The conservative line of policy analysis as to why healthcare in America is so expensive is simple. People are too insulated from the actual cost of delivering goods and services so they massively overconsume. Making people pay for 80% or 90% of their acturial value of care with a catastrophic insurance policy to take care of outliers would make people much more price sensitive and cause healthcare expenditures (in the short term at least) to crater as people decide that their broken leg can be treated better with whiskey and duct tape rather than a series of pins and screws inserted along the fracture zone. There is the minor problem of a dramatic drop in herd immunity as people will massively underutilize vaccinations and other long term preventative care, but those moochers will die quickly as the market intended.
Dani Rodrik in 2007 had an awesome post defining the two major tribes of economic policy analysis.
I think the best way to understand the source of these disagreements is to recognize that there are two genres of economists. I call them “first-best economists” and “second-best economists.” Here is my guide to them.
You can tell what kind of an economist someone is by the nature of the response s/he offers when confronted with a policy issue. The gut instinct of the members of the first group is to apply a simple supply-demand framework to the question at hand. In this world, every tax has an economic deadweight loss, every restriction on individual behavior reduces the size of the economic pie, distribution and efficiency can be neatly separated, market failures are presumed non-existent unless proved otherwise (and to be addressed only by the appropriate Pigovian tax or subsidy), people are rational and forward-looking to the first order of approximation, demand curves always slope down (and supply curves up)….
Those in the second group are inclined to see all kinds of complications, which make the textbook answers inappropriate. In their world, the economy is full of market imperfections (going well beyond environmental spillovers), distribution and efficiency cannot be neatly separated, people do not always behave rationally and they over-discount the future, some otherwise undesirable policy interventions can generate positive outcomes, and general-equilibrium complications render partial-equilibrium reasoning suspect….Since they have given up on the textbook model, members of this group have an almost-infinite variety of “models” to choose from as they think of public-policy issues.
The first group’s instinct is always to apply the first-best reasoning to the case, ignoring market imperfections in related markets, while the second group almost always presumes some market imperfections in the system. I am over-simplifying a bit, but not a whole lot.
I worship at the book of Herb Simon, I genuflect in the direction of behavioral economists, and I say five “Our Agglomorations per historical coincidence” every night.
I will agree with first best economists that there are some serious market imperfections and distortions in the healthcare market, but I have amazingly strong doubts concerning the power of “liberated” consumers to spend their own dollars in controlling healthcare costs without seeing a significant spike in mortality. Let’s go below the fold to talk about an area where free market reforms could lead to improved outcomes and lower expenditures.
Provider pricing is amazingly non-transparent, byzantine and convoluted. In a well functioning market, similar procedures at the same facility should be pricing very close to each other. In a well functioning market, similar procedures at different facilities should (quality and risk adjusted) have price clustering. That is not the case.
When I had my vasectomy, the total contracted rate for that procedure had six different options. The options were dependent not on any unexpected complications or choices of anethesia, but on what fee schedule I was on. If I was on Medicaid, the contracted rate would have been roughly half of the rate I actually paid. Medicare would be different, Exchange narrow would be different, Exchange broad would be different, and out of network would have been different. The pricing variation increases if I went to a different facility such as a community hospital or an outpatient surgical center.
Uwe Reinhardt has a good explainer in the New York Times about the original Medicare payment system and the incentives for price inflation it set up:
Medicare was required to reimburse each individual hospital (and other inpatient facilities) retrospectively for all the money that individual facility reported having spent on treating Medicare patients. These pro rata costs included operating costs, annual depreciation of the capital investments in the facility, interest of debt incurred to finance that capacity and, for investor-owned hospitals, a guaranteed rate of return to equity capital invested in the hospital….
organized medicine struck a deal under which each physician (and certain other professionals) was to be paid his or her “customary, prevailing and reasonable (C.P.R.)” fee for each service…..
These systems beg for ever increasing costs for the same service to be performed. There is another major cost driver in Medicare pricing. Medicare pays academic medical centers a training bonus on all fees to cover the slowdown implied in training new docs and other professionals. There have been modifications since 1965 but the basic structure has been set up for several generations. This would not be a problem except that almost all commercial price schedules are derived from Medicare pricing.
Setting consumers against a non-transparent pricing structure where the pricing had almost no reflection to the average or marginal cost of a procedure is a situation that is destined to fail if we want to keep people healthy, alive and non-bankrupt. The power imbalances are too strong.
However, de-bundling Medicare payments into a variety of separate payments would be a step that most first and second best economists would agree would be an improvement in the market for healthcare. Major academic medical centers would receive a training subsidy that is explicitly separate from their care payments. All facilities would receive a separate capital reinvestment payment that could be calculated on some average rate of reinvestment to minimize the incentive to overinvest in capital instead of bundling capital investment costs into every single procedure code’s billable amount.
This would not equalize prices for Medicare across a market. There would still be pricing differentials, but the procedure level pricing would be flattened a bit and slightly more transparent. It would be a step to cleaning up the dysfunctional health care market, but it is not the only required step.