I have written in the past about the healthcare issue in the United States, but mostly to complain about the horrid attempt to solve it, now known as Obamacare. I’m not sure I’m going to offer any concrete answers in this post, but I would like to do a better job of laying out just what the problem is. Among other things, this will help make clear why Obamacare has zero chance of making things better but will, as we heard in Supreme Court testimony this week, set the U.S. constitution on its ear. What is really starting to annoy me is that nobody at either end of the political spectrum or anywhere in between seems to be talking about the two biggest structural problems with our healthcare system and, most definitely, nobody has proposed meaningful reforms to address them.
I’ll get to that, but first I want to pause for a moment and talk about economic theory…..and pancakes. Bear with me. There’s an economic theory I’ve been doing some reading on called “the theory of second best.” I don’t recommend trying to read the original economists’ papers on it because, like anything ever written by an economist, they’re largely unintelligible to us mere mortals. But, I’m hoping a quick trip to the kitchen may shed some light. And, if so, help us understand what’s going on in healthcare and, in fact, many other instances of government intervention into markets.
Suppose you woke up one fine Saturday morning with a hankering for a nice big breakfast. So, you announced to your family you were going to make a big pancake breakfast for them. Everyone got all excited as you started pulling out the ingredients and greasing up the frying pan. But, then, dammit, you realized you were out of baking powder and eggs. My ultra layman’s read of the theory of second best suggests that, having realized the lack of eggs and baking powder, your second best option is not pancakes without eggs and baking powder. Your second best option is a bowl of oatmeal.
But, you go ahead and make the baking powder and egg-free pancakes because there was regulation that restricted oatmeal consumption on weekends (perhaps due to over-farming of the required oats). And, when the pancakes come off the griddle – shocker – they taste like shit and have the consistency of a cardboard box. The pancake breakfast was a bust, but when you wake up the next morning you find that the government, in the name of fairness, has now mandated that all pancakes be made without eggs or baking powder. But, your government is also benevolent so, in order to address the shortcomings of bad-tasting cardboard pancakes, they add a regulation that all pancake eaters have to use 4 times the usual amount of syrup. It turns out that does help a bit because the syrup is sweet and does cover up some of the bad taste and it does help you forget they are the consistency of a corrugated box. In fact, once there’s a mandate in favor of egg and baking powder free pancakes, the syrup regulation kinda makes sense, even if it doesn’t address the root cause of the problem.
This works OK for a while because of all the yummy syrup, but over time you develop diabetes and gain weight because of all the extra syrup you have to put on your bad tasting, cardboard pancakes. Might this be a wake up call to stop making pancakes without baking powder and eggs and stop covering it up with extra syrup? Well, not if you’re the federal government. Your government will recognize the problem, but now mandate that you eat your crappy cardboard pancakes with extra syrup, but take an insulin injection with them, and perhaps mandate that McDonald’s can’t sell hamburgers because too many people are gaining weight from bad pancakes with extra syrup. And, on it goes with new regulations piled on top of each other, each trying to fix the unintended consequences of the one before it.
Oooookay, I think I’ve just about exhausted this analogy. Clearly, the problem isn’t that people put too much syrup on their pancakes or that they need insulin to tolerate all that syrup. The problem is that when you ran out of eggs and baking powder, you made a bad second choice. You should have had oatmeal. And, more important, once the bad second choice was made, the government kept piling on “fixes” that turned a small problem into a much bigger one, without ever going back to fix the original problem.
So it is with healthcare. We’ll come back to this theory later (though I gotta admit, I’m really hungry now).
After World War II, the government imposed price controls and prohibited employers from increasing wages. Faced with an inability to entice new employees or retain current ones with higher wages, employers turned to “fringe benefits,” which was a backdoor way of paying people more while not running afoul of government-imposed wage freezes. What resulted, we now know, is a healthcare system where most of us get our insurance through our employer. This was a bad second choice and has created the first of the two huge flaws that nobody is talking about. Namely, there is no connection whatsoever to market pricing because the payor* and the consumer of healthcare are two totally different people.
Think about how you allocate your personal resources among other expenditures in your life (cars, dinners out, clothes for you and your kids, vacations, etc.). You make very informed decisions and trade-offs, particularly for expenditures that are above a certain level. For example, if you need to buy a new car, you’ll research it for a few days on the Internet, know precisely the dealer’s cost down to the floor mats, and you’ll pay a price accordingly. You will also research the quality of each car relative to others and probably ask a few friends about the various dealers and their level of after-sales service. Likewise, before you go to a new restaurant, you’ll read a few on-line reviews, consult Zagat’s, ask a few friends, and read the menu on-line to see how much the entrees cost. In other words, you’ll make a market-based decision, fully armed with all relevant data. As a result, the automotive and restaurant (and most other) markets function very efficiently and pricing is rationale.
Now, suppose you twist your knee playing racquetball and you go see the orthopedic surgeon. He tells you that he’s pretty sure it’s just a sprain and you’ll be fine with rest, but if you want, you can confirm that with an MRI. Do you say, “Doc, how much is the MRI going to cost?” No, why would you? If you opt to get it done, your insurance will pay. Cost is literally no factor in the decision. You’re a tad worried that you might have actually torn a ligament so, even though the orthopedist has told you he thinks that’s unlikely, you decide to get the MRI. The doc then hands you the name of one MRI center (that is probably run by his golfing buddy). It’s near your house and your doc recommended it so you go there. You don’t even consider looking into other MRI centers. You don’t call around and ask them how much they charge for an MRI of the knee. Studies have shown the remarkable extent to which people will inconvenience themselves to save even a little bit of money (e.g., driving across town to buy a bottle of chardonnay for $14 instead of the $15 charged by the liquor store across the street). Yet, in the MRI example, you spend no time trying to optimize price for a very expensive item. And, you certainly don’t negotiate (or necessarily even know) the price. Why? Because you don’t give a shit. You’re not paying for it. I’m not even sure the information is available to the consumers of healthcare because heretofore they have had no motivation to demand it. That is a seriously inefficient market.
The second, and related, issue with healthcare relates to the evolution of what we call “health insurance” and how we use it. Insurance, in its purest form, involves the pooling of higher and lower risk groups so that nobody ends up paying for something they simply cannot afford. I do not carry car insurance to cover a $500 fender bender. I can afford that. I carry car insurance because if, God forbid, I got in a serious accident and got sued for $1 million, I can’t afford to pay that and, thus, need to insure against it.
By contrast, what we call “health insurance” has really become “health payment.” It blows my mind that when I take my kid to the doctor with an ear infection, a visit that probably costs $100 or so, my “insurance” company pays for all but $15 of it (my “co-pay”). Except, of course, the insurance company doesn’t pay for it. My employer pays for it through ever higher premiums. I don’t care about the cost of the visit or the premium because I’m not paying for either (though employers are starting to shift costs back to employees, which, believe it or not, will ultimately be a good thing).
Insurance only makes sense for expenses we can’t otherwise afford and thus we need to pool the risk. If, again God forbid, someone in my family gets a serious chronic disease that costs $50,000/year, I need insurance for that. I don’t need it for every $100 visit to the doctor. Yet, that’s exactly how we use it today. Go back to the racquetball injury and forget about the MRI. Did you really need to go to the orthopedic surgeon in the first place? Would your leg have fallen off if you had just waited a few weeks to see if it stopped hurting and maintained its stability? I’m not being glib nor suggesting that serious medical issues should be ignored. However, if you had to cough up $200 (plus maybe another $500 for the x-ray) to have your orthopedist tell you it’s just a sprain, you may have waited a few days to see if the pain subsided a bit, no? But, when someone else pays for it, what the hell, go have it looked at. When our kids were little, we had friends who took their kids to the doctor for every cough and cold even though, last time I checked the medical literature, the common cold was still curable only with chicken soup and about a week’s time. But, since it didn’t cost them anything, off they went to the doctor. The automotive insurance analogy would be that you put in an insurance claim to the Geico Gecko for every oil change. It’s crazy!
For the avoidance of any doubt, I am not advocating for a system where people with chest pains sit home and wait to see if they’re having a heart attack. Serious or potentially serious medical disorders need immediate attention. But, lots of money gets wasted on unnecessary consumption of medical care simply because we’ve created a payment system where even the smallest amount of risk, risk that should be borne by the consumer, is borne by the insurance company.
What’s my point? Seriously, readers, I hate when you do this to me. It always seems to happen somewhere after about 1,500 words. I can see you sitting at your computer screens or straining to read my drivel on your iPhone and you’re anxiously tapping your foot, saying, “get to the friggin’ point, Robertson!” Do you have any idea the pressure that puts on me?
So, here’s the point. In healthcare, we have a market that has basically no price discovery because payors and consumers of the product are two totally different people, leaving the buyer/decision maker completely insensitive to price or consumption levels. And, at the same time we’ve created that woefully inefficient market mechanism, we’ve evolved an “insurance” system that is not really insurance at all and encourages unnecessary consumption (at these inefficient pricing levels). Frankly, as I re-read my own words, I’m not even convinced it’s two problems. It may just be a restatement of the same problem twice.
I warned at the outset that this screed would be more the statement of a problem than the offering of solutions. But, I think the first step in solving any problem is to make sure you have the problem statement correct. To do it any other way risks the problems introduced by the theory of second best. In healthcare, we headed down a “second best” type solution many years ago and we’ve compounded the problem over and over. This is what government does best. It heaps bad regulation on bad regulation without ever addressing the root cause. I’m really not pointing the finger just at President Obama. His healthcare law is just the latest bad idea to address the wrong problem. And, yes, it is very unfortunate that he did it in a way that is so threatening to the basic economic freedoms upon which our country was founded. I’m hopeful that (Diana Ross and) the Supremes will make that right with their decision on the individual mandate in June. But, I’ve seen almost nothing from the Republicans that offer solutions to the market-based problems I’ve raised here.
Maybe I’ll tackle solutions to these issues in a future post, but for now, I’m starving and plan to go eat some cardboard pancakes with a lot of syrup.
*For reasons I’ve never understood, when you’re talking about healthcare, “payor” is spelled with an “o” instead of the correct spelling of the word, which is “payer.”