This Minneapolis Fed interview of Kevin Murphy is full of great bits. I've excerpted two points he makes (about health care) that have implications for higher ed.
This first quote illustrates the importance of value added measurement (to make rational cost-benefit decisions).
Let’s say we have our War on Cancer, and we’re going to spend $100 billion. And we have a 50 percent chance of being successful in finding a 10 percent reduction in cancer. So we have a 50 percent chance of getting a $5 trillion return, a 50 percent chance that we’ll discover nothing. Okay?This second quote illustrates the danger of third party payment.
Now let’s say there are two cost scenarios, to make it really simple. One is that the treatment is nearly free; it’s a really low-cost treatment. The other one is it costs $10 trillion. If each of those happens with 50 percent probability, well, as you can quickly realize, the expected gain is now zero. We’re going to discover this treatment with probability one-half, in which case we get $5 trillion in gains. But we have $5 trillion in expected cost, and so the net expected payoff is zero. I set it up that way to make the algebra simple.
Now let’s say we had a sane health care delivery system that didn’t use treatments that cost more than their benefits. Well, now your probability of failure is 75 percent, since half the time you discover nothing and half the time you discover something that is too costly to use. But rather than being lower, your expected gain is now $1.25 trillion. Half the time, you’re going to discover it. Of that, half the time it’s going to be low-cost. So a quarter of the time, you’re going to get $5 trillion, so you’ve got a $1.25 trillion expected gain for a $100 billion investment.
By rationalizing the care system, we’ve changed what was a zero, or actually negative, net return investment into a hugely positive net return investment. We didn’t make science better. We didn’t make the probability of discovery better. All we did was rationalize our care system so we don’t overspend.
I see that disconnect between the payers and the developers as being a major problem... in the private market, we don’t worry about people developing TVs that are too expensive. People have no incentive to do that. In the medical area that’s not true. In the current system, people have the incentive to develop things for which the costs could outweigh the benefits. As long as they’re still going to get used, people are going to supply them. So research is going to respond.And just for fun, here are the top 10 facts about Kevin Murphy.