What’s Really Wrong with the Healthcare Industry

Mises Daily:
Wednesday, May 26, 2010
by

On May 3, 2010, I gave a talk to a class of students studying public
health policy at the University of Washington. I began the talk by
asking the students how many of them believed that the current
healthcare system in America was flawed; everyone in the class raised
their hand. I then asked how many of them believed that the recently
passed healthcare legislation, supported by President Obama, was a step
in the right direction in reforming America’s healthcare system. Once
again, everyone raised their hand.

While I agreed with the students on the first point, I disagreed
that the recently passed legislation was a step in the right direction.
My aim in giving the talk was to present the students with a
consistent, libertarian, free-market perspective on healthcare reform,
covering both the morality and the economics of why it would be
desirable to eliminate government interference in the market.

The Morality of Healthcare Reform

One of the most important factors animating the libertarian
rejection of public policy in general is the recognition that any state
action must ultimately resort to the use or threat of aggression. As
Ludwig von Mises observed,

It is important to remember that government
interference always means either violent action or the threat of such
action. Government is in the last resort the employment of armed men,
of policemen, gendarmes, soldiers, prison guards, and hangmen. The
essential feature of government is the enforcement of its decrees by
beating, killing, and imprisoning.[1]

Libertarians who value justice and recognize that the use of
aggression cannot be logically justified must reject all state action
in principle — this includes the use of aggression in implementing
healthcare policy.[2]

The Economics of Healthcare Reform

A common argument advanced in support of greater government
intervention in the American healthcare market is that a large and
growing fraction of the gross domestic product (GDP) is spent on
healthcare, while the results, such as average life expectancy, do not
compare favorably to the Western nations that have adopted some form of
universal healthcare. This argument is spurious for two reasons:

  1. A growing fraction of GDP spent on healthcare is not a problem per se.
    In the early half of the 20th century, the fraction of GDP spent on
    healthcare grew significantly as new treatments, medical technology and
    drugs became available. Growth in spending of this nature is desirable
    if it satisfies consumer preferences.

  2. Attributing
    national-health results to the healthcare system adopted by different
    countries confuses correlation with causation and ignores the many
    salient variables that are causal factors affecting aggregate
    statistics (such as average life expectancy). Factors that are likely
    to be at least as important as the healthcare system include the
    dietary and exercise preferences of a population.

Another argument commonly used in healthcare-policy debates is that
there are almost 46 million people who have no health insurance at all.[3]
Again, this is not a problem in and of itself. According to the
National Health Interview Survey, 40 percent of those uninsured are
less than 35 years old, while approximately 20 percent earn over
$75,000 a year.[4]
In other words, a large fraction of those who are uninsured can afford
insurance but choose not to buy it or are healthy enough that they
don’t really need it (beyond, perhaps, catastrophic coverage).

The real problem with the American healthcare system is that prices
are continually rising, greatly outpacing the rate of inflation, making
healthcare unaffordable to an ever-increasing fraction of the
population — particularly those without insurance.

If prices in the healthcare market were falling, as they are in
other markets such as computers and electronics, the large number of
uninsured would be of little concern. Treatments, drugs, and medical
technology would become more affordable over time, allowing patients to
pay directly for them. Identifying the cause of rising healthcare costs
should be the first priority for anyone who seeks solutions to
America’s broken healthcare system.

As I explained to the students in the public-healthcare-policy
class, there are four major causes of rising prices in the healthcare
market, and in every case government intervention has either directly
caused or greatly exacerbated the problem.

Employer-Provided Health Insurance

Perhaps the most important cause of rising healthcare prices in
America is the employer-provided health-insurance system. The very
existence of the system is itself a very strange occurrence and a big
hint that government intervention played a key role in its creation.
After all, employers do not pay for food or gasoline; why do they pay
for healthcare?

Employer-provided health insurance has its origin in a tax policy
passed in 1943, which made insurance provided by employers tax free. At
the time the United States was engaged in World War II and had enacted
wage and price controls,[5]
preventing employers from competing for scarce labor using the normal
mechanism of offering a higher salary. Instead, businesses used the
availability of newly tax-subsidized healthcare as a means of
differentiating themselves.

The tax advantages were made even more attractive and fully codified
in the 1954 Internal Revenue Code. Over the next few decades, the
government’s subsidization of employer-provided health insurance lead
to the dominance of that model of healthcare delivery, as the following
data from the 1965 Sourcebook of Health Insurance Data makes clear.

The number of people with employer-provided health insurance

The most important economic consequence of the existence of the
employer-provided health insurance is that consumers are much less
likely to discriminate on cost. Beyond the deductible, the employer
pays the cost of medical procedures through an insurance company. As
anyone who has gone on a business trip knows, if the company is paying,
then the employee is likely to purchase a more expensive ticket and
accommodation. Where an economy ticket may have sufficed for a personal
budget, a business-class ticket becomes far more attractive.

Not only are consumers less likely to discriminate on cost, but
providers of healthcare services have greater incentive to provide
medical treatments that are only marginally more effective at much
higher cost. This is the opposite of how the price mechanism works in a
free market, where consumers (who are paying out of their own pocket)
search for the cheapest prices and providers work hard to provide
services that are equally efficacious but less costly.

"The real problem with the American healthcare
system is that prices are continually rising, greatly outpacing the
rate of inflation, making healthcare unaffordable to an ever-increasing
fraction of the population — particularly those without insurance."

While employer-provided health insurance undermined price
sensitivity among consumers, it did not completely destroy it.
Businesses, being profit-maximizing organizations, have an incentive to
push back when costs increase. However, because of privacy concerns,
businesses are less able to push back against rising healthcare than
they are for plane tickets. An employer is less likely to pry into the
cost effectiveness of a particular surgical procedure undertaken by an
employee than they would be to pry into the purchase of a substantially
more expensive first-class plane ticket.

In 1965, Medicare was passed as part of the Social Security Act,
essentially supplying employer-provided health insurance to all
citizens above the age of 65. However, the "employer" in this case was
the US government, which does not have the same economic incentives as
a business, but rather has political incentives. Elected officials have
a strong incentive to promise their elderly constituents an expansion
in the range of treatments covered by Medicare, as well as to lower the
deductible that Medicare consumers pay out of their own pocket. Both
these factors further undermine a consumer’s desire to discriminate on
cost when seeking medical treatments.

In 1960, the government covered 21 percent of total medical
expenditures with 55 percent coming out of consumer pockets. In 2000,
43 percent were covered by the government with 17 percent coming out of
pocket. Unsurprisingly, the passing of Medicare in 1965 almost
immediately lead to a precipitous rise in US healthcare spending as a
fraction of GDP.

While price sensitivity has widely been undermined in the American
healthcare system, there remain some exceptions to the rule, where the
normal market mechanism remains intact. I gave two examples to the
students of how price sensitivity is working in healthcare today in
order to illustrate how it would work in a free market.

The first example was the LASIK corrective-vision procedure, which
has become very popular over the last decade. LASIK is an elective
procedure that is not covered by standard insurance, and consumers must
pay directly for the service — which means that they are much more
likely to discriminate between providers both on cost and reported
quality of the surgeon. With these incentives in place, the LASIK
procedure has been reported to have fallen in cost by over 30 percent
during the last decade.[6]

Even more importantly, the quality of the procedure has improved
dramatically in that period as providers competed to deliver the most
efficacious treatment. According to Erik Gross, an expert in the field of LASIK technology,

Early procedures were not LASIK at all, but
uncomfortable surface ablations with no astigmatism correction.
Subsequent generations of the procedure increased the treatable range,
added correction for astigmatism, correction for hyperopia, the
lasikflap to increase stability and comfort, accuracy and safety
features, and finally moved to true custom wavefront analysis and
correction.[7]

The second example I gave the students was from a personal
experience, when I wanted to have a small epidermoid cyst removed from
my back. The first practice I visited was a dermatologist’s office,
which deals primarily with insured customers and can afford to charge
exorbitant rates. I explained to the assistant on my first consulting
visit that I didn’t have health insurance — I choose not to — and asked
how much the procedure would cost if I paid cash. She quoted me $700
for a riskless procedure that takes about 15 to 20 minutes to perform,
and would not in this instance be performed by the dermatologist, but
by the assistant herself. As I explained to the students in the
public-health-policy class, the fact that there are very basic
procedures that cost the equivalent of $2,100 an hour is a glaring sign
that the market’s normal price mechanism has been broken.

On the recommendation of a friend, I decided to visit another
medical practice, Country Doctor, which deals mostly with lower-income
patients who do not have health insurance. Because its customers pay
out of pocket, Country Doctor has a much stronger incentive to charge
prices that its customers are willing to pay up front. When I had the
procedure to remove the cyst done at Country Doctor, it was performed
by an actual doctor, and it cost less than $50.

The moral of the story is that price sensitivity is a crucial factor
in driving prices down over time. Government policy has undermined
price sensitivity, and this has been a very important cause in the
rising costs of the American healthcare system.

Licensure

Licensure is the practice of restricting entry into a market by
forcing practitioners and providers to seek permission before doing so.
A common fallacy is that medical licensure protects consumers — yet
having a license is no assurance of the ability of a person to practice
medicine. Some who have received their license decades ago may no
longer be fit to practice, demonstrated either by incompetence or lack
of continued education.

From its inception, the practice of licensure has been motivated
primarily by the control of supply by organized medicine — in
particular, the American Medical Association (AMA) — to allow the
increase of wages for members of the licensed group. In the early 20th
century, for instance, a physician named J.N. McCormack spent several
years traveling the United States on behalf of the American Medical
Association in an attempt to convince doctors of "The Danger to the
Public from an Unorganized and Underpaid Medical Profession."[8]

"The fact that there are very basic
procedures that cost the equivalent of $2,100 an hour is a glaring sign
that the market’s normal price mechanism has been broken."

The restriction of supply and the attendant rise in prices faced by
consumers is not the only detrimental factor that can be attributed to
the actions of the AMA. As Milton Friedman pointed out,

It is clear that licensure is the key to the medical
profession’s ability to restrict the number of physicians who practice
medicine. It is also the key to its ability to restrict technological
and organizational changes in the way medicine is conducted.[9]

In other words, the AMA has sought not only to limit supply, but
also to regulate who can practice various aspects of medicine. For
instance, many medical procedures and decisions about prescriptions
could be handled by nurses or medical technicians rather than doctors,
whose labor is more expensive. Licensure limits the extent to which
market forces — that is, forces that lead to the cheapest and most
effective results for consumers — may determine the most efficient use
of doctors, nurses, and technicians.

A recent example of the AMA’s use of licensure was their attempt —
ostensibly for "patient safety," — to regulate Walmart’s creation of
low-cost retail clinics by preventing the clinics from operating using
only nurse practioners.[10]
The practioners would have only been providing very basic medical
services, such as administering needles and prescribing drugs, which
Van Ruth et al. conclude carries no extra risk to patients.[11]

It is precisely the sort of clinics operated by Walmart that allow
consumers — and especially the poorest in society — access to basic,
affordable healthcare. By regulating these clinics and reducing the
supply of doctors and providers, the AMA has caused higher prices for
American consumers of healthcare.

The Obesity Epidemic

In terms of its cost, obesity is perhaps the largest medical problem
in America. Finklestein et al. estimate that medical expenditures for
treatment of patients who are either overweight or obese accounted for
almost 10 percent of all medical expenditures in 1998, at a cost of 92
billion dollars (in 2002 inflation-adjusted dollars).[12]
They also estimate that almost half of all Americans are either
overweight or obese, with the numbers in each category growing by 70
percent and 12 percent, respectively, during the decade prior to 2003.
Sturm estimates that obese adults incur annual medical expenditures
that are 36 percent higher than those of normal weight incur.[13]

One might conclude from these statistics that obesity in America is
a clear example of a failure of the free market — that undirected
consumers, without the protection of a benevolent government agency,
have taken to consuming increasingly high-calorie and unhealthy foods,
leading to America’s obesity epidemic. However, this specious (yet
popular) narrative is contrary to the facts and disregards the crucial
role government policy has played in encouraging the production of
unhealthy foods supplied to American consumers.

"It is precisely the sort of clinics
operated by Walmart that allow consumers — and especially the poorest
in society — access to basic, affordable healthcare."

Recent research has uncovered the baneful influence that corn-based
sweeteners have had on America’s obesity epidemic. It is estimated that
Americans consume 73 pounds of corn-derived sweetener per person per
year,[14]
and as Michael Pollan points out, the growth of corn-based sweeteners
is a direct result of the government’s farm policy, which subsidizes
corn production.[15] A basic consequence of economic law is that when something is subsidized, more of it will be produced. Pollan writes,

Very simply, we subsidize high-fructose corn syrup
in this country, but not carrots. While the surgeon general is raising
alarms over the epidemic of obesity, the president is signing farm
bills designed to keep the river of cheap corn flowing, guaranteeing
that the cheapest calories in the supermarket will continue to be the
unhealthiest.

Pollan also correctly notes that the calories from high-fructose
corn syrup are unhealthier than those from natural sweeteners such as
sugar. Research by Powell et al. concludes that "[r]ats with access to
high-fructose corn syrup gained significantly more weight than those
with access to table sugar, even when their overall caloric intake was
the same."[16]
Avena, commenting on their study, said that "[o]ur findings lend
support to the theory that the excessive consumption of high-fructose
corn syrup found in many beverages may be an important factor in the
obesity epidemic."

The obesity epidemic in America has been exacerbated by the
abundance and relative cheapness of high-fructose corn syrup. The
growth of calories produced, and in particular the abundance of
unhealthy calories, is not an outcome of the free market but rather the
direct — if perhaps unintended — consequence of government farm policy.
As Pollan observes,

Since 1977 an American’s average daily intake of
calories has jumped by more than 10 percent…. This was, of course, the
same decade that America embraced a cheap-food farm policy…. Since the
Nixon administration, farmers in the United States have managed to
produce 500 additional calories per person every day.[17]

Only by removing the subsidies available to corn producers, and
allowing local and organic farmers to compete on an even playing field,
will healthier calories become more economically attractive to
consumers.

Intellectual Property

A patent is a government-granted monopoly on production. Holders of
pharmaceutical patents are free of the strictures of competition when
deciding the price at which to sell the drugs they produce. In practice
this means that drug companies are able to charge significantly higher
prices than they could in a market free of government intervention.
Kesselheim et al. estimate that for three drugs alone (amoxicillin,
metformin, and omeprazole), the delayed availability of generic
alternatives cost Medicaid 1.5 billion dollars between 2000 and 2004.[18]

The following chart illustrates the effect of generic competition on
the price of a cocktail of antiretroviral drugs, used to treat HIV,
between 2000 and 2001.[19]

Before the availability of a generic competitor the brand cocktail
cost over $10,000. Once generic competition was introduced, the price
rapidly dropped to $712. The dramatic difference in cost hardly covers
the human cost of government-granted monopolies on drug production —
namely, the tens of thousands infected with HIV who died for want of
affordable treatment.

One common myth in the economics profession is that
intellectual-property rights are necessary to foster innovation in the
production of ideas. Recent work by Boldrin and Levine[20] and Stephan Kinsella[21] has exploded the fallacies underpinning this widely believed economic shibboleth.

In particular, Boldrin and Levine devote a chapter of their book, Against Intellectual Monopoly,
to the pharmaceutical industry. They argue that the actual cost of
bringing drugs to market is substantially lower than the estimates
produced by the pharmaceutical industry — a group with a vested
interest in lobbying for strong patent protections. They also provide
evidence that in many instances the existence of patents hinders
research in drug production.

Patents are not a natural outcome of the free market but are
government-granted monopolies on production. Contrary to conventional
economic wisdom, patents are not an unequivocal benefit in fostering
the development of ideas. The existence of patents is, on the contrary,
a clear contributor to the high cost of medical treatments available to
American consumers.

Conclusion

In giving the talk to the class of public-health students, my aim
was to disabuse them of the widely held belief that America’s
healthcare system is an example of a free-market failure and that a
free market in healthcare compares poorly to that of
government-provided, universal care. In fact, the US healthcare system
has endured substantial government intervention — albeit intervention
of a different variety than that of Europe or Canada. And the areas in
which the government has intervened in the market have seen substantial
increases to costs for consumers.

None of the causes of higher prices identified in this essay are adequately addressed by the recently passed healthcare legislation.
Indeed, the problem of high costs will be further exacerbated by
extending insurance to cover more people and more procedures while also
reducing deductibles.

The only solution to increasing costs is to eliminate government
interference in the market and to allow the price mechanism to work as
it should. Consumers who pay out of their own pocket will search for
the cheapest solutions to suit their needs, while providers of
healthcare will compete, through constant innovation, to drive prices
down and discover the most efficacious treatments.[22]

Vijay Boyapati is a former Google
engineer. In 2007 he started Operation Live Free or Die, a grassroots
organization to help Ron Paul’s 2008 presidential campaign. Since 2009
he has devoted himself to studying Austrian Economics.
Send him mail. See Vijay Boyapati’s article archives.

Comment on the blog.

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Notes

[1] Ludwig von Mises, Economic Freedom and Interventionism (Indianapolis: Liberty Fund, 2006), p. 15.

[2] For a discussion of the logical justification of libertarian morality, see Hans-Herman Hoppe, The Economics and Ethics of Private Property: Studies in Political Economy and Philosophy (Auburn: Ludwig von Mises Institute, 2006), ch. 13.

[3]
Carmen DeNavas-Walt, Bernadette D. Proctor, and Jessica C. Smith,
"Income, Poverty, and Health Insurance Coverage in the United States:
2008," p. 27.

[4] For a summary of the National Health Institute Survey, see here.

[5] "Compensation from World War II through the Great Society," Bureau of Labor Statistics.

[6] "Lasik Price and Quality Concerns Raised to Congress."

[7] This paragraph comes from my personal correspondence with Erik Gross, formerly an engineer with Visx, AMO, and Abott labs, who worked on many of the improvements to LASIK mentioned.

[8] Illinois Medical Journal, vol. 9 (Springfield: The Illinois State Medical Society, 1906), pp. 260–2.

[9] Milton Friedman, Capitalism and Freedom: Fortieth Anniversary Edition (Chicago: University of Chicago Press, 2002), p. 154.

[10] Meg Marco, "American Medical Assocaition Goes After Walmart-Style Retail Clinics," The Consumerist.

[11] L.M. Van Ruth, P. Mistiaen, and A.L. Francke, "Effects Of Nurse Prescribing Of Medication: A Systematic Review," The Internet Journal of Healthcare Administration, vol. 5 no. 2 (2008).

[12] Eric A. Finkelstein, Ian C. Fiebelkorn, Guijing Wang, "National Medical Spending Attributable to Overweight and Obesity: How Much, And Who’s Paying?," Health Affairs (2003).

[13] R. Sturm, "The Effects of Obesity, Smoking, and Drinking on Medical Problems and Costs," Health Affairs (March/April 2002): p. 245–53.

[14] "Sugarcane Profile," Agricultural Marketing Resource Center.

[15] Michael Pollan, The Omnivore’s Dilemma (New York: Penguin, 2006), p. 108.

[16] M.E. Bocarsly, E.S. Powell, N.M. Avena, and B.G. Hoebel, "High-fructose corn syrup causes characteristics of obesity in rats: Increased body weight, body fat and triglyceride levels," Pharmacology, Biochemistry, and Behavior (2010).

[17] Omnivore’s Dilemma, pp. 102–3

[18] Aaron S. Kesselheim, Michael A. Fischer, and Jerry Avorn, "Extensions Of Intellectual Property Rights And Delayed Adoption Of Generic Drugs: Effects On Medicaid Spending," Health Affairs 25 no. 6 (2006): 1637–47.

[19] "AIDS, Drug Prices, and Generic Drugs," AVERT.

[20] Michele Boldrin and David K. Levine, Against Intellectual Monopoly (New York: Cambridge University Press, 2005).

[21] N. Stephan Kinsella, Against Intellectual Property (Auburn: Ludwig von Mises Institute, 2008).

[22]
I would like to thank my friend Amy Iacopi for her original invitation
to speak to the public-health-policy class, and Professor Doug Conrad
and his students for being so welcoming and open to considering a
perspective on healthcare different from their own. I was pleased, and
a little surprised, that after giving the talk most of the questions
the students had focused on the morality of a free market (since I had
only devoted a small portion of the talk to issue of morality and spent
most of it on the economics) and how a purely voluntary society might
function in practice. I would also like to thank my friend Jon Perlow,
whose brilliant essay, "Government, Free Markets, and Healthcare," was the original motivation for my talk.

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