Communism which once prevailed in the entire "second world" persists today only in North Korea and Cuba. Communism failed because of the basic laws of supply and demand which form the basis of economics. Among developed nations, market-priced medical care persists only in the USA. It is those same fundamental principals of economics, not humanitarian concerns, which will eventually end market-priced medical care in the USA. Investors who ignore this do so at their peril.
For 75 years, it was said that Roosevelt's New Deal saved capitalism. By softening the rough edges of the free market capitalism with reforms such as social security and unemployment insurance, FDR may have prevented adoption of much more radical changes.
75 years from today it is unlikely that anyone will think Obama saved market-priced medical care. Rather, he only prolonged it, and that will not be thought of as a good thing. In the developed world, market-priced medical care still exists only in the USA. It is only a matter of time until market-priced medical care joins communism, slavery, racial segregation and fascism as systems that no longer exist in developed nations.
The USA is the last holdout with market-priced medical care not only because of any inherent conservative or free market ideology. Rather, as the wealthiest nation that ever existed we are the last ones who can afford it. Switzerland was one of the last advanced economies to abandon market-priced medical care. It is arguably a greater bastion of conservatism than the USA. Switzerland's women were not granted the right to vote until 1971.
During the debate as to whether Switzerland would abandon market-priced medical care there was considerable concern about how it would affect the major Swiss pharmaceutical giants such as Hoffmann-La Roche (RHHBY) and Novartis (NYSE:NVS) which was Sandoz prior to the merger with Ciba in 1996. However, it was then realized that the Swiss pharmaceutical giants made much of their profits in the American market.
The reason that no nation, including the wealthiest can allow markets to set the prices of medical care indefinitely is that demand for medical care is inelastic. Demand for a good or service is inelastic if a percentage increase in price results in a smaller percentage decrease in the quantity demanded. Basic economics tells us that sellers facing inelastic demand will continuously raise prices until prices reach the elastic portion of the demand curve. Consequently in every developed country in the world, all goods or services with inelastic demand have their prices regulated by government. Medical care in the USA being the only exception.
Health care is one of the very few things for which the sellers face inelastic demand. The prices of all other goods and services facing inelastic demand in the USA are regulated by government. Retail electricity service providers face inelastic demand. Consequently, their prices are strictly controlled by all governments worldwide, including the USA.
The inelasticity of retail electricity is obvious. If Consolidated Edison (NYSE:ED) or any other electric utility were to triple retail service prices, people might be a little more careful about turning off the lights. Turning off their refrigerators? Watching less television? Not likely. Thus, tripling the price would result in only a small reduction in kilowatt-hours sold. Almost all other goods and services are price elastic. That includes non-medically necessary elective cosmetic and lasik surgery whose prices have actually relatively decreased over time. Medical care in the USA is the only instance in any developed country where any product facing inelastic demand is not substantially price regulated.
Medical prices are controlled in various ways in the rest of the developed world. In Japan, the land of $100 melons and tiny $10,000 per month apartments, all medical care prices are listed in a book, thicker than the Manhattan telephone directory. The prices set in the book are usually less than a third of those in the USA. An MRI that costs $1,200 in the USA costs $88 in Japan. Japanese insurance companies are private as are most doctors. Japan spends less than a third per capita on medical care than America. However, the Japanese are greater consumers of medical care than Americans. They visit doctors and hospitals more often, have much more diagnostic tests such as MRIs. They also have better health outcomes as measured by all metrics such as life expectancy. They also wait less for treatment than Americans do as Japanese doctors work much longer hours for their much lower incomes.
Japan's explicit price controls are roughly emulated in other countries via the use monopsonistic systems. Monopsony, meaning "single buyer" is the flip side of monopoly. A monopolist sets prices above free market equilibrium. A monopsonist sets prices below free market equilibrium. It does not matter if there is an actual single payer or many buyers (or payers) whose prices are set by the government or by insurance companies in collusion with each other. More competition among sellers generally leads to lower prices. However, more competition among buyers leads to higher prices. In the health insurance industry the beneficial effects of more insurance companies competing for patients are far outweighed by the adverse effects of insurance companies competing for doctors and hospitals in their HMO plans. This was completely misunderstood during the recent debate on health care reform. With health care, more competition among insurance companies on balance results in higher prices.
Focusing attention on the insurance companies, which are simply intermediaries between the doctors and the patients, was a tragic error. It would like trying to solve a problem of high energy prices by focusing on gasoline stations. Only if the government sets prices can health care prices be controlled. Controlling prices does not automatically result in longer waiting times. Japan and Switzerland generally have shorter waiting times to see doctors than does the USA. Additionally, if prices were controlled there would be no such thing as "in-network" or "out-of-network" since all doctors would accept all insurance plans.
Price inelasticity in medical care stems not from the physical nature of its delivery as is the case of retail electricity. Rather, it is the dynamics of how medical care is delivered via the patient -doctor relationship. How many people have ever negotiated with a doctor over the price before undergoing necessary treatment? Have you ever met anyone who got up off an examination table and walked out because the doctor quoted too high a price? In theory, sick people could shop for the lowest price, but they don't. An individual gasoline station faces elastic demand. People must buy gasoline, but if one station raises its price enough, customers will go elsewhere. When an individual doctor increases fees, most customers don't go elsewhere. Thus, fees will continue to rise until prices reach the elastic portion of the demand curve.
In the USA we have attempted to deal with the combination of inelastic demand and unregulated medical care prices in various ways. One method of keeping medical care expense as a percent of GDP to "only" double that of other developed countries was to have a significant portion of the population uninsured and denied medic care in some circumstances. Obamacare will reduce the number of uninsured and untreated. However admirable this may be from a humanitarian perspective, absent price controls, it will exacerbate the cost problem. The existence of large numbers of uninsured (conscripts in the war against rising medical costs) did moderate the growth in health care costs. Now the number of uninsured and untreated will be declining and uncontrolled prices will be rising.
HMO's were once thought to be a way of dealing with the inexorable price increases. The problem is that HMOs have to compete against each other for services of doctors and hospitals. As long as medical prices are set by market forces, the inelasticity of demand will force market prices inexorably higher. In a "mixed system" with both free-market and controlled health care prices like the USA, prices inexorably are driven upwards to the market level as long as demand is inelastic. Prices such as payments from Medicare that are "controlled" have to be increased continuously with legislation such as the "doctor-fix" to stay competitive with market prices. Medical prices can only be effectively controlled either by direct price controls as in Japan or with systems where everyone gets care for "free" from the government (Canada, UK, France). In those countries only the extremely wealthy can chose not to use the government paid health services that they have already paid for with their taxes and patronize the relatively small market-priced sector. In those countries, forgoing the government priced system is not an option for almost all doctors, as it is in the USA.
In some respects, free-market capitalism mixes with medical care almost as badly socialism mixes with agriculture. The economic failures of communism are well known, particularly the inability of state-run agriculture to provide even basic staples. In free markets "consumer sovereignty" directs the producers of goods and services to follow the dictates of supply and demand. As Adam Smith explained in 1776, no central authority coordinates the delivery of food and the plethora of goods that a major city like London needs every day. Rather, the "invisible hand" of competitive free markets results in an abundance of goods and services being provided to consumers in the most efficient manner. The "consumption" of medical care overturns many of the economic assumptions that underlie free-market efficiency. Usually, the conditions under which medical care is provided are the exact opposite of consumer sovereignty. In most cases the "sellers" i.e. the doctors, tell you, the "buyer" what and how much you need and set the price. The prevalence of third-party payers further removes medicine from the purview of the normal supply and demand market economics that prevails for goods and services whose sellers do not face inelastic demand.
The price inelasticity of health care is also a consequence of the success of the medical science. Two hundred years ago, consultation with a physician did not significantly alter the outcomes of most medical conditions. Doctors could do very little for patients prior to 1800. Since then, the medical science has made tremendous progress. As treatments became more effective, people became willing to pay increasingly more for health care. It is quite logical that as doctors could do more and more to improve people's lives; people would be willing to pay more for their services.
From a humanitarian perspective this medical progress is great. However, in any unregulated market, the price of a product facing inelastic demand will eventually increase until the price reaches the elastic portion of the demand curve. For the USA, that would mean spending much more than 50% of GDP on health care. Most of those not engaged in the health care industry would see their standard of living plummet. This is politically unacceptable. Thus, well before the prices of health care reach that level the USA will join the rest of the developed world and control medical prices.
In the short-run, Obamacare with 30 million more people with health insurance means greater profits for the health care sector. However, retention of a basically market-priced healthcare system will ultimately prove untenable. One scenario could be that politicians in the USA who so far have demonstrated abysmal ignorance of the economics of healthcare will attempt a "free market solution". As unfettered health care prices would be a disaster, that would probably then cause the USA to join the rest of the world with some type of monoposonized health care system. As most observers of the various health care system in world, except possibly Michael Moore, are aware this would not be a total panacea;
The USA spends about twice as much per person on health care as other developed countries. However, the prices paid by Americans or their insurance carriers for medical procedures are typically about triple what is paid in other developed countries. Hence, Americans consume less health care services than their foreign counterparts. Obamacare does not seriously address the price problem and would thus appear likely to only exacerbate the problem.
Government spending has been increasingly driven by medical care prices. Government pays half of the costs of health care in the USA. When the tax spending aspects of the tax deductibility and exclusions of medical care and insurance expenses are included, the impact of health care costs on the deficits is even larger. In many respects, the health care price crisis in uniquely American. Our Government spending on healthcare per capita exceeds that of any other country in the world, including those where there is very little private health care expenditures,
Adopting the second worst healthcare system in the world, Canada, Germany and the UK are probable the best candidates for that dubious honor, would allow the USA to eliminate much of the Federal budget deficit. That would probably be beneficial to financial markets. See: The Market Multiple On The S&P 500 Can Be Explained: P/E Ratios Are Inversely Related To Future Federal Spending Being the second worst healthcare system after the USA, is like being the second worst nuclear accident in the last decade after Fukushima. There probably was another nuclear accident where a few people were injured in the last decade, but none comes to mind immediately.
Long-term investors should assume that it is just a matter of time before the USA mostly abandons market-priced health care. As in the rest of the industrialized ,one way or another, doctors fees would be set by the government or by insurance companies acting in concert with government approval. Doctors in Tokyo where living costs exceed that of New York are paid less than a third of their New York counterparts and work much longer hours. Regulating doctors' fees in the USA would greatly reduce the "backward-bending supply curve problem". Any introductory economics textbook will explain that when the amount that a doctor, or anyone else, can earn per hour increases two effects come into play. If the amount a doctor can earn in an hour increases from $500 to $1,000, the substitution effect causes the doctor to put in more hours as the opportunity cost of not working for an hour increases. As anyone's income increases, the income effect means they tend to buy more of all normal goods including "buying" more leisure by working less. When the income effect overtakes the substitution effect, the supply curve becomes backwards bending and higher hourly rates result in less hours being supplied. That is why doctors in New York work much fewer hours than those in Tokyo and why it is difficult to get an appointment with a specialist in New York for a Friday.
It should be noted that doctors are not any more greedy wealth maximizers than anyone else. Many doctors volunteer their time in impoverished areas for many weeks at a time and are generous in many other ways. There are many examples of people who are great humanitarians and philanthropists while conducting their business and professional lives in ways to maximize their income. Bill Gates of Microsoft (NASDAQ:MSFT) employed aggressive business tactics that brought prosecution by the justice departments of many countries and is one the greatest humanitarians and philanthropists of our time. In previous times Andrew Carnegie and John D. Rockefeller were reputed to maximize their wealth via dubious actions but were renowned philanthropists.
There are downsides to government control of health care prices. There are no backward-bending supply curve problems with pharmaceutical and medical supply companies. However, politically, no government has been able to control doctors fees without also controlling prices of pharmaceutical and medical supply companies. Thus, there will be collateral damage to pharmaceutical and medical supply companies when government control of health care prices comes to the USA. It will affect companies all over the world since the USA is by far the most profitable country for the health care sector.
Governments are in many cases inept and/or corrupt. A classic example occurred when Eli Lilly & Co. (NYSE:LLY) and Amylin, since bought by Bristol Meyers Squibb (NYSE:BMY), introduced the diabetes drug Byetta in Denmark. One member of the board that had to approve the drug for use by the Danish Health care system voted against Byetta on the grounds that it was more expensive than other treatments. Byetta was a breakthrough drug that employed a totally new method of action which greatly improved outcomes for diabetics. Money spent on Byetta would save many multiples of its cost in terms of reducing amputations, blindness and other expensive complications of diabetes. A cynic might point out that the Danish company Novo Nordisk (NYSE:NVO) was a major producer of diabetic drugs such as insulin that would lose market share to Byetta.
Regardless of what anyone thinks of government price control of health care prices, a rational investor has to assume it is coming sooner or later. The strategy should be to make money when Obamacare brings health insurance to 30 million more people, but to be ready to bail out when the USA is forced to abandon market-priced health care.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.