creating the structural legacy that so burdens today's Russia. But wishing away today's and tomorrow's oil is stupid. Russia without oil won't be Sweden, or even Hungary or Poland. It won't even be Ukraine. It will be Ukraine with Russian-size Bear Traps. The only hope Russia has to deal with the Bear Traps is to take advantage of the oil and gas -- the Resource Track.

A Nightmare Ends (actually January 1, 2016)

The Great Nightmare will finally end. The USGA and the Royal and Ancient Golf Club of St Andrews have finally announced that they will implement the ban on anchored putting. Here is the USGA letter:

May 21, 2013 Dear USGA Member: The USGA cherishes its strong relationship with our Members, and we appreciate the support you provide in helping us lead the game toward a sustainable future. Your membership bolsters the critical mission of the USGA in many important ways and has helped to make the game more enjoyable for golfers of all ages and skill levels. Recognizing the role that you play in all we do to protect and nurture the game, we want you to be among the first to know about an important announcement. Last November, after an extensive review, the USGA and The R&A proposed Rule 14-1b, a new entry to the Rules of Golf that prohibits anchoring the club in making a stroke. This morning, together with The R&A, we are announcing the adoption of Rule 14-1b for players at all levels of the game, effective January 1, 2016. Final approval of Rule 14-1b follows a comprehensive and unprecedented process for playing Rules in which comments and suggestions from across the golf community were collected and considered. In our best judgment and having considered all of the input that we received, both before and after the proposed Rule was announced, we concluded that Rule 14-1b was necessary to protect the essential nature of the traditional method of stroke and eliminate potential advantages that anchoring the club provides. Throughout the game's 600-year history, the essence of the traditional method of golf stroke has involved swinging the club with both the club and gripping hands held away from the body, requiring the player to direct and control the movement of the entire club. Anchoring one end of the club against the body, and creating a point of physical attachment around which the club is swung, is a substantial departure from the traditional swing. Our judgment, based on tradition, observation and experience, is that anchoring creates an unacceptable risk of changing and reducing the challenge of making a golf stroke. The new Rule does not alter current equipment standards and allows for the use of all conforming golf clubs, including mid-length and long putters, provided such clubs are used in a non-anchored manner. The Rule narrowly targets only a few types of strokes in which the club is anchored, while preserving a golfer's ability to play with a variety of permissible gripping styles, putter types and swing methods. The effective date of January 1, 2016, at the start of the next four-year cycle for revisions to the Rules of Golf, provides an extended period in which golfers currently using an anchored stroke may adapt their method of stroke, if necessary, to conform to the requirements of the new Rule. We know that not everyone will agree with our final decision. However, we hope the new Rule will bring to a close the longstanding, controversial debate about anchored putting and its place in the game. Of equal importance, we hope that those who have expressed concerns know that they have been heard; can understand our reasons for concluding that Rule 14-1b is in the best interests of the game; and will now join with us in assisting any golfers who need help moving to a non-anchored stroke. Recognizing that you may have questions, and that you may also want to share this information with fellow golfers, we have developed videos, images, graphics and other materials that are available at www.usga.org/anchoring to help you become more familiar with the specifics of Rule 14-b. We have also provided a comprehensive document that explains the basis for our final decision and addresses the primary questions and concerns voiced by those who expressed opposition to the new Rule. Thank you for your support and passion for the game as we continue to serve all golfers around the world and work to secure the health and traditions of the game for current players and for future generations. Sincerely,
	Glen Nager President		Mike Davis USGA Executive Director
For the good of the game®

Unfortunately, the rule goes into effect only on January 1, 2016, but at least we know it will end.

This is a great day!

Energy Errors

Charles Mann has an interesting article on unconventional oil and gas in the Atlantic. Lots of good stories and  he cites Morris Adelman so it is a worthwhile article. But two glaring errors induce this post.

First, is this concept of EROEI. Let's quote Mann:

Economists sometimes describe a fuel in terms of its energy return on energy invested (EROEI), a measure of how much energy must be used up to acquire, process, and deliver the fuel in a useful form. OPEC oil, for example, is typically estimated to have an EROEI of 12 to 18, which means that 12 to 18 barrels of oil are produced at the wellhead for every barrel of oil consumed during their production. In this calculation, tar sands look awful: they have an EROEI of 4 to 7.

I am fully aware that some analysts use this concept, but I cannot believe that any economist would. The whole point of economics is to compare the value of inputs and the value of outputs. Not their physical unit measures. If you use lots of low-cost energy to create high value energy that is a good thing even if the quantity of the low-cost energy is huge. In this example, Mann talks about barrels of oil for barrels of oil. Sometimes the measure is in BTU's or some other physical unit, but the same error arises. We use coal to produce electricity because electricity is a more valuable type of energy -- try powering your ipad directly with coal.  Later in the article Mann talks about Econ 101, but if he took it he would not make this error.

Second, Mann goes on and on about the resource curse. The idea that resource abundance causes deteriorating economic performance has been much studied. But as Mike Alexeev and Robert Conrad clearly demonstrated it is an elusive curse. Alexeev and Conrad's paper should have ended these discussions, but they endure. This despite the fact that the empirical work that purports to find a resource curse is flawed for many reasons. But the most important is the failure to consider what the wealth of the country would be without the resources. That is correct, this is actually ignored.

To find the resource curse cross-country regressions are employed to explain growth performance. You always need some measure of initial GDP since growth slows down as you get richer. But most resource abundant countries discovered their oil before 1960 or 1970, the typical years used for initial GDP. So resource abundance led to higher GDP but its effect in the regression is explained by initial income not natural resource wealth (no matter how mismeasured -- I leave that for another time).

This fundamental error pervades the analyses. You typically find that a country like Russia has very high corruption for its level of GDP and this is explained by its resource abundance. But if Russia had less resources it would have much lower GDP! The reason Russia is off the regression line is not that its oil makes it more corrupt but that its oil makes it wealthier than its institutions and other fundamentals would suggest. Take away the oil does not make it richer!

Energy Independence and Analysis

The revolution in production of unconventional oil and gas in the United States is no doubt an important development for the economy. But it also has been accompanied by a lack of analysis. Case in point, Sunday's NYTimes piece on the "Dark Side of Energy Independence."  The authors, editors at Foreign Affairs, argue that increased US production could lead to a 50% reduction in oil prices, and then analyze the effects of this on oil producers elsewhere.  They point out that:

lower energy prices will undermine the stability of the Persian Gulf monarchies, whose hefty oil revenues have allowed them to win their populations’ loyalties through patronage and a lack of taxation. These countries do not always share American values or help advance American interests, but anything that destabilizes them would create problems that Washington could not afford to ignore.        

What is amazing about their argument is that they never consider how oil producers will react to lower oil prices. They do not consider the impact of $50 per barrel oil on the profitability of unconventional producers. If prices fall in half which oil projects are likely to be cut back? Presumably those with the highest costs. 

Nor do they consider how OPEC producers might react to this increase in oil production from elsewhere. They could, cut back their production, as comments from Saudi oil minister, Ali Naimi, suggests. But if OPEC cuts back then why would prices fall in half? Alternatively, facing lower prices desperate countries might increase production causing a further fall in prices, as Michael Levi notes. 

But the key point to remember is that unconventional production of oil and gas is a response to high oil prices. As prices fall the projects that are cut back are those that have the highest marginal cost. Failing to consider this is an invitation to faulty analysis.