Arnold Kling  

Replying to Thoma on Health Care

What Every Worker Believes... Singaporean Sense...

Mark Thoma writes,

when I think about moving P to G, I also think about moving the revenue stream with it (e.g. individuals would pay monthly premiums in taxes rather than to the insurance company). Thus, if we move all of P to G, we also move all of the revenue with it. Therefore I don't see why the budget problem has to get worse

So, as a first approximation, it's just a reshuffling. Instead of paying a tax to health insurance companies, workers pay a tax to the government. Their take-home pay is the same, and the government deficit is the same. OK.

He goes on,

Why do costs per unit fall? Because of all the administrative savings, savings from buying drugs in bulk, and the ability to manage care (e.g. preventative measures, solving information problems that cause wasteful expenditures by doctors and consumers).

Put a number on the savings from "buying drugs in bulk." Considering that drug company profits are rounding error in the overall health budget, and assuming that you can't force profits to be negative, it's pretty demagogic to suggest that you are going to salvage the health care budget that way.

The other savings are all hypothetical. Suppose we were to abolish private health insurance tomorrow and put everybody on Medicare. Here are the things that would happen.

1. You could get rid of everybody in the private health insurance industry. That would save at most 15 percent of health care spending.

2. There would no longer be a private-sector benchmark for Medicare to use in pricing. You would need to hire a lot of those former private health insurance folks to work for Medicare to figure out what every medical service is worth, to negotiate prices with doctors, hospitals, and so on.

3. Medicare would have to process more claims, which means you would have to hire back some more of those former insurance workers.

After (1)-(3), costs might be less than the existing system. By a small amount. For a short time. But innovation in health care management and administration would slow to a crawl. Health care providers would need permission from Washington to try anything new. In the long run, administrative costs will be higher than they would have been under private health insurance.

In the short run, getting rid of competition and installing a monopoly lowers overhead. In the long run, it's not so brilliant.

In any event, the cause of rising health care spending is not administrative costs. It is the increasing use of medical procedures, including procedures with high costs and low benefits. In that regard, Medicare as it exists today works no better than private health insurance.

What Thoma wants me to believe is that as soon as we get rid of that pesky private health insurance, Medicare will become expert at weeding out cost-ineffective procedures and paying for cost-effective care. That would be wonderful, but I'm from Missouri. Show me that Medicare can do that for its existing customer base before you go out and shut down private health care. I am reluctant to start toting up lots of savings that could occur in theory when we do not see those savings in practice.

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COMMENTS (20 to date)
Me, Myself and I writes:
In the short run, getting rid of competition and installing a monopoly lowers overhead. In the long run, it's not so brilliant.

Actually, not even that.

During the switchover, efficient systems will be replaced with systems that are new and very inefficient.

The huge balloon in costs will be there from day 1.

The Sheep Nazi writes:

Thus, if we move all of P to G, we also move all of the revenue with it.

In my real life, I am a contractor working on a DoD contract. (Yep, one of those people.) Bring on the government-run health care, says I: daddy needs another swimming pool, filled with diesel for his brand new truck.

liberty writes:

brilliant post. I agree that you were probably too easy on the theoretical cost savings, but doing so allowed you to explore with arguments and retain balance.

One way that socializing medicine can - and does in many countries - cut down on costs is by not allowing people to consume those expensive medicines that do drive up our current costs.

On the one hand, it could be seen as good, since they can be wasteful (see my anecdote below). But on the other hand, they are sometimes critically necessary, and even when not necessary they are a choice - we like freedom to choose - and use of them will ultimately lower their price. Demand leads to profits and profits encourage innovation, new entry and cost cutting when a private system is used.

On the other hand, the only way that government can reduce their usage is through mandate, and they can't get the costs of the medicines themselves down at all (except through "buying in bulk" which doesn't lower cost, it only lowers price). They have only their words and their swords, they have no power of the market.

Recognition that use of expensive medicines (due to third party payer systems, and to wealthy people choosing freely to use them) is where the cost is coming from, and is the only place where it can be reduced by socialization, leads to a reasonable debate.

a quick anecdote:

I have allergies. They were getting bad so I went to the doctor (paid for by my private firm) and the doctor gave me three prescriptions. I filled them (paid for by my private firm) at no cost to me, barely noticing the total was $250 until I'd signed for them. I didn't care - its not off my back - except I was a bit shocked. A month later, filled the prescription again.

My allergies got no better. I spoke to my father and he suggested bee pollen or local honey, as it worked for him. $4 later and my allergies cleared up.

scott clark writes:

Part of the reason medicare has lower admin costs is because they aren't really evaluating the claims they are processing. They get a claim, they pay it. No questions asked, for the most part. Private insuranace companies actually deny claims, try really hard to prevent paying fradulent claims. Medicare fraud is a huge expense, but doesn't get counted into admin expense ('cause you can't count it). If everybody moved into medicare, and they only reviewed a small % of claims for fraud, as they do know, the program would get pummeled.

Scot writes:

Arnold Kling wrote, "The other savings are all hypothetical."

Isn't that true of your arguments as well? You haven't demonstrated that privatization of medical care would result in a more efficient market.

Off the top of my head I can't think of any examples of privatised health care systems, but from what I've seen the more/less nationalized systems of the European welfare states plus Canada provide similar or superior outcomes at a lower cost. So, I think Thoma does have quite a bit of evidence on his side.

I'm just a layman, so I could be mistaken about the (non)existence of more privatised healthcare systems.

Matt writes:

Paul Krugman makes a similar error, counting low transaction costs as an efficiency measure. The government could give away shoelaces, for example, and the transaction costs are zero, but the economic efficiency would be way off as more and more products are constructed of free shoelaces.

Efficiency is the rate at which the sector approaches equilibrium. National health care most assuredly moves us away from equilibrium. The mere projection of Medicare costs indicates a path toward instability.

The problem, naturally, are the monopoly effectsl but Thoma, for some reason, ignores all these years of economic discovery to proclaim that monopoly effects are beneficial.

RogerClemens writes:

Another great post, except for one thing. You say, "There would no longer be a private-sector benchmark for Medicare to use in pricing. You would need to hire a lot of those former private health insurance folks to work for Medicare to figure out what every medical service is worth, to negotiate prices with doctors, hospitals, and so on."

You have it backwards. With the exception of Part D, Medicare sets prices for services using basically a "cost of inputs" framework. Private sector insurance companies use Medicare prices to help their price setting, not vice versa.


Victor writes:

Arnold, great post, but I think you are missing the biggest problem with Thoma's argument.

Specifically, I *want* to pay my healthcare premiums, because I want the insurance benefits. I therefore work to acquire the resources to satiate my desire. I don't ever want to pay any taxes, and I will never work specifically in order to pay taxes. Whether I pay taxes or not, whether I work or not, presumably I would still receive my healthcare benefits. Early retirement, here I come!

You can't just take nationalize 15% of someone's compensation and expenditures and expect their behavior to remain unchanged. This is even more true with something as important as one's health. I hesitate to refer to this as deadweight loss, because I'm not aware of any deadweight loss studies that would be applicable to as large a shock as what Thoma discusses.

Other note: the flaws with the Medicare cost administration estimates are numerous. To reinforce one of your points, private companies do Medicare claims processing. Moving workers from one side of the house to the other won't improve their underlying efficiency. The gains he imagines are in the areas of letting lower risk individuals pay less (underwriting) and in the area of encouraging participation (commissions), which are points for another day.

floccina writes:

Scot why look over seas when we can just loo at Utah? Maybe we could do what Utah does (I am just kidding).

Utah spends about half the USA average on healthcare.
Life Expectancy: 78.7 years
State ranking: 3

The top two counties in Utah with the highest life expectancy are Morgan and Summit Counties, both at 80.8 years.

Ward writes:

Complete socialization with rationing is the best course because that way it will cause a political firestorm against rationing and it will allow for the creation of a completly private health care delivery system initially available only to the rich but eventually to everyone much as Fedex has done to the post office and as private schools are doing to public education.

David N. Welton writes:

I'd be curious to see Dr. Kling's "really free market" system, but I think that the political reality is that between Reagan, Bush 1 & 2, and even Clinton who was in some ways not unfriendly to market based systems... there has been no move at all to improve the system we currently have, which seems to keep getting worse for many people. The systems (remember, they do change a bit from place to place) in Europe, Canada, etc... do work pretty well and cost less, so I think that's where we'll be headed soonish.

floccina writes:

Regarding the idea that governments can save money spend of unproductive healthcare, I was very disappointed watching the PBS Frontline “Sick around the world”. It seems that other countries do not cut useless procedures; in fact they seem to cover wacky stuff like traditional Chinese medicine and acupuncture. They save money by squeezing providers with various forms of price controls.

Normally price controls will cause shortages and there are some shortages and waiting but in a situation like we have of exercise licensing where the supply of providers is artificially restricted, squeezing provider does not cause as much harm as normal. It may lower the quality of student entering medical school or nursing school but the quality today is much higher than it needs to be and so no shortages of doctors and nurses should occur. Hospitals today are over equipped so shortages or equipment will be blunted, hidden and come on slowly. The effects on drugs will be completely hidden since it will not affect supply of current drugs.
Also the shortages that countries do cause are not very harmful because expensive healthcare has little benefit, unlike the cheap stuff e.g. vaccinations and antibiotics.

8 writes:

Great point, Victor. I know several people who accept low wages in exchange for healthcare benefits. They would have no reason to work if their healthcare was "free".

B.H. writes:

Why is everyone forgetting the deadweight burden of taxation?

Suppose that the government could provide medical care with exactly the same "efficiency" that the private sector can. Does that mean we should be indifferent to private vs. government medical care provision?

With the private sector, we are charged for what we consume. I have every reason to work and save to increase my income in order to pay for medical care and everything else I want.

With the government, I am taxed on income or payroll to provide me with "free" medical care. I get the same care if I work little and save nothing. The economy bears the efficiency loss of taxation. Experience of other countries indicates that medical care payroll taxes will be substantial. European countries have much less hours worked as a result and higher unemployment rates.

Here is a thought experiment. Let's nationalize health insurance, but charge every person a lump-sum fee for the insurance instead of a payroll tax. If the government is so efficient at medical care relative to the private sector, everyone still ought to come out ahead. The reality is that the Left is intoxicated not with the virtues of government health care but with the prospects for another massive redistribution of income.

Adam writes:

The fundamental question is whether or not you think that the health care system is subject to large scale market failures ... Since I personally think it is I am forced to conceed that the best solution is likely a socialization of health care. E.g., Canada's system where costs are substantially lower. While it is true that wait times are higher, this is not true acrocss the board. Indeed, while Prof. Kling claims all of Prof. Thorma's savings are 'hypothetical' he offers no evidence of his own. To be sure the only large scale evidence I know of supports nationalization.

I fear that Prof. Kling has argued for the private system so vehemently simply to appease his political ideologies rather than his professional duties as an economist which would involve empirical evidence. Perhaps it could be called soft headed and hard hearted economics.

Ajay writes:

The benefits and problems of the current system of medical funding come from the fact that it is a compromise, with half of it paid for by the government and half paid for by private insurance. One benefit is that we have high-tech procedures that are paid for by private insurance: patients from all the other socialized health systems come here for those procedures when their country won't pay for them. One big problem is that our system is probably the worst you can come up with in terms of costs. It neither has the discipline of market forces, as Medicare sets the prices (as noted by Roger above and as told to me by a medical practice manager years ago when he explained that private insurance just uses the medicare-set prices with a markup of 15-30%), nor does it have the supposed benefits of monopoly government pricing because the government does not pay for the whole system. The current system is optimal for high doctor pay and large expenditures on high-tech medical technology while allowing patients not to think at all about the real problem of medical cost-benefit, as some third party has to always deal with that with the drawback that the patient pays a lot more for these luxuries. As Milton Friedman once said about high medical costs, "We have the worst of all of all worlds on that score." However, since there are avid proponents of both government and market systems, I see no way that we can have anything other than a political compromise come out of D.C. As Arnold has suggested before, the only way to break this gridlock is to have various state governments experiment with both approaches and see what happens. Massachusetts could try a completely socialized system and see how it works while Texas could try a free market system and see what happens. We free marketeers will never allow universal health care until this is tried and I doubt that the socialists would allow a free market system either, despite the evidence of a century of socialist failure, until it is pounded home by the failure of some socialized state plans.

Dave Schuler writes:

The problem with arguing for a completely free market system is that there's no way to get from where we are to there. There's absolutely no political will to privatize the consumer portion of the equation and even less to marketize the supplier side. So we're going to have a hybrid system for the foreseeable future and I think our efforts should be focused on having the best possible hybrid system rather than either a fully socialized system (which IMO would be a catastrophe) or a fully privatized system (which practially nobody wants).

Arnold is quite right on point 1. Current total claims administration costs are running somewhere in the 30-35% area. Canada's are about 15% so our savings are likely to be somewhere in the middle. That includes his point 3. Good optimization practice suggests that, since claims administration is such a high proportion of the total health care pie, it's a good place to start looking for savings.

BTW I don't believe it's true that the biggest factor in costs, exclusive of claims administrative costs, are high cost procedures. I think it's salaries.

Babinich writes:

"Why do costs per unit fall? Because of all the administrative savings, savings from buying drugs in bulk, and the ability to manage care (e.g. preventative measures, solving information problems that cause wasteful expenditures by doctors and consumers)."

What make Mr. Thoma think that this government run organization will be run free and clear of corruption and greed?

How does Mr. Thoma expect the health care industry to improve if it does not engage in "creative destruction"? Where does the innovation and entrepreneurial originate from when the entity running health care is an entanglement of bureaucratic controls?

We've seen examples where government guarantees have risen the risk GSE's like Fannie and Freddie engage in.

What about the duplicity and ethical malfeasance exhibited by some congressmen involved in sweetheart deals with Countrywide?

Is Mr. Thoma telling us that there will be no political entanglements with government run health care? No earmarks, or pork, or kickbacks?

What part of our US health care system is comprised of the public sector? How efficient is the public component of our current health care system?

Some thoughts cross my mind:

I, like Arnold, would like to see a "dry run" of this great benevolent government health care platform before us citizens get robbed some more by the bandits draped in the flag.

Who is Mr. Thoma to say that this idea is the panacea when it comes to alleviating excessive costs, greed, and personal advancement at the expense of the consumer?

Who is Mr. Thoma, and why would anyone ever send a loved one to his bailiwick to get indoctrinated with his brand of central planning?

Dave writes:

Great discussion.

I'm not sure I understand why a private healthcare industry is necessarily better at reducing costs. The incentive in private healthcare is to maximize profits, not minimize costs.

When you have a good which is highly inelastic, such as healthcare (among the most inelastic goods in existence?), it is much easier to increase the price than decrease the cost. I haven't seen any interesting replies yet to the fact that the US does seem to spend more on its healthcare than many countries with 'socialized' systems. What else could this be evidence of? (I don't ask this question rhetorically - does anyone have an idea?)

Governments, on the other hand, do not care about profits, but DO care about costs. The political reality of a post-nationalized US healthcare system is that the pressure to reduce costs would be enormous. Tougher stances in negotiating with suppliers of equipment (drugs, machines, doctors) would be immediate, but with a more social perspective in setting pricing. Economic profits may drop for the remaining healthcare industry, but the true benefit of a health care system, health, would be keenly monitored by the public (obviously). Would this benefit society? Is public health to any degree a public good?

I am, however, sympathetic about the idea of competition being the best way of achieving efficiency. We're getting wacky here, but what about two competing government agencies?

Chris Conover writes:

Victor and B.H. are correct. The marginal excess burden (deadweight loss) on each dollar of spending financed by taxes is at least 40 cents (and some-- such as Nobel-prize-winning economist Martin Feldstein--have calculated it may exceed $1).

Thus, even apart from any monopsony/monopoly effects, there is no conceivable way the administrative savings from single payer could conceivably outweigh the massive increase in costs (hidden, of course) resulting from these deadweight losses.

More than half of US healthcare already is tax-financed, but taking the remaining $1.3 trillion that isn't, running this amount through the tax system would cost us a minimum of $500 billion in lost economic output. Conversely, getting government out of health care would free up the corresponding amount of resources!

Certainly for the poor, near-poor, and catastrophically ill, there would need to be some sort of subsidies, just as we do for Food Stamps. But note that in the case of food--arguably a far greater necessity than the typical dollar spent on health care--we don't solve the problem of inability to pay by creating a system of government-run grocery stories or massive government regulation of prices or whether/where Food Lion can build another store. Instead, we provide income-related vouchers (gasp!) that permit the general public to enjoy all the benefits that come from private sector competition and those relying on subsidies to enjoy access to the very same stores as everyone else. In sharp contrast to Medicaid (and increasingly Medicare) those on Food Stamps don't encounter stores unwilling to take these vouchers
because of government's refusal to pay the market price for apples, for example.

The point is that for far less than the $1.3 billion in government subsidies going to health care today, we could have a private medical market that is far more price competitive (read: lower cost) while still retaining sufficient income- and health-related subsidies for those who cannot afford essential care.

Thus, while neither Obama nor McCain have offered visions for health reform that are perfect, it's a no-brainer to determine which moves us in the direction of far greater efficiency and effectiveness.

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