Can Congress Price Risk Effectively?

There's an interesting parallel between the recent debate about the F-22 and the current debate over health care. Health insurance (all insurance) is a hedge against risk. An individual looks at the potential that they may become sick in the next ten years. Say the risk of catastrophic injury is 10% over 10 years, with a cost in the event of injury of $100,000, so total "cost of injury" once the risk is factored in is $10,000. In hedge against this risk, the individual should be willing to pay $1,000 a year for 10 years. In order for the insurer to make any money (or pay overhead, processing, etc.) and individuals are willing to pay this because the marginal utility of safety against catastrophic illness is slightly higher then $1,000. Say, $1,010 a year and everyone is happy.

What does any of this have to do with the F-22? The F-22 is a dogfighter. It's probably the best dogfighter every built. But there is currently no other airforce in the world that can effectively contest our current dogfighters, let alone a super-advanced, super-expensive next-gen dogfighter. The F-22 is essentially a hedge against a peer-competitor that might arise in the future, likely China. The problem is that, unlike catastrophic illness with a risk of 10%, we can see China coming. The price of fighting a war with China and losing is, lets say, 10 trillion dollars in today's money. Enormously catastrophic. But if China wants to build a dogfighter that can challenge the F-22, there are enormous hurdles it has to jump over first, with clear markers that make such a development easy to observe from the outside. So lets say the risk of China developing a sufficiently sophisticated dogfighter without YEARS of advance warning is 1%, and a hedge of $100 billion would be appropriate.

But that's not the end. Let's set the likelihood of war with China fairly high at about 10% (no two nuclear powers have ever been to war.). Now, combined with the 1% likelihood of China developing an F-22 rival without us noticing, despite years of leadtime, the total likelihood of "being caught with our pants down" in a war with a China armed with a dogfighter capable of challenging the F-22 is now 0.1%. With the total cost of the war at $10 trillion, the appropriate hedge would be $10 billion. The total cost of the F-22, prior to current cuts, was $62 billion. And even that assumes that the F-22 is the effective hedge, and without it we would be facing certain Chinese victory (even generously setting the odds of that at 50%, we're down to a $5 billion hedge).

The problem is that Congress is insensitive to price. If "the USA" was a single, rational actor consuming insurance (and that's all a fighter program really is) it would have cancelled the F-22 in 1991 when the USSR collapsed. But Congress isn't a cost-sensitve actor. Rather than hedge effectively against national risk, Congress hedges against "risk of failure in re-election campaign" where showering F-22 related jobs on their districts is more important than safeguarding the nation's coffers.

None of this is to say that Congress can't effectively create a national program for health insurance. But when "keeping costs down" is asserted as a rationale for national health insurance, we should be more than a little skeptical.