Top Student Exam Answers, Spring 2001

Note: These were, in my judgment, the best answers received under examination conditions. They should not be taken as model answers, in that they all contain extraneous material as well as omitting useful information. Some even reach incorrect conclusions. However, they all take intelligent approaches to the questions, are well organized and reasoned, and make sensitive use of the facts.

Question 1, Answer 1 
 
There are four primary grounds on which the FAA can be defended: ( 1) justice, (2) economic efficiency, (3) reduction in litigation costs, and (4) retention of the right not to sign an arbitration agreement. Each of these arguments has its strengths, but each neglects possible market failures and other, non-economic concerns.

Pro-arbitration

Justice

From a libertarian standpoint, workers and employers should be free to choose the mix of wage and non-wage terms that they prefer. Workers receive a wage premium for giving up their right to sue, which may be more valuable than maintaining that right. A ban on arbitration is pure paternalism, displacing material choice without benefit to third parties.

Economic efficiency

If workers and employers are banned from contracting on preferred terms, some may choose not to contract at all, leading to dead weight loss. Depending on the magnitude of this effect and the elasticity of supply and demand, a substantial increase in unemployment could be observed. Likewise, employers may simply alter the terms on which they are willing to deal, hurting workers in some other way. In this sense, partial regulation of private contracts is not an appropriate means for reaching distributional ends.

Litigation costs

Litigation is expensive and vastly ineffective at compensating victims. Allowing workers and employers to avoid this waste creates sharable financial benefits.

Right retention

If a specific workplace prefers not to require private arbitration, they are free to do so. Likewise, if an individual employee is uncomfortable with their contract, they can pursue employment elsewhere. Of course, workers will likely give up wage for this concession, but that is the choice they are making.

As a last ditch effort, our opposition could also claim that the interactions in question are simply too complex to understand, thus creating the possibility of a second best problem. This nihilistic argument is not very persuasive as it essentially argues against regulation in any context.

 

Counter Arguments

While these arguments are persuasive, they have serious problems when market failures and other, non-economic theories are considered. Most obviously, these arguments assume an efficient market; i.e. adequate information, large numbers, and everything allocated on the market. In fact, these conditions are not always met.

Information failure

Workers may not have full information regarding, or may not fully understand, the details of private arbitration. For instance, if arbitration has a payment cap, affected workers may not find out until too late. In addition, heuristics and cognitive dissonance often lead individuals to underestimate risk.

This observation undermines the justice rationale, as workers are not really choosing to contract. In addition, information failure makes us question whether cost savings will actually be passed to employees or whether employees can actually decline arbitration agreements.

Of course, a ban on private arbitration agreements is not the only solution to this problem. Requiring appropriate amounts of accurate information more directly addresses this market failure, while avoiding paternalism. Given adequate information, workers should be capable of making this decision.

Adverse distributional effects

In a complex bargaining process, marginal players have disproportionate power. Depending on the elasticity of worker preference, the marginal workers may not reflect the preference of the average worker. Thus, private arbitration agreements may represent a distributional shift among workers, with an influential minority forcing its will on the majority.

A similar skewing of preferences could also be observed between current and prospective employees, as an arbitration agreement may benefit those established in their jobs while disadvantaging newer employees.

Thus, we can question whether these agreements are actually just, how potential benefits will be divided, and whether all workers are freely contracting.

Price rigidity/rent-seeking

There is always some cost in changing jobs, making it difficult for an employee to select a job based solely on the existence or lack of an arbitration agreement. Pension funds and seniority increase transition costs. Thus, workers may effectively be held captive by an undesired private arbitration agreement. This situation also brings up the possibility of employer rent-seeking.

The same logic could be used to suggest that workers have little bargaining power in general. This is clearly not the case. Instead, this factor may exacerbate the distributional effects mentioned above.

Monopoly

Reinforcing the price rigidity and distributional concepts, if employers have unbalanced market power they may be able to force unwanted terms on employees. Once again, it is hard to see why this effect would be felt more in the arbitration than wage context.

Public goods

Individual workers may be unwilling to invest in contract provisions that benefit the entire group, or employers may be unable to accurately determine preferences. For example, if no union is present, it may be difficult for workers to adequately organize and negotiate. Observed logic and consequences are similar to those seen with distributional effects.

Externality

Even if a group of workers knowingly and freely agrees to an arbitration agreement, that decision may have effects on society for which workers are not responsible. For example, risk-preferring workers may eventually fall to the social security net, or be unable to care for their families.

Thus, arbitration agreements may not truly be economically efficient, as they do not adequately internalize all externalities.

Non-economic arguments

Just as our opposition relies on libertarian philosophy for rhetorical strength, non-economic arguments provide us with additional support. A la Radin, society may consider the right of an individual to sue in court to be inalienable. Under this theory , the right to sue is so sacred that people should not be allowed to trade it. This stance could best be defended on prophylactic grounds, i.e. if workers agree to private arbitration they were probably coerced.

The concept of "naming, blaming, and claiming" may also come in to play. If workers are systematically unable to recognize problems as problems, private arbitration may worsen the situation.


Conclusion

Our opposition will likely raise several persuasive points in support of the FAA, however those arguments are vulnerable as they rely on some fundamental, and possibly erroneous, economic and philosophical assumptions.

Question 1, Answer 2 

Though the sanctity of the contractual relationship between worker and employer has been supported by many, including Justice Shaw in Farwell, government regulation in selectively enforcing certain arbitration agreements may promote a better outcome on efficiency, distributive, and fairness grounds.

EFFICIENCY

Government inaction is seemingly supported by the economic argument that workers and employers are in the best position institutionally to adjust their contractual relationship. Each party knows their preferences better than the government and can make accurate tradeoffs. If worker willingness to accept the job at a given wage included the agreement to settle claims through private arbitration, costs would be internalized through wages. Those workers who value the right to settle claims in court would remain free to insist on retaining this right by trading material benefits.

While this economic efficiency argument appears strong, there are still several problems. First, it is unclear whether or not a wage differential actually exists between agreements to settle through binding arbitration and those without such a provision. Without empirical data, this argument fails. Indeed, the validity of the argument that workers who value the right to go to court remain free to retain this right depends on the freedom of both parties to bargain competitively. In a monopoly situation where all employers demand binding arbitration, a worker who would rather sacrifice wages may not have this option (fairness concern). Also, individuals on the lower end of the economic spectrum may not have the means to turn down a coercive contract offered.

In addition, information failures favor government regulation. People do not typically assess their alternatives as rationally economic actors, but are dependent on messages they receive from other people. This social dependence impacts the naming, blaming, and claiming process through which disputes arise. Actual claiming may be stymied by allowing this Act to stand since employees may see the remedy as not worth the hassle; private binding arbitration may appear to render less justice than a verified judicial procedure.

Also, cognitive heuristics may prevent individuals from understanding the arbitration agreement. A potential employee may fall victim to the representativeness heuristic, thinking that the probability of having to bring a claim against an employer is very small. The availability heuristic may also prevent correct assessment of the risks of having to settle claims in private binding arbitration, as the potential employee may not know anyone who has brought a claim before starting the job. Finally, cognitive dissonance may prompt a potential employee think that claims may need to be brought by other people but not by them.


DISTRIBUTION

Economists typically argue that it is not possible to redistribute wealth by mandating a compulsory term in a contractual relationship. The assumption behind this conclusion is that economically rational actors will respond to regulatory mandates by altering the terms under which they will enter into exchanges (also known as "landlord will raise the rent"). Thus, the distributional consequences of regulation, in this case - the potentially lower costs from instituting mandatory arbitration clauses, will be passed on depending on the elasticity of demand and supply but shared by workers and employers alike.

This economic argument appears stronger on the efficiency side (though less strong than the first argument) but is not especially compelling as a distributional reason for government intervention. There are many reasons why lower costs may not be passed on from employers to workers, even outside of the elasticity of demand and supply that redistributes to a certain extent between marginal and inframarginal workers. There is, again, an information disparity since employers know how much they might save but workers do not. There would then be no reason for the employer to pass on the savings to a worker because the worker, lacking knowledge, would not decline employment. Also, workers may not value the arbitration clause, and hence would not be willing to pay for it.

If those workers who do not want the arbitration clause are also those who were most willing to accept anyway, most workers will benefit even if the arbitration clause was inefficient by Kaldor-Hicks standards.

In regard to distribution, the key point is that it is often hard to predict how redistribution will impact classes, especially between marginal and inframarginal workers. There are also good reasons to question whether the government should even attempt to redistribute through enforcing arbitration.


FAIRNESS & PATERNALISM

Allowing enforcement of arbitration agreements recognizes that employees can validly trade their right to settle claims in court for a potentially higher wage. An economist could assert that this incorporates the value of alienability, as rights that cannot be sold are worth less than those that can be. Thus, the right to settle claims in court would be traded for compensating wage premiums or benefits.

While economically sound, this approach can be criticized externally on moral grounds (weakest of economic assertions). Some rights, such as the right to bring claims to court, may be inalienable. The commodification of justice may prevent human flourishing. In addition, paternalistic concerns may justify government regulation. The government, as a more impartial, well-sourced participant with a wider perspective than any individual, may have an advantage in judging what is in an individual's best interest. This argument is applicable here, since consideration of the prospect of having to settle any claims through private binding arbitration likely requires a long-term .view. Having to bring a claim is also an event for which there is a small chance of serious consequences occurring for anyone individual, which also supports government regulation.


POSSIBLE AMENDMENTS TO THE FAA

Instead of enforcing all valid arbitration agreements, the government should stipulate specific agreements that it will enforce. For example, agreements made in industries where there is a clear wage differential based on inclusion of the arbitration clause, and those made with greater information could be enforced. The government could also punish the more unfair agreements, such as coercive contracts in industries where there is no choice of trading the right to settle claims for material benefits.

Question 1, Answer 3 

In preparation for the upcoming report by our Rival Advocacy Group (RAG) regarding binding arbitration contracts, I have outlined anticipated points, with our potential responses. I would any appreciate additional suggestions on strategizing the upcoming advocacy campaign.

Restricting ability of employees to waive their right-to-sue violates freedom of contract, ultimately hindering efficiency. The flexibility of the market works better than the legal system at calculating risks and providing compensation, by automatically adjusting wages and benefits to the pressures of supply and demand. If an employee values her right-to-sue, employers will be forced either to maintain the right-to-sue, or offer appropriately higher wages/benefits in return. The government shouldn't hinder a worker's ability to choose the employment terms she finds most attractive.

Unfortunately for RAG, the freedom to contract argument destabilizes when faced with the realities of the employment market and inflexibility of employment contracts. Some glitches, listed in order of strength, entail:

Bargaining power: Employers face a collective action problem only partially mitigated by unions. Due to size, an individual employer has greater ability to act as a price setter, while employees are faced with a take-it-or-leave-it" situation. Moreover, individual workers who objects to a particular clause and attempts to bargain out, will appear more litigious and thus less attractive to employers. RAG may respond that bargaining power of employees remain strong, especially given the force of unions and the abundance of small firms industries. Moreover, even without collective action, employers remain sensitive to inframarginal workers; however, such workers may value right-to-sue differently than the general population.

Sunk costs: Entry/exit rigidity increases based on expenditures such as: locally-based friends, family, or property; job-related skills; familiar co-workers; retirement plans and accumulated benefits. Sunk costs have less importance if the arbitration clause only applies to beginning employees, but nonetheless affects lack of mobility beyond present industry and geographic location.

Informational Problems: Employment information is an underproduced public good, leaving workers without optimal information for informed decision making. Cognitive bias increases the danger that workers will undervalue their right-to-sue, by considering themselves unlikely to face harm or to contract with a risky or discriminatory employer. RAG may argue that risk aversion counterbalances this tendency, creating an appropriate amount of coverage. They may propose methods of increasing information access, but even availability of information doesn't guarantee accurate evaluation.

Rigidity of wages: Wages aren't perfectly tied to variations, but can reflect countervailing efficiencies, i.e. values for dynamic incentives, significance of inequality or equality in workplace. RAG may reason that this 2nd best problem argues against regulation.

Decreasing private lawsuits benefits both employers and employees by higher revenues. Arbitration decreases administrative costs (currently 50% of tort costs), mitigates rent seeking, discourages frivolous claims by making them less lucrative, and reduces inefficiencies of excessive deterrence created when courts over-respond to defendants. Additionally, arbitration increases access to remedies by simplifying the process and decreasing reliance on lawyers.

Given current trends against lawyers and overabundant lawsuits, we may have trouble defending the right-to-sue. Nonetheless, there are several cogent points, again presented in decreasing order of persuasiveness:

Moral Hazard: Any decrease in likely amount and expenses of claims buffers employers from expenses of their actions. Employers will have decreased incentive to avoid discriminating against workers or to provide an optimal amount of workplace safety. However, availability of punitive damages will increase costs, reducing moral hazard.

Lawsuits as an Underproduced Good: Despite popular beliefs, lawsuits can actually be underproduced. Given the difficulties of transforming an unperceived injurious experience into an actual dispute, only a small fraction of injuries result in legal claims. In addition, lawsuits create positive externalities. Discrimination suits provides compensation for individual employees, but also deters employers from repeating discriminating behavior. RAG will argue that decreased expenses and simplicity of arbitration will increase the likelihood that interested parties seek remedies. Even so, arbitrations still contains significant cost, particularly when opposing your employer, but with smaller potential benefit.

Importance of Lawyers: Arbitration does not necessarily decrease the need for lawyers, who impose costs, but also protect employee rights. Without lawyers, employees may have difficulty navigating the arbitration system and effectively presenting their grievances, Employers will have greater power to choose arbitrators and arbitration methods. This issue will be particularly important if arbitration settlements don't cover legal fees.

Externalities: Injuries by employers impose costs on outside bodies, which increase proportionately with the decline of lawsuits. Instead of suing, an injured employee can turn to insurance, government benefits, or less favorable employment. A worker discriminated against in layoffs may resort to social services or family support. Additionally, even if decreased lawsuit may reduce costs, benefits won't necessarily go to employees or other burdened parties.

Our agenda should mention normative issue that RAG may not address.

Market Alienability: RAG will argue that commodification makes right-to-sue more valuable: while most workers would never use it, they can now sell it. Commodification can have serious social consequences by forcing workers to choose between economic opportunity and individual rights. Moreover, law has unquantifiable value as a socially transformative force: Title VII legislation, for example, has decreased discrimination not only by imposing economic costs, but by decreasing social acceptability. Employees without the right to a Title VII suit may no longer feel equally entitled to a non-discriminatory workplace.

Distributional Consequences: If losing the right-to-sue leads to increased wages, all workers benefit, but the costs fall disproportionately. As mentioned, individual employees have little bargaining power. Group that see themselves as more likely to be injured or discriminated against can accept this risk or switch into less attractive industries that cannot impose arbitration contracts. While this could have efficient consequences - clumsy or litigious workers now pay the costs of their behaviors - it also affects minorities such as the disabled, African-Americans, and transgendered, who already begin with decreased bargaining power. Current employment discrimination will be exacerbated as minorities who value their right-to-sue risk lower wages and appear as unattractive employees.

Question 2, Answer 1 
 

Mental health parity should be supported as a socially advantageous policy.

Lack of mental health coverage has serious distributional cost. Mental health problems can be even more devastating than physical illness, by combining debilitating effects with social stigma. Untreated mental illness undermines civic ideals by obstructing one's ability to function in society . Addressing parity in insurance can counterbalance some of the effects of discrimination in other areas.

Though potentially expansive, positive externalities compensate for costs. Mental illness and substance abuse affect society as well as affected individuals. These disabilities entail substantial emotional and financial hardship for friends and family. The mentally ill are often incapable of working, decreasing national productivity while imposing costs on family members and social service agencies. Mentally illness and drug dependency can also lead to other health problems; for example, depression is known to impair the immune system, while drug abuse can increase spread of AIDS. In severe cases, mental illness can result in homeless and criminality (i.e. the untreated manic depressive who kills his wife, or the drug addict who steals to support her habit).


Mental health parity involves some of the same concerns and policy implications as insurance in general.

Moral Hazard: Mental illness presents a decreased likelihood of moral hazard, given the lack of choice involved. Individuals can engage in dangerous behaviors that create physical problems, i.e. smoking, but generally have no power to effect the probability or severity of mental illness. Drug dependency may arise as the result of individual action, but the stigma associated with substance abuse provides sufficient counter incentives that insurance will likely have no effect. Additionally, individuals generally avoid care for such illness, decreasing potential moral hazard. While insured consumers may be more likely to recognize illnesses and seek care, such actions will result in efficient — not excessive — amounts of care. Nonetheless, insurances plans must still address increased consumption of marginally beneficial services.

Adverse selection: Given current high costs of mental health expenditures and the chronic nature of many mental illnesses, individuals have elevated incentives to choose insurance programs based on mental health benefits. Risk aversion usually combats adverse selection by encouraging overinsurance; however cognitive dissonance reduces risk aversion: due to the shame associated with mental illness, people systematically. underestimate their own risk. However, adverse selection difficulties would become negligible if all insurers provide mental health parity.


When MHPA is re-authorized, the plan should include some of the features below.

Co-payments: Mental illness presents danger of moral hazards by overconsumption of services, despite the accompanying stigma. Insurance companies, consumers, and even doctors find it difficult to determine appropriate levels of care. A patient may find it comfortable to stay in therapy for years even as marginal benefit decreases. Co-pays reduce moral hazards as well as diminishing costs for insurance companies. Nevertheless, co-pays should be equivalent to physical aliments, to encourage appropriate levels of care. Additionally, low caps should be avoided as they disadvantage the poor and gravely ill. High deductibles also disproportionately burden low-income households and promote ' inefficiently low levels of treatment.

Drug addictions: Parity should also cover substance abuse and chemical dependency. While political expediency may encourage a "tough on drugs" stance, in the long run, treatment centers provide better results in affecting drug problems.

Premium Increases: Exempting insurance companies facing greater than a 1% cost increase could undermine parity attempts by making it inapplicable to practically anyone. Nevertheless, premium increases should be kept to a minimum so as to not disturb voters, though potential impact is unlikely before November.

Required Benefits: Insurance companies should be required to offer mental health care benefits comparable to physical benefits. Otherwise, MHPA could actually decease mental health care coverage: insurers would drop mental health benefits when faced with increased costs. Caps should remain equal to physical health ceilings. Additionally, limits on visits and hospital days should be equalized given the importance of recurrent care in treating mental illness.

Screening: MHPA ought to include anti-discrimination provisions. Insurers should not be able to deny coverage based on pre-existing mental health conditions. Otherwise, as MHPA increases coverage cost, the mentally ill risk being excluded from the insurance market for physical benefits as well as mental health benefits.

Additionally, as politically expedient, legislation could promote improved coverage though the following proposals: (a) expanding the often arbitrary list of mental illness covered, (b ) discouraging small business exemptions, and ( c ) endorsing possible safety nets that cover insurance costs if they rise above the set premium increase.


Support of mental health parity should not have negative political consequences for the upcoming election.

Political economy: MHPA provides benefits for a small group of potentially marginal voters, while dispersing incremental cost increases among a large group unlikely to notice or organize. Insurers are sufficiently concentrated for political organization to prove beneficial, but as part of a competitive industry , they have decreased incentive to invest in political lobbying. While the mentally ill have faced difficulty organizing in the past because of social stigma, organization such as the National Alliance of the Mentally Ill have increased current political clout.

Public Approval: Political implications will largely depend on appropriately slanting potentially volatile issues. Americans are concerned with drug addictions, but often have little support for drug addicts. And unlike six year-olds in need of organ transplants, the mentally ill are less popular figures and at times considered morally blameworthy. Legislative propaganda will need depictions of the mentally ill as likeable, socially valuable individuals. Any mention of drug treatment must stress the direct relation between treatment programs and the decline in substance abuse as well as its potential harms: crime, lost productivity, spread of disease, poverty, birth defects, etc. Crime should be especially emphasized, as an always-popular political issue, perhaps focusing on highly visible acts of violence committed by the mentally ill, (though that could have a negative effect by creating backlash against mental health consumers). Publicity could also to highlight the large percentage of homelessness caused by untreated mental illness.


Question 2, Answer 2 

Presumably, MHPA attempts to address efficiency and distributional problems that result from private insurers' efforts to deal with the adverse selection problem. Assuming mental health care is more costly than medical and surgical care, insurers who offer to cover mental health benefits will have incentives to discriminate between them. MHPA, possibly for the distributional goal of helping people with mental illness, limits insurers' ability to deal with the adverse selection problem through prohibiting the discrimination between the two types of benefits with respect to annual or lifetime limits.

This legislation has several problems. First, to the extent that it imposes higher cost on insurers while keeps the offer of mental health benefits optional, there could be shortage of mental health insurance, depending on the elasticity of the supply of mental health insurance. If the supply is elastic, many insurers will simply refrain from providing such coverage and people who are really willing to buy the insurance win not be able to purchase it, thus creating a dead weigh loss. Tighter restriction on setting lifetime or annual limits could also drive up premiums and price out some marginal insurance buyers.

Second, to the extent that MHPA requires less restriction on annual or lifetime limits, other things being equal, people will have more incentive to overuse the mental care resources, creating a moral hazard problem. The moral hazard problem may in turn exacerbate the adverse selection problem, because as people overuse mental care resources, the overall cost of insurance will go up. Thus the insurance will be less:, attractive for lower risk people on the margin, who will be more likely to drop out.

Third, as the legislation does not apply to small employers, it perpetuates the distributional pattern of the medical insurance market-that individual insurance buyers face higher cost and greater difficulty in acquiring insurance than those who buy as part of a group plan; and those who belong to small groups face higher cost and difficulty than those in large groups. What's more, the exclusion of treatments of substance abuse and chemical dependency, sensible from the adverse selection point of view though, seems particularly problematic from a distribution equity perspective, as these people are the ones who need the insurance the most.

Fourth, and more importantly, the legislation leaves so much room for insurers to continue restricting mental health coverage that practically it will have little impact. For example, insurers could limit the number of treatments beneficiaries may receive, set high co-payment or deductibles, or refuse to provide the coverage at all. In addition, the legislation will not apply in cases where the increase of cost is greater than one percent. If there would be only one percent of cost change, private insurers could have stopped discriminating between the two types of benefits with respect to lifetime or annual limits without government intervention.

If the legislation will not in fact make much difference, why was it passed? Possibly it was a compromise between the beneficiaries of expanded mental health coverage, like psychiatrists or other mental health service providers, and the insurance industry . By giving the purported beneficiaries a symbolic victory while keeping the leeway for insurers to manage costs, the politicians could show that they are serious about the issue and take the credits for effecting some social change.

If the senator really wants to efficiently achieve the distributional goal of broadening mental health benefits, MHPA could be renewed with several modifications and cautions.

First, Congress could make the offering of mental health benefits mandatory to all insurers and bundle private insurers together through reinsurance. Then insurers that have higher cost win be reimbursed out of the pool. With broader participation, thus bigger risk pools, the adverse selection problem will be avoided and the premium would be lower and more affordable. But this arrangement has its own up-side and down-side. For the down-side, it could create moral hazard problem for insurers because they would be protected from bad underwriting and policy design; and adverse selection problem for the pool as a whole because as high risk people buy insurance from one insurer, they drive up the cost of the entire pool, resulting in some marginal buyers without insurance. On the up-side, it is hard now for low risk people to leave the entire pool. And insurers now have less incentive to excessively screen mental health insurance buyers.

Second, Congress could give tax preference for the cost of mental health case. A tax deductible would be more politically feasible than a tax credit, as a tax deductible is regressive in that it proportionately benefits the rich more. A medical savings account for mental health care could also be useful in encouraging people to conserve medical care resources. Under the medical saving's account system, there win be higher deductible and individuals will have less incentive to overuse. The savings will then be passed to the insured. But there win be distributional tradeoffs. People with high risk will pay more out of pocket cost and get little or no money back. Conversely, people who are less likely to contract mental disease will benefit more.

Third, it would be wise to keep the co-payment and deducible restriction in order to mitigate the moral hazard problem. Assuming mental health benefits are more expensive than medical and surgical benefits, the Clinton order will create serious moral hazard and adverse selection problems because people with higher risk of mental problem will be more likely to overuse the medical resources thus drive up average cost. Low risk people will then be more likely to drop out.

Fourth, it would be advisable to keep the regulation at the federal level in order to achieve the distribution equity goals more effectively. This is so because it is more difficult for state government to redistribute within the local area, as people could easily enter or leave the jurisdiction; and there will be less collective action problem-if one state imposes cost on insurers, they may leave the state; whereas federal regulation makes it less possible.

 

Question 2, Answer 3 


The Mental Health Parity Act should be renewed.


Not to renew it would send the wrong message:

But complete parity may be difficult to achieve. If complete parity were required from the plans that currently offer both physical and mental health coverage, there would likely be some market failures common to insurance markets:

Similarly, there may be a fiduciary problem.

While many of these issues also arise in insurance plans for physical health, the problems may be more pronounced in mental health plans:

The flexibility permitted by the MHPA as it is allows insurance companies that offer mental health benefits to address these issues:

However, this flexibility also makes the plan somewhat ineffective in reaching parity


The plan might be made more effective.

  • This will address the problem of adverse selection and distribute the costs of mental health care more evenly.
  • This will make mental health care more affordable for those previously unable or unwilling to pay, and will thus include more people who would benefit from mental health care.
  • This is a rather significant departure from the current regulation. Those who support larger government will likely support such a measure.
  • Conversely, those who dislike government regulation of markets may see this as unacceptably intrusive.
  • This measure may have difficulty garnering bi-partisan support.
  • However, it stops short of a ban on such measures thereby limiting the potential effects of market failures, discussed above, which might result.
  • This is a slight move, and may be criticized as such by those wanting significant reform.
  • Nonetheless, it is further regulation of an area traditionally left to market forces, so it may be criticized by those who prefer smaller government.
  • Because it is not drastic it may be supported by those seeking a compromise.

 

Question 3, Answer 1 
 
Command-Control Regulation: Traditionally, environmental regulation has consisted of standards requiring either particular pollution reducing technology, or certain levels of emissions reduction. Technology Setting Regulation: Such standards compel use of set technologies to reduce pollution levels, while preventing employment of inefficient equipment or devices that impact negatively on other goals, (such as the tall smokestacks disaster). These regulations are easy to administer and enforce.

However, technology-forcing regulations can freeze technology, as companies have no incentive to pursue more cost-effective ways of reducing pollution. If the agency chooses an inefficient or inappropriate technology, the result could exacerbate current problems. Moreover, it ignores the possibilities that some companies can reduce pollution more efficiently than others.

International Applications: Technology setting faces additional problems given the differing levels of industry and development faced by specific countries. The likelihood of determining an efficient pollution mechanism for use on an international level is even slimmer than on a national level.

Emission Setting Regulation: By setting maximum level of emissions or minimum percent reductions, countries can reduce pollution while allowing companies to determine cost-efficient methods.

Requiring a percentage reduction rewards heavy polluters by allowing them to maintain large emissions, while imposing hardest costs on those who have previously reduced pollution. In contrast, setting emission levels benefits those who already operate in environmentally friendly manner, but provides no incentive for companies below that level to reduce emissions, even if they could do cheaply.

International Applications: International agreements setting emission level would address current externalities created by border-crossing pollution. However, countries would have extreme difficulties deciding on a single standard. The costs of reduction and resulting benefits vary greatly. Additionally, as with technology setting, countries may be reluctant to pay costs when gains occur elsewhere. Standards also ignore the fact that counties value pollution reduction at different rates. Developing nations may be hesitant to accept costs imposed by developed countries given (a) the lower levels of wealth available to address environmental problems, (b ) the presence of greater economic and social concerns necessitating scarce resources, and (c) the desire for equal opportunity to develop unhindered by environmental concerns.

Emission Disclosure Requirements: This regulatory approach requires companies to disclose emissions standards. While not compelling any set reduction in pollution, companies are encouraged to reduce pollution in response to negative publicity . This allows a gradual reduction in pollution based on environmental awareness, but depends on people valuing the environment enough to pressure companies and alter purchasing behavior.

Voluntary Reductions: Each company makes its own cost-effective decision on whether increase in consumer approval outweigh costs. Aditionally, companies create a race to the top as each attempts to look better than its competitors.

International Applications: Emissions disclosure can easily be applied county by country . Individual nations have increasing economic incentive to adapt disclosure requirement as its trading partners do. Moreover, regional groups of consumers can make discrete decisions on how they value environmental protection. However, countries with little interest in pollution reduction may be forced to alter their behavior in response to consumer demand in other locations.

Inefficient Incentives: The market system places identical motivation on all companies to reduce emissions and rewards them equally with popular approval even when costs and benefits of pollution reduction vary greatly.

Geographic Difficulties: Disclosure ignores the fact that emission reduction in some region may be more valuable to the environment then those achieved elsewhere. Moreover, given the global economy, a free rider problem develops. Decreased purchases of high emission products by one consumer group has an international effect, benefitting areas where consumers are unwilling to trade convenience for reduced environmental degradation. Consumers may be less willing to alter their behavior if reward fall elsewhere.

Information Problems: The value of emissions disclosures hinges on information being easily accessible and understandable to consumers. Both issues create extremely difficult administrative problems, especially internationally. People are also likely to undervalue risks by discounting the importance of individual actions, as well as ignoring intergenerational equity concerns.

 

Marketable Emissions Permits: The permit approach system encourages cost-efficient pollution reduction. By allowing the sale of pollution permits by under-polluting companies (or imposing fees for excessive emissions), regulators take advantage of private incentives and privately held information regarding control costs. Each individual polluter makes the decision to reduce emissions when cost of the reduction is less than reduction price. Permits also encourage development of new technology.

Efficiency: The permit system works best given (a) low transaction costs, (b) high level of pollutant mixing in the receiving airshed/watershed, and (b ) uncertain and highly variable marginal abatement costs. Setting optimal permit levels also requires determining when costs and benefits equal. If pollution reduction costs are very elastic, insufficient information in fixing prices could result in considerable deadweight loss.

Permits Range: Global permits would create a large, available market, keeping compliance costs low and avoiding potential collusion, but allows development of hot spots of concentrated pollution with potentially disturbing distributional consequences. Pollution reduction achieved in the most cost-effective manner does not necessarily lead to the greatest environmental impact, especially if it ignores the regional nature of the acid rain problem and the role of prevailing winds.

Commodification: As a license-to-pollute, trading in pollution may create alienation from the environment and have a downvaluation effect. Permits also remove the moral stigma of pollution, decreasing incentive for voluntary emission reduction.


International Applications: Market permits present numerous administrative problems on an international level. As discussed, different counties have varying costs and benefits and value pollution reduction at different rates. Determining an efficient international permit price, if it exists, could require prohibitively expensive amounts of information. However, as with any regulatory system, if caps are not applied across the board, companies will have incentive to switch their emissions to unregulated countries, creating emissions leakage. Additionally, adverse selection develops when countries can opt out, as nations with pre-existing low pollution levels will participate disproportionately; in the aggregate, such behavior could augment emissions by increasing available pollution permits.


Question 3, Answer 2 

Any global warming solution that ignored the US would suffer tremendous free-rider problems. Negotiating for American involvement, given the Bush administration's opposition to Kyoto, should force us to seriously consider market-approaches to the problem of pollution externalities. I offer three proposals given this political climate.

First, trading credits for emission reductions.

American support for trading credit proposals is informed by the Clean Air Act's SO2 allowance program, which shows signs of moderate success. In the SO2 program, utilities buy allowances to pollute beyond a ceiling, which is set by limiting the number of allowances in the market. Conceivably, a similar market for CO2 permits can be established.

A central body could offer a set of permits, perhaps with variations to account for levels of pollution or industry . The political expenditures in negotiating the appropriate number of permits to ration will be immense and may lead to rent-seeking. The alternative of government auction, though it would secure revenue for administration, disadvantages poor countries, which may have difficulty affording necessary permits. In contrast, an initial allocation distributionally serves those non-industrialized countries as they can enjoy the revenue from the sale of unused allowances.

Most importantly, with such a plan, the government sets a goal of acceptable level of pollution and leaves it to the market of finding the most efficient means of arriving there. In the long run, a drop in pollution is expected as firms look to reduce their costs of production including lowering permit purchases and replacing older, heavily polluting fixed costs. This could encourage technological innovation, such as efficient and cleaner alternative energy sources.

There are numerous disadvantages. First, with SO2, the concern over acid rain led to the regulation of utilities. However, power plants are just one of many sources of greenhouse gas emission. Enforcing the SO2 output probably entails visits to utilities to check gages of pollution and penalizing those lacking needed permits. The administrative costs of monitoring the emissions of entire nations are likely to be substantial; and it is uncertain who gets penalized. If nations pass the costs of penalties accrued to tax payers, there may be helpful popular pressure to reduce emissions; but if the tax pressure is severe, it may lead to calls for abandoning the program altogether. Moreover, any central enforcement body levying penalties against the US would run into conservative opposition to any perceived erosion of American sovereignty .

Second, national tax policies.

A Pigouvian tax that would seek to align social costs with private costs is theoretically equivalent to a trading permit, but there are administrative and distributional differences worth noting.

In contrast to the above trading program, this tax can be levied on inputs, such as coal and oil that lead to harmful emissions, providing a substantial savings in the administrative costs of { monitoring and enforcement.

A distributional difference is that revenue won't line a producer's pockets through the sale of permits but instead fill government coffers. Depending on one's view of governmental competence, this mayor may not perceived as a problem. One consideration could involve the possible uses of the money.

Unfortunately, such a tax plan involves substantial political difficulty as it would harm a wide number of energy producers, who may wield political influence. In America, despite some support from moderate Republicans and plant-owners to reduce emissions, there may be insufficient political will for such a tax. Even given the will, care should be taken to avoid large, established producers from granting themselves exemptions and locking out new entrants to business.

Developing counties may claim that both of these proposals leave them worse off. The burgeoning industries that are raising the standards of living in poorer countries tend to be heavily polluting. In relief, side payments both as a portion of consolidated tax receipts or a sale of trading credits might mitigate harm to industry, but only if targets are set appropriately, allowing for economic growth and for transition into less-polluting industries. This is especially important as international labor rights regulation, in addition to pollution caps, may possibly constitute an excess burden.

Further, these market approaches require both a careful setting of an efficient amount of pollution — with the tax, the difficult estimation of the social cost of pollution — and the value-laden weighing of costs and benefits. Cost-benefit analysis in one country alone is controversial; in the international context, the problems are aggravated. Hedonic pricing rests on properly functioning markets, which are not commonplace; and both this revealed preferences approach along with contingent valuation are context-specific. We know for instance that those in non-industrialized .governments tend to value economic efficiency very highly, relegating priorities like intergenerational equity through sustainable development to the periphery. Moreover, political power will cloud any CBA — rich countries will select the indicators useful to them. They may for instance choose a higher discount rate, which lessens future benefits as measured against high present costs. All of this even before we include the loud voices urging that due respect for ecology counsels against commodifying the environment and setting optimal levels of its ruin.

Third, subsidizing lowered emission.

In response to the Bush administration' s concern over diminution of production during an ostensible energy crisis, America can lower electricity prices by helping to increase supply that does not contribute to global warming. So one regulatory response would be to offer subsidies, the source for which may come from a Pigouvian tax, to those companies that invest in alternative energy sources. Another method to reduce price is to of course lower demand. So another possible governmental response could involve using above tax receipts to fund an informational campaign on the lowering of the demand for energy.

The only disadvantage here is political will. Presidential proposals to reduce demand for energy or to increase cleaner supply have been absent. The troubling perspective seems to be that global warming goals, although necessary, ought to be suspended whenever economic skies are dark, on the assumption that the needs of nature will conform without complaint to a nation's economic cycles.

Question 3, Answer 3 

Three possible regulatory strategies

1. One possible solution is to adopt international emissions standards for all greenhouse gases. An international body would determine specific target emissions levels for stationary polluters on a yearly basis. A requisite tax would be imposed by each nation on its own polluters in proportion to their failure to comply with the regulations. The policy would set standards for allowable admissions, but not rules for how the reductions must be achieved.

Advantages:

Direct regulation of individual polluters leads to relatively uniform pollution reduction. All nations and all polluters would be subject to the same standards.

Basic standards, rather than rules for how to reduce pollution leave significant discretion to individual polluters as to how best to meet those standards with a requisite efficiency gain.

Regulation of all major greenhouse gases may ultimately lead to less confusion among polluters and encourage the development of integrated methods to reduce all emissions simultaneously.

Tax penalties impose a social stigma on polluters for non-compliance. Proportional tax penalties also compensate society in an imperfect way for the negative externalities of pollution.

Disadvantages

There is no additional incentive for innovation. There are no tangible benefits to be derived from the added short term expenditures necessary for innovation.

There are high transaction costs from the need to closely scrutinize individual polluters' compliance with the standards.

The tax penalty system is difficult to administer on an international scale. Tax payments also would tend to go to the governments of the most industrialized nations with little compensation for less industrialized nations also affected by the increased pollution.

This system makes no allowance for drastic differences in the marginal cost of emissions reductions between individual polluters. Polluters that face very high marginal costs because of abnormal circumstances are subject to severe distributional consequences by complying with the mandated standards.

Especially in light of its inability to account for severe differences in marginal cost, this measure may impose significant cost increases on consumers. It also makes domestic energy policy subject to internationally imposed standards.

This system only sets standards for individual polluters. It has difficulty regulating aggregate levels of pollution since new polluters may continually emerge.

 

2. Another possible solution is to develop an international system of emissions trading for all greenhouse gases similar to that implemented under the 1990 amendments to the U.S.'s Clean Air Act. An international body would determine the annual tolerable aggregate limits on each of these gases and distribute permits in accordance with these levels to stationary polluters by means of an auction. Polluters could trade these emissions freely. Permits would be allocated on a yearly basis and would not be bankable.

Advantages:

This policy places the burden of emissions reduction on the least cost provider. Individual polluters can determine whether it is cheaper to reduce emissions or to purchase permits.

It accounts for differences in the marginal cost of cutting pollution. Firms may purchase permits where the marginal cost of reduction is unusually high.

There are tangible incentives for innovation. There is a monetary incentive for polluters to pursue innovations which allow them to further cut their emissions.

The transaction costs of the system are relatively small. Individual polluters would need to be monitored but the system is simpler to enforce and almost supervises itself. It is not terribly difficult to implement on an international scale.

By allocating all permits by auction, the pricing system for permits tends to be more accurate and the problem of industrialized countries buying up permits from non-industrialized states is mitigated.

It is possible to accurately track aggregate pollution levels by controlling the quantity of available permits. The prohibition on banking permits keeps aggregate pollution levels constant over time.

Disadvantages:

A policy of free admissions trading without geographic limitations may lead to creation of pollution hot spots" with severe distributional consequences for the people living in those areas.

Such a policy may not stigmatize polluters sufficiently. There is already heavy international opposition to the idea of emissions trading. The commodification of pollution in this way is objectionable to many.

This policy may lead to increased costs to consumers, though probably less so than direct regulation.

Tight limitations on available permits might disproportionately affect emerging industrial development in poorer countries.


3. A third possible strategy might involve granting subsidies for voluntary measures to reduce aggregate pollution levels. One specific measure might focus on transportation innovations. Nations that develop improved transportation technology such as clean cars or significantly reduce their emissions by improved mass transit would be rewarded with monetary subsidies. The determinations of qualifying improvements would be determined by an international board of experts. This policy might be implemented along with an emissions trading or standards regulation so that the monetary subsidies could be paid from the contributions of polluters.

Advantages:

Such a policy would be voluntary and wouldn't necessarily impose costs on consumers. Though international in scope it places no restrictions on domestic energy policies.

It provides nations with a strong, direct incentive for technological innovation. Transportation is an important source of greenhouse gases.

Greater technological innovation may lead to more permanent solutions to pollution reduction. Innovations developed in one country may be applied internationally.

The policy would redistribute from polluters to nations that develop long term pollution solutions. This may embody a certain conception of social justice.

Disadvantages

It is an incomplete policy. On its own it may not lead to sufficient reductions to meet the standards of the Kyoto Protocol.

The standard of innovation necessary to receive a subsidy may be too vague. There may be significantly high transaction costs both in determining what qualifies and in paying out the subsidies.

The pursuit of subsidies may lead to wasteful rent seeking. Nations pursuing the subsidies may waste valuable resources in the pursuit of those subsidies.

Wealthier countries, with better developed technical infrastructures and excess resources would be in a better position than poorer countries to compete for the subsidies.