Joe Nocera and Bethany McLean’s The Great Failure: What the Pandemic Has Revealed About Who America Protects and Who It Leaves Behind has been very critical of the way medical institutions operated during the pandemic (and in general). Every now and then you hear that the United States is showing why a free market in health care cannot work. (I must confess that this is a pet peeve of mine, because the health care system we have in the United States is not within light years of a free market. Even if you are convinced that a free market in health care really would be a terrible idea, it’s still wildly dishonest to claim that the United States has that.) With respect, Nocera and McLean never quite describe the United States health care system as an example of free market capitalism. The closest they come is to describe the system that exists as “a perverse version of the free market economy” or “a corruption of capitalism.”
Here’s an example they give of this in action:
The second reason the poor and uninsured end up in safety net hospitals is a series of public policy decisions that sound logical in theory but are both callous and misguided in practice. Take, for example, the decision by many states to reduce the number of hospital beds. They did this in the belief that fewer beds would help control rising Medicare and Medicaid costs. Theoretically, that makes sense. But the game was rigged: the closure of hospitals was determined by their profitability, which was already determined by the government’s reimbursement policy.
Boston University health care management expert Alan Sager notes that the main effect of cutting beds by closing entire hospitals was to further separate wealthy hospitals, which were rarely affected, from poor hospitals, which suffered most from the cuts. . It was a classic example of a policy passed down by elites who would never be influenced by it, and imposed on people who had no say in the decision.
The result of this policy? “In fact, Medicare spending has actually increased.” Why did this government policy aimed at reducing spending actually result in an increase in spending? Here’s what the authors have to say:
The answer was quite simple: the kind of hospital that could easily be closed – the hospital with little or no power and prestige – was not the kind of hospital that was likely to save the government money. The same number of people would still need to visit a hospital; they should just visit one that was still open…
… The same pattern played out across the country; hundreds of hospitals in disadvantaged neighborhoods were closed, ostensibly to save money, but neither hospital costs nor overall health care costs went down. All that was really achieved was a massive reduction in the number of hospital beds in neighborhoods that needed them.
While a casual reader might skim through the book and come away with the idea that it shows that markets don’t work in healthcare, a more careful reading of Nocera and McLean reveals the problems they suggest arise precisely because the peculiar how government regulations are structured in the healthcare market. A full treatment of this subject can be found in Christy Ford Chapin’s book Caring for America’s health: The public creation of the corporate health care system. As Chapin puts it:
Insurance companies occupy a central position in medical care. Insurers decide which services and procedures qualify for policy coverage, influence physician compensation and hospital revenues by setting reimbursement rates, and shape medical practices by requiring providers to follow treatment blueprints to obtain compensation. Many scholars have taken this authority for granted, assuming that insurance companies serve an intrinsic role in private medical care. Yet the insurance company model was only one option among a series of organizational options that could have structured the private market. And compared to alternative arrangements, the insurance company model has made medical services less efficient and more expensive to deliver.
How did insurance companies acquire such a dominant role in healthcare? Politics – not market logic – placed insurance companies at the heart of American health care.
Chapin shows how the healthcare system we have in America has not evolved into its current form because that is how a healthcare market naturally organizes itself. It was structured step by step, from the top down, through an endless series of policies and policy reforms that created a system with the worst possible combination of incentives for all parties involved.
Nocera and McLean are aware of this and quote the book approvingly Overcharged: Why Americans Pay Too Much for Healthcare, written by Charles Silver and David Hyman and published by the Cato Institute, which argues that the way the government has regulated and structured healthcare payments has resulted in an incredibly dysfunctional system. Nocera and McLean write:
The flaws in the payment system – and the government’s inability to fix them – essentially encouraged hospitals to extort the government. The basic issue was that historically hospitals were paid by performing procedures and the more procedures they performed, the more money they made. The 1965 law that created Medicare and Medicaid did not change that; rather, rather than capping what it would pay for a procedure, the government agreed to pay hospitals on a cost-plus basis.
(As an aside, Nocera and McLean think the “fee-for-service” model, where “the more procedures they performed, the more money they made” is a serious cause of healthcare dysfunction. And they are doing something – like Johnathan Gruber it aptly put it: “This issue can best be summed up in the saying that having a doctor tell you how much medical care you should get is like having a butcher tell you how much red meat you should eat. United States is a broken health care system where doctors and providers are paid based on the amount of care they provide, not how healthy they make you.” But this fee-for-service system was itself created as a result of government regulation , as Chapin documents in her book.)
Simplified, a cost-plus basis worked something like this. The government would pay hospitals what it “costs” to perform a given procedure, plus an additional percentage. Let’s say 10% to make the numbers simple. So if a hospital performed a procedure for $100, the government would pay the hospital $110, while the hospital would receive $10 for that procedure. But if the hospital instead spent $1,000 to perform the procedure, the government would pay the hospital $1,100 — a profit of $100 instead of $10. This payment method gave hospitals a very strong incentive to drive up costs as much as possible – and that’s exactly what happened.
A similar problem was pointed out in an EconTalk episode where Russ Roberts interviewed Keith Smith of the Surgery Center of Oklahoma. Like Michael Huemer in summary the problem:
Later in the podcast, he details some of the scams happening in the industry. If hospitals claim they are underpaid (the patient has not paid the full cost of treatment), they receive money from the government. That sounds reasonable, right? They should be compensated for their good work.
This has led to hospitals jacking up prices to absurd levels so that they can regularly claim that they have only been paid a small portion of the costs so that they can get more money from the government.
The hospitals make agreements with insurers whereby the insurer only pays a fraction of the absurdly high price. This is all fun for the insurance companies too, because it allows them to claim that they have negotiated incredible discounts (like an 80% or 90% discount) for their customers. It also makes it unaffordable for a patient to get medical care without insurance, which is also fine with the insurance companies.
Now you might look at the way hospitals or insurance companies are behaving in response to these regulations and feel like they deserve condemnation. And you might also read what Nocera and McLean think alike about the actions of the various medical organizations they describe. But I think this is the wrong reaction. To quote an old saying I heard often in my younger years: don’t hate the player, hate the game. If the government writes a law that gives companies strong incentives to inflate costs, and then companies respond to that incentive by inflating costs, the best response is not to yell at the company for responding to the incentives it gets. Instead, you should be angry at the people who wrote the rule book and created those incentives.
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