What's Really Wrong with the Healthcare Industry

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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.

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 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 practitioners.[10]
The practitioners 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.

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]

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 Association 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.

Reprinted
from Mises.org.

June
22, 2010

Vijay
Boyapati [send him mail] 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.

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