The Left’s Misdiagnosis of U.S. Health Care

You’re unlikely to get a patient’s prescription right if you haven’t properly diagnosed the illness you’re trying to treat. Predictions both rosy, catastrophic, and everywhere in between have issued forth from supporters and opponents of the recent health care reform bill. The truth is that economics is not a precise, predictive science, and we simply don’t know what the medium-term consequences of the bill will be. But we do know that if the bill’s treatment of the ailing U.S. health care payment system is based on a faulty diagnosis, it is likely to fail. So let’s be good empiricists and look at the evidence: What is wrong with U.S. health care payment system, and are these problems rationally related to the solutions offered by supporters of a government regulatory takeover, whether Obamacare or something more radical like single payer? Virtually everyone agrees that rising health care costs are the main problem we need to address, but why are health costs rising so much?

Any argument for government intervention must depend on showing that any health care payment system suffers from market failure. Market failure comes in essentially two varieties: public goods and market power.*

Public goods are goods that have to be provided for “everyone” if they are provided to anyone. You can’t find ways to exclude non-payers – thus, strategic customers will not pay even if they want the good, and the good isn’t provided. Everyone is worse off. Public goods include externalities, the tragedy of the commons, etc. Is health insurance a public good? Probably not. The left’s main complaint about market-provided health insurance is that those who cannot pay are excluded from it. However, during the course of the health care debate, supporters of the Democrats’ plan argued that health insurance was a public good, mainly because people who do not have insurance can obtain emergency care anyway and impose costs on others (“uncompensated care”). Therefore, everyone would be better off if everyone were forced to obtain health insurance.

To this argument there are three main responses: 1) uncompensated care represents no more than 3% of health care expenditures, so it cannot be responsible for much of the escalation of health care costs; 2) the rational solution to uncompensated care is not forcing everyone to buy insurance, but forcing everyone who can pay to pay for the care that they actually receive, for instance through wage garnishments; 3) even if #1 weren’t true, and #2 weren’t feasible, at most this argument would justify forcing people to obtain coverage for emergency care, but Obamacare essentially prohibits high-deductible, emergency-only plans! (See also here.)

What about market power? Economic theory predicts that monopolies – and maybe oligopolies too – will raise prices to the consumer and reduce the quantity of service. Health care prices have risen, but is there any more direct evidence of market power in health insurance?

We can look at profits. Monopolies should be able to reap profits well above the norm for most industries, because they enjoy monopoly power only due to the inability of other firms to enter the market. According to Henry Aaron at the liberal Brookings Institution, “Insurance company profits in the large picture have very little to do with the overall rising cost of health care.” Insurance companies’ profit margins tend to be under 5%, right about average for the American economy as a whole. In most states (those that have not regulated the industry to the brink of expiry), the health insurance market is competitive.

So why have health insurance costs risen so much? Because health care costs have risen so much. What does Obamacare do about health care costs? Almost nothing. Instead, the bill forces insurance companies to take all comers (guaranteed issue), forbids them from pricing risk (community rating), and gives the federal government review over their prices (price controls). These policies might make sense if the main problem with U.S. health care were market power in the insurance market, but it isn’t, and so they don’t.

Obamacare makes no economic sense. It should be repealed and replaced with true, consumer-powered reform that will force doctors and hospitals to reduce their prices.

*Allow me to quickly dispense with a third set of problems that really don’t count as market failure, because they don’t actually lead to socially suboptimal outcomes in competitive markets. I’m referring to moral hazard and adverse selection, which afflict finance and insurance markets in general. When a person is insured against a risk, that person is more likely to engage in behavior likely to actualize that risk (moral hazard). When insurance is offered, more risky persons are more likely to seek it out (adverse selection). But all insurance and financial markets have ways of dealing with these problems, from credit checks to claims adjustment. If you really thought these were insuperable problems requiring massive federal intervention, then you would also advocate this same intervention in, say, auto and homeowners’ insurance. But no one does.

8 thoughts on “The Left’s Misdiagnosis of U.S. Health Care

  1. This is funny. I keep reading about how you conservatives BELIEVE that competition will improve prices and service. But your own arguments put you squarely against that idea, as does your party’s opposition of the Health Care Bill; as did the Bush Administration’s telco policy.

    No matter how you may lawyer about it, we both know health care competition’s limited, prices are uncompetitive, and service terrible. ]So, just remember, if you want good capitalism, just vote Democrat…..

    It’s extra-funny because this’ just v2.0 of the bipartisan Romneycare that a GOP governor took credit for. It’s not like there’s even a public option…

  2. This is funny. I keep reading about how you conservatives BELIEVE that competition will improve prices and service. But your own arguments put you squarely against that idea, as does your party’s opposition of the Health Care Bill; as did the Bush Administration’s telco policy.

    No matter how you may lawyer about it, we both know health care competition’s limited, prices are uncompetitive, and service terrible. So, just remember, if you want good capitalism, just vote Democrat…..

    It’s extra-funny because this’ just v2.0 of the bipartisan Romneycare that a GOP governor took credit for. It’s not like there’s even a public option…

  3. But your own arguments put you squarely against that idea

    I really don’t see where “opposing competition” comes out of my argument here.

    as does your party’s opposition of the Health Care Bill

    I’m actually neither a conservative nor a Republican.

    we both know health care competition’s limited, prices are uncompetitive, and service terrible.

    The post did note that health care costs are too high and rising too fast. But what does regulating health insurance have to do with solving a health care cost problem?

  4. I’m sorry – I wrongly misjudged you must be partisan pro-GOP to be grumbling about that bill.

    Yet, nobody likes that bill, except maybe Levin or Reid. I don’t like it myself because I want a public option, a shorter bill with less pork and fewer specific new regulations and a few other things that weren’t even on the table.

    I was around for the AT&T breakup. It worked far better at cutting long-distance cost than I ever expected. Official profit doesn’t say much because profitable companies tend to raise salaries, benefits and other expenses. To its credit, AT&T spread its wealth pretty well beyond its execs.

  5. I agreed with the breakup of AT&T, but AT&T was a monopoly – a legally guaranteed, regulated monopoly. In that case it was rate caps that kept their official profits normal-sized, although they had unusual profit stability and, as you say, high salaries and benefits. But in health insurance we don’t have rate caps right now, so that can’t explain the normal-sized profits there. (The new bill does put “rate caps lite” into place – federal review of all rate increases.)

  6. Fascinating point about emergency-only coverage. A few persuasive (in my estimation) arguments for intervention that I’ve heard elsewhere but haven’t been addressed here:

    – The insurance industry might not have outsize profits, but it has enormous overhead costs (specifically, compared with Medicaid, the VA, etc.) incurred by trying to wriggle out of paying insurance claims. This behavior reflects an information-asymmetry market failure, and more importantly is yet another piece of empirical evidence that healthcare is a rare realm in which govt-administrated systems are actually more efficient.

    – Doctors oversubscribe treatment because it makes them money. In theory market competition should take eliminate this, but because of information asymmetry, it doesn’t.

    – More generally, individual health-care consumers don’t have the expertise, time, or information to distinguish between doctors which oversubscribe and those who don’t, or between insurance providers which will try to trick them and those who won’t. Centralized regulation or at least an impartial, public-interest-minded provider of information (a role I’d argue only the government can fill) is necessary to correct for this inefficiency.

  7. * Medicaid keeps costs down by paying doctors a pittance and not even bothering to check whether treatments are medically necessary. My wife has had a lot of medical problems, and she has noted that whenever a Medicaid patient wants an MRI, he can get it. There’s no oversight. Of course, all these costs are essentially paid by everyone else in taxes and in higher insurance & costs for health care.

    * To the extent that overprescription is a problem, it is only a problem because patients have abdicated their responsibility to take charge of their own care. And why have they done that? Because insurance now covers almost all of the costs of almost all routine procedures – patients have no financial incentive to question a doctor’s recommendation. Repeal the insurance mandates that require comprehensive coverage, and then watch patients start to take charge of their care – as they should. Medicine is generally not so complex that patients can’t do their own research to assess whether their doctor is honest & competent or not. My wife has seen it time & again in cancer care: patients who actually do the research get better care than those who just follow their doctors’ recommendations. Do you think government is going to limit doctors’ overprescription of care? Think again! Instead, they’ll just pay doctors less and wash their hands of the rest.

    * If government could solve asymmetric info problems better than health insurance companies & patients can, then why not nationalize auto repair shops, general contracting, used car sales, restaurants, and legal representation? Asymmetric info happens in many industries, and people figure out how to deal with it.

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