Wednesday, September 28, 2011

Why "the market" has "failed" for health care...

There's something in this Washington Examiner editorial that is fundamental to the issue of health care in the United States. Fundamental, widely unknown and almost never publicly discussed.
Price signals, a staple of any functioning free market, have been muffled in health care, where third parties (insurers and the government) pay roughly 88 percent of health care costs, up from 52 percent in 1960. Because patients don't pay the bills, most of them have no idea how much services cost, let alone what they are worth. This leaves doctors and hospitals in a competitive vacuum where price and value bear little relation to one another.

When people talk about health care as a good for which the market doesn't work, and therefore the government needs to step in, they're completely missing the point that, for the most part, the market isn't working because it's been broken by the intervention of the government.

Q: Why do so many people have health insurance as a "fringe benefit" of their employment rather than purchasing an appropriate policy themselves?
A: Government intervention in the market.
While its origins can be traced back to 1929, when a group of Dallas teachers contracted with a hospital to cover inpatient services for a fixed annual premium, the link between employment and private health insurance was strengthened by three key government decisions in the 1940s and 1950s. First, during World War II the War Labor Board ruled that wage and price controls did not apply to fringe benefits such as health insurance, leading many employers to institute ESI. Second, in the late 1940s the National Labor Relations Board ruled that health insurance and other employee benefit plans were subject to collective bargaining. Third, in 1954 the Internal Revenue Service decreed that health insurance premiums paid by employers were exempt from income taxation.

Q: What is the consumer view of the price of health care services as fee-for-service is replaced by fee-for-insurance, with no direct costs associated with consumption of services?
A: The per-service price has dropped.

Q: On a demand curve, what happens to quantity demanded as price drops?
A: It increases.

Q: So, it's pretty clear that the transition to "insurer pays" theoretically increases demand for health care services. Has that actually happened?
A: Clearly.

Q: So, what happens in a market when quantity demanded increases?
A: Well, quantity supplied must increase to match it. Or there are going to be shortages.

Q: What makes quantity supplied increase?
A: Increased prices.

Q: But the increased prices would then cause the quantity demanded to drop, would it not?
A: Well, it would if the consumers were paying the service prices. But they are not. The purchasers of services are insurance companies and government agencies, not the consumers of those services. So the price goes up for the purchasers of health care insurance, but that price is disconnected from the price for the purchasers of health care services.

Price is a feedback mechanism. Price drops, quantity demanded increases and quantity supplied drops, until you reach an equilibrium, a point at which the price makes the quantities demanded and supplied the same. That's "the market" in action. But when the consumer of the services is not paying the cost of those services directly, there's no feedback mechanism, no incentive not to use the services. In fact, the incentive is opposite - "I'm paying for the insurance, the insurance will cover it, why not go do it?" Whether the "it" is an MRI for a migraine or an office visit for a cold or an emergency room visit for a muscle pull, if you're paying for coverage but not services, you're much, MUCH more likely to consume the services than if you were paying for them directly.

That's why it's infuriating to listen to people say that "the market doesn't work" in health care. There is no "market" in health care, and hasn't been for a long time. The consumers of services rarely, if ever, pay directly for services, so there are no direct controls on prices. And there's no price control on consumption.

And that's why Obamacare is a plan that moves in exactly the wrong direction to deal with the problems that we have. Our health care issues stem from rising demand for services, and the partisan plan that the Democrats rammed through last year does nothing whatsoever to curb that demand. It further increases the disconnect between the consumers of services and the payers of those services. The only conceivable result of that plan is forced rationing. Economically, there is no other option.

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