Unique economics of health care

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I was prompted to write this follow-up on health economics after seeing a recent post by blogger Noah Smith, who weighs in with some reasonable views after some intense criticism of the ‘freakonomic’ Chicago-boy Steven Levitt. In a meeting with UK PM David Cameron, Levitt and his co-author apparently made some rather absurd remarks about health care.

They told him that the U.K.’s National Health Service — free, unlimited, lifetime heath care — was laudable but didn’t make practical sense.

“We tried to make our point with a thought experiment,” they write. “We suggested to Mr. Cameron that he consider a similar policy in a different arena. What if, for instance…everyone were allowed to go down to the car dealership whenever they wanted and pick out any new model, free of charge, and drive it home?”

Rather than seeing the humor and realizing that health care is just like any other part of the economy, Cameron abruptly ended the meeting…

This nonsense reminds me that what constitutes economic debate in the US is often laughable at best.

Health care is obviously not like most other parts of the economy. As I said last week medical services are credence goods – goods which we don’t know whether we need, and even once we’ve consumed them, still don’t know if they were good value. In economic terms, these goods suffer from the worse of possible information failures, particularly with respect to the asymmetry of information between the seller (in this case the doctor) and the consumer.

For these goods the demand curve may slope any which way, and people are often left to use price as the only signal of quality (or quantity for that matter). This means that a socially optimal level of medical service provision cannot be determined using basic marginal economic analysis.

Not only that, but there are substantial positive externalities to most health care services. Vaccinations are the obvious example, but the same principle applies more broadly.

Once you’ve accepted that health care and medical services don’t fall neatly into preexisting economic models, you need a better way to think about the potential efficiency of any health care system. Rarely is this step taken in public debate.

One way to assess any health system is in terms of the two main sets of incentives – those of the patients, and those of the medical service providers (doctors and suppliers of medicines, equipment and accessories).

We often hear about the patients, with the archetypal case of the lonely hypochondriac making a few extra trips to the GP or emergency department when the service is provided free of charge. Sure they exist, but as I’ve said before, pricing these visits deters both the time-wasters and those with genuine medical needs. Making prices for patients reflect production costs in health care systems has the benefit of reduced health expenditure, but comes at a cost of poorer health outcomes.

But in general no one wants major medical services even at a zero price. Here’s a comment from Noah’s blog making that point

Most medical treatments are painful, unpleasant, and time consuming, and are only desired when non treatment is worse. While making treatment costly will deprive some of access, it will do little to make treatment more undesirable than it already is.

On the other side of the ledger we have the incentives of doctors and other businesses involved in the supply of medical services – drug companies, suppliers of medical equipment and so on.

Here there are usually financial incentives to over-treat or over-prescribe. As just one example, new evidence from Australia’s two-tiered system shows that in private hospitals there are more medical interventions for low-risk births than in public hospitals.

Indeed, there is some evidence of these interacting incentives following the announcement of the $7 GP co-payment in the Australian federal budget. Some medical centres have been text-messaging patients to remind them that they are not charging fees, possibly due to lower patient numbers. On display is the doctor’s incentive to earn a living providing medical services, interacting with the uninformed patient reacting to a price that doesn’t even exist yet.

As a final point, we rarely hear about the monopsony buying power of the single medical provider which can be significant. A single national (or State level) healthcare entity is in quite a position of power in negotiating supply contracts when they are the only game in town. In the world were drug companies a heavy political hitters, having incentives within the government to reduce drug costs to economise on health spending seems an important consideration.

If we are going to have an intelligent debate about efficient health care we have to remember three key points

  1. We must consider benefits as well as costs (including externalities)
  2. There are serious moral judgments necessary about the scope and priorities of health care
  3. Medical services are credence goods, hence there are unique incentives at play

Comments

  1. That is an informative analysis. The US system is a problem because all the political and regulatory pressure on private providers has been to hold them responsible for any failure to provide gold-plated, 100% diagnosis and treatment. All the pressures are in the direction of cost inflation, including in the drugs and treatment development sectors.

    But the common alternative, a state-run taxpayer-funded public system, always ends up rationing provision of services and interventions, and entrenching operating inefficiencies because of the absence of commercial imperatives.

    It is a mystery to me why “third way” proposals seem to be regarded with such suspicion by the voting public. My own experiences with a public health system has led me to believe that “cradle to the grave free health care” is the biggest and most successful ever insurance fraud. No private business or cabal could have got away with what it does. That is, it takes your tax money – a lot of it – with a certain vague promise that you will be looked after better than those evil private sector capitalists would; then when you need the help you might as well be in a bread line in a former Soviet economy. And numerous health interventions are not funded at all, leaving you either debilitated for life or impoverished by ongoing costs of paying your own way for treatment outside the public system.

    • migtronixMEMBER

      No private business or cabal could have got away with what it does

      That’s a load of crap, ever heard of 3rd party?

    • drsmithyMEMBER

      But the common alternative, a state-run taxpayer-funded public system, always ends up rationing provision of services and interventions, and entrenching operating inefficiencies because of the absence of commercial imperatives.

      Private systems have the same problems.

      History has demonstrated, comprehensively, that publicly funded healthcare delivers the best overall outcomes.

      That is, it takes your tax money – a lot of it – with a certain vague promise that you will be looked after better than those evil private sector capitalists would;

      No, it promises universal access.

      On average it ends up providing better care than “evil private sector capitalists”, because some medical care is better than none.

      then when you need the help you might as well be in a bread line in a former Soviet economy.

      In which country ?

      How does being in a “bread line” compare to not getting any care at all ?

      And numerous health interventions are not funded at all, leaving you either debilitated for life or impoverished by ongoing costs of paying your own way for treatment outside the public system.

      For example ?

      • migtronixMEMBER

        That’s rubbish too history proves no such guide, the idea that the NHS delivers better outcomes in every case is utter tosh!

        You go too far in defence of a worthy cause here sir.

      • drsmithyMEMBER

        That’s rubbish too history proves no such guide, the idea that the NHS delivers better outcomes in every case is utter tosh!

        Nor did I say it did.

        You go too far in defence of a worthy cause here sir.

        No, you are burning a straw man. As usual.

      • migtronixMEMBER

        Sorry I meant in terms of medical practice – ie coronary or angio or oncology – they are not overall better served via universal and rationed care.

        No strawman just a misunderstanding. As usual.

      • drsmithyMEMBER

        Sorry I meant in terms of medical practice – ie coronary or angio or oncology – they are not overall better served via universal and rationed care.

        Firstly, private care is also “rationed”.

        Secondly, they are, because a privatised system provides no attempt of universal access, and a public system does not prevent those with the means to pursue private care if they desire.

        Some care is better than no care.

      • Breadline anecdotes? My GP referred me to an allergy specialist around April last year. When I called to book an appointment I was told the first available slot was in September. That seems pretty breadliney to me. And we live in Canberra, which is not exactly remote and rural or anything like that.

        And as for unfunded interventions, when I eventually saw the allergist and then an ENT guy, the total cost of two short visits was nearly a grand. Those medical specialists have definitely got things well sorted.

        And my wife required surgery two years ago. Despite having paid tens of thousands of dollars into the public health system over the years, we still had to hand over more than $5000 in direct fees. That’s a pretty substantial wedge, and it hurt us financially.

        Our public health system is pretty good, but there’s some truth to what PhilBest says.

      • With regard to specialists who are very adept at managing supply using claims re ‘quality’ to maintain pricing power.

        Entrance requirements to a speciality must apply to all existing members of that speciality on a regular basis.

        By making existing members of a speciality re sit the entrance exam – say every 5 years – we will have more confidence that the entrance exams involve what is important to actual practice rather than a hurdle designed to operate as a barrier to entry.

        The colleges will not set exams that current members cannot pass.

        Service provider ‘cartel’ pricing is an excellent place to start if the cost of health care is considered excessive.

      • migtronixMEMBER

        Firstly, private care is also “rationed”.

        Not if you pay its not! What are you talking about? If I pay to keep a personal doctor on hand who is going to ration that?

      • drsmithyMEMBER

        And as for unfunded interventions, when I eventually saw the allergist and then an ENT guy, the total cost of two short visits was nearly a grand. Those medical specialists have definitely got things well sorted.

        And my wife required surgery two years ago. Despite having paid tens of thousands of dollars into the public health system over the years, we still had to hand over more than $5000 in direct fees. That’s a pretty substantial wedge, and it hurt us financially.

        And if it was twenty grand, or if you earned half as much as you do, would it have looked like a “bread line” or being homeless in an alley begging for change ?

        Our public health system is pretty good, but there’s some truth to what PhilBest says.

        There’s not, because he assumes under a private system accessibility would remain unchanged, which is supported by neither theory nor evidence.

      • drsmithyMEMBER

        Not if you pay its not! What are you talking about? If I pay to keep a personal doctor on hand who is going to ration that?

        FFS, are you really this dense ?

        It’s rationed by your ability to pay. If you can’t afford care, you don’t get any at all. Not you don’t get care immediately, or you don’t get AAA+ care in your own private ward with nightly blowjobs from the nurse. You don’t get care AT ALL.

      • disco stuMEMBER

        Pfh007,

        you have pretty much hit the nail on the head with regards to where the 3rd way model, of combined private and public, is falling down in Australia.

        Basically it is the same ole rent seeking opportunity being deployed by the AMA that is used by the Taxi industry and their license plates.

        The AMA control the specialist medical colleges, and have absolutely no interest in allowing in sufficient numbers of new entrants that may in any way moderate the extreme incomes of their existing members.

        The Govt, typical in its pandering to vested interests in this country, handed over the administration of these colleges to the medical profession, and the result is, lots of relatively low paid doctors struggling to be admitted to a speciality college, and a few high paid specialists, picking and choosing was to who gets in. Take Bone surgeons for instance – as well as wearing the correct old school tie, you have to practically submitted to being the squire for some existing medical bone lord and specialist for years, before they’ll accept you into a college program.

        In ‘socialist’ Scandinavian, if there is a shortage of specialists in some area, the Govt increases places in whatever college and the shortage is dealt with. The result is they have lots of highly qualified doctors on very good high incomes, but not the astronomical million dollar incomes that the quango specialists in Australia command.

        A simple legislative change, requiring existing specialists to be compelled to retake these exams every 5 years, would see many new entrants to these specialist fields, with absolutely no reduction in the quality of the service provided.

        Indeed, it may even be possible to get in to see some of these guys, before you die in their waiting rooms.

      • migtronixMEMBER

        You don’t get care AT ALL.

        Exactly! That’s not rationing! Its not me being dense FFS.

        Rationing means “everybody gets some part” and hey! here are some rules we’ve drawn up earlier for deciding who does and doesn’t! Ijiot

        EDIT: @DiscoStu absolutely my man, its rent seeking and a brand new merc every year when you join the club…

    • “But the common alternative, a state-run taxpayer-funded public system, always ends up rationing provision of services and interventions, and entrenching operating inefficiencies because of the absence of commercial imperatives.”

      What a load of crap.

      Under the NHS i never heard of someone not getting something they truly needed .. perhaps they had to wait a while, but they got it.

    • That is, it takes your tax money – a lot of it – with a certain vague promise that you will be looked after better than those evil private sector capitalists would; then when you need the help you might as well be in a bread line in a former Soviet economy.

      Such a common complaint (long waiting lists), but where is the data?

      What do you have to say about Rumple’s point RE: the monopoly power of a single payer system to get better prices for medicines and healthcare equipment?

      • I was not disputing the good points of the single payer system, only that its advocates fail to grasp its bad points.

        If the government could get certain interventions done cheaper by private hospitals than what they have worked out it is costing in the public system, why not do it this way? NZ was moving in this direction but the Clark socialists killed it, promising to fix the public system. They had nine years, and……?

        The fact that the public system is totally devoid of any sort of cost accounting is a scandalous betrayal of the taxpayer’s interests. Nobody even gets to know that interventions done by the public system actually cost more than simply paying a private hospital or specialist to do it, simply because the public system is so inefficient.

        It is always noticeable how the true believers in “government can be more efficient than the private sector” always come to the fore in discussions like this. Utter rubbish. Otherwise people on wait lists would not be paying out their own money to get an op “done private” right now before they die.

        It is a perennial problem, parallel to the inherent problem with Communism. In creating equality of access by adopting a Statist monopoly model, you always reduce the average quality of services and/or goods.

        My solution would be to have a public system, but make health insurance tax deductible (up to a limit), AND make private health interventions ALSO tax deductible whenever the private system was able to offer it earlier than the public system and within an acceptable cost level, honestly taking the true cost in the public system as a benchmark.

        I would also make a lot more health services and interventions tax deductible, than what the public system now does not fund at all. Massage therapy for sufferers of arthritic and myalgia conditions, for example. The point of tax deductibility is to reward people who stay in the workforce and do their best to “help” their own condition. The status quo of “no help” except a sickness benefit if you stop working altogether, is all wrong.

      • drsmithyMEMBER

        I was not disputing the good points of the single payer system, only that its advocates fail to grasp its bad points.

        Now there’s some irony.

        The fact that the public system is totally devoid of any sort of cost accounting is a scandalous betrayal of the taxpayer’s interests. Nobody even gets to know that interventions done by the public system actually cost more than simply paying a private hospital or specialist to do it, simply because the public system is so inefficient.

        Evidence ?

        It is always noticeable how the true believers in “government can be more efficient than the private sector” always come to the fore in discussions like this. Utter rubbish.

        Like the “true believers” who believe that the private sector is always more efficient ?

        Otherwise people on wait lists would not be paying out their own money to get an op “done private” right now before they die.

        Non-sequitur.

        It is a perennial problem, parallel to the inherent problem with Communism. In creating equality of access by adopting a Statist monopoly model, you always reduce the average quality of services and/or goods.

        Only if you ignore the people who are excluded if equality of access is removed.

        No care is infinitely worse than average care.

        The point of tax deductibility is to reward people who stay in the workforce and do their best to “help” their own condition.

        Ah yes, that core Libertarian article of faith that only the shiftless and lazy are unemployed.

        People who stay in the workforce are rewarded by not being poor. You don’t need to further incentivise them with direct or indirect threats of harm, despite the ardent beliefs of right-wing sadists.

    • Ronin8317MEMBER

      The ‘consumer’ (i.e. the patient) is not in a position to know what is needed. In a private health system, the doctor can abuse this to extract money. This is why the US system is so expensive. In a public system, the money available is limited, so there are waiting list for elective operations.

      If you want to limit your spending on healthcare, then a public system is the best way to do it. Using the ‘Freak-o-nomic’ as an example, in a public health system, the number of cars available is fixed and you don’t get to choose the car. In a private health system, the only car available for sales are Ferrari because the car dealer makes the decision, and they decide that everyone just NEEDS a Ferrari so they can make more money.

      • I don’t agree that the doctor “decides everyone needs a Ferrari” under the US health system; the doctor knows he is going to get sued right out of business if he misses ANYTHING in his diagnosis. Hence “defensive medicine”.

        But in the public system, it is “tough luck; you’ve now got three months to live because we DIDN’T do that extra test that would have picked up that cancer 12 months ago……” I hear stories like this all the time.

      • drsmithyMEMBER

        But in the public system, it is “tough luck; you’ve now got three months to live because we DIDN’T do that extra test that would have picked up that cancer 12 months ago……”

        And in a private system where the person doesn’t go to the doctor because they can’t afford it, they die not even knowing they had cancer.

        I hear stories like this all the time.

        Bullshit.

    • The problem with the US system is that it costs more than twice as much as ours, and for paying double, life expectancy in the US is less than here. According to WHO figures.

      If the US were to have reformed their health system when Hillary Clinton attempted it in the eighties, the money saved would have meant that today, the US would be debt free.

      The right in America having, for ideological reasons, refused to reform, ended up with a massive public debt, but they refuse to take responsibility for their decisions, and want others to pay.

  2. Tassie TomMEMBER

    Regarding the paragraph about financial incentives to overtreat and overprescribe, followed by the example of more obstetric interventions in private hospitals:

    My understanding is that obstetricians are reimbursed per birth, regardless of whether it is vaginal or abdominal, and regardless of what interventions or tests are performed during the birth.

    The only financial incentive in this example is to not get sued for damaging the baby.

    • migtronixMEMBER

      Not true the consultant gets reimbursed for everything from blood test to to sedative drugs used to ventilation etc if required. Not saying it shouldn’t be but it is the way medical intervention coding works.

      • Tassie TomMEMBER

        Not true for the above example, otherwise I wouldn’t have made the point.

        Check the MBS description.

        Other examples would have supported the point and been more appropriate (eg, bulk-billing GP practices with 6-minute appointment time slots.)

    • I would think that the private hospital could make a lot more margin on a C-section than a regular birth, because it would require more specialists.

    • There is also the incentive for an orderly life.

      An induction or Ceasar on Friday means dinner with wine on Friday night and golf on saturday.

      Australia’s mixed heath system is one of the best in the world in terms of overall cost effectiveness.

      Every system has faults and areas of weakness or inefficiency, both public and private.

      Private system treat the rich and the poor have very bad health outcomes even when young and intervention would gain many productive years.

      Public systems ration by queuing and triage, but sometimes make mistakes.

      The public system makes a major contribution to the private system as nearly all major teaching hospials are public. This enables doctors to learn while young by practicing on public patients under supervision of visiting specialists and consultants. Later, the now experienced and competent doctors go into the private system where they charge more but don’t train other than as visiting specialist in the public system.

      The two parts of the mixed system are symbiotic in Australia and both perform valuable roles in the overall health system and do it with interantionally recognised efficiency.

      • migtronixMEMBER

        The public system makes a major contribution to the private system as nearly all major teaching hospials are public

        That’s exactly why we should be encouraging the public hospitals to be more efficiency/communications focused and not siloed up between practices, units, residents and consultants etc etc.

        There are massive improvements that can be easily made but its not on anyones budget radar.

  3. migtronixMEMBER

    Universal healthcare has the problem of triage but IT can do a lot to drive system efficiency, we’re not doing any of it really.

    User pays healthcare has the problem that they’re going to try and amortised the cost of dialysis with all the people getting flu shots.

    Better keep universal care and just invest in upgrading the medical establishment to also become a communications/efficiency-maximizing industry

    • moderate mouse

      The sooner we can replace doctors with machines the better. Human error, mis-diagnosis/no-diagnosis are the biggest inefficiencies in the provision of healthcare. Bring on the microchips and nanobots….

  4. Once again, this article ignores the fact that most medical costs in the developed world are related to self-inflicted disease (obesity, smoking, alcohol, drugs, noncompliance, trauma).

    One of the main problems with free healthcare, and with most forms of socialism, is that it discourages responsibility.

    You mentioned car maintenance/mechanic services as a credence good once.

    If car maintenance was funded free by the government, then people would not bother to change their oil, make sure they were using the correct fuel, and would not car about bangs and scrapes in the car park. As such the total amount of money spent on car maintenance would increase.

    This is what occurs when the user does not have to pay. A major oversight for an economist.

    In any case, no system is perfect

    • migtronixMEMBER

      This is what occurs when the user does not have to pay. A major oversight for an economist.

      What? Because they’re not morbidly obese in America?!?!

      • You may find that a large proportion of the morbidly obese in America are on Medicaid or Medicare (as obesity/smoking/alcohol predominantly affects the poor), or on health insurance plans provided by their employer.

        In any case, your example does not disprove my thesis

      • In the states most people have employer supplied healthcare which means that the health care spending is hidden. This is a historic anomaly due to tax rules where a company can claim the expenditure as a tax deduction but the employee cannot.

        It would be much better if employers gave the employees the money currently spent on healthcare on their behalf and let them choose their insurer – allow the payments as a deduction if necessary.

        Those who look after themselves can select policies with less coverage or exclusions for lifestyle diseases and pay less.

        No need for a co-payments on doctor visits unless you choose to have an excess policy.

        Those of limited means can receive public support or vouchers towards the cost of their policies or can be covered by a public policy option.

      • Exactly, Pfh007. Common sense. Don’t know why anyone has to keep believing that the State doing it all can be the best of all worlds.

      • drsmithyMEMBER

        Don’t know why anyone has to keep believing that the State doing it all can be the best of all worlds.

        Another straw man.

        I don’t think anyone believes “the State doing it all can be the best of all worlds”.

        I am fairly confident most people without an ideological agenda can look at data and history and conclude that publicly-funded or very heavily regulated private healthcare has been found to consistently deliver the best overall outcomes.

    • drsmithyMEMBER

      Once again, this article ignores the fact that most medical costs in the developed world are related to self-inflicted disease (obesity, smoking, alcohol, drugs, noncompliance, trauma).

      If America wasn’t the world leader in obesity, et al, and there weren’t numerous countries with publicly funded healthcare full of healthy, fit people, you might just have been able to pass the laugh test.

      One of the main problems with free healthcare, and with most forms of socialism, is that it discourages responsibility.

      I propose to you that death is a much stronger motivator for most people than money.

      If car maintenance was funded free by the government, then people would not bother to change their oil, make sure they were using the correct fuel, and would not car about bangs and scrapes in the car park. As such the total amount of money spent on car maintenance would increase.

      Comments like this say far more about the mentality of the writer than they do about anyone else.

      In any case, no system is perfect

      Indeed, but we know from experience that publicly-funded (or brutally regulated private – like Switzerland) healthcare is by far the “least worst” option.

      • Mind you, the availability of better and better health interventions tends to make people a bit more casual about death.

        Popular music from the 1800’s is often cringingly maudlin, but back then people were surrounded by dying babies, infants, youth, young mothers, working fathers younger than 60, etc etc

      • drsmithyMEMBER

        Mind you, the availability of better and better health interventions tends to make people a bit more casual about death.

        I would have concluded the exact opposite.

        Ninety-year-olds on the edge of dying will dump everything they own into buying another couple of months of life.

        We keep brain-dead people alive for years and will not allow people who *want* to die to do so in a time and place of their choosing, with dignity.

        Parents won’t even allow their children to walk a kilometre or two to school in case they get run over.

        Casual about death ? Our longer lives have made us *petrified* of death.

      • Why there is no obesity among the richest people? Maybe the answer of this question will give you more reason to argue for universal health system.

    • Coming,

      The US system costs twice as much per person than Australia.

      Twice.As.Much.

      US life expectancy is less than Australia.

      Our system is less than perfect, but all evidence points to the fact that the last place to be looking is a US style system.

  5. There will always be less sick people under a Coalition government than there would be under a Labor government.

    We will decide who goes to the doctor, and the manner in which they do it.

    A Coalition government will Stop the Patients !

  6. It is simple to understand health system and cost when one realises that we are the national human capital. As such we are resource for the national capital production and turnover. What happens to other elements of productive capital? Machinery, buildings etc. have amortisation and repair cost. Capital pays for it. Amortisation and repair of human capital are covered by health cost, which has to be paid by the national capital. Why? Because people as human capital are used only for productive purposes and capital growth and their amortisation and repair should be born by the user – national capital, e.g. the universal health system supported by contribution from income and wage above the necessary minimum cost of living, which forms and determines the maintenance cost of human capital. Health cost is not an ordinary product, it is characterised with highly asymmetry for both sides of the health service -the doctor and the patient and It is absolute market failure because of that.

    • Capital pays for it

      Those were the days ! Capital now prefers to just reap the benefits, and if it’s ok with you whingers, can you all please bear the costs yourself, thankyou very much.