Message to Debaters

by

John C. Goodman

President

National Center for Policy Analysis

This document has been revised as of 8/21/2007.  The new material is in bold.

Table of Contents

I. What Is Public Health?

   a. Externalities

   b. Public Goods

   c. Private Production of Public Goods

II. How Could Anyone Be Against Spending More Money on African Public Health?

   a. Opportunity Cost

   b. Revealed Preferences

   c. Substitution

   d. Public Choice

III. What is the Answer to Africa's Public Health Crisis?

   a. Superior Goods

   b. Economic Growth

   c. Economic Efficiency

   d. Efficiency and Economic Incentives

   e. Incentives and Economic Growth

IV. What Factors Affect Economic Growth?

   a. Political Institutions

   b. Legal Institutions

   c. Property Rights

   d. Common Law

   e. Rule of Law

   f. Culture

   g. Geography

   h. Economic Freedom

V. The Special Role of Capital

   a. Financial Capital

   b. Human Capital

VI. The Economics of Health Insurance

   a. The Value of Insurance

   b. Government-Provided Health Insurance

   c. Private Insurance

   d. Individual Self-Insurance in South Africa

   e. Self-Insurance for the Chronically Ill

VII. The Economics of Charity

   a. Giving Back?

   b. Benefiting Whom?

   c. Making People Better Off or Worse Off?

VIII. Getting the Most of Foreign Aid

   a. Diminishing Returns

   b. Marginalism

   c. The Equimarginal Principle

   d. Cost-Effective Spending on Health Care

Resolved: The United States federal government should substantially increase its public health assistance to Sub-Saharan Africa.

                               -- 2007-2008 CX Debate Topic Resolution.

At first glance, this year's debate topic appears to be all about health.  Yet once debaters delve more deeply, they will discover the topic is really about economics.  Poor health is a symptom of a deeper problem.  Other symptoms are: low educational achievement, low productivity and low incomes.  All of these symptoms have a single cause: bad economic policies chosen by African governments. 

When I first learned about this year's topic, I was disappointed.  Of all the problems in Africa today [see the side bar], why focus on public health?  Surely ending slavery, stopping ethnic genocide or eradicating famine is more important.  The movie Blood Diamond depicts an African country ravaged by rival gangs of thugs who cut off arms, rape and pillage, kill indiscriminately and enslave the children. Granted, not every Sub-Saharan country is that way. But most could become so.  As Nicholas Kristof writes in the New York Times, "It's pointless to build clinics when rebel groups are running around burning towns and shooting doctors."[1] 

Yet the more I thought about this year's topic, the more I liked it.  The reason: the topic will accomplish something that is very hard to do.  It will force debaters to confront the stark difference between the Hollywood/rock star view of the world and the way economists view the world.  (Read Debate Central's Topic Overview for more on the health crisis in Sub-Saharan Africa.) 

Sub-Saharan Africa's Other Problems

Although the public health problems in Sub-Saharan Africa seem daunting, there are many other issues that compete for our attention:

• Nearly 2 million people have been killed, tortured, imprisoned, and forced into exile in the Northern Ugandan genocide.[1]
• Human rights organizations in Zimbabwe have recorded over 1,200 cases of human rights violations by law enforcement including torture, assault, and unlawful arrest.[2]
• Between 800,000 and 1 million people were killed in an ethnic cleansing genocide in Rwanda in 1994; the conflict has since moved to the Congo where at least 5 million people have died.[3]
• Ex-Liberian leader Charles Taylor allegedly committed 11 war crimes and crimes against humanity including supporting rebel forces and using child soldiers.[4]
• More than 450,000 people have lost their lives since 2003 in the ethnic cleansing in Darfur.[5]
• The Ugandan government has been accused of torturing political opponents with severe beatings, electric shocks, and suspending them from ceilings by their hands and feet from ceilings.[6]
• In Sudan, 400,000 people have been killed and as many as 2 million have been displaced by violence led by a Sudanese government-backed militia.[7]
• More than 100,000 people are held as slaves in Darfur, including children forced into domestic or agricultural labor; he buyers pay about $33 in local currency for each slave.[8]
• Pygmies in the Congo face cannibalism by the nation's soldiers.[9]
• More than 10,000 children live on the streets in the Congo and Ethiopia, abandoned by families that are too poor to support them.[10] 
• 34 percent of the African population is undernourished as a result of widespread famine.[11]  
• 42 million school-age children are not enrolled in school.[12]
• Thousands of African women suffer as a result of female circumcision, a brutal practice often performed without anesthetic by lay practitioners; in Sudan, doctors estimate that 10 to 30 percent of young girls die from its complications, especially in areas where antibiotics are not available. [13]
• Nearly 3,000 people have been killed in inter-communal fighting between Muslims and Christians in Nigeria.[14] 

---

[1] Olara Otunnu, "Northern Uganda: A Profile of a Genocide," The Monitor, January 8, 2006. 

[2] "Who Guards the Guards? Violations by Law Enforcement Agencies in Zimbabwe," Zimbabwe Human Rights NGO Forum, 2006. 

[3] "Rwanda: How the Genocide Happened," BBC News, April 1, 2004. 

[4] Ibid. 

[5] "Q&A: Sudan's Darfur Conflict," BBC News, May 29, 2007. 

[6] Human Rights Report, Amnesty International, 2004. 

[7] Joel Wendland, "Darfur Crisis Continues," Political Affairs, April 29, 2005. 

[8] "Slavery and Slave Redemption in Sudan," Human Rights Watch, May 2002; "Sophomore skips orientation to free 4,000 slaves in Sudan," The Harvard University Gazette, September 28, 2000. 

[9] "Pygmies' Plie," Daily Record, May 23, 2003. 

[10] "Street Children in Ethiopia," Global Security, January 2004.

[11] Mark Rosengrant and Siet Meijer, "Appropriate Food Policies and Investments Could Reduce Child Mortality by 43 percent in 2020." The Journal of Nutrition, Vol. 132, November 2002. 

[12] "Human Development Report: Africa," United Nations Development Programme, 2003. 

[13] Frances Althaus, "Female Circumcision: Rite of Passage or Violation of Rights," International Family Planning Perspectives, Vol. 23 No. 3, September 2004. 

[14] "Revenge in the Name of Religion," Human Rights Watch, May 2005.

The Hollywood/rock star view of African aid follows a simple causal chain: The only thing keeping Africans from being healthy is that they lack the public health systems of Western, developed countries; the only reason they don't have our public health system is because we haven't given them enough money; and the only reason we haven't given them enough money is because we don't care enough.  Solution: we need to care more.  (Remember the Beatle's song "All You Need Is Love?")

Against this dewy-eyed, emotional world view is a cold, steely reality: trying to import our public health system into Africa or giving African countries huge amounts of money (with no change in other political institutions) would likely make the average African worse off. 

As you get into this topic, you will find yourself dealing with a great many basic economic concepts.  What follows is a brief review. 

What Is Public Health?

You might suppose that public health is whatever is done publicly (principally by government), as opposed to health care provided in the private sector.  No doubt some affirmative teams will try to define the term that way.  Historically, however, the term has been associated with the production of what economists call "public goods." This concept, in turn, is closely related to the concept of "externalities."  Let's start with the latter concept first. 

Externalities.  In normal markets people tend to bear the full cost and reap the full benefits of their actions.  That's a good thing.  Most of us are self-interested.  We tend to weigh personal cost against personal benefit when we choose among alternative courses of action.  As a result, we are more likely to make good decisions if we bear the full costs and reap the full benefits of our choices.

An externality exists whenever this principle is violated.  There are occasions when we bear only part of the cost of our actions, with the remainder being borne by others.  In these cases, our actions are producing external costs for others, or "negative externalities."  Secondhand cigarette smoke, for example, is a negative externality for nearby nonsmokers.  There are also cases where people create external benefits for others, or positive externalities.  Most of the benefits of the theory of relativity, for example, were not realized by Albert Einstein.  The overwhelming bulk of the benefits of that theory have been enjoyed by others.

A convenient way of thinking about externalities is to think of them as external to the market.  They tend to be side effects which bystanders never agreed to in any contract - for better or for worse.

This distinction is a good way to think about the traditional issues that arise in public health.  Most illness and most health care are of a private nature.  But not all.  Communicable diseases such as AIDS and tuberculosis are spread when one person's pursuit of his own interest and pleasure creates harmful negative side effects for others.  Malaria, dengue fever and other insect-borne diseases illustrates the importance of externalities in a different way.  If one landowner allows a mosquito-infested pond to form on his property, the spread of malaria to his neighbors is a negative externality.  On the other hand, if a landowner engages in mosquito control activities, his actions (by reducing the spread of malaria) create positive externalities for his neighbors.

In the marketplace, people pursing their own interests have weak incentives to increase their production of positive externalities or reduce their production of negative externalities.  The reason: there are no economic rewards for the former or economic penalties for the latter.

This is why people have traditionally turned to government to perform this function or, when government fails to act or does a bad job, to the private, nonprofit sector.  This is especially true in health care.  Efforts to control communicable diseases - by isolating (quarantining) the infected, educating people about the causes of disease and promoting prevention - are all "public health" activities that traditionally fall within the realm of government and the nonprofit sector.  Similarly, efforts to control infectious diseases by controlling conditions that breed supply, by inoculations and by other acts of prevention are all part of traditional public health activities.

Public Goods.  If a good is a "public good" (in the technical economic sense of the term), one person's consumption of it does not diminish another person's ability to consume it.  The classic example is a lighthouse.  If a ship-owner builds a lighthouse, he derives direct benefits - the avoidance, say, of wrecks on a reef.  But other ship-owners may get just as much or more benefit from the lighthouse, even though they may have contributed nothing to its construction.  Economic theory says that public goods will be under-produced in the private sector.  The reason: the producers cannot capture the full benefits of their creation. (Economic theory does not say they will never be produced; indeed, shipping companies historically built lots of lighthouses.)

For this reason, people have often turned to government and the nonprofit sector to produce public goods.  Libraries and museums are a few other examples, along with police and fire fighting services.  The same principle applies to certain health activities.  Efforts to control communicable diseases and insect-borne diseases may be thought of as public goods.  Everyone in the affected community benefits, whether or not he contributes to the effort.  And one person's benefit does not in any way diminish another person's benefit. 

Certain infrastructures, such as access to clean water and sewage disposal systems, also have public good aspects to them.  And because these infrastructures solve health problems (such as avoidance of cholera, dysentery and other diseases) they are sometimes thought of as components of public health. 

The converse of a public good, by the way, is a "public bad."  A pond that breeds malaria-infected mosquitoes may be thought of as a public bad.  Efforts to reverse the process and control the mosquito population may be thought of as a public good.  Absent government and the nonprofit sector, there will be too many public bads and too few public goods.  In public health that means, for example: too much malaria; too little mosquito control.

Private Production of Public Goods.  Wherever there are positive or negative externalities, or wherever there are underproduced public goods, opportunities exist - at least in principle - to make everyone better off by reorganizing social institutions.  Sometimes the cost of such reorganization is so great it is not worth the effort.  But sometimes entrepreneurs find ways to produce public goods privately and make a profit by doing so.

For example, access to clean water is normally thought of as a public good.  But when clean water is not available, an entrepreneur may find a way to ship in bottled water and sell it.  In this case, the entrepreneur is able to capture the benefits of clean water through the sales price.  Users of clean water bear the cost when they purchase it.  This process is called "internalizing the externalities."

Similarly, a developer of a high-rise residential building might supply water through pipes to each unit, charging a price directly or including it in a rental agreement.  The developer of a gated community may provide water lines to every resident, exacting a charge based on usage or adding the fee to the homeowner's monthly dues.  Similar principles apply to sewage systems and mosquito and other pest control systems.

Another traditional example of a public good is roadways (important to the topic, by the way, since lack of roadways impedes the ability of doctors and patients to see each other).  Once a road exists, travelers have traditionally been able to use it even if they contributed nothing to its construction and maintenance.  One way to internalize the externalities here is through a system of tolls.  Builders of roads can extract the benefits by charging travelers for its use, and travelers pay the cost of their actions each time they pay a toll.  (In the old days, paying tolls typically meant slowing down and traffic delay; today you don't even have to obey the speed limit - electric toll readers can "collect" from autos traveling 100 mph!) 

Private production has two advantages.  First, only consumers who use the service are charged for it.  That means you avoid a problem that arises so often in political systems: some people pay taxes to finance someone else's benefits.  Second, producers are directly rewarded to the extent that they satisfy someone's needs.  This creates incentives to find other innovative ways of producing more public goods.

How Could Anyone Be Against Spending
More Money on African Public Health?

At first glance, debaters may wonder: How could anyone develop an effective negative case on this year's topic?  Who could be against giving health aid to people who need it - other than an ogre or a scrooge?  As it turns out, the case against this year's resolution is much stronger than you might suppose.  To see why, we need to introduce three more economic concepts: "opportunity cost," "substitution" and "public choice."

Opportunity Cost.  Before asking "Why don't Americans spend more on African public health?" We should first ask, "Why don't Africans spend more of their own resources on public health?"  Surely part of the answer is opportunity cost.  To economists, the cost of any action is the value of the next-best opportunity foregone.  So if you're an African and you have a pot of money, what is the cost of spending that money on malaria control?  The cost is the value you place on the next-best opportunity to spend that same money.[2]

In terms of this year's topic, we cannot have more health spending without giving up some other goods or services. This idea is illustrated by the production possibility curve in Figure I.  The curve shows the most that society can have of health services, given its production of other goods and services.  Conversely, it shows the most society can have of other goods and services, given its production of health services.  Note that as we move around the curve from

A -> B -> C, we get more health - at the cost of foregoing more of every thing else. 

The figure also illustrates another important economic idea:  As we move around the curve, say, from A -> B -> C, the cost of each additional unit of health increases in terms of other goods we must give up.  Beginning at one axis, the first little bit of health does not cost very much. But by the time we reach the other axis, the last little bit of health is very expensive.

If public health is not the highest priority for Africans, why should it be the highest priority for us? To Americans who live in comparative luxury, the value of malaria control might be quite high.  But if you live in Africa and you are starving, living in a hut with no electricity, running water or sewage system, and wearing only the clothes you have on your back, malaria control may not be your highest priority. 

What difference do local preferences make when the aid is given by outsiders?  Answer: They make a great deal of difference.

Revealed Preferences.  How do we know what people's preferences are?  We could take polls.  Or conduct surveys.  Economists have a more reliable solution.  They assume people reveal their preferences through their actions.  For example, if a person is allowed to choose between an apple and an orange, and she chooses the apple, economists conclude she preferred the apple. 

This may seem like a trivial observation, but what comes next is not trivial.  If we give the chooser the apple rather than the orange, economists conclude she is better off from her own point of view.  If we take away the apple and exchange it for an orange, economists conclude she is worse off from her own point of view.  To see the relevance to the debate topic, consider a recent National Public Radio report which concluded that:[3] 

"For want of a condom or the will to use one, there were seven million infections of HIV last year."

Commenting on that tragedy, Terri Bartlett (Vice President for Public Policy and Strategic Initiatives, Population International) had this to say:[4] 

"You know, we travel around the world, and at the end of every dirt road, there's bottled water, a Coca-Cola and a pack of Marlboros.  Why can't we have a condom there, too?" 

Why indeed?  Anyone who can afford bottled water, a Coca-Cola or a pack of Marlboros could easily purchase a condom instead.  If the condom is not there, in all likelihood the reason is that people are not going to purchase it.  Put differently, the goods that are at the end of every dirt road reflect the buying preferences of the people who live there. 

Much of what happens in international public health efforts is an attempt to substitute Western preferences for local preferences.  And that, we shall see, usually does not work. 

Substitution.  This is one of the most important concepts in all of economics.  For example, capital and labor are substitutes for each other in production.  Most food stuffs are substitutes for each other in consumption.  An important application for this debate topic is the realization that foreign aid is a substitute for domestic aid.

Suppose an African country is spending 5 percent of its national income on health (broadly defined).  Americans might naively believe that foreign aid targeted at health will increase the country's spending in that area.  They may be surprised to learn that for each $100 in aid, net spending on health increases by only $5.  Why?  Domestic preferences do not change simply because people get a gift.  If their preference is to spend 5 percent of their income on health, it is also likely to be their preference with regard to any new funds given by a foreigner.

On paper, the foreign gift will appear to have been spent on health care.  But as foreigners spend more, the local population will tend to spend less on health from their own resources.  Foreign health dollars substitute for domestic health dollars.  People satisfy their preferences through acts of substitution.  (For more on why aid does not achieve its goals read Debate Central's Topic Overview.)

Public Choice.  This is the name given to a relatively new field of economics in which scholars use traditional economic tools to try to understand political decision-making.  In our case, a few simple principles will help explain why the goals of developed-country donors rarely get realized in African countries.

Consider a textbook example of democratic voting in which political outcomes tend to reflect the preferences of the average voter, or more precisely, the median voter.  Let's suppose the median voter wants the government to collect taxes and spend 5 percent of national income on health care.  Of the remaining voters, half want to spend more than 5 percent.  The other half wants to spend less than 5 percent.  The preferences of the median voter (5 percent) prevail because no other platform can win a majority of voters in a contest with it.

Note that many African countries are not democracies.  But even in those that are not, rulers still depend upon political support from those who are governed.  And the further a ruler veers away from the preferences of the median voter, the more support he will lose and the more vulnerable he will become against a potential challenger.

So one reason why African governments so rarely see eye-to-eye with the governments of a typical developed country is that the median voters in both countries are very different people with very different preferences.  Americans (at a very high level of economic development) want African countries (at a very low level of economic development) to accept donations to create elements of an American-style public health system.  But since the average African has very different options, small wonder that African countries take the money and spend it on something else.

An example of a misguided approach is the one proposal by Colombia University economist Jeffery Sachs, in his role as an advisor to the World Health Organization (WHO).[5]  Sachs wants developed countries to spend billions of dollars on health care in places like Sub-Saharan Africa-effectively doubling the share of national income devoted to health care and bringing it up to the European average.  Although Europeans apparently prefer to spend 10 percent of their income on health, Africans prefer 5 at their current level of development and will almost certainly resist any attempt to force European standards on them.  (See the discussion of "superior goods" below.) 

Of course, idealized voting does not tell the whole story.  In both democracies and nondemocracies, people with common interests band together to offer politicians support in return for favorable government policies.  When this happens the question is: How much are opposing interest groups willing to offer (in terms of votes, money or other forms of support) in return for benefits they hope to receive?

On the one hand, there are victims of AIDS, malaria, dengue fever and tuberculosis - scattered here and there, sick and poor.  How much will they be able to offer politicians per dollar of spending compared to groups that are well organized, rich and powerful?  Probably not nearly as much. This is yet another reason why the goals of Western giving entities are so often thwarted.  (For more on corruption see Debate Central's Topic Overview.)

For all of these reasons, the money developed countries give Africa will likely displace the money they currently spend on health.  As the U.S. and other countries give more to Africa, the local population will tend to spend less on health from their own resources.  This is a key point negative teams can make to argue that an affirmative case based on Sachs' plan will not solve Africa's problems. (See the discussion of "substitution" above.)

What Is the Answer to Africa's Public Health Crisis?

If foreign aid is not the answer, what is?  Higher income is the answer.  To see why, we need two more economic concepts: "superior goods" and "economic growth."

Superior Goods.  In the lexicon of economics, there are three types of consumer goods:

• When income rises and consumers spend fewer dollars on the good, it is called an inferior good.
• When income rises and consumers spend more dollars on the good, it is called a normal good.
• If income rises and consumers spend a greater proportion of their income on the good, it is called a superior good.

So why is this important?  Because health care is a superior good.  And it's not just a little bit superior.  It's a lot superior.  That is, as people move from poor to rich, they don't just spend a slightly higher percent of their income on health; they spend a lot more of their income on health.

For example, in Sub-Saharan Africa, per capita income is only $1,500 (US$), and the typical country spends only 4.5 percent of its gross domestic product (GDP) on health.  By contrast, in Western Europe, where per capita income is about $28,000, average health care spending is about 11 percent of GDP.  In the United States, the figure is 17 percent.

This is illustrated in Figure II.  As the production possibility curve shifts out, away from the origin, it illustrates higher standards of living.  On a higher production possibility curve, people can have more of everything.  However, the figure also illustrates (by the arrow) how consumption changes as income grows.  Note that, at a higher standard of living, (A à B à C à D) people are spending more and more of their income on health.  This conclusion is borne out by studies of individuals, by studies of countries over time and by cross-country studies at a point in time.

The bottom line: As countries grow wealthier, people will want to spend more of their own income on health; they will want more of their tax dollars spent on health; and if they receive foreign aid, they will want more aid dollars spent on health.  However, the opposite is also true.  If income is not growing - or even worse, if it is contracting - people will not want to spend more of their resources on health and will resist attempts by outsiders to artificially force them to do so.  (For more on how economic growth leads to health gains visit our Topic Overview.)

Economic Growth.  Debaters will not spend long on this topic before confronting a stark reality.  Personal income per capita in the United States is about $36,000.  Yet in Africa, the average annual income is about $4.00 per day.

Why is there such a disparity?  This is precisely the type of question that was asked by Adam Smith, the founder of the discipline of economics, in his book, An Inquiry into the Nature and Cause of the Wealth of Nations.

Before turning to Smith, however, let's consider some recent successes and failures.  One study concludes that:[6]

• Between 1970 and 2000, the number of people living below a standard poverty line in China fell by 250 million; this occurred despite a 400 million person increase in the total population and rising income inequality. 
• Over the same period of time, the poverty count in India fell by 140 million people. 
• By contrast, the number of people in poverty rose by 200 million in Sub-Saharan Africa. 

So what did China and India do that Sub-Saharan Africa didn't do?  Writing in the Wall Street Journal, Harvard economist Robert Barro says there are two important differences:[7] 

1. China and India adopted market based institutions (substantially substituting capitalism for communism in China and for socialism in India); with a few exceptions, African governments did not become more market oriented.
2. China and India received little, if any, foreign aid - while Africa received an enormous amount of aid, relative to the size of the economies.

By making appropriate changes in public policies, China and India have been able to enjoy some of the highest rates of economic growth found anywhere in the world.  Other countries that have also had remarkable economic success and enjoyed very high rates of economic growth are Hong Kong, Singapore and Chile.  African countries, by contrast, have experienced a much lower rate of growth and, at times, no growth or even negative growth.

What is economic growth?  It is the rate of increase of a country's output of goods services.  If a country is experiencing a 3 percent rate of growth, for example, each year it is producing 3 percent more output than the year before.  What difference does economic growth make?  Consider that a 7 percent growth rate is certainly within the realm of possibility for a typical African country - at least for a period of time.  Moreover, at this rate, national income doubles every 10 years.  With that in mind, compare two countries: Country A growing at 7 percent per year and Country B not growing at all.  Beginning at the same starting line:

• In 10 years, Country A will have twice the national income of Country B.
• In 20 years, Country A will be four times richer than Country B.
• After 30 years it will be eight times richer.

This is why a well-known economist once said, "Once you start thinking about economic growth, it's hard to think about anything else."  The effects of growth are so overwhelming; in time they completely swamp everything else.  Indeed, had African countries established the conditions necessary for growth a quarter of a century ago, the public health problems in Africa today would be minor compared to the current crisis. 

Economic Efficiency.  "Efficiency" is a term everyone uses in casual conversation, but economists mean something very specific by it.  If a county has inefficient institutions, it could in principle produce more of everything by changing its policies. 

Consider the Production Possibility Curve shown in Figure III and suppose a country is initially at point A, producing both wheat and corn.  Because the county is inside its frontier, it is possible at least in principle to produce more corn, given its production of wheat (and move to point B).  Alternatively, the country could produce more wheat, given its production of corn (and move to point C).  Or it could have more of both (by moving to point D). 

Being efficient, means being on the Production Possibility Frontier.  Once there, it is in possible to have more of one crop without having less of the other. 

Efficiency and Economic Incentives.  Whenever we find significant inefficiency, it almost always is the product of perverse economic incentives.  For example, under Mao Tse Tung's Communist China, virtually everything was collectivized - all food production, all housing, etc.  In agriculture this meant that if a farmer worked harder and produced more wheat, he did not get to keep the additional wheat his efforts produced.  Instead, the larger wheat crop was shared by all other farmers who were part of the collective farm - as well as by the government.  In fact, the farmer got to keep only a small portion of the extra production caused by his efforts.  The reverse was also true.  A farmer who worked less hard or was less diligent would cause the crop to be smaller.  But his share of the loss was only a small part of the total loss his actions created. 

The upshot is that collectively owned farm ventures create perverse incentives for all participants.  People realize only a small portion of the benefits of their good (productive) behavior and bear only a small portion of the costs of their bad (unproductive) behavior. 

When the Chinese began to privatize agriculture - giving farmers property rights in the crops they produced, they changed incentives and behavior.  People who had a property right in the crops they produced discovered they could reap the full benefits of their good behavior.  They also bore the full costs of their bad behavior.  Not surprisingly, under the new institutional arrangements more was produced.  [8]

Incentives and Economic Growth.  Moving to the Production Possibility Frontier is a good thing (as in Figure III).  Having the curve shift outward away from the origin is even better (as in Figure II).  What causes these shifts? 

As we shall see below, a county increases its ability to produce by increasing it's a capital stock - both physical and human capital.  Physical capital includes machinery, equipment, computers and other tools that are combined with labor to produce goods and services.  Human capital refers to the skills and abilities of workers.  An increase in either type of capital expands a country's ability to produce - given its population and natural resources. 

People's willingness to invest in either type of capital expansion, however, is directly related to incentives.  Why should the Chinese farmer save to purchase a new tiller, if his comrades get most of the benefit from his sacrifice?  Similarly, why should the farmer spend time, money and energy learning new farming techniques, if he reaps only a small fraction of the benefits that flow from those educational efforts? 

In general, where there is a weak or nonexistent relationship between effort and reward, people will be unwilling to make the sacrifices needed to expand the capital stock and shift the Production Possibility Frontier.  Conversely, where people get to reap the full benefits of their efforts, their willingness to invest will be much stronger. 

What Factors Affect Economic Growth?

Given that economic growth is so important, an effective counter plan for this year's topic might be to focus U.S. resources on encouraging growth rather than public health.  By way of background, what are the factors that influence the rate at which economies grow?  We can broadly subdivide them into "institutions" and "geography."  (Our discussion will refer to quite a few economic concepts which we will mention only briefly.)

Political Institutions.  These were the focus of Adam Smith's famous treatise.  At the time, national governments enacted tariffs[9] and quotas[10] designed to protect domestic industries from foreign competition.  They also subsidized favored companies to give them advantages in international trade.  National and local governments also created monopolies and tried to protect some producers from competition by others.[11]

Smith argued that these interventions made countries less efficient and therefore less wealthy.  The solution: free trade and free markets.  People will naturally tend to specialize[12] in the production of those goods for which they have a comparative advantage[13] and they will trade with others to obtain the consumption they prefer. (A demonstration using production possibility curves of why everyone can, in principle, be made better off, is contained in Appendix A.)

Legal Institutions.  In his classic work, El Otro Sendero (The Other Path),[14] Hernando de Soto writes about large numbers of poor people in Lima, Peru, living outside the formal legal system.  They live instead in what de Soto calls the "informal economy."  These people are very entrepreneurial and very capitalistic.  They run businesses, trade with others and, in general, engage in the same economic activities as those in the formal sector.  However, in the informal sector people have no legally enforceable right to the land they live on.  They have no access to the courts, so they can not make legally enforceable contracts.  This makes it very hard for them, for example, to negotiate loans, make long-term agreements, sell shares of stock in their businesses and so forth. 

In The Mystery of Capital, de Soto estimates the total value of the real estate alone held but not legally owned by the poor in developing countries is at least $9.3 trillion.  This is more than twice as much as the total circulating in the U.S. money supply and 46 times as much as all the World Bank loans to developing countries in the past three decades![15]  According to de Soto's estimates, in Africa, the wealth that the poor have accumulated totals $97 billion.

Table I

Urban and Rural Dead Capital in Real Estate in Africa (1997)

De Soto notes that because people do not have rights to their possessions, the assets cannot readily be turned into wealth.  De Soto also found that moving from an informal to the formal sector can be very daunting because of all the regulatory barriers created by government bureaucracies:[16]

• In Egypt, for example, a person who wants to acquire and legally register a lot of state-owned land must complete at least 77 bureaucratic steps at 31 public and private agencies. This can take up to 14 years!
• To build a dwelling on former agricultural land would require six to eleven years of bureaucratic wrangling.
• De Soto explains that this is why 4.7 million Egyptians have chosen to build their dwellings illegally.

In addition, daunting government regulations also make it very difficult to start a business in most of Africa.[17]

For example:[18] 

• It takes 153 days to start a business in Maputo (the capital of Mozambique), but only 2 days in Toronto.
• It takes 21 separate procedures to register commercial property in Abuja (capitol of Nigeria), but there are only 3 procedures in Helsinki.

Like the poor squatters on the city limits of Lima, Peru, too many Africans cannot start a business or pursue a profitable venture without worrying about government intrusion, confiscation of their property, and a host of other threats.    

In general, what de Soto found throughout the less developed world, was capitalism without institutions of capitalism.  What are these institutions and why are they so important?

Property Rights.  The right to property is the right to its use and disposal.  In the informal sector throughout the less developed world, people are living on land (often the result of squatting), but they have no legally enforceable right to it.  As a result, they are reluctant to build durable structures and make other improvements, because after they invest their time, labor and money, someone else can take it from them.  Long-term contracts (I'll do something for you today if you will do something for me next week) are difficult, because the rights and obligations created in such contracts are not enforceable in any court of law.  Credit institutions are virtually nonexistent because there is no court to enforce the rights of the lender and the obligations of the borrower.

Common Law.  Rights and courts go hand in hand.  Property rights are not very valuable unless they are legally enforceable.  Legal enforceability means that people can go to court to stop encroachments on their rights, collect compensation from people who violate their rights and enforce provisions of voluntarily-entered-into contracts.

Economist Gerald Scully has shown that although any stable legal system is a good thing, the British common law is superior to civil law (e.g. found in France), or Muslim law.[19]  That is not surprising.  The common law was explicitly developed over time to meet the economic needs of people engaged in trade in the marketplace.

Rule of Law.  No matter what the system, legal institutions will be of limited value if they are managed by people who are corrupt.  The term "rule of law" is usually contrasted with "rule of men."  It means that in making plans, people can count on the permanence of legal rules rather than be at the mercy of the whims and preferences of individuals.  The rule of law, by the way, is one of the institutions so often missing in Sub-Saharan Africa.  Transparency International consistently ranks Sub-Saharan African countries among the governments with the highest levels of corruption in the world.[20]

1. Here are four principles relevant to this year's debate topic:
2. Aid given to corrupt governments does not make them less corrupt.
3. Aid given to non-corrupt governments may encourage them to become corrupt.
4. Aid given to corrupt governments subsidizes the corruption and makes the consequences more than they would otherwise be.
5. Whatever the public health benefits of aid given to corrupt governments in the short term, they are likely to be more than offset by the harmful effect on public health in the long run-brought about by a lower standard of living.

Culture.  In recent years, there have been a number of attempts to transport American institutions to other countries.  Russia is one example.  Latin America is another.  These attempts have proved disappointing.  One reason may be that it is difficult to transport institutions that arise in one culture to a very difficult culture.

For example, in the 19th century a number of Latin America countries copied the American form of government including our Constitution and even our Declaration of Independence.  Yet today, those countries have been far less successful than the United States in keeping the benefits of those institutions.  Since both North and South America were colonized by Europeans, why did the two continents develop so differently? 

MIT economist Daron Acemoglu and his colleagues theorize that where colonies were predominantly extractive in nature - such as the gold and silver mines in Latin America - the ruling elites had little incentive to develop institutions that protected property rights.  Rather, they set up coercive, extractive institutions.  Commodities for export could be extracted by coercing the native populations into service.  In the societies that lacked large quantities of commodities that could be dug out of the ground, the economy could only be developed by importing settlers who would invest and produce only if they had sound institutions and rule of law.  Why did the extractive institutions persist in areas after colonialism ended?  The new ruling elites had much to lose from institutional reform. Thus they maintained the extractive intuitions introduced by the former colonial rulers. [21]

Historian Leonard Liggio hypothesizes that another difference is related to who settled in the new world and where they came from.  The British settlers in North America came from a civilization that had a long history of resisting government, especially abusive government.  However, neither the Spanish soldiers who settled in the south nor the indigenous populations who lived there had a similar cultural history.   That may be yet another reason why the two continents developed so differently even though they started with the same political institutions, at least on paper. 

Geography.  Stanford economist Thomas Sowell notes that Europe has many navigable rivers along with natural bays and harbors that facilitated trade and communication with the outside world.  This means that innovations and advances in ship building and skills had economic payoff.  By contrast Africa's smooth, high coastline affords many fewer bays and harbors.  Many of its rivers are not navigable for long distances due to waterfalls and other obstacles. These barriers also contributed to the great number of languages and dialects that developed in Africa, inhibiting communication on the continent.  Because Africans did not have the same economic incentives, they did not develop water-based transport and did not benefit from the free flow of ideas and innovation that Europe did.  Europe also had more ample and reliable rainfall and a climate that does not support devastating tropical diseases.[22]

Jared Diamond, goes a step further.  He argues that the chief reason for the difference in economic development around the world stems from geographic differences such as ecology, climate and natural resources.[23]  For example, Africans lacked horses (at least in Sub-Saharan Africa) and were unable to domesticate zebras or elephants.  Thus, Africans lacked the economic incentive to develop land transportation vehicles found elsewhere in the world.  Also tropical diseases, such as malaria, rendered densely populated agricultural communities difficult to maintain.  In addition, farming developed independently in different parts of the world from domesticated seed-grass.  However, early development was limited to available plants.  The Mediterranean region was endowed with 33 different native grasses with large seeds compared to Sub-Saharan Africa's four.   Animal husbandry for meat or draft animals also provided an advantage for would-be farmers and herders.  Eurasia was endowed with 72 large mammals, of which 13 were domesticated.  Sub-Saharan Africa only had 52 large mammals for possible domestications.  However, none proved suitable for various reasons and none were domesticated.[24]

In similar vein, Columbia University economist Jeffery Sachs, argues that the low economic growth rates prevalent in Africa can be explained by disease burden.  As noted, through a World Health Organization Commission he chaired, Sachs argued for the need to fight AIDS, tuberculosis and malaria through a global fund as a way to improve economic development.[25]

But is it true that geography is destiny?  Acemoglu and his colleagues show that geography is not sufficient to explain the major differences in rates of economic growth.[26]  It is true that most of the countries that are very poor are located near the equator, where tropical diseases are rampant and the weather is very hot with annual periods of torrential rainfall.  However, an examination of countries with national incomes one-twentieth of the United States reveals a profound lack of legal and political institutions conducive to growth.  By contrast, all rich countries have these legal and political institutions. 

In fact, many countries that were urbanized and wealthy in the sixteenth century are today poor, and vice versa.  The difference is sound institutions, which must include a legal system that protects private property, laws restraining the ability of elites to expropriate income and institutions that guarantee some level of equal opportunity.  Moreover, these protections must apply to the vast majority of the population rather than applying only to political elites.  Improve the institutions and economic growth will ensue.  Acemoglu finds, for example, that importing Chilean institutions into Nigeria would raise GDP by a factor of seven![27]

Economic Freedom.  Respect for property rights and rule of law are part of a much larger foundation that is crucial to economic growth but is sorely lacking in African countries:  According to Gwartney, Lawson and Easterly, economic freedom is composed of four ingredients:  personal choice, the existence of markets for voluntary exchange, the freedom to participate in those markets and the protection of private property.[28]

In the Fraser Institute's Economic Freedom Index 2006, Gwartney, et al.,[29] examine 130 countries using several variables as measures of economic freedom, including the size and burden of government, freedom to trade internationally, the stability of a country's currency, and enforcement of contracts and property rights. Sadly, seven of the 10 worst countries are in Sub-Saharan Africa.  Only Ghana has shown significant gains in economic freedom since 1980, while two other Sub-Saharan countries, Zimbabwe and the Republic of Congo, are among those experiencing the greatest losses in economic freedom.  On the flip side, Hong Kong, ranked as being the most economically free, has experienced substantial GDP growth rates over several years - about 6.8 percent in 2006 alone. 

 (For ideas on how to promote economic growth in Africa read our Topic Overview.)

The Special Role of Capital

There are three elements that are important to a country's ability to produce goods and services: capital, labor and natural resources. Clearly Africa has an abundance of natural resources including 20 percent of the world's oil and 60 percent of the world's diamonds.  It also has an abundance of labor.  What Africa lacks (or what it has less of than other regions of the world) is capital.

Capital plays a special role in economic growth and there are three senses of the word that are important: physical capital, financial capital and human capital.

Physical Capital.  Broadly speaking, these are the tools that people work with to produce things.  In agriculture, for example, people can work with such simple tools as hoes and tillers or more complex tools such as tractors and combines.  In general, the term capital refers to buildings, machinery, computers and any other physical implement that raises the productivity of labor.

Africa is poorer than other regions of the world because Africans are less productive. (They produce fewer goods and services per hour of work.)  They are less productive because they have less capital.

A very important type of capital is infrastructure.  This includes roads, bridges and electric power systems, as well as running water, sewage disposal and other public health infrastructure.  As noted above, these are sometimes thought of as public goods and are often furnished by government.

Financial Capital.  This is the wherewithal to purchase, maintain and replace physical capital. It comes from the savings of local citizens as well as foreign investment.  For example, when the United States was developing in the 19th century, much of our capital came from Europe, including the capital needed for much of our infrastructure.  Some of our major toll roads, steamship lines and even our railroads were funded by Europeans.

One reason we were able to attract investment from abroad is that the U.S. economy was (and still is) a capital-friendly environment.  People who invest in the United States know they are investing in a country where property rights are secure, where contractual rights and obligations are enforced by courts and where the rule of law is honored and respected.

These are precisely the conditions so often lacking in Africa.  While Africa has seen a modest increase in foreign direct investment over the past decade, capital inflows to the region still fall short of what they would and should be.[30]  African Development Bank President Omar Kabbaj notes that the investment rate in Africa is about 16 to 22 percent of its GDP.  A rate closer to 30 percent is needed for high economic growth.  In 2001, for instance, Sub-Saharan Africa received only 8 percent of foreign direct investment to developing countries.  U.S. firms have cited corruption, red tape, lack of infrastructure and weak legal systems for the reluctance of outside firms to conduct business in Africa.[31] 

The experience of Africa contrasts with the experience of other regions of the world, where developing countries are really developing.  For example:[32]

• In East Asia, there is more than twice as much private capital as public capital.
• By contrast, Africa has twice as much public capital than private capital.

Moreover, but for bad government policies, Africa would be a very attractive place to invest. The reason: in addition to its rich natural resources, the very fact that it has a capital shortage means that the return on capital is potentially very high. (See the discussion about diminishing returns below.) China, for example, is experiencing huge capital inflows.  However, African countries are not only discouraging private capital inflows, they are encouraging their own capital to leave. By one estimate, 38 percent of all African private wealth is held abroad![33] This is the largest capital flight of any region in the world.

Human Capital.  The stock of intelligence, health and acquired technical skills of an individual that determine his or her labor productivity is called human capital.  Investments in human capital can take many forms - including education, on the job training and medical care to improve health.  People in good health have a greater capacity to work, will likely live longer and can expect to earn more during their lifetime. 

Human capital is important in this context for two reasons. First, just as there has been a flight of financial capital from Africa, there has also been a flight of human capital. In fact, Paul Collier predicts that the countries of the "bottom billion" (see the Overview) will hemorrhage their best and brightest, as the most educated people seize opportunities to migrate elsewhere.[34] At the same time, those who remain have reduced incentives to invest in their own human capital.

Economist Theodore Schultz notes that people will invest more in activities that improve their skills if they benefit economically.  For example, people who expect to have a long life span are more likely to invest in their own education or on the job training.  Conversely, if life spans are short, people are less likely to spend the few productive years they have in activities that produce benefits they may not live long enough to realize.[35]

Here is how the concept of human capital in especially relevant to the debate topic: When incomes are low, lives are short and prospects for a better future are dim, people have less reason to avoid risky behaviors that lead to the spread of infectious disease.  Sub-Saharan Africans particularly have weak economic incentives to lead healthy lives.  University of Chicago economist Emily Oster has analyzed how income levels in Sub-Saharan Africa and the U.S. affect risky behaviors that increase their chances of contracting HIV.[36]  Individuals in wealthier nations take greater precautions to prevent HIV transmission, she finds.  What motivates people to change their behavior is not fully understood. This may be partially due to the greater expectation of having long lives.  A young adult who expects to live another 20 years has less to lose from contracting HIV than the same person who expects to live an additional 40 years.  In rich countries, people with higher incomes appear to take fewer chances with their health than lower-income individuals.  The same is true for individuals in poor countries.  Those with higher incomes tend to take fewer chances that could result in HIV transmission.  Since Africans are poorer, reasons Oster, they have less to lose if they become infected with HIV (from an economic point of view).  If they already have a short expected life span, they may also be more apt to engage in risky behavior.

Additionally, Oster found that as viable AIDS treatments became more readily available, risky behaviors tended to rise.  AIDS drugs are not a cure for HIV.  Rather, treatments tend to delay the onset of symptoms and death from the disease by a few years.  This suggests that providing access to AIDS treatments without increasing opportunities to improve individual's standard of living may increase risky behavior that leads to the transmission of HIV.  Ironically, access to inexpensive AIDS drugs could make the problem of AIDS even worse! 

The Economics of Health Insurance

Table II is a remarkable table.  It shows the percent of health care spending that consists of out-of-pocket spending.  As the table shows:  

• 86 percent of all health care spending in Guinea is spending by patients out of their own pockets. 
• The figure is 72 percent in the Congo and two-thirds of all spending in Cameroon, the Ivory Coast and Togo. 
• In eight other countries out-of-pocket spending is more than half of all spending. 

To put this in perspective, in the United States only 10 percent of spending is out-of-pocket.  The remainder is spent by private and public health insurance.  In Europe, the figure is slightly above 10 percent, but in the same ballpark. 

Noting that government pays a small portion of the health care bill in so many countries, many advocate expanding government-provided health care services.  However, some health economists have concluded that the better solution is to expand private insurance instead. 

The Value of Insurance.  Imagine a disease that hits one out of every 100 people, once a year.  When it strikes, medical costs equal half of the victim's annual income.  So once a year, one person will face very high medical costs and another 99 people will face zero costs.  At the beginning of the year, however, all 100 are at risk, much like a game of roulette. 

Insurance allows the group to spread the cost of the illness over all 100 people.  Each person pays 1/100 of the cost of caring for one victim as a premium to an insurance pool.  After the disease strikes, the insurance pool pays the cost of medical bills for the victim who gets the disease. 

In this way, people are able to transfer risk.  They can do so for a cost that is roughly equal to their expected cost if they remain uninsured.  So if people are risk averse (and most of us are), insurance allows them to transfer the risk to an insurer for a very small cost.[37]  The economic ease for insurance is so strong that Nobel Laureate Kenneth Arrow once said the "case for insurance of policies of all sorts is overwhelming."[38] 

As attractive as insurance is, three things can interfere and make it less attractive: (1) high overhead costs, (2) individual members abusing the system and (3) unwise government policies. 

Overhead.  These are the costs of collecting premiums, paying bills and making sure members don't abuse the system.  They may be thought of as a wedge between what people pay in and what they can expect to get back.  The bigger the wedge, the less attractive the insurance contract becomes. 

Member Abuse. A common type of member abuse is what economists call "moral hazard."  It is yet another example of how people through their own actions can impose costs or create benefits for others.  Once people have paid their premiums and entered the health care system, they will often have the opportunity to overuse medical resources, if left unchecked.  That is, they can take advantage of more medical tests, more physical therapy, etc.  In doing these things, they create additional costs for the pool and cause their own future premiums to go up.  Yet, while they realize the full benefits of their own wasteful consumption, they bear only a small portion (their share of the total premium increase) of the cost to the group as a whole.  To the degree that moral hazard increases insurance costs, or to the degree insurers have to spend funds to monitor and discourage moral hazard, insurance becomes less attractive. 

Unwise Public Polices.  Government policies can make insurance less attractive than it would otherwise be.  For example, governments often bow to pressure from special interests in and force private insurers to cover services most of the insured do not want to pay for.  In the United States, for example, insurers cannot sell health insurance in some states unless their policies cover acupuncture, in vitro fertilization, marriage counseling and other services.[39]  Public insurance also is subjected to political pressure, as politicians are tempted to use health care money to win political support rather than save lives and cure diseases.  (See the discussion below.) 

Government-Provided Health Insurance.  In most Sub-Saharan African countries, the government theoretically pledges to provide health care for free - much like the governments of Britain and Canada.  Yet in 21 countries government spending on health care is less than half the total.  Should these governments be doing more?  Although many advocate that they do so, there may be better alternatives. 

Unlike developed countries, most Sub-Saharan African countries do not have efficient systems of tax collection, especially in rural areas.  This means that these countries must spend a large part of their revenues in the very act of collecting them. Even in the United States, the cost of tax collection is quite high. Harvard University economist Martin Feldstein estimates that the cost to the U.S. economy of the personal income tax is 30 percent of the revenue raised. At the margin (for the last dollars collected) the cost is much higher. In fact, the cost of raising an additional dollar by increasing income tax rates is nearly $2 for each $1 of additional revenue.[40] In Sub-Saharan Africa, the social cost of tax collection must be many times higher.

In addition, governments face enormous political pressure to spend health care funds in ways that touch the vast majority of people.  This means overspending on services that are of minor (or even trivial value), while skimping on expensive, life-saving treatments that could help the smaller number of people who are really ill.[41]  For these reasons, Wharton (business) School economist Mark Pauly and his colleagues have concluded "private insurance could fill in the gaps that limited public resources cannot cover."[42] 

Private Insurance.  When people cannot get the services they want from government, they tend to turn to the private sector.  In health care, this observation can be verified in all developed countries.  As we have seen, it is even more relevant in Sub-Saharan Africa. Yet with few exceptions, most private-sector spending in Africa is out-of-pocket.  The existence of private insurance is very limited.  As Table II shows: 

• An exception to the general rule is South Africa, where almost half of all health care spending is private insurance spending. 
• In Uganda, private insurance accounts for a third of the total. 
• In Botswana, Gambia, Namibia, Rwanda and Zimbabwe the figure is close to one-fourth. 
• However, in 24 Sub-Saharan African countries, private insurance accounts for 10 percent of health care spending or less. 

Given the overwhelming economic case for insurance and given the limited role of government provision (and the high cost of tax collection) in these countries, expansion of private insurance is an attractive alternative.  How could this be done? 

One method is a voluntary, community-based pool, or buyers cooperative.  Another approach is nonprofit insurance, similar to traditional Blue Cross/Blue Shield insurance in the United States or British United Provident Association (BUPA) in Britain.  A third alternative is for-profit insurance, similar to Aetna or Cigna or United Health Care in the United States.  In all cases, enlightened public policy is needed.  Currently, private insurance is outlawed in some less-developed countries.  When it is permitted, it is often highly regulated. 

Case Study:  The Venamher Clinic in Miami.  This is a home grown example of low-cost, basic care insurance that emerged (with modest help from local charities) for Venezuelan refugees in Miami.  It is a possible model for less developed countries everywhere. 

This facility opened in 2002 and now has about 2,700 regular patients, about the same number of patients a typical physician in a family practice would have. Patients pay a monthly fee, comparable to an insurance premium, to be an "affiliated member" of the clinic. These monthly fees range from $15 (single) to $35 (family). Members also pay a fee at the time of service. The clinic has two doctors and a dentist in-house, who charge reduced rates for their services. For example, a physician or dental visit costs $25. The clinic also has agreements with specialists, including cardiologists, surgeons and obstetricians that let members receive treatment at discounted prices.

 "This clinic can give the otherwise uninsured the care they need at a low cost, preventing major medical problems that would otherwise send them to the [hospital] emergency room," said Dr. Jose Ramon Martin, the clinic's medical director.[43]

Case Study: Grameen Bank Health Insurance.  Prof. Muhammad Yunus, who recently won a Nobel Prize for his work, is the father of micro-lending.  Through the Grameen Bank in Bangladesh, he developed a self-sustaining organization that makes small loans to help poor entrepreneurs start businesses. After 20 years of experience, the Bank now has 3.2 million borrowers serving more than 41,000 villages and is now expanding to other countries including some in Africa. (See the discussion in Overview.)

A relatively new activity of the Bank is health insurance. For example, the Bank offers low-cost health insurance to poor individuals for around $2.00 per family.  It has used the health insurance payments to develop an independent health company, with fully qualified doctors, paramedics, health workers, a pathological lab, a medicine supplier and discount prices for medicine.[44]

Individual Self-Insurance in South Africa.  Insurance pools work best when the health events are observable, objective and involve very little discretion on the part of patients. They do not work very well when the converse is true. Take pain relief for arthritis, a common ailment affecting millions of people. In the United States, Vioxx, Celebrex and Bextra are brand-name prescription drugs that have been on the market at various times. They cost almost $900 for a year's dosage and they have side effects, including increased risk of heart attacks. An alternative is Ibuprofen, an over-the-counter drug that costs almost $40 for a year's supply and has no serious side effects.

Pain relief is experienced subjectively. What works for one patient may not work for another. Is the increased pain relief worth the risk of side effects and an additional $800? Or could Ibuprofen suffice? These are decisions none of us can make for someone else. However, when insurance companies were paying the bill, far too many patients were taking Vioxx (subsequently removed from the market) because the drug was perceived as free.

Considerations such as these have led to a new type of insurance product, called Health Savings Account (HSA) plans. Part of the idea is that third-party insurance (an insurance company, employer or government) should pay for large medical expenses and expenses for which patient discretion is not desirable or appropriate. On the other hand, people should manage their own health dollars when spending on low-cost procedures and procedures for which patient discretion is appropriate and desirable.

A typical HSA plan works like this. There is an across-the-board deductible, say, of $2,500. The insurer pays for all costs above that amount, the individual pays for all costs below. To meet the below-the-deductible costs, employees and their employers make deposits (up to $2,500) in their savings account. Any funds not spent stay in the HSA and rollover to the next year. These funds are owned by the employee and can eventually be withdrawn (after paying taxes) to spend on non-health care goods and services. People are encouraged to manage their HSA funds wisely, because when they spend from an HSA they are spending their own money. By contrast, when they spend money above the deductible, they are spending insurance company money.

In the United Sates, about 10 million people have HSA plans. Although the number has been growing, they are still a small part of the U.S. insurance marketplace. South Africa, by contrast, has had these types of accounts (called Medical Savings Accounts) for a longer period of time and they have proved even more popular in that country.  Under the regime of Nelson Mandela in the 1990s, South Africa conducted a unique and interesting experiment in the market for private insurance. After deregulation in 1994, virtually every type of health insurance plan sold in the United States was able to enter the South African market. Thus in South Africa, MSA plans competed against other forms of insurance on a level playing field. The result was remarkable. By the end of the decade, MSA plans captured about half the market for private insurance.[45] In South Africa, insurers have been free to innovate and experiment. The result is a far more interesting product - one better designed to meet customer needs:

• In South Africa, a typical deductible would be about $1,200.
• Whereas a U.S.-type HSA plan has an across-the-board deductible covering all medical services, South African MSA plans typically have varying deductibles.
• For example, a representative plan has no deductible for hospital care on the theory that patients exercise little discretion within hospitals, but a $1,200 deductible for outpatient care on the theory that patients have a lot of discretions in that setting.
• The high deductible also applies to drugs, but for chronic conditions, for which skimping on drugs could lead to more expensive care later, the deductible drops back to zero.

The evidence shows that MSA incentives work. When spending from their MSA accounts, people make fewer unnecessary doctor visits and fewer unnecessary emergency room visits. They switch from brand-name drugs to less expensive generic drugs; and they are less likely to purchase drugs they never use.[46]

Self-Insurance for the Chronically Ill.  Patients with chronic illnesses are responsible for the spending of more than half of U.S. health care dollars. Moreover, a recent development has been the discovery that chronic patients can often manage their own health care. Studies of diabetics and asthma patients, for example, show that when patients assume more responsibility for managing their own care, costs are lower and quality is higher than under traditional care. What we are learning in this country, moreover, may serve as a model for completely rethinking health care in Africa.

For example, about half the states have set up cash accounts for disabled Medicaid enrollees to manage their own health care dollars and directly purchase needed services.[47]  These programs, often called "Cash and Counseling," use a defined contribution approach.[48]  The patient is given a set dollar contribution and is free to hire and fire those who provide medical as well as custodial services.  The programs also involve counseling to assure that the patient is well-informed.  Under traditional Medicaid, the states select the providers without patient input.  Under this program, patients can now choose their providers.  Surveys of participants in the program show that they have a higher quality of life with fewer unmet health needs.[49]  Remarkably, patient satisfaction is almost 100 percent.[50]

The Economics of Charity

The idea of "charity" may seem as remote from economics as any idea could be.  Yet there is an emerging literature on the subject.  Here is a recent example. 

Bill Gates is the creator of Microsoft.  He is also the richest man in the world.  Although Gates dropped out of Harvard to start his company, he recently returned to get an honorary degree.  In a commencement speech, he talked not about Microsoft but about the desire "to give something back."  Specifically, Gates has established the Bill and Melinda Gates Foundation to reduce world poverty, with an emphasis on advances in health. 

All of this caused Harvard economist Robert Barro to ask whether Gates really understood what he was talking about.  If Gates really wants to give away his $90 billion fortune, wrote Barro, a better use would be to write everyone else in the United States a check for $300.[51] 

Giving Back?  Does Gates really need to give anything back?  That implies that he "took" something in the first place.  Barro calculates that the capitalized value of Microsoft is almost $1 trillion.  So Gates has already given to the world something that is 10 times the value of the fortune he proposes to give away.  Like Albert Einstein and many others (see the discussion of "externalizes" above), Gates has already created far more benefits for others than he has personally enjoyed. 

Benefiting Whom?  An important distinction in the economics of charity is the difference between the way the donor and the recipient value the gift.  If we are contrasting Bill Gates' preferences with people who live in third world poverty, clearly the preferences are not the same. Given the choice between Coca-Colas, Marlboro cigarettes and condoms to prevent AIDS, we have seen that local residents prefer the cokes and the cigarettes. If Bill Gates wants to make the recipients of his bequests as well-off as possible from their own point of view, he should hand out cash. The recipients will then spend the money on items they most prefer.

However, Gates' goal may not be to make people better off from their own point of view. Instead, his goal may be to satisfy his preferences, not their preferences. After all, it is his money.  Gates, for example, may be like Jeffrey Sachs. He may want to "force" third world countries to accept first world health care systems, whether they like it or not. As we have seen this will not be easy. People do not change their preferences just because they receive a gift. Given a supply of condoms, they may try to exchange them for cokes and cigarettes. Given more outsider spending on health, they may reduce their own spending.

All too often, aid from the West reflects donor preferences rather than local preferences. For example:

• The United States requires recipients of aid to spend about three-fourths of the funds on products made by U.S. companies (other countries have similar restriction, but the United States is the worst).[52]
• Although the returns on instructional material are up to 14 times higher than the returns on physical facilities, donors to education prefer to see observable buildings over less observable textbooks; as a result the quantity of education has gone up, but quality remains low.[53]

Making People Better Off or Worse Off?   In complex social systems, actions often have unintended consequences. This happens so frequently that some economists refer to a "Law of Unintended Consequences." Foreign aid to Africa is an example par excellence. Although motivated by good intentions, such aid has often made Africans worse off than if there had been no aid at all.  Foreign aid, we have seen, can make the recipients worse off:

1. If foreign aid injects cash and other resources into a system already plagued with corruption - thus making it more corrupt.

2. If foreign aid props up corrupt governments by:

  a. Giving them control over more resources;

  b. Relieving problems the government would otherwise have to deal with;

  c. Lessening the pressure for badly needed economic and political reforms.

3. If foreign aid creates dependency on the giver, thereby removing incentives for the recipients to become self-reliant and solve their own problems.

4. If foreign aid substitutes for and crowd out self-help.

5. If foreign aid depresses prices and returns for entrepreneurs and businesses which would be addressing the problem in the absence of aid.

(For examples, see the discussion in our Overview.)

The idea that aid can make the recipient worse off is not a new idea. In fact, it was one of the major reasons for the reform of the U.S. welfare system during the Clinton administration. In 1965, the United States embarked on a War on Poverty and since then has spent $9 trillion on the effort.[54]  Until the early 1970s, the programs seemed to be working, as the poverty population diminished. Yet after 1973, the number of people living in poverty began to grow. In fact, the more we spent, the more poverty we had. Increasingly it became clear that rather than alleviating poverty, our welfare programs were paying people to be poor. The more generous the welfare, the greater the number of people who managed to qualify to receive it.

Barro concedes that Gates may be smarter than folks at the World Bank and at other giving institutions. But the odds of improving life for Africans, in Barro's view, are slim.

Gregory Clark, an economic historian at the University of California Davis, also argues that foreign aid harms recipient countries.  His book, A Farwell to Alms, explains that Western aid-especially public health aid-is making Sub-Saharan Africa countries worse off than if they had no contact with the West whatsoever.

Clark says that most less developed countries are caught in the Malthusian Trap, named after the 19th Century British demographer Thomas Malthus.  In the absence of Western intervention, many people in these countries would be living at a subsistence level of income-with populations expanding and contracting to match the availability of local resources.  However, Western public health aid unnaturally extends life expectancy without doing anything to raise productivity on national income.  As a result, we are left with a larger population living off of a fixed supply of resources.  The result is a standard of living even lower than the subsistence level-perhaps the lowest standard of living in the history of the world!

Getting the Most Out of Foreign Aid

Given a decision to give aid to a country or group of countries, how do we make the most of it? Four concepts are relevant: diminishing returns, marginalism, the equimarginal principal and cost effective health care expenditures.

Diminishing Returns. Figure IV shows a hypothetical relationship between foreign aid and economic growth. Although hypothetical, it reflects the results of two economic studies. First, it reflects Paul Collier's finding that foreign aid from the West has added about one percentage point to the rate of economic growth for the typical African country.[55] (For example, if the rate of growth is 0 percent, this implies that it would have been 1 percent without aid.)  Second, it reflects the estimate that foreign aid ceases to become effective when it reaches about 16 percent of national income.[56]

Note that as aid goes from 1 percent to 2 percent of the country's national income, there is a boost to the country's growth rate. As aid goes from 5 percent to 6 percent of national income, there is another boost-but not as large as the previous boost. As we continue to increase the level of aid, economic growth continues to increase at a diminishing rate. That is, each incremental increase in aid gives less of a boost to growth than the previous increment. When aid reaches 16 percent of national income, small changes in aid have no effect at all on economic growth. Finally, when aid grows beyond 16 percent of national income, the rate of economic growth begins to fall.  (Beyond the 16 percent level, aid makes the country worse off.)

The figure illustrates the law of diminishing returns.  Initially, aid increases the country's rate of growth, but it does so at a diminishing rate.  Economists believe that the law applies to all human activities. Foreign aid designed to increase growth, treat AIDS, prevent malaria, boost education-all of these activities should obey the principle of diminishing returns.

Figure IV also can help us understand why different economic studies could arrive at different conclusions. Depending on how much aid is being given to the hypothetical country (that is, depending on where we are on the curve) independent investigators would find that the relationship between aid and economic growth is positive, zero, or negative.

Finally, it is worth noting that the current level of giving to the typical African country is already 16 percent, at the very time when developed (G-8) countries are calling for a doubling of foreign aid![57]  So if the figure is correct, such spending is likely to lower rather than raise economic well being in the poorest countries. 

Marginalism. The idea behind marginalism is that decisions should be made at the margin. In the context of the debate topic, this means that any affirmative plan will be in the context of spending and programs already underway. So the question is not: what would public health aid in the abstract accomplish? The relevant question is: what would additional public health aid accomplish, given existing public health programs and other foreign aid?

The Equimarginal Principle. We are now in a position to answer the question we started with: How do we get the most bang for the buck from foreign aid dollars? This complicated sounding principle gives us a very simple answer. Each additional dollar of spending should be allocated to the activity (or country) that produces the greatest return. So if activity A is giving us a greater return per dollar spent than activity B, we should spend more on A.  As we continue to spend on A, the return from A will fall (because of the principle of diminishing returns) until eventually the return from the last dollar spent on A and B are the same. At that point, the equimarginal principle tells us that we are getting the most positive impact from our aid dollars to the two actvities.  

As shown in Table III, the amount spent in foreign aid as a percent of national income varies radically among the countries in Sub-Saharan Africa.  If it is really true that aid ceases to become effective at 16 percent of national income, then far too much aid is being given to some countries and far too little to others.  The equimarginal principle implies that we could benefit the entire region by shifting aid away from some countries toward others.  Of course, these countries are not all alike.  Some are plagued more by the traps discussed in the Overview than others.  Even so, research tends to confirm that the current pattern of aid is far from optimal.  [More on this point in future editions.]

Table III

Foreign Aid as a Percent of Gross National Income

Cost Effective Spending on Health Care. The above principles also apply in the field of health care. Here, "the returns" in question are health outcomes. For example, Table IV shows the cost of different health interventions in Africa.

Suppose we only had $1,500 to spend, how should we spend it? Consider that $1,500 would:

• Treat 1 HIV + person for one year.
• Prevent 75 people from contracting polio, diphtheria, pertusis, and tetanus.
• Treat 150 people with TB for one year.
• Prevent 500 people from contracting TB (each year).
• Treat 1,500 people with intestinal worms for one year.
• Treat 1,500 people with malaria for one year.

How can we choose among these alternatives?  A common technique employed by health researchers is to measure the payoff from health care spending in terms of "years of life saved," which is the number of extra years of life the health intervention produces. Sometimes the measurement is expressed as "quality adjusted life years" or "disability adjusted life years" (DALY) in recognition of the fact that the goal is not simply to keep people alive but to keep them alive and functioning as healthy human beings.

Table IV

Cost of Health Interventions Per Person Per Treatment

Source: William Easterly, White Man's Burden, Pages 249-253; Michael Kremer, "Pharmaceuticals and the Developing World," Journal of Economic Perspectives, Vol. 16 No. 4, 2002, pages 67-90; Creese, Floyd, Alban, & Guinness, "Cost-Effectiveness of HIV/AIDS Interventions in Africa: A Systematic Review of the Evidence,"  The Lancet, Vol. 359,  2002, pages 1635-1643

Table V shows the World Bank's estimate of the payoff in terms of DALY per dollar spent for some common health care interventions in Sub-Saharan Africa.  As the table shows, immunizations appear to give us the best return at the moment-producing one extra (disability adjusted) year of life for every $7 of spending.  So if we want to maximize the impact of the new health spending, we should start with immunizations-other things being equal.

If we spent a great deal of new money on immunizations, however, the return on dollars spent would begin to fall (or, what is saying the same thing: the cost per DALY would rise) because of the law of diminishing returns.  The equimarginal principle tells us that once the cost per DALY reaches $11, the payoff from immunizations is the same as the payoff we currently get from providing people with insecticide treated bed nets.

From that point on, the principle says we should continue spending on both immunizations and bed nets until the cost per DALY for both these activities reaches $17.  At that point, these two activities yield the same return as malaria prevention by mosquito spraying in homes.

The equimarginal principle, then, tells us we should begin at the top of Table V and work our way down.  To do other wise would waste money.  And to the degree that current aid programs fail to spend in this way, we could in principle save a lot more lives in Sub-Saharan Africa by reallocating money from the activities where the return is low to activities where the return is high.

By way of example, consider antiretroviral (ARV) drug treatment for AIDS-currently so popular among rock stars and politicians.  As table V shows:

• The cost of ARV drug treatment for AIDS in Table V is $922 per DALY.
• Yet if this same amount of money were reallocated to immunizations we could save 132 years of life instead of one year for an AIDS patient.
• Using the higher (and more realistic) AIDS treatment figure of $1,500, we could theoretically save 124 years of life through more immunizations for each year of life currently saved by treating AIDS.

Table V

Cost of Disease Interventions Per Year of Life Saved

Source: "Intervention Cost-Effectiveness: Overview of Main Messages," Disease Control Priorities in Developing Countries.  (New York: Oxford /World Bank, 2006.)

* DALY=Disability adjusted life year

Table V, however, only gives us the demand side of the picture.  That is, it shows us opportunities for donors to save lives through targeted health interventions.  What the table does not show is what is happening on the supply side.  Because health personnel are limited in number and African health infrastructures are skimpy, to say the least, any significant increase in spending on any intervention in Table V will draw health resources (doctors, nurses, clinics, etc.) away from other interventions in the table. 

As explained in the Overview, significant increases in spending on the treatment of AIDS almost certainly cost more lives than will be saved as the spending draws resources away from immunizations, strategies for combating malaria, school health and nutrition programs, etc.

Aid, Trade and Debt Relief

You might suppose that having abundant natural resources-such as oil or diamonds would be a good thing.  Yet it often is not.  In fact, development economists often write about the "curse" of depending on a significant natural resource.  Economists sometimes call this the "Dutch disease," named after the effects of North Sea gas on the Dutch economy.

The reasoning goes like this:  In order for countries to buy goods on the world market, and import them, they must first produce and export in order to get the foreign exchange to buy the imports.  In the process of producing for export, moreover, a country's businesses must compete with rivals in other countries all over the world.  It is precisely this competition that forces enterprises to be efficient and get increasingly better at what they do.

This very natural process is subverted, however, when there is a resource that is a significant part of the economy.  Instead of producing for export and competing in the world economy to get foreign exchange, an oil-rich country can sell the oil to the world market instead.  A diamond-rich country can sell diamonds instead.

To make matters worse, governments that have access to oil or diamond revenues do not have to tax their own citizens in order to fund public expenditures.  As a result, the citizens do not develop the normal resistance to wasteful spending and engage in normal scrutiny of government activities.  Ironically, the presence of democracy seems to make these outcomes even worse.

Note: Although we have introduced the problem of the Dutch disease in the context of an abundance of natural resources, the very same analysis applies to foreign aid and debt relief-since these sources of funds also relieve countries of the need to acquire foreign exchange through competition exports. 

Indeed, the International Monetary Fund Chief Economist, Raghuram Rajan, says that for just this reason foreign aid is killing economic growth in recipient countries by killing off exports.

Resources for Debate

1) Acemoglu, Daron. Simon Johnson, and James Robinson, "Disease Development in Historical Perspective," Massachusetts Institute of Technology, September 20, 2002.

Health conditions and disease environments are important for economic outcomes.  Acemoglu argues that the main impact of disease environments on the economic development of nations is not due to the direct effect of health conditions on income, but rather because of their indirect effect via institutions. 

(http://econ-www.mit.edu/faculty/download_pdf.php?id=661)

2)Ayittey, George. Africa Betrayed, (New York: Palgrave Macmillan, 2003).

This vigorous attack on corruption and mismanagement by post-colonial African leaders is bolstered by the author's experience as a dissident in his native Ghana. Ayittey blames African elites, foreign powers and even black Americans for aiding and abetting black dictators. Ayittey proposes decentralized, democratic government based on indigenous principles to counter tribalism, a problem examined too briefly. Arguing that the West can best help Africa by promoting freedom of expression, Ayittey calls upon Africans to author their own intellectual, political and economic reforms. (http://www.amazon.com/Africa-Betrayed-George-B-N-Ayittey/dp/0312104006/ref=pd_bbs_sr_1/104-4426078-4345509?ie=UTF8&s=books&qid=1181057197&sr=1-1)

3) Bovard, James. "The World Bank and the Impoverishment of Nations," in Perpetuating Poverty: The World Bank, the IMF, and the Developing World, Doug Bandow, Editor, (Washington, DC, The Cato Institute, 1994).

The World Bank has consistently financed the massive expansion of government throughout the developing world. The Bank has thus underwritten human atrocities, helped cripple Third World economies, and degraded the environment.

(http://www.swaminomics.org/articles/19940724_imfwbabolished.htm)

4.  Gregory Clark, A Farewell to Alms: A Brief Economic History of the World, (New Jersey: Princeton University Press), 2007.

Why are some parts of the world so rich and others so poor?  Why did the Industrial Revolution-and the unprecedented economic growth that came with it-occur in eighteenth-century England, and not at some other time, or in some other place?  Why didn't industrialization make the whole world rich-and why did it make large parts of the world even poorer?  In A Farewell to Alms, Gregory Clark tackles these profound questions and suggests a new and provocative way in which culture-not exploitation, geography, or resources-explains the wealth and the poverty of nations.   

(http://www.amazon.com/Farewell-Alms-Economic-History-Princeton/dp/0691121354)

5. Paul Collier, The Bottom Billion: Why the Poorest Countries are Failing and What Can Be Done About It. (Oxford University Press, 2007.)

Global poverty, Paul Collier points out, is actually falling quite rapidly for about eighty percent of the world. The real crisis lies in a group of about 50 failing states, the bottom billion, whose problems defy traditional approaches to alleviating poverty. In The Bottom Billion, Collier contends that these fifty failed states pose the central challenge of the developing world in the twenty-first century. The book shines a much needed light on this group of small nations, largely unnoticed by the industrialized West, that are dropping further and further behind the majority of the world's people, often falling into an absolute decline in living standards.

(http://www.amazon.com/Bottom-Billion-Poorest-Countries-Failing/dp/0195311450/ref=sr_1_1/104-4426078-4345509?ie=UTF8&s=books&qid=1181915954&sr=8-1)

6. Diamond, Jared. Collapse: How Societies Choose to Fail or Succeed, (New York: Penguin, 2005).

Collapse uses the geographic and environmental factors to examine why ancient societies, including the Anasazi of the American Southwest and the Viking colonies of Greenland, as well as modern ones such as Rwanda, have fallen apart. Not every collapse has an environmental origin, but an eco-meltdown is often the main catalyst, he argues, particularly when combined with society's response to (or disregard for) the coming disaster.

(http://www.amazon.com/Collapse-Societies-Choose-Fail-Succeed/dp/0143036556/ref=pd_bbs_sr_1/104-4426078-4345509?ie=UTF8&s=books&qid=1181056942&sr=1-1)

7. Diamond, Jared. Guns, Germs and Steel, (New York: W.W. Norton, 2005).

Diamond argues that geographical and environmental factors shaped the modern world. Societies that had a head start in food production advanced beyond the hunter-gatherer stage, and then developed writing, technology, government, and organized religion-as well as nasty germs and potent weapons of war-and adventured on sea and land to conquer and decimate preliterate cultures.

(http://www2.wwnorton.com/catalog/spring99/gunsgerms.htm)

8. de Soto, Hernando. The Mystery of Capitalism, (Jackson, TN: Basic Books, 2003).

Hernando de Soto proposes and argues that it's not that poor, post-communist countries don't have the assets to make capitalism flourish. The real problem is that such countries have yet to establish and normalize the invisible network of laws that turns assets from "dead" into "liquid" capital. In the West, standardized laws allow us to mortgage a house to raise money for a new venture, permit the worth of a company to be broken up into so many publicly tradable stocks, and make it possible to govern and appraise property with agreed-upon rules that hold across neighborhoods, towns, or regions.

(http://www.amazon.com/Mystery-Capital-Capitalism-Triumphs-Everywhere/dp/0465016154/ref=sr_1_1/104-4426078-4345509?ie=UTF8&s=books&qid=1180554151&sr=1-1)

9. de Soto, Hernando. The Other Path, (London: I B Tauris & Co Ltd, 1989).

Of all the terrorist movements since World War II that had any realistic potential to form a national government, only one was decisively defeated on the battleground of ideas. Sendero Luminoso, the Shining Path, arose in Peru in 1980.  The task of making the Shining Path politically irrelevant was accomplished primarily by ideological means. Hernando de Soto offered an alternative vision of Peru's poor. Rather than see them as the proletariat, he showed that they were in fact budding entrepreneurs whose greatest desire was not to bring down the market economy but to join it.

(http://www.amazon.com/Other-Path-Hernando-Soto/dp/1850431442)

10. Easterly, William. White Man's Burden, (New York, Penguin Press, 2006).

Easterly brazenly contends that the West has failed, and continues to fail, to enact its ill-formed, utopian aid plans. The do-gooders' fundamental flaw, he argues, is that they are "Planners," who seek to impose solutions from the top down, rather than "Searchers," who adapt to the real life and culture of foreign lands from the bottom up. With all of Easterly's aid-bashing, one might imagine that he is a conservative promoter of market solutions. But some of his most powerful criticism is reserved for the Planners who advocated "shock therapy" free-market reforms in Eastern Europe and the former Soviet Union. (http://www.amazon.com/White-Mans-Burden-Efforts-Little/dp/1594200378)

11. Garrett, Laurie. Betrayal of Trust: Collapse of Global Public Health, (New York: Hyperion, 2001).

Thanks to a recent extraordinary rise in public and private giving, today more money is being directed toward the world's poor and sick than ever before. But unless these efforts start tackling public health in general instead of narrow, disease-specific problems -- and unless the brain drain from the developing world can be stopped -- poor countries could be pushed even further into trouble, in yet