So everyone’s been making fun of Steven Levitt and Stephen Dubner lately, thanks to a story they recount in their new book Think like a Freak (sequel to Superfreakonomics, sequel to Freakonomics). It concerns a meeting they had with David Cameron, sometime before he became the British Prime Minister. They offered him some advice on how to deal with the problem of expanding health care costs in the U.K.. The problem, they said, was that government was giving it away for free:

What’s wrong with that? When people don’t pay the true cost of something, they tend to consume it inefficiently. Think of the last time you sat down at an all-you-can-eat restaurant. How likely were you to eat a bit more than normal? The same thing happens if health care is distributed in a similar fashion: people consume more of it than if they were charged the sticker price…

We tried to make our point with a thought experiment. We suggested to Mr. Cameron that he consider a similar policy in a different arena. What if, for instance, every Briton were also entitled to a free, unlimited lifetime supply of transportation? That is, what if everyone were allowed to go down to the car dealership whenever they wanted and pick out any new model, free of charge, and drive it home?

We expected him to light up and say, “Well yes, that’d be patently absurd….” But he said no such thing. In fact he didn’t say anything at all. The smile did not leave David Cameron’s face, but it did leave his eyes. Maybe our story hadn’t come out as we’d intended. Or maybe it did, and that was the problem.

Now I’m pretty sure I know exactly what was going through Cameron’s mind, at the point where the smile left his eyes. He was staring at them in disbelief, thinking to himself, “Oh my God, what a couple of jackasses.” That would be natural, because only a couple of jackasses would walk into Cameron’s office and say such a thing. What is astonishing is that Levitt and Dubner are such jackasses, they don’t even realize that this story makes them look like a couple of jackasses. They retell it in the book as if it reflected poorly on Cameron, not on them. This is taking jackassery to a whole new level.

This story is actually quite astonishing, in several different ways. The first is their assumption that David Cameron, who graduated first class honours from the Politics, Philosophy, and Economics program at Oxford University, might not be familiar with this most elementary, Econ 101 point about the function of prices in a market economy. While the basic claim about pricing and efficiency is correct, it is also the sort of thing that gets taught in the first month or so, in the first year of the undergraduate curriculum. So to say that Levitt and Dubner had insulted Cameron’s intelligence would be a vast, vast understatement.

In fact, this line about pricing is so tired, so generic, it’s even one that I’ve used in the past, when talking about road pricing:

Roads are congested because they are free. If we gave away cheese for free, too many people would eat too much cheese. Similarly, when we give away use of roads, we get too many people driving too much of the time. (In fact, people drive more than they actually need to, in terms of their own preferences. Imagine standing in line at the cheese stall, thinking “half these people don’t really like cheese, they’re just here because it’s free.” That’s exactly what you should be thinking next time you are caught in a traffic jam.)

Now if Levitt and Dubner had been talking about traffic congestion, that would have been fair enough. (Although the British don’t need any lectures from Americans about road pricing, since London has one of the most sophisticated congestion pricing systems in the world.) But they weren’t talking about roads, they were talking about health care.

And according to Levitt and Dubner, the problem with health care in the U.K. is that “no one pays a penny for it at the point of service.” But how many Americans with “private” health care pay for it at the point of service? Answer: practically no one pays for it out of pocket, at the point of service. In fact, in many private hospitals in the United States, it’s not actually possible to buy health care with a credit card. The economic transaction between health care provider and consumers is everywhere mediated by insurance.

So to characterize a public health care system as “giving away health care for free” is an absurd misunderstanding. Consider the implications of thinking this way — suppose we agree to “think like a freak” and forget all about insurance. Then according to Levitt and Dubner, our society does give away free cars. Just the other day I got a free car. I had a traffic accident, totalled my old car. What did I do? Well I went down to a car dealership and picked out a new one, free of charge, and drove it home. Why was it free? Because the bill got sent to my insurance company. Just like when I got sick the other day, and I went to the doctor, and the bill got sent to my insurance company. (In many parts of Canada, both automobile insurance and health insurance are public. Does this mean that the government is “giving away free cars” the same way that it is “giving away free health care”? Obviously not, in either case.)

Ah yes, but isn’t it true that when you are covered by insurance, you have a tendency to inflate claims and overconsume? Yes. It’s called moral hazard. It’s a generic feature of all insurance systems, whether public or private, and it’s an issue that is central to the debates over cost containment in both public and private systems. It is also the point of departure of every adult discussion about health care. (This is what Paul Krugman was alluding to, when he said that Levitt and Dubner’s remarks ignored “the insights of Ken Arrow.”) To confuse moral hazard in insurance systems with mispricing in ordinary commodity markets is to commit an elementary error in economic reasoning.

Both Noah Smith and Krugman have raised the obvious empirically-based objection – the idea, again, that a couple of Americans have anything to teach the British about cost-containment in health care is hubristic in the extreme, given the way that “markets” perform in the United States. But neither Smith nor Krugman diagnose the more fundamental conceptual confusion, which involves treating the lack of payment at the point of service as a feature of public provision, rather than of insurance systems generally.

This is all unfortunate, because informed economists do actually have an important, yet counterintuitive, point to make about health care, which is not adequately appreciated by many politicians. It is that the great debates over health care are not really about health care, they’re all about health insurance. Because it is the health insurance markets that are the ones that fail most egregiously, and that therefore require state intervention.