Wednesday, August 19, 2009

Some Thoughts on the Health Care Debate

It’s been painful watching the ridiculous arguments and accusations in the current U.S. debate over health care. This issue in particular seems to have brought out the worst of democracy, with a rationally irrational public shouting about death panels and calling names. Health Economics is not one of my fields, but some things can be said without being a specialist in the field.

First of all, many people are comparing health systems around the world and making unjustifiably strong claims, sometimes using questionable data or results. For example, the oft-cited WHO study ranking countries’ health care systems focuses almost entirely on the distribution of health care, rather than the level, and has error bars so large that the results are almost worthless. Rankings of life expectancy are also of questionable use when comparing countries’ health care systems, as life expectancy can vary for reasons unrelated to health care systems. For example, Americans tend to be more obese, get in more care accidents, and experience violent crime more often than people in other countries. These may be serious problems with American society, but they are not problems with the health care system. Another measure that has been used recently is a comparison of preventable deaths for people under 75 years of age. This suffers from a problem similar to life expectancy—Americans may be more prone toward particular kinds of health problems, and treatment of them may be less successful, for reasons unrelated to the health care system. A real study of the subject would need to control for more variables.

Similarly, one hears that around 50 million Americans do not have health insurance. While technically correct, this number is of dubious value. What fraction of those 50 million people qualify for government aid but have not used it? What fraction are wealthy but have opted not to buy health insurance? How many actually went for an extended period without health insurance, and how many went without for a short period only?

There are also questionable statements about health care in other countries. They are sometimes presented as utopian, and at other times as hellish, depending on the position taken by the discussant. Conservatives like to claim that wait times in Canada for medical tests and procedures are outrageously long; others claim that waits lists in Canada are reasonable.

Do other countries do a better job controlling costs? David Goldhill argues that if they do, it’s not by much:

From 2000 to 2005, per capita health-care spending in Canada grew by 33 percent, in France by 37 percent, in the U.K. by 47 percent—all comparable to the 40 percent growth experienced by the U.S. in that period. Cost control by way of bureaucratic price controls has its limits.

Perhaps other systems get the level of costs down, but cannot control growth, meaning they will end up where the U.S. is eventually.

None of this is to say that the U.S. health care system could not use some dramatic changes. To explain what kinds of changes might work—and by “work”, I mean provide the same or better care at a lower cost to more people—I need to talk about some basic economics, and then some particular economics of health care.

Students in any economics class learn that resources are limited, or scarce. We cannot all have as much of anything as we want. This is true of cars, gasoline, televisions, computers, clothing, leisure, and everything else people enjoy consuming. One can have more of something, but only at the cost of giving up something else. Over time, economic growth allows us to produce more goods and services with fewer resources going into each of them, but this is a slow process. Even with growth, getting more of something is not free.

This applies to health care just as much as it applies to everything else. From society’s point of view, providing more health care means providing less of something else. When people become doctors, nurses, medical device engineers, or other medical specialists, they cannot also be computer programmers, chefs, or produce other non-medical goods and services. No health care system—government run, purely free-market, or anywhere in between—can produce as much free health care as everyone wants. They can be more or less efficient, depending on the incentives of the system (which I will discuss later), but unlimited free health care is not an option, and anyone that tells you it is possible is lying to you.

Economists call the process by which things get allocated to people “rationing”. In a purely market-based system, economists say that the price acts as a “rationing mechanism”—people who are willing and able to pay enough for something get it, and people who are not willing or able to pay enough for something do not get it. In a purely government-run system (say, Soviet-style central planning) bureaucrats decide who gets what, and base it on a calculation of needs, political influence, or some other measure. There are possibilities in between the two extremes.

In any health care system (as in every part of an economic system), someone ultimately says “no”. There are entities that decide who will get care, and who will not. In the U.S. those entities are insurance companies (who decide what to cover and what not to cover, as well as to whom policies are sold), governments (state and federal, which administer programs for government employees, the poor, and the elderly), and individual consumers, whose incomes limit the amount of health care they can afford. All these people—insurance companies, governments, consumers—can say “no” to getting a particular kind of care. Obviously a consumer would prefer never to hear “no” from the other two groups of decision makers.

One might object that doctors get to decide who gets what kind of care, if any, and to an extent that’s true—they (hopefully) will not treat a torn ACL with chemotherapy. Yet doctors are ultimately paid by someone, and if that someone (consumers, the government, insurance companies, charities, whoever) stops paying, they will eventually reduce the amount of care they provide.

In other countries the decision makers may be government officials. The NHS in the U.K. decides which treatments are acceptable for what health problems, and which ones are not acceptable (and therefore will not be funded). When controversies arise in such systems, they are often over whether the government should pay for one treatment or another (one would expect such controversies to arise most often when new treatments become available). Governments can also ration care using queues—care is given out first-come, first-serve. The waiting time for a service depends on what kind of resources a government allocates to it, and how efficiently those resources are used.

Whether government decision makers do a better or worse job than private decision makers is an interesting question, and you might have gathered from the discussion of international comparisons above, it is a difficult question to answer. Nonetheless there is a consensus that the U.S. system is not working as well as it ought to. Health care is getting more expensive rather than less (contrast health care costs with, say, the cost of DVD players). Why is this so?

There are two economic primary theories to explain why this would be the case: adverse selection and moral hazard (both having to do with the economics of insurance). Both can be expected to drive up the costs of health care, pricing many consumers out of the market.

The adverse selection argument goes like this: Suppose that there are two types of consumers, those who will get sick (the unhealthy) and those who won’t (the healthy). Suppose consumers know which type they are, but insurers do not. Then the healthy types, knowing that they do not get sick, will not buy health insurance. The unhealthy types, knowing that they will get sick, will try to buy health insurance. Should insurers sell to them?

They should not. If only the unhealthy types buy, then selling health insurance is a sure way to lose money. Each consumer is going to incur, say, $10,000 in average medical costs, which the insurer will have to pay, and then pay his workers and stockholders. But the consumer isn’t willing to pay more than $10,000 for the insurance policy, so there’s no way for the insurer to make a profit.

This is an extreme version of the adverse selection story, in which the insurance market completely disappears. A more realistic version would involve probabilities, rather than certainties, and when one creates such a model, an interesting result can emerge: If enough healthy consumers drop out of the market, health care can get sufficiently expensive that only the most risk-averse, wealthy consumers (of either healthy or unhealthy type) can afford to buy. That is, even if I am a healthy consumer, I might still want to buy insurance because I am particularly risk-averse—but I can’t, because it’s too expensive, because of adverse selection. If everyone could be forced to buy insurance, it would be cheaper for all. (Here is a clever related argument regarding car insurance, suggesting that cities that require all drivers have car insurance should experience lower rates.) Adverse selection is why health insurance companies try so hard to screen for preexisting conditions, smoking, and other factors that can increase the risk that a consumer will become ill; they are trying to sort out the good risks from the bad.

Does this argument help explain why health care is so expensive in the U.S.? I don’t think so. Recent reforms in Massachusetts have succeeded in getting almost everyone in the state (97% of the population) insured, yet health care costs have risen dramatically, and the state is having trouble with its budget. Adverse selection is really an argument about health insurance costs, not necessarily health care costs.

Moral hazard is a simple response to incentives: Once insured, people have fewer incentives to take precautions to prevent future illness, because the medical costs will be paid for by a third party (the insurer or the government). This makes small medical problems into big medical problems, driving up the cost of treatment (and the cost of insurance). In fact, in the U.S., around eighty to ninety percent of all health care expenditures are paid for by third parties (again, insurers or governments, rather than the patients). This has additional incentive effects beyond simply failing to take precaution. People stop shopping around when someone else is paying. They also request additional procedures or tests, or go to the emergency room instead of a less-costly physician. Doctors, who are paid for procedures and tests performed, have little incentive to resist, leaving it up to insurance companies or the government to say “no”—which, naturally, makes consumers angry, and they exert pressure to make “no” a difficult thing to say.

When a large portion of consumers are no longer paying attention to costs, and no longer shopping around, competition stops functioning. Competition—the process that gave us the $20 DVD player, instead of the $900 DVD player we started with—is an important mechanism for disciplining producers, whether they are producing cars, newspapers, computers, or cancer treatments. Competition keeps producers on their toes, forcing them to find better, more efficient ways to do things. I find the moral hazard/lack of competition argument compelling. In health care, competition seems broken.

Robin Hanson has argued that overconsumption of medical services means we could cut health care spending in the U.S. in half (by simply denying care or refusing to undertake procedures or tests) with almost no effect on health care outcomes. If correct, is a pretty stunning result—if we can get people to consume more carefully, we can dramatically reduce costs.

What reforms should be enacted? It is possible that moving to something like Canada’s system might be an improvement; I don’t know. I am skeptical because our government has budgetary problems with the current large medical program, Medicare. Taking on additional large expenses will be problematic. Furthermore, I do not think our federal government is good at running technocratic programs. Remember, there are more than 300 million people in the U.S. (compared to 33 million in Canada); I am not convinced that the federal government can run a health care program that serves them all. That is, I do not think the U.S. government would run Canada’s health care system as well as Canada has. The more government involvement in the system, the less competently I think the U.S. government performs. I shudder to think how badly the U.S. government would run a system like the U.K.’s NHS.

This brings me to a reform that I think would work. Bryan Caplan, Tim Harford, and others have praised Singapore’s health care system. It seems designed to address all the problems people have with the U.S system, without requiring a large amount of government management or intervention in health care markets. It is certainly not laissez-faire, but it is not single-payer or nationalization, either.

You can read Caplan’s account of Singapore’s system here. I think the most important features of Singapore’s health care system are:

1) Mandatory medical savings accounts: Every person pays into a savings account that accumulates over time, and can even be passed on to one’s children. The money in the account can only be used for medical care. This gives consumers an incentive to shop around—they are spending their own money, after all. It may also give them an incentive to undertake preventative care, as doing so increases the amount in their account in the long run. This policy puts competition back in health care markets.

2) Mandatory published price lists: All hospitals and medical facilities must say what their procedures and tests cost. This allows consumers to shop around, and even establish reputations for low prices. Try calling a local hospital in the U.S. and ask them what a procedure costs; they usually won’t be able to tell you. Your insurer might be able to tell you what they pay a particular hospital, but they might not. This policy, like the first, encourages competition.

3) Optional low-cost catastrophic coverage: When health care expenses go over a certain threshold, the government steps in and pays. Because catastrophic illness is uncommon, this coverage is relatively cheap to provide. Private insurance can also be purchased. This is sort of like the “public option” of the current health care reform proposal in the U.S., but it is far less generous, covering extreme situations rather than routine medical expenses.

There is one aspect of Singapore’s policy that I’m not so sure about: supposedly the government pays for“80% of basic health care services”. I’m not sure what that means. I’m guessing checkups and other services that catch disease early. It surely can’t mean a much broader swath of health care services, or the “buffet mentality” (as they call it) would emerge, with some people overconsuming care, driving costs up. So far, Singapore has managed to provide a high quality of care with low costs (that rise slowly!).

I think such a system might be manageable in the U.S. because the government’s role in it is simple; competitive markets do most of the hard work. There are other reforms that should also be enacted in the U.S., such as removing (or at least equalizing) the tax advantage of getting insurance through an employer, and making interstate health insurance sales legal. There may be other ways to get similar results to that of Singapore, perhaps with health care vouchers (much like education vouchers).

Realistically, however, I do not think we will get reforms that will make a significant difference, for better or worse.


brent butgereit said...

When they say "health care costs are rising" do they mean that the cost of the same procedure five years ago is now higher (inflation adjusted) or that the amount we spend on health care is greater. Even saying that the percentage of our income that we spend on health care is greater now than ever is a bit confusing. Couldn't that just mean that the amount we spent on most other things is lower and that we could afford to spent more on possibly unnecessary procedures? It seems like the actually rising cost of health care is masked.

Mike Hammock said...

I think they mean both things. That is:

1) The costs of procedures are rising at a rate faster than inflation.
2) The fraction of our income that is spent on health care is large and rising, and is both larger and rising more quickly than in other developed countries.

Anonymous said...