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The Unhappy Marriage of Economics and Health Care

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America's health care system is collapsing, and we can blame the Economics profession. Most economists approach health care in the wrong way, viewing it as a commodity

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JL A (281)
Thursday May 16, 2013, 11:01 am
The Unhappy Marriage of Economics and Health Care

May 7, 2013 by Healthcare-NOW!

By Gerald Friedman –

America’s health care system is collapsing, and we can blame the Economics profession. Most economists approach health care in the wrong way, viewing it as a commodity like shoes or the laptop on which I write. Instead, health care is an idiosyncratic commodity, subject to uncertainty and “asymmetric information” leading to destructive behavior. Trying to force health care into a box, treating it like other commodities, economists have promoted cost sharing, market competition, and insurance oversight of health care providers that have inflated the administrative burden while denying ever more Americans access.

Health care spending has been rising throughout the world as aging and more affluent populations spend on their health. Nowhere, however, has the cost of health care risen as fast as in the United States where costs soared because of rising administrative expense. Compared with other affluent countries in the Organization for Economic Cooperation and Development (the OECD), the United States spends over twice as much per person as is spent elsewhere. Before 1971 when Canada enacted its Medicare program, a single-payer government funded health care system, Canada spent a higher share of its national income on health care than did the United States; since then, however, while Canada has controlled costs, spending has soared in the United States so that we now spend over $3000 more per person. That is $12,000 for a family of four that is not available for travel, education, housing, or food.

Elsewhere, increases in health care spending have been associated with improvements in the provision of health care and, therefore, go with increasing life expectancy. In the United States, however, spending has increased because of rising administrative costs and increases in the price of prescription drugs and, therefore, has yielded relatively few benefits in improvements in care. Comparing changes in health-care spending and life expectancy between 1971 and 2008, other affluent OECD members gained a year of life expectancy for every $453 in spending; in the United States, however, life expectancy has increased less and spending has risen sharply more so that each year of increased life expectancy has cost over twice as much as in these other countries. Health care spending in the United States has increased by $1283 for every additional year of life expectancy; had our spending per year of added life increased at only the rate of other countries we would be spending over $4500 less per person, $18,000 saved for the average family of four. Most of the difference in relative expenditures, most of the growing waste in spending in the United States, is due to increasing administrative costs in the provision of private health insurance and in the billing and insurance operations within doctors’ offices and in hospitals. The average physician in the United States now spends four-times as much interacting with insurance companies as does the average physician in Ontario, Canada, over $80,000 per physician compared with a little over $20,000 in Ontario. Prescription drug prices and administrative expenses have been the fastest rising costs in the United States health care system; from 1980 to 2005, administrative costs rose by 1300% while drug prices rose by nearly 2000%. There are now 2.5 million administrative support personnel in the American health care system; more than the number of nurses, and five times the number of physicians. We now have more health-care managers than physicians and surgeons.

Rising costs drive up health insurance premiums so that a family health insurance plan now costs about 40% of the average family wage income, up from 7% in 1960. Rising costs are denying ever more Americans access to health care even while businesses and governments wrestle with rising health care spending that squeezes resources available for other purposes. While other countries have controlled health care costs by restraining administrative expenses and drug prices, ballooning costs in the United States come from policies promoted by economists who have urged governments and providers to control costs by making consumers responsible for more of the costs even while raising administrative costs and ignoring monopolistic pricing of pharmaceuticals. Viewing the injured, sick, and disabled as “consumers,” economists see insurance as the source of rising costs because they are not responsible for the costs of care they receive and, therefore, overuse health care. Rising copayments and deductibles are intended to discourage “consumers” from “abusing” health care, as if the victims of auto accidents or cancer should shop around for cheaper, and competition among insurers while limiting provider services by providing more administrative supervision. Ignoring evidence that Americans are less likely to see doctors and other health providers than are residents of other affluent countries, these economists have blamed the high cost of our health care on insurance which, they assume, leads to wasteful over-practice and the provision of unnecessary health care services. Their solution is greater cost sharing, more regulation of providers, capitation, and even the end to insurance by substituting medical savings accounts for insurance.

For 40 years, many economists’ have promoted increasing cost sharing through higher copayments and deductibles, the replacement of fee-for-service payment systems with capitation where providers are paid a fixed amount for patients as in Health Maintenance Organizations, and competition where multiple insurers offer a variety of plans catered to individual consumer’s interests and in competition with each other. Far from limiting health care cost increases, these practices have produced the worst of all worlds, rising costs along with restrictions on access. Costs have risen because these recommendations have inflated the administrative burden in health care, the costs of the billing and insurance activities within provider offices as well as the cost of the health insurance industry itself. While restricting access, limiting the benefit to Americans of some of the dramatic improvements in health care practice of the last decades, these practices have not bent the cost curve or slowed health care inflation even while denying more and more Americans access to affordable health care.

The failure of price incentives and competition to control health care costs could have been predicted had economists appreciated that health insurance is not a commodity and the sick are not consumers like those shopping for the best pair of sandals or brand of peanut butter. Producers of commodities might try to accommodate consumer wishes because they can profit by selling more. Health insurers, on the contrary, can better increase their profits by selling less, by identifying people likely to need care and driving them away (“lemon dropping”) even while attracting the lucky and healthy (“cherry picking”). Most health care expenditures go to a relatively few people, the unlucky who develop an illness or suffer an accident; insurers, therefore, can dramatically lower their costs by finding those who will be expensive and getting rid of their business; encouraging them to find another insurance plan or even to die.

A form of “adverse selection,” or screening of potential customers by insurance companies, can be profitable for the individual firm but it comes at the cost of raising costs for the community as a whole. As a country, we now spend almost $200 billion administering the health insurance industry and over $800 billion in administering the health care industry, or over a quarter of total spending. Add to this the inefficiency in delivery that comes from a fragmented finance system that inhibits coordination of care, and the inflated prices for prescription drugs, and easily a third of total spending is wasted or going to monopolistic profits.

The waste involved in the current system has a redeeming feature: it provides abundant space for an improved system that could improve access and services even while dramatically lowering costs by eliminating administrative waste. If we lowered administrative costs and drug prices to the Canadian level, we could save nearly $600 billion dollars, more than enough to provide coverage to all of the uninsured while improving access for the millions of underinsured. If we see past the bad recommendations of market-fundamentalists, we can improve health care and save money. An outcome that even economists should favor.

Gerald Friedman Professor of Economics University of Massachusetts at Amherst, Amherst, MA. 01003

Professor Friedman has written extensively on single payer health care and HR 676. His article explaining the economics of single payer is available here:

mag.w.d. Aichberger (34)
Thursday May 16, 2013, 1:26 pm
On the other hand: a perfect marriage !

(Whasscalled) "The Economy" being not-at-all economic and often outright anti-economic, and a $y$tem of 'making money' from producing/dealing-with/'treating'/managing sicknesses called "Health Care"

JL A (281)
Thursday May 16, 2013, 1:30 pm
You cannot currently send a star to Frack because you have done so within the last day.

Roger Skinner (14)
Thursday May 16, 2013, 6:11 pm
"Economics profession"? How about just Capitalism? For-profits have been taking over medical care for decades, with exorbitant profit margins. People always need healthcare and will spend just about anything to get well and stay alive.

Stephen Brian (23)
Thursday May 16, 2013, 10:09 pm
Economists are correct, within the limitations of their economic theory. Health care is a commodity, though a highly inelastic one like food or energy. Without a growth in supply, price will go up with demand, and demand is based not upon the consumer's wealth, but upon the wealth available to the consumer to use. (This is also the reason why many people believe that the availability of student-loans has driven up tuitions.) Reducing the available funds for low-cost expenses would reduce the overall number of transactions, freeing up resources in healthcare. There are hypochondriacs and self-diagnosing "wiser-than-the-doctor" patients who abuse the system where they have little incentive not to do so, and these drive up the cost of healthcare. Defensive medicine, where doctors prescribe unnecessary tests, ties up the U.S. system to an incredible degree, drives up costs, and can be countered by giving patients incentives to avoid such tests.

All that said, the economists are still wrong because there are answers which lie outside of the usual constraints of macro-economics, which do not consider internal business-practices of companies, and the problem is on a scale not normally considered in micro-economics, which tends to focus on individual businesses. (Economists tend to focus their work in one of those two sub-fields, and generally get even more specialized within them.) The profit-model of insurance-companies, and theor overall structure, assume something which is not true for healthcare, that claims are generally large and rare. Responding to this assumption, they verify every claim carefully. Where claims are large this is necessary, and where they are rare this is not overly costly. Payment-intermediaries and consumers' collective bargaining-groups are better suited for "insurance" for general check-up and visit, and for medication. Not being oriented towards checking, they would have much lower overhead, and as fraud is more difficult with large numbers of claims and less damaging with small ones, the reduction in overhead may well more than balance out the damage from fraud. However, for more expensive hospital-stays, series of tests, operations, etc. an insurance-based system may still be best, especially if companies refuse to pay for tests which are not recommended under normal medical guidelines (unless they could be proven useful or necessary for the case).

Past Member (0)
Friday May 17, 2013, 4:22 am
Money can't buy everything

Eternal Gardener (745)
Friday May 17, 2013, 4:45 am
Maybe they should have a divorce, and both try to embrace common sense instead...

. (0)
Friday May 17, 2013, 6:04 am
Very interesting. Thanks for sharing.

Jaime Alves (52)
Friday May 17, 2013, 7:15 am

JL A (281)
Friday May 17, 2013, 8:11 am
Most western countries have chosen to not have health care be a commodity at all for the sake of the greater good and public good.
You are welcome Laura and Jaime.
You cannot currently send a star to Eternal because you have done so within the last day.
You cannot currently send a star to Fi because you have done so within the last day.

Theodore Shayne (56)
Friday May 17, 2013, 9:09 am
Noted. Everything's a commodity today including you.

JL A (281)
Friday May 17, 2013, 12:38 pm
You cannot currently send a star to Theodore because you have done so within the last day.
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