Fixing Health Care

For me the central issue in health care is getting the alignment of incentives right. I realize that sounds dull, so let me explain.

In a private system of allocation it is the price that helps force all the various components fall into line. If a price is too high then a consumer won’t buy the product and eventually the producer reduces prices or goes out of business. So rising prices indicate rising acceptance by consumers of the inherent value of what they’re buying. At the same time, rising prices encourages new producers to try to innovate and offer similar products more cheaply. And os it goes on.

The problem we have with our health care system is that none of these usual market type incentives work. In fact most often the opposite effect is in operation: doctors and hospitals have no incentive not to prescribe drugs or tests since patients have little or no clue about the test outcomes. Patients rely on doctors both for the test recommendation and assurance that the test is needed. This is an open invitation for profiteering. The result is a spiral upward of expense, but no reliably associated spiral upward of beneficial outcomes. More and more tests, procedures, and drugs are consumed, but the population as a whole sees no benefit. This is a perverse way to run any economic system. And it is unsustainable over the long haul.

It’s almost impossible to fix. Why?

Because the people who actually foot the bill are middle men. The insurance companies do have an incentive to try to influence the nature of the tests or drugs. They have every need to reduce costs, but at the same time they need to support the search for beneficial outcomes. They need the patients who subscribe to their insurance plans to get good results otherwise, through time, patients will drift away to other insurers who do pay for successful treatments. So insurers should want to structure their coverage to encourage the use of least cost effective solutions. That should control costs.

Where insurers go off track is that they cannot control what the patient seeks. And the patient, as I mentioned above, has none of the normal market provided information to fend off the profiteering bias of doctors and hospitals. As a consequence, even though insurers should act as the cost bulwark in our system, their fear of loss of business prevents them from doing so.

It gets worse: we could get patients to drive prices down by exposing them to the full costs of their treatments. This, of course, is totally impractical because very few patients could afford the full cost of health care. That’s why we all need insurance: to spread the costs and share them with healthy people who are not getting any care but are paying premiums. It’s the same principle as any insurance scheme.

So, in a very distilled nutshell, this is the problem we have to solve. If we want a ‘private’ system we have to inject incentives to lower costs. That means exposing doctor and hospitals to more effective competition and the elimination of their profiteering bias. We have to force them, by creating the right market structure, to focus on outcomes on a truly cost effective basis the way that other industries are managed.

Frankly I do not see a way to do that.

The huge information advantage that doctors and hospitals have over their patients will always represent an insurmountable barrier to cost effectiveness. That profiteering opportunity will always exist and produce perverse results.

We could appeal to the moral virtue of doctors and ask that they do not seek to profit from their information advantage. But the evidence suggests we won’t get far: doctors and hospitals seem to want to be ‘for profit’ and look upon the practice of medicine as a way to get rich. There’s nothing wrong with that. But it doesn’t necessarily supply the country with a good health care system. In fact it hasn’t.

The US is well known to have very expensive health care areas mixed with much cheaper areas. All the studies that compare the health outcomes by region find absolutely no relationship between cost and the healthiness of the patients. This is true, of course, for the US as a whole: it has a very expensive system that produces moderate results at best.

So, if our goal is to reduce costs – as I believe it should be given the burden on GDP that health care already represents – and the market system cannot be relied upon to engender a cost efficient price regime, we are left with government intervention of some sort.

This should not be a surprise to anyone. The kinds of savings available in a government sponsored health plan are enormous: the actuarial pay offs from the scale of insured population alone make the system much cheaper than any conceivable private system, and the mass buying power of drugs will also drive prices way lower than they currently are.

So a government plan it has to be. Or at least there must be a government alternative on offer to help establish sufficient cost pressure to induce the other plans to adopt cost effective behavior.

Ultimately health care is a classic example of a product where market forces fail. This is not an ideological statement. It is a statement derived from the application of market type thinking.

So serious health care reform must incorporate a significant government presence.

The sooner we all learn that, the sooner we can discuss what the new system should look like.

Addendum:

The debate about a government sponsored health care option is bound to attract the attention of the ‘market magic’ school of thinkers. Gary Becker at the University of Chicago, and one of my personal least favorite economists, naturally wades in deeply. Among his points are that comparisons with foreign systems have to be made carefully. In particular we shouldn’t look at thing like life expectancy without taking into account the poor lifestyle of the average American: we eat too much, and what we eat tends to be bad, so we also tend to have slightly shorter life expectancies. Instead we should look at survival rates after disease detection. In this latter category he says that the US tends to look ‘pretty good’. Pretty good? I should darned well hope so. We spend a fortune more than anyone else. So being ‘pretty good’ is a pathetic return on investment.

Try harder Professor Becker.