Healthcare Proposals Should Change Market Incentives

By James Kwak

What is the lesson of McAllen, Texas, the focus of Atul Gawande’s celebrated article (discussed here and here)? This is my attempt at an answer:

Currently, our health care system has high-cost and low-cost areas; the high-cost areas have no better outcomes than the low-cost areas. So theoretically we can solve our health care cost problem by making the high-cost areas behave like the low-cost areas.

However, the market incentives go in the other direction; the economically rational thing for providers (doctors, hospitals, etc.) to do is to run up procedures and thereby costs. It would be better if providers focused more on patient outcomes or organized themselves into accountable care organizations, as Gawande prefers; but there is no economic reason for them to do so. People are not magically going to become more altruistic overnight. Even shame has only a temporary effect on behavior. Here’s Gail Wilensky from a Health Affairs roundtable:

It’s only by being able to offer compelling evidence that it’s the physician that is the outlier relative to his or her peers, that the patients really aren’t different, and in fact they are not having better outcomes, that you are able to pull back physician behavior — although there seems to be a high recidivism rate.

(Emphasis added.)

In some ways McAllen isn’t the aberration; according to the old Chicago economics department, everywhere should be like McAllen.

Remember all the people who said that you can’t blame mortgage brokers and investment bankers for being greedy, because that’s how a capitalist economy works? Well, you could make the same defense for the McAllen doctors. We long ago stopped expecting lawyers and accountants to behave contrary to their economic interests; now we simply expect them to conform to the law and to certain professional codes of conduct, and otherwise make as much money as possible. Why should we expect anything different from doctors?

In a capitalist economy, the thing that is supposed to keep prices in check is the buyers. If someone offers me a product that costs more than it is worth to me, then I won’t buy it. But we can’t count on patients to play this role in health care, because there is no way to make patients internalize all of the costs of their care; they simply don’t have the money. Furthermore, most people don’t understand the health production function (the relationship between treatments and outcomes), so they don’t have the ability to select treatments that provide benefits that are worth their costs. (And, in many cases, it’s not obvious even to professionals that a treatment isn’t worth the cost; it’s only obvious when you look at the data in aggregate.)

Prices will rise

What about payers (health insurers?) A “market” solution would be to change the reimbursement rates for different procedures – increase payment for things that doctors should do more of and reduce payment for things that doctors should do less of. Theoretically, payers should be doing this already. However, in the current situation, a private payer who tried to reduce the rates for popular, expensive procedures would find itself unable to attract providers. The only payer with any real negotiating power is Medicare. The private payers have little ability to control costs. Or, if they have the ability, they aren’t exercising it.

In short, prices will only go up. As a result, the cost of health insurance goes up, and the market finally kicks in in the crudest possible form: people who can’t afford it become uninsured. At some point, if we have enough uninsured people, the health care industry will hit a point where it cannot increase revenues anymore, because it has fewer and fewer paying customers.

The proposed public health insurance plan would have the power to negotiate lower rates with providers. That’s why some providers don’t like it. That’s also why private payers don’t like it; they would be at a cost disadvantage to the public plan. (They can live with Medicare because Medicare leaves them the entire under-65 market.) Maybe that’s unfair. But the current situation isn’t working.

Comments

[Trane250:]

Watched Michael Moore's "Sicko" last night on Showtime. I especially liked the segment on the UK's National Health Service. The GP interviewed said that his base SALARY was £ 85,000 per year and that his main concern was treating sick people not running up the insurance tab and that he could earn a bonus by helping his patients quit smoking and adopt a healthy lifestyle. The UK NHS and private insurance together consume less than 7.5% of GDP. Here in the USA, our FEE FOR SERVICE system consumes more than 16% of GDP and British medical outcomes are better than in the US in just about every category.

The plan dreamed up by Teddy Kennedy's staff is a monstrosity. All it will do is run up the tab without tackling the real problems.

Jun 22 08:47 AM

[TinyTim:]

No question that true market forces are distorted in US healthcare. We pay more for worse results. Since everyone with a vested interest is extremely polarized, the problem becomes correcting the biggest distortions with minimal changes.
The US has some of the most high tech advanced medical procedures, but only accessible to insured or wealthy. The development of these procedures is paid for by the market distortions.

IMHO healthcare needs to be considered as separate segments to maintain the innovation, yet provide basic care to all. Most visits are low tech, routine and in a lot of cases preventive. This is the segment that needs reform.

Jun 22 03:05 PM

[BRUCE E. W.:]

If you take away the very formidable financial status of physicians, most of the foundation for their prestige would be seriously tested. To say the emperor has no clothes is about on par with questioning the medical community. Anyone who works in or around the medical fields know who are deserving and who are parasites on the system. There are many problems inherent to this very closed order. The degree to which moumental financial obligations have both serviced and corrupted the pretext of medical delivery is extremely complex and self perpetuating. In the early days of medical self-consciousness, physcians complained about being turned into business men. Now its business first and the bigger the better. Excess money must be invested so many become venture capitalists on the side. To suggest that this is not a distraction is simply arrogant. The principle of "Do no Harm" so often qouted from ancient Socrates has been side stepped to though shall not take on liabilities. Patients are routinely categorized as commodities and every private practice operates under pressure to manage sufficient revenue overall. Overhead is outrageous by normal standards because every segment of health service is a separate economy from the norm. On the health side of things there is "practice variance" to excuse a generous range of errors; intuition/art/science divisions as separate but equal categories appeals to judgement; a protocol of interaction with patients that is highly individualized but generally preconditioned against educating the patient (like mushrooms: kept in the dark and fed shit...is a joking phrase I have heard). And finally, the general tendency to proctor rather than doctor has been instrumental in avoiding costly/timely commitments to patients. But the honest Doctors create the image and also suffer under this system. But we all know all this...we just can't say it out loud. Your Doctor might get mad at you...and then your REALLY in trouble.

Jun 23 12:13 AM

[Chris Butler_:]

First of all, the comment above mine inaccurately credits Socrates with the quote "do no harm." It's almost universally believed to be from Hippocrates, hence the Hippocratic Oath from which it comes.

More on point, however, the author of this post makes the argument that the capitalist system doesn't work in healthcare because patients cannot internalize expenses. Why? We're told the reason is that patients simply don't have the money. Actually, that's wrong. We don't know if they have the money. The problem is they never pay what the doctor would charge and uninsured person. I don't care to shop cost/benefit on doctors because all I'm worried about (as an insured person) is benefit. Insurance will charge me the same whether I see Doctor Good or Doctor Bad. Cost of service is no longer relevant to me. Only cost of insurance.

As far as benefit is concerned, we're told here that even smart people can't figure out if outcomes were worth the cost. We will only know in "the aggregate." There are so many problems with that statement, I hardly know where to start. Suffice it to say that if I have cancer, I don't want my doctor concerning herself with whether a treatment is worth the cost in the aggregate. Let me worry about the cost. And at that particular time, I can assure you I'm not going to care much about "the aggregate."

Jun 23 05:09 PM

[dcb:]

As a physician I can safely state that the reason I decided to get an MBA was determine why the system was so screwed up and how one could effectively change it. I see much of the same problems in the financial industry and the health care industry. I do not have any hopes for reform and have given up practicing in hospitals because the environment is so dysfunctional it interfered with my mental health.

These are large established systems that are more bent on protecting themselves and ensuring that those in power continue to enrich themselves at the expense of our overall economy and the health of its citizens. To fix the system you would really have to destroy it and rebuild from the ground up. Sine we are only seeing tweeks in our financial system after the greatest crisis in modern times There ain't going to be any real health care reform. Of that I am sure.

Jun 24 09:26 AM