Assistant Professor of National School of Development
November 5th, 2009
Part 1 - Summary of contributions
Question: You are a Nobel Prize winner, you have done great works on social choice, general equilibrium, economics of information, and many other issues, how do you rank the importance of these works?
Kenneth Arrow: I would say social choice is my No. 1. For No. 2, somebody may not think of it, I think it is my paper on the economics of medical care. It is not just the medical care; it is the whole idea of asymmetric information being the central problem of medical care. What makes it the special industry, what are the problems with it is that, essentially, when a doctor meets a patient, the doctor knows more than the patient, therefore the patient is not able to say whether the doctor is doing a great job. There is this relation between the doctor and the patient on the one hand, and there is also a relation with the insurance company on the other hand. The point is that the details of the case are onto the doctor, and maybe onto the patient, but not so much onto the insurer. Therefore there will be tendency to overuse the medical resources. The insurance company has recognized this long time ago. There are certain categories called moral hazard and adverse selection … I do not want to go through the whole lecture. It turns out this is not only the medical care question, and in particular, it is the financial regulation and a number of other things. The idea of this asymmetric information is a problematic property of the economic system. In some places it is less important; in some places it is more important. The result is that the market may fail. Subsequently there is a great literature by Akerlof, Stiglitz, Spencer and other people exploring different aspects of that matter. My third contribution would be the general equilibrium, but in particular not so much the existence theorem. I am very proud of it, but it is technical problem. The idea is being around, the proof of the existence was what Gerard Debreu and I did. It was a very empirical and hard work, and it really involves stating what general equilibrium was in very careful way. We simply state what the theory said in a much clear way than anybody else has done. But I would like to say it was not so original because the idea has been around. In fact, four or five people were working in the same direction. I think what is more important is the general equilibrium with uncertainty. I would like to say these are the three most important contributions.
Question: Some people thank that you should have won the Nobel Prize for three times.
Kenneth Arrow: Well…(Laugh)
Part 2 - Medical care
Question: Now let's talk about the economics of medical care. What's your opinion on the current U.S. medical care reform?
Kenneth Arrow: My first choice would not be any of the plans being discussed now. It would be a single payer system, as you have in most European countries. That's one aspect. The other thing is, because of this moral hazard problem, how do you control costs? The trouble is it is not just a perfectionism idea; the costs are just absolutely enormous. Medical costs are growing relative to other things in every country. The United States has the biggest fraction; about 17% of national income goes to medical care. When I wrote that paper 47 years ago, the percentage was 4%, now it's 17%, which is bigger than any other country. Canada is like 11%. But they are all going up. The question is somehow this can't just go up. You can't have the whole resource of the country just going to the medical care. Although you could argue that medical care gives you something more valuable than most other things. So it is not entirely ridiculous that we are spending all these money. We have a theory that life is worth 6 million dollars in the U.S. This was actually used for determining air pollution regulations. There are economic costs with these regulations that you can tell. So what's the gain? Typically you have some health gain. Usually it reduces the number of death. So it's a tradeoff. You can see there are gains in longevity due to medical care. Medical care is not a bad investment compared to other things. So I don't think there is a strong argument to say. Medical care is not supplied by the market, which means you have taxes, and taxes create distortions, and that's the problem. There is resistance to higher taxes. Whatever is this resistance, medical care is not going to be paid through the market, and medical care can't be paid through the market completely.
Question: China is reforming its medical care system. There is a debate on the role of the government and market. What do you think is the key in this debate?
Kenneth Arrow: Well, there are two ideas. One is somehow contrary to most economic think. People who can't afford medical care should get it anyway. Usually we say if you can't afford Mercedes Benz, you drive cheap cars. You can't afford good house, you live in poor house. You can't afford meat, you eat vegetables. We treat medical care differently. That's new. That was not historically the case. And one of the reasons is that medical care can do much more. Even in the U.S. nobody is really saying let's undo it. So we have a program for the retired people, Medicare. This is for all retired people, including wealthy people. Apart from that, we have a medical care program for poor people, Medicaid. It is part of states' burden. A major part the expenditure in most states today is on Medicaid. It is not a trivial matter, it is pretty expensive. It is squeezing out state universities. They have real problems now, and part of the reason is that state universities are less supported than they used to be due to the high expenditure on Medicaid. So we really are making choices. But nevertheless, nobody is suggesting that we repeal Medicaid, no republican, nobody. Somehow there is a commitment to support poor people. When you look at the actual use of medical care, it is more or less independent of income. The amount of medical care in the U.S. is almost independent of income. So we actually are very imperfectly doing this. Ok, so we have this model of socialized obligation.
The second idea, which comes from my paper, is that even apart from that, medical insurance doesn't work very well because of adverse selection. It turns to run up the costs. The only real hope is to have government control which says we don't do certain things. It is called rationing. That is what the British do. The Great Britain is the most successful country at keeping cost down. In Great Britain, the medical service is actually operated by the government. In most places government runs the insurance and the private sector actual supplies the medicine.
There are other needs to control medical costs as well as you can because there is no question there is useless medical care. One of the reasons we know this is that there is a group of doctors from the university, they just compare different parts of the country and they find that some places spend twice as much as per capita medical care than others, but no difference in outcomes. So we have some wastes. The trouble is that it's not so easy to pick out and say this is useful and that is not. Because every case is different, you can't impose from outside since every case is really different. It is difficult to do. And I think there are certain things can be done, one is competition, more intense competition among the health plans, and this was done in many countries, say the Netherlands, Israel, the German's, have competitive plans. The general view among experts is that among plans in the U.S., some are much better than others. And in addition, I think what the British and some other countries do is to have an impartial agency evaluating every new procedure, new drug, new surgical procedure, new device; evaluate how valuable it is. This group could say, no we don't pay for it, maybe that's too harsh. One difficulty is that it's not easy for doctors to really know. Even costs can change. He did it and worked, but that's … you know there are lots of variations, so that it may work in one time but not in others. If you could pool thousands of doctors to do it efficiently, if you can put some kinds of central information, maybe use this as a base for pay and maybe just announce it, will be relevant. I think the total cost is a serious matter, because we are running into situations where there are resistances to taxes, thus we are running into these huge, cumulative deficits. They are building up our national debt. Obviously this can't go on forever.
Part 3 - Climate change
Question: Now let's switch to the topic of climate change. Do you think there is solid evidence that human being had contributed to the global warming?
Kenneth Arrow: It's a very important question to China specifically. To me there is no question that there is a man-made factor in the climate change. There are natural cycles. That's true, that is one thing happening. But there are other things. It was very elementary. I studied meteorology during my service in World War II. The training is like a master's degree in meteorology. The professor said the amount of carbon dioxide in the atmosphere has been greatly increased because of industrial revolution. There are factories, so there are much more burden went on today than 60s or 70s. We have oil, natural gas, coal, they all contain carbon. We burn a lot more and more to run our factories, to heat our houses, drive our transportation, they maybe coal, maybe oil, and all these have carbon. When the carbon is burned with oxygen, it results in carbon dioxide; this just goes to the atmosphere. So the amount of carbon dioxide goes up. Therefore the professor concludes probably there will be global warming. This is my first introduction back in 1942. Twenty-five years later, I heard people worrying about climate change. One trouble is we don't have measurement going back in time that well. You don't have direct measure, but people can get things on the ground, like the ice caps in Greenland. You dig down so you get evidence. Anyway the evidence is pretty clear; one thing we have observed for a long time is that glaciers have been retrieving since the middle of 19th century almost everywhere. There is a place in Alaska which is called glacier bay, a place where glaciers come down to the sea, they break off. The whole big piece of glacier becomes iceberg and floats away. They took a lot of pictures since 1880s and compare pictures with pictures took today, you could see there are far less glaciers today than there was. It is true almost everywhere. That is something quite striking. So I think today there is no question that the warming is due to man-made factors. This is absolute. There are fluctuations you find cold here and warm there, keep on finding that. The evidence about tropical storms is that, it does not appear there is any greater number of them; there is conservative evidence that they are more intense. There is no evidence that water temperature is heating because we don't have good record on water temperature. But there is little doubt that the ocean temperatures are rising. And evidently this gives rise to more intense tropical storms with more energy. Thus we have Katrina.
Question: With global warming, China faces the tradeoff between reducing carbon dioxide emission and economic growth. So what's your opinion?
Kenneth Arrow: This is a problem. I think regional matters have to be studied specially. I don't know how vulnerable China is. Of course China would gain by restricting global warming. Somebody has to do a lot research because it certainly differs from place to place. But from a global basis, assume that China is like everybody else, it looks like the world devotes one percent of its GDP to measures restricting global warming, to reducing carbon dioxide, to switching out of coal, to replacing with nuclear, or solar, or something else. I did some calculation based on the Stern's report. A one percent GDP would pay for itself. So China would benefit greatly. The immediate effect would be a one percent reduction in growth rate for a while. It doesn't seem to me the cost is very high. The U.S. is moving in that direction very slowly. There are bills now before the congress. Some versions of the bill would probably pass, including a carbon trade system. But I think that China is on the position to gain by going along, because China is now the world's biggest contributor of carbon dioxide emissions.
Part 4 - China's economic growth
Question: Let's continue on China. You will talk about sustainability next Monday. Do you think China's high growth rate during past 30 years is sustainable? What are the important factors to maintenance this high growth?
Kenneth Arrow: China is of course in a good position because it can take advantage of technologies developed elsewhere. The productivity of China is still relatively lower than the U.S., so just keep on borrowing technologies and narrowing the gap. Of course you can't just rely on borrowing. But certainly the basic idea is to learn from the U.S. I guess most countries haven't done that. The rates of growth of China are higher for a longer period than anything Japan has done, so this is a new record for growth. It is hard for me to believe you can continue simply because you are using up easy gains, you must be getting to the harder ones. I can't say any more details than that because I don't know yet and I doubt anybody does.
You already get everybody have at least the basic education. So that gain can't be maintained. I think you get a lot of problems because of this social structure. I think this would be very long-lasting difficulties. But in principle, they could gain a lot by educating your people a lot better. There is no doubt that you can have your higher education to be expanded and that would undoubtedly contribute something. You know obviously there are other regions that are interior which probably you could. You can migrate people from there to the coastal area. There is probably room for gain. I find an eight percent growth almost conceivable, and I don't know how it can continue. But may be you can.
Question: You have mentioned migration. Do you think urbanization is a key point in China's growth?
Kenneth Arrow: I assume you already have this. Urbanization doesn't mean adding necessarily to the existing cities, it could be creating new cities. This is what happened in the U.S. There are all sorts of places: there are very small cities. The population in New York is not particularly bigger than it was 50 years ago. People are not moving to New York, but to all sorts of places. People would move to Texas, Alabama and Arizona. There is lots of growth in Arizona. If you go back to the 1930s, Los Angeles has very few people, but now it is a big city. There are cities with 10 thousand people; there are also cities with 200 thousand people. The place where I live is not San Francisco; it is the area south of it. When I moved there 60 years ago, there were farms that produce very high quality fruit. But the population went up enormously. In that region, San Jose is less well known, but it actually bigger than San Francisco. All those communities, including the Silicon Valley, have a lot of population.
So I think the answer is not necessarily urbanization, the march that continues. But there are lots of arguments that economic growth is increased by urbanization to those people, the serious people with much more contact with different ideas. I think Shanghai is getting bigger Beijing is getting bigger, but there are new cities to develop.
Li Lixing is an assistant professor of China Center for Economic Research at Peking University.