Month: October 2010

Does supply and demand work in healthcare?

[Update: This is one of my first posts on this blog, and it’s also one of my most popular. Too bad it’s a long post that isn’t the clearest. So here’s a shortened and clarified version.]

On Wednesday, I went to the Health System Reform Task Force meeting at the Utah State Capital building. I recently learned that most governmental meetings are open to the public, so you can go to them whenever you want! During the meeting, they often have someone present some kind of informational presentation to help them get a better idea of what’s going on in healthcare. Last month, a physician from Intermountain Health Care presented on prescription drug abuse in Utah. (It’s pretty bad, if you didn’t know. Actually, I think he said that Utah is the worst state for prescription drug overdose fatalities.) This month, a physician talked about some “demonstration project” he’s leading to improve pediatric care in Utah. It was pretty interesting, but the most interesting part was when he said the following: (These are direct quotes transcribed from the audio recording of the meeting.)

“Supply and demand, which in most markets works perfectly, doesn’t work so well in healthcare. The demand for healthcare really sees no limit, especially if cost is not a factor for the consumer, and that is the case, of course, in most third-party payment situations. But I think it’s also the case in situations where life is in the balance. It’s hard to put a limit on how much you’re going to demand. And also, I think consumers can’t adequately evaluate their options. Shopping around for a physician, shopping around for a surgeon is not easy. Shopping around for emergency care when you really need it is impossible. So the ability really to be a wise and educated consumer and make conscientious choices is difficult. And also the supply of physicians and providers is not driven by normal market forces. We see a lot of increasing specialization for reasons that aren’t necessarily fitting with the supply-demand curve. Specialization is driven by income, especially because specialists make considerably more in most cases than primary care physicians.”

This got me thinking, and I started evaluating his statements and typing notes on my phone. Then I was surprised when the senate chair of the committee challenged him on it after the presentation.

“I just had one comment, and maybe you could clarify if it was an intended comment. You mentioned in your presentation that supply and demand did not apply.”

Physician’s interjection: “I didn’t say it did not apply, I said it didn’t work, like it does in most markets. So, just to clarify your question.”

The Senate Chair continued, “Well, the comment I have on that is that supply and demand function, whether we want it to. It functions, it’s natural law, whether we want it to or not. We can try and interfere with it, but, a lot of the things, I believe I could demonstrate a lot of the problems you presented there are a result of interfering with supply and demand. And so, the idea that it doesn’t function and we can try and overcome it, I think that’s a basis for failure in the long run, that we’re just going to have to control healthcare more and more because if supply and demand is going to function, and its results are, the unintended consequences we’re trying to control. So we continue to regulate more and more. . .”

And the physician’s response, “I’m probably not sophisticated enough economically to speak to the question, but I hear what you’re saying and I agree.”

At this point, I almost raised my hand, walked to the microphone, and answered his question. I should have. But I wasn’t sure if I was allowed to do that, so I hesitated and missed the opportunity. That means I get to say here what I would have said there:

My honorable legislators, supply and demand carry with them a few assumptions. When those assumptions are violated, supply and demand don’t work as well as we would expect. Two key assumptions are violated by our current healthcare system. The first is that consumers have price/quality information so they can shop around for the best value. The second is that consumers actually pay the price of what they buy.

The First Broken Assumption. Let’s think about an example of digital cameras. Without important information like how much a camera costs or how many mega-pixels it has and how many times zoom it can do, how do consumers choose the best value? They can’t! And thus, there’s not much incentive for camera manufacturers to take risks to improve cameras because it won’t help them make more money. Innovation is stifled without that incentive. To bring this back to healthcare, why would a doctor’s office make an innovation like install an electronic medical record that would temporarily disrupt process flows and require a large upfront cost if it won’t help convince more patients to come?

The Second Broken Assumption. This is a tricky one. Yes, consumers pay the full cost for their healthcare–they have already done it through insurance premiums or reduced salary. But they don’t see that full price directly like it’s coming straight out of their wallet, so they don’t perceive that they’re paying the price. Thus, they don’t care so much what the price is. This inflates demand in a big way! Think about the man whose father is about to die. He’ll tell the doctor to do whatever it takes to keep the father alive, but how willing would he be to do that if the man knew he was going to have to pay $600,000 right out of his own bank account?

That’s what I would have said. It’s almost exactly what the physician said, but I don’t think he understood it quite well enough to realize that the things he was talking about were actually just the broken assumptions of supply and demand in healthcare.

After I thought this, I understood a part of the health bill in an entirely new light. It’s requiring states to form these “health insurance exchanges” that are essentially websites that list all the state’s available insurance plans, their prices, and their benefit packages. What will this do? Help people know prices! Help people know value! It’s a way to solve the first broken assumption.

There are many critics of “market-driven healthcare.” They say it has never worked in the U.S., so how can advocates of it be so ridiculous? Well, I guess now we know why it has never worked, and now all you conservatives can understand your argument for less government in healthcare, assuming (as does the Senate Chair for the Health Reform Task Force) that it’s the government that is causing those assumptions to be broken.

Innovation, Infrastructure, and a Bankrupt Government

Since I’m on the topic of healthcare costs lately (and will be for a while, probably), I’d like to talk about the potentiality of healthcare spending bankrupting our national government. Is it possible? I don’t really know, but that’s obviously the worst-case scenario with all this crazy spending we’re doing. I’ve heard a number of different quotes that say effective, cost-curve-flattening health reforms would solve virtually all of the federal government’s fiscal woes. At 18-ish percent of GDP, that’s not that hard to believe.

But there is a little-known upside and a somewhat-known upside to huge amounts of spending.

The somewhat-known upside: innovation. Yes, America’s health system is best known for more than just spending. It’s the source of more healthcare innovations than anywhere else. So maybe that means we’re just subsidizing the world’s cures to . . . everything. This aspect of our system is what I always think about when I wonder how we could reduce spending, because if we reduce spending at the expense of the strong incentive to innovate, is that a net positive or negative?

The little-known upside: infrastructure. Yes, investors follow the money, and why do you think the United States has the nicest hospital facilities and technologies in the world? There’s money in healthcare! This health infrastructure might be the best thing that ever happened to healthcare in the U.S., because it will keep on giving after we’ve found a way to spend less. Think of the internet bubble. Remember how this country spent tons and tons of money on the internet in the ’90s, and then there was that huge stock-market crash? Well, most people probably don’t know that, even after that huge crash, we now have tons and tons of fiber-optic cable all over our country. That infrastructure is said to be one of the leading factors that allowed the internet to grow as fast as it did in the U.S., probably helping us maintain a world-power economy in the midst of huge changes in the structure of business. So a long-term upside to crazy health spending is the infrastructure that it gives us.

I guess what I’m saying is, yes, we’re spending a ton of money on healthcare, but we are also reaping some benefits too, namely innovation and infrastructure. So here’s the final question: Do we think it’s better to have healthcare innovation and infrastructure or a fiscally solid federal government?

Kinds of Healthcare Costs

I learned that there are two kinds of medical costs, broadly categorized: care costs and managerial costs. They’re kind of self explanatory, don’t you think?

The interesting thing about the U.S. healthcare system is that I’ve never seen an aggregate percentage estimate of just how much of our total healthcare spending (you know, that 18-ish percent of GDP) goes to managerial costs. Maybe some health economist has come up with that number somewhere, but I haven’t seen it. Think about it–you would have to estimate and add the total managerial costs of Medicare, Medicaid, the private insurance sector, CHIP, the VA system, the system for congress and for those with kidney failure and for native Americans. . . . Sounds fun. Other countries have anywhere between 2 to 5 percent estimates for their total managerial costs.

What I have heard, though, are estimates for the total managerial costs of Medicare (2 percent) and the private insurance industry (20 percent). You’d think the 2 percent is awesome and the 20 percent is horrible. Well, the 20 percent is horrible, but not bad considering they’ve got to spend so much money on screening applicants and trying to find ways to deny claims and developing thousands of new compensation plans and payment schedules and paying awesome executives. (It is the private sector, after all.)

And as for the 2 percent, I think it might be a little too low. Maybe a little more spending on managerial stuff could go towards ways to prevent fraud, cause apparently that’s a pretty big thing with Medicare. So maybe every extra dollar of fraud prevention would save a few dollars of fake claims, up to a point. That would maybe leave the Medicare number up around 3 percent, which is still not too bad. Unless you don’t trust government’s estimates of their own efficiency. They want to look good, right? Number-fudging isn’t that hard to do, especially with something so complex as healthcare.