Friday, August 14, 2009

Free Market Healthcare - Continued Discussion

This post is in response to comments by "Anonymous Aug 11, 7:01 am" on the August 6th, 2009 COTG post entitled "The Free Market Approach to Healthcare". This response was submitted by today's "guest blogger" - David Aron.
Thank you for asking some great questions about health care. I agree with the tenor of your argument that the role of insurance companies need to be diminished. However, they need not be replaced by the government. Instead, in the immortal words of Ronald Reagan "Government is the Problem!"

I can understand that from a liberal perspective, the concept of free market health care sounds nightmarish and cruel. This is simply not the truth. Free market health care will bring low cost quality health care to all. When we did have (almost) free market health care, back in the 50's, doctors made house calls, visits to the hospital were cheap and prescriptions were not an issue. In fact, true cruelty is inherent in government programs, which always hurt the poor, confiscate property from the middle class and benefit the political elite.

I would never advocate government limitations on access to health care. I advocate using the free market price system to rationally allocate health care resources to where they are most needed. Health care resources, such as a doctor’s time, medications, etc… are scarce. There is a finite amount available at any one time. However, there is an infinite demand for health care, since we all want the best possible health care we can get. So, health care providers (doctors, specialists, hospitals, prescription drug companies, etc...) set prices based on cost and existing demand. Consumers who really want health care will organize their finances to pay for it at those prices. Those who decide they can go without will choose not to pay. In this way, scarce resources are allocated to the consumers that need them most based on individual preferences and voluntary trade.

You can see though that prices are based on both cost and demand. Under a competitive system, health care providers would enter the market and try to increase profits by offering lower prices and higher quality care. True profits, which include both input and opportunity costs, are a signal to the market that there is an unmet demand in one area of the market. Profits are an indicator to entrepreneurs that resources need to be shifted from other areas of the economy into the profitable area. As more companies enter the market, competition for customers and the increased supply of health care would reduce prices. Eventually, the price of health care would be about equal to the actual cost of providing that care. True profits would disappear and only nominal profits would remain (ie. revenue minus cost).

Moreover as companies enter the market they would diversify to capture different markets. For example, some companies would offer higher quality care at a higher price for those who were willing to pay more, while others would offer cheaper care for those willing to accept lower quality health care. Some would offer care specifically to the elderly, while others would offer care to the young. Some would treat specific diseases. This is much the same way in which we purchase food today. Some people are willing to pay for the organic hormone-free milk, while others are willing to settle for the store brand, while still others buy chocolate milk.

Now that you see how a free market operates to lower costs through competition, you can see how the current system encourages over-consumption. Currently everyone is consuming health care at a level that they feel is appropriate. However, that level of health care consumption is supported by the low DIRECT cost to the consumer (i.e. Co-pays). The full cost of health care is only borne INDIRECTLY by the consumer through their employer-paid benefits, insurance premiums and taxpayer funded programs. The lower direct cost increases demand, as more people can purchase health care at the lower price. Since health care resources are scarce, health care providers need to increase the price in order to ensure that they don’t run out. What would “running out” of health care look like? Crowded waiting rooms, empty pharmacy shelves, and long waits for specialist care.

To return to our milk analogy, imagine that the government instituted subsidized or universal single-payer milk. Currently, we just drink it for breakfast and bake cakes with it. Under this government milk program, there would be virtually no direct cost to the consumer. As a result consumers would use milk as if it were water. We would quickly run out of milk and those who need it most (Kids with growing bones?) would not get it. The question “Got Milk?” would be a reality.

The key to lowering health care costs and increasing access is to allow consumers to pay for the full cost of health care themselves, purchase catastrophic health care insurance for unforeseen disasters, and shop for the health care appropriate to their needs. This places health decisions directly into the hands and wallets of consumers. If you look at areas of the health care industry that have not been subject to the forces of government tax-incentivized insurance, subsidization or heavy regulation, such as plastic surgery or lasik eye surgery, you can see that costs have come down dramatically over the last decade and both quality and convenience have increased.

Prescription drugs are another area where government intervention has led to higher prices. The recent entitlement program instituted by the Bush administration and similar state programs all offer subsidized prescription drugs to political favorites. Tax incentives have also been provided to encourage people into employer-provided health insurance programs that cover prescription drugs. Before these plans were instituted, individuals were making the decision whether to purchase prescription drugs or not, based on their own preferences. By artificially lowering the direct costs, the government has made it possible for more people to purchase more prescription drugs than before. This increases demand, which in turn raises prices. In the end, subsidies and tax incentives such as these raise costs instead of lowering them, which hurts those who do not qualify for the program and raises the amount of tax revenue needed to pay for the increased cost of the subsidy.

Prescription drugs are also heavily regulated by the Food and Drug Administration (FDA). The purpose of the FDA is to decide which drugs you can take and which you cannot. They do this by requiring about 10 years worth of research and development testing for any new drug allowed on the market. The costs of this certainly prohibit certain medications from ever being offered to the public. It also empowers large drug companies such as Pfizer, since smaller companies do not have the resources to deal with the paperwork and testing required by the FDA. Perhaps a small startup company has several ideas for various lifesaving drugs, but need to shelve all but one since they only have the resources to get a single drug past FDA regulations. How many good drugs have been kept out of the market this way? The costs are high for large drug companies too, which is why they try to recoup their costs by advertising their products to doctors and to the public.

The government has essentially deemed the public incapable of deciding for themselves, in consultation with their doctor, what prescription drugs to take. What could be done voluntarily through private testing and quality certification agencies (like Kosher certification or the Better Housekeeping Seal) is instead done by force through the coercive power of the state. By abolishing the FDA and allowing private agencies to assist consumers in assessing the quality of prescription drugs, we can increase the number of life saving drugs on the market and lower the cost.

Malpractice is certainly a problem as well. All patients, including myself, want doctors to provide the best possible care. However, doctors are human and make mistakes. At that point, they are rightly sued for damages. Courts should award remuneration to patients in proportion to the extent of the damages they have suffered and the degree to which the doctor was responsible for those damages. Lately though, more suits are being brought and courts are awarding increasingly larger malpractice awards. As a result, malpractice insurance rates are skyrocketing, which have led to an increase in doctor’s fees. Therefore, one solution is to place caps on medical malpractice awards and put a stop to rising malpractice insurance costs. This is a short-term solution, which may possibly have other unintended consequences.

Doctors see the increase in malpractice awards and take steps to protect themselves. They order scores of tests to cover their butts in the case of a lawsuit. Sometimes doctors explain to patients the tests that they want to run and what information they can provide. Other times doctors just order the tests as soon as a patient is admitted for care. Under our current system, the direct cost of those tests to the patient is minimal, as they are covered by insurance. Now, if the patient had to pay for all of those tests in full, they would certainly direct the doctor to perform the tests they thought were most necessary and eliminate those that were not. In the case of a charge of malpractice, the doctor could claim that he offered the tests, but that they were declined by the patient. Therefore, one solution is to discourage the current insurance based system (by removing existing government tax incentives) and allow patients to pay for medical tests out of their own pocket. Another solution is to allow patients to sign a form promising not to sue the doctor for malpractice (or to limit malpractice damages) in exchange for a lower price.

It’s nice to think about everybody getting great health care. It makes you feel warm and fuzzy inside. But universal health care proposals, government subsidies, and all the other feel good health care programs will only exacerbate the problem they seek to solve. Just look at “universal” education. Here, government schools “compete” with private schools. The only problem is it’s not a level playing field. If private schools perform poorly, they will lose customers (students and their tuition paying parents) and eventually go out of business. Since government schools have an unlimited pool of taxpayer funds (confiscated by the force of government) and politically protected positions to cover their poor decisions, they have almost no incentives to make changes if the students fail. On top of that - failing schools are rewarded with more money! Moreover, the taxes taken from the public to pay for this monstrous system make it very difficult for all but the upper classes to afford private school. Thus, private schools are limited in number due to the limited demand and cater to these customers. What do you get from “universal” education? A two-tiered system where the wealthy elites can receive a quality education, while the poor and middle class are forced to accept a poor quality public option. Universal Health Care, or any other government meddling in the industry, will similarly lead to the poor and middle classes being prevented access to quality low-cost care and guarantee the rich exclusive access to private health insurance. The only difference between education and health care is that if a child receives a poor education, they have the rest of their lives to undo the damage. If a patient receives poor health care, the damage may be permanent and even fatal.
CATO Institute has other Free Market suggestions.