By: Ethan Lamb
Artificial barriers designed to stifle supply explain a large part of our underwhelming health care system.
Failures in healthcare outcomes are often misattributed to the purportedly free-market system. In reality, healthcare is perhaps the most regulated industry in our economy. Healthcare is considered to be a private good, meaning that it’s economic properties are both excludable and rivalrous. This classification means that microeconomic principles should apply and the free-market should provide this good efficiently. Economist John Cochrane states, “the simple fact that hospitals won’t tell you a price ahead of time makes it blatantly obvious. No competitive industry would dream of getting away with this.” An academic study found that, when searching for the price of a hip replacement, from the few hospitals that revealed a price, it varied from $11,100 to $125,798. In a healthy free-market, there would be price transparency, robust competition between healthcare providers, and low barriers to entry. The absence of these characteristics indicates that the healthcare industry is rife with regulatory burdens. More specifically, several fixable regulations incur tremendous damage to the incentive structure that is necessary to attract suppliers.
Lack of Innovation
Most rudimentarily, there are fundamental issues suppressing the introduction and implementation of cost-reducing technology. In virtually every free-market sector, innovation and technology generate higher quality services and cheaper prices. In an extensive study by Amitabh Chandra and Jonathan Skinner at the National Bureau of Economic Research, it is concluded that “there is increasing evidence of the potential for cost-saving technologies (with equivalent or better outcomes) in the management and organization of health care to yield substantial productivity gains. But these types of innovations are unlikely to diffuse widely through the health care system until there are much stronger incentives to do so.”
The regulatory barriers suppressing innovation are readily apparent in the pharmaceutical industry. Specifically, Kefauver-Harris Amendments of 1968 contained myriad of new regulations designed to test the safety and efficacy of new drugs. Since the 1970s, As Economists Charles Hooper and David Henderson point out, Capitalized drug development and approval costs “increased at “7.5% per year in real terms.” In fact, economist Sam Peltzman created a model to determine the number of drug approvals if the Kefauver-Harris amendments had not been enacted. Peltzman found that the current level of approvals is 60% below that projection. More recently, according to the CBO, The Affordable Care Act imposed the $24 billion medical device excise tax and a $30 billion tax on brand-name drugs. These shocks on the supply side have been measurable. The growth of total US R&D expenditures from 2012 to 2014 was just 2.1%, compared with a 6% average over the fifteen years prior.
Cross Subsidies and Certificate of Need
On a broader level, the primary mechanism that undermines competition in the healthcare industry is a payment method known as cross-subsidization. Cross-subsidization is a paying scheme in which one group of consumers is charged higher prices in order to subsidize another group of consumers. In this case, Medicare and Medicaid reimbursement rates are markedly below the costs. In order to offset the undercharges, hospitals severely overcharge private insurance and cash-based customers. Over the years, this trend has been increasingly exasperated to the extent that in 2014, Medicare paid 88.5% of the average costs, while private payers paid 144% of the average costs. Effectively, a hospital is required by law to accept underpayments from Party A (government-sponsored patients) and must, therefore, overcharge Party B (private patients) to offset the loss. However, as Economist John Cochrane notes, “If the hospital is going to overcharge private insurance and paying customers to cross-subsidize the poor, the uninsured, Medicare, Medicaid and, increasingly, victims of limited exchange policies, then the hospital must be protected from competition.” In other words, in a free-market exchange, hospitals could not get away with eminently overcharging private-insurers, otherwise competing hospitals would offer a lower cost and hospitals that cross-subsidize would be driven out of the market. Furthermore, a lack of competition removes the incentive to introduce innovation and cut costs. One does not even have to be in favor of cutting Medicare and Medicaid spending to make an argument that the cross-subsidies raise market prices and ought to be dispensed with. Put simply, cross-subsidies can effectively be viewed as hidden taxes on private insurance patients.
Notwithstanding the unsustainable future cost projections of Medicare and Medicaid, a better solution than the status quo would be a straightforward use of tax revenue to subsidize Medicare and Medicaid. It would be a far more effective use and would not distort market prices for all of the other consumers because there would be no reason to over-charge and suppress competition. Cochrane goes on to draw a parallel to airplane companies in the 1970s. During this time, the government mandated airlines provided service and routes to small airports in rural cities. Because these routes were unprofitable, airlines had to charge higher prices to the remaining customers. Like healthcare, the supply of airlines was significantly restricted through certificate-of-need laws adjudicated by the Civil Aeronautics Board. The reform of certificate-of-need laws in the late 1970s led to a predictable increase in competition and markedly lower prices.
The protection from competition often manifests itself in certificate of need laws. In 36 states, every new hospital and major purchase of hospitals requires a certificate of need. This petition must be approved by the hospital equalization board, which is generally appointed by the governor. Unsurprisingly, incumbent hospitals and healthcare providers lobby to ensure Certificate of Need laws remained enshrined. For example, the Institute of Justice recently brought a lawsuit regarding a specialty Colonoscopy practice in Virginia that was unjustly rejected. A more conspicuous example of corruption was included in Revive the Healthcare System Without Destroying It, by David Dranove, in which a hospital CEO wore an FBI wire to prove that bankers and developers associated with the deal threatened to have the planning board reject a hospital request if she didn’t use their services in return. Any healthcare policy that fosters protectionism is bad policy, and Certificate of Need laws only serve to benefit existing players.
Milton Friedman wrote his Ph.D. dissertation on the phenomenon of occupational licensure. Occupational licensure, as the name suggests, requires a license to become certain professions and perform certain procedures. While it is sensible to require a high level of expertise in matters of healthcare, occupational licensure has been used as a vehicle to restrict the supply of doctors and artificially raise wages. One notable example includes the California Medical Association ardently opposing a bill that “would have allowed qualified nurse practitioners to offer a defined scope of primary care services in independent primary care practices, without supervision by a licensed physician.” This bill was endorsed by the AARP and already approved in seventeen states. There is a myriad of rudimentary procedures that nurse practitioners are perfectly capable of performing, as evidence suggests, but are prohibited by state law. Such trepidation is understandable when talking about medical licensure, but certain harmless procedures can certainly be done without the supervision of a doctor. Conflating life-threatening procedures with small procedures is often unproductive and stalls potential progress in this field. By mandating such procedures be conducted or under the supervision of doctors, the cost of compliance and services rise markedly, along with the coinciding restriction of the supply of doctors.
One way to demonstrably reduce the costs of these procedures is through retail clinics. Retail clinics, which are often owned by pharmacies employ nurse practitioners and physician assistants to perform flu shots, blood tests, monitor blood pressure, and other rudimentary tasks. The appeal of retail clinics are the low costs of services and convenience to consumers. These clinics have short waiting times and long hours of availability. According to Scott Atlas of the Hoover Institution, “researchers found that eleven medical conditions (outside of preventive care and immunizations) accounted for 88 percent of acute care visits to retail clinics; all the treatments involved relatively low medical costs. Care initiated at retail clinics is 30–40 percent cheaper than similar care at physician offices and about 80 percent cheaper than at emergency departments.” To little surprise, these retail clinics are often met with resistance from Health Associations intent on preserving the artificially high wages.
In short, the American healthcare system is far from perfect. However, many of the failings are in spite of the free market. If policymakers were to apply basic free-market remedies such as removing the rent-seeking regulations to free up the supply and induce innovation, healthcare would be far more accessible, affordable, and at a higher quality.
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