The other ex-ante moral hazard in health

Abstract

It is well known that pooled insurance coverage can induce a form of ex-ante moral hazard: people make inefficiently low investments in self-protective activities. This paper identifies another ex-ante moral hazard that runs in the opposite direction: it cases people to choose inefficiently high level of self-protection. This other ex-ante moral hazard arises through the impact that self-protective activities have on the reward for innovation. Lower levels of self-protection and the associated chronic conditions and behavioral patterns such as obesity, smoking, and malnutrition increase the incidence of many diseases for an individual. This increases the individual's consumption of treatments to those diseases, which increases the reward for innovation that an innovator receives. By the induced innovation hypothesis, which has broad empirical support, the increase in the reward for innovation in turn increases the rate of innovation, which benefits all consumers. As individuals do not take these positive externalities on the innovator and other consumers into account when deciding the level of self-protective activities, they each invest an inefficiently high level in self-protective activities. In the quantitative part of our analysis we show that for obesity the magnitude of this positive innovation externality roughly coincides with the magnitude of the negative Medicare-induced health insurance externality of obesity. The other ex-ante moral hazard that we identify can thus be as important as the ex-ante moral hazard that has been a central concept in health economics for decades. The quantitative finding also implies that the current Medicare-induced subsidy for obesity is approximately optimal. Thus the presence of this obesity subsidy is not a sufficient rationale for "soda taxes", "fat taxes" or other penalties on obesity.