A healthcare case for (and against) Wall Street ...

Enquiring minds want to know, or so we're led to believe. If they do, then perhaps they want to know some reasons why the US government seems fixated on making sure Wall Street, the stock market, is stable and successful. Of course, we all think we know the primary reason: People get panicky when their investment portfolio values--particularly those held in their retirement funds--head South. And these people vote in a way that's highly correlated with their investment portfolio growth. Alternatively, the conspiracy theorists among us believe there's some dark collusion between the US government and the investment banks. It seems, however, there might be other critically important reasons as well. Read on ...

The Medicare program is essentially heath care insurance covering most all US citizens over age 64; part of the US' long-term trend towards socialized medicine. Medicare spending is the third largest component of US federal government spending, representing approximately 16% of total expenditures. Suffice it to say, it's important to understand what drives this component of US government spending. I have come to believe that an important factor driving Medicare spending is closely related to the health of Wall Street, so to speak.

Microeconomic theory suggests Medicare spending is a function of:

• time, since prices tend to increase because of monetary inflation;
• population over age 64, since more people requires more expenditure; and
  
• societal wealth, since societies with more wealth tend to provide higher levels of government-funded social services).

If we are to estimate average effects of each of the factors on Medicare spending, it's necessary to develop an econometric model that can be estimated using observable data. While time and population are observable, societal wealth is not; at least it's not easily observable. There are good theoretical arguments, however, suggesting US equity market values are highly correlated with societal wealth. This in turn suggests using an observable index of equity market values, such as the S&P 500 Index, as a proxy for societal wealth in an econometric model. Putting this all together, stating the relationships in terms of annual percentage changes, and adding quadratic terms as (hopefully) an approximation of more general forms of non-linearities, results in a model like this:

I chose to model the growth rate in Medicare spending on physician and clinical services--an important subset of total Medicare spending--because I thought it was the component most directly associated with the over age 64 population.

Because such relationships tend to be non-stationary over time, I estimated the model using FGLS estimation with heteroscedasticity-robust standard errors and publicly-available data that I downloaded from www.freelunch.com with the following parameter estimate and statistical significance results:

Decimal numbers below the parameter estimates are p-values, showing the estimated probability the parameter is actually zero in the real world (i.e., the probability the factor has no effect on Medicare spending) given the sample data and that necessary assumptions underlying the model hold.

So what, you ask?  Consider the estimated marginal effects of a 20% change in S&P 500 returns on Medicare spending:

The econometric results suggest a 20% increase or decrease in the S&P 500 return results in an increase in Medicare spending for physician and clinical services, which at 2008 levels results in an estimated $14.5 billion increase in Medicare spending.  Hmmm ... that's a lot of money.


How often do 20% increases or decreases in S&P 500 returns occur?  Consider  the following histogram:

The histogram shows that 20% or greater absolute changes in the S&P 500 return from the prior year return occurred 14 times in the 41 year period ended 2008; so, about 34% of the time.  Ouch.  Moreover, consider what happens in the really volatile years:

Ouch, that hurts even more ... .  

Do the results make sense?  If humans (and politicians too) are into pain avoidance, one might suspect they would do their best to avoid volatile stock returns ... because apparently there are a lot more people seeing physicians, getting lab tests, etc. when the stock market goes crazy.  Considering (i) the high level of stress most people are under in developed, highly competitive  economies, and (ii) how many people obsess daily on their investment portfolio market values (e.g., even I go to Google finance daily to check on the markets and I don't even have any investments!), this seems entirely reasonable to me: Stock market volatility sends people over their health tipping points due to the  psychosomatic effects of the incremental stress.

So ... as promised by the title, here is the health care case for, and against, Wall Street:

Theory and evidence presented above, skeletal though it may be, suggest that (1) to the extent Wall Street firms promote stability in the financial markets, they are good for US health care, and (2) to the extent Wall Street firms promote instability in the financial markets, they are bad for US health care.

It's not completely clear, at least to me, whether Wall Street firms promote stability or instability in the financial markets.  My guess is that they benefit most, and most immediately, by promoting instability: Wall Street makes money from trading.  But perhaps if the conspiracy theorists are correct and the US government is trying to protect Wall Street firms from competition of various types, then lessening the pressure to produce trading profits might lead the firms to promote more stable financial markets.  But at this point, it seems the only thing to do is reserve judgment on whether Wall Street is good or bad for US health care.

MMc
São Paulo