Joe Nocera and Bethany McLean’s The Big Fail: What the Pandemic Revealed About Who America Protects and Who It Leaves Behind has a lot of criticisms of how medical institutions operated during the pandemic (and also generally). One occasionally hears that the United States shows why a free market in health care can’t work. (I confess, this is a pet peeve of mine, because the health care system we have in the United States isn’t within a light year of a free market. Even if you’re convinced a free market in health care would genuinely be a terrible idea, it’s still wildly dishonest to claim that’s what the United States has.) Respectably, Nocera and McLean never quite describe the health care system in the United States as an example of free-market capitalism. The closest they come is referring it the system that exists as “a perverted version of free-market economics” or “a bastardization of capitalism.”
Here’s one such example they give of this in action:
The second reason the poor and the uninsured wind 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 instance, the decision by many states to reduce the number of hospital beds. They did so believing that fewer beds would help control spiraling Medicare and Medicaid costs. Theoretically, that makes sense. But the game was rigged: the closure of hospitals was determined by their profitability, which had already been determined by government reimbursement policies.
So, notes Alan Sager, the Boston University health-care management expert, the primary consequence of eliminating beds by closing entire hospitals was to further separate the wealthy hospitals, which were rarely affected, from the poor hospitals, which bore the brunt of the reductions. It was a classic example of a policy being handed down by elites who would never be affected by it and imposed on people who had no say in the decision.
The result of this policy? “In fact, Medicare spending actually increased.” Why did this public policy aimed at reducing spending actually result in a spending increase? Here’s what the authors have to say:
The answer was pretty simple: the kind of hospital that could be closed easily – the one 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 were still going to need to visit a hospital; they would just have to 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, yet neither hospital costs nor overall health costs went down. All that was really accomplished was a massive reduction in hospital beds in neighborhoods that needed them.
While a casual reader might breeze through the book and come away with the idea that it demonstrates markets don’t work in health care, a more careful reading of Nocera and McLean shows the problems they point to occur precisely because the peculiar ways government regulations structure the health care market. An entire book length treatment of that issue can be found in Christy Ford Chapin’s book Ensuring 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 pay and hospital revenues by setting reimbursement fees, and shape medical practices by requires that health care providers follow treatment blueprints to obtain compensation. Many scholars have taken this authority for granted, assuming that insurance companies are filling an intrinsic role in private medical care. Yet the insurance company model was only one option among an array of organizational possibilities that might have structured the private market. And in comparison with alternative arrangements, the insurance company model has delivered medical services less efficiently and more expensively.
So how did insurance companies acquire such a dominant role in health care? Politics – not the logic of the market – positioned insurance companies at the heart of American health care.
Chapin shows how the health care system we have in America didn’t develop into its current form because that’s how a market in health care naturally organizes itself. It was structured, step by step, from the top down by 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 – they approvingly cite the book Overcharged: Why Americans Pay Too Much for Health Care, written by Charles Silver and David Hyman and published by the Cato Institute, arguing that the way the government has regulated and structured health care payments has resulted in an incredibly dysfunctional system. Nocera and McLean write:
Indeed, the flaws in the payment system – and the government’s failure to fix them – essentially encouraged hospitals to extort the government. The foundational issue was that hospitals were historically paid by performing procedures and the more procedures they performed, the more money they made. The 1965 law that created Medicare and Medicaid did nothing to change that; on the contrary, instead of 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 find the “fee-for-service” model, where “the more procedures they performed, the more money they made” to be a serious cause of dysfunction in health care. And they’re on to something – as Johnathan Gruber aptly put it, “This issue is best summarized in the saying that having a doctor tell you how much medical care to get is kind of like having a butcher tell you how much red meat to eat. What we face in the United States is a broken fee-for-service health care system where physicians and providers are paid based on how much care they deliver, not on 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 the following. The government would pay hospitals whatever it “cost” to perform some procedure, plus an extra percentage. Let’s just say 10% to make the numbers easy. So if a hospital performed a procedure for $100, the government would pay the hospital $110, with the hospital gaining $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 $100 gain rather than $10 gain. This method of payment gave hospitals a very strong incentive to inflate costs as much as they possibly could – which is exactly what happened.
A similar issue was pointed out in an EconTalk episode where Russ Roberts interviewed Keith Smith of the Surgery Center of Oklahoma. As Michael Huemer summarized the problem:
Later in the podcast, he describes some of the scams that go on in the industry. When hospitals claim that they were underpaid (the patient didn’t pay the full cost of treatment), they get money from the government. That sounds reasonable, right? They should be compensated for their good work.
This has caused hospitals to jack up prices to absurd levels, so they can regularly claim they were paid only a tiny fraction of the costs, so they can get more money from the government.
The hospitals make agreements with insurance companies whereby the insurance company only pays a fraction of the absurdly inflated price. This is all cool with the insurance companies too, because it enables them to claim that they negotiated unbelievable discounts (like an 80% or 90% discount) for their customers. It also makes it cost-prohibitive for a patient to get medical care without insurance, which is also fine with the insurance companies.
Now, you may look at the way hospitals or insurance companies behave in response to these regulations and feel like they are deserving of condemnation. And you may also read what Nocera and McLean and feel the same way about the actions of the various medical organizations they describe. But I would suggest this is the wrong reaction. To quote an old adage I often heard in my younger years – don’t hate the player, hate the game. If the government writes a rulebook heavily incentivizing businesses to inflate costs, and then businesses responds to that incentive by inflating costs, the best response isn’t to yell at the business for responding to the incentives they are given. You should instead be upset with the people who wrote the rulebook and created those incentives.
READER COMMENTS
John Smith
Nov 6 2024 at 12:44pm
“Just a reminder to all that I accurately called this election, and had publicly posted in writing beforehand. With my forecast for the electoral margin of victory being very likely to be >95% accurate as well, pending final votes.”
https://www.econlib.org/remunerations-determined-by-markets-or-politics/
David Seltzer
Nov 6 2024 at 3:00pm
Kevin: Good Stuff. The Animal Healthcare Industry is valued at about $38 billion dollars. I have two dogs treated by a vet. There are no less than 15 animal hospitals within a 10 mile radius of our home. No certificate of need required for these facilities. I pay the vet directly on the spot for service. No third party payer. They post prices and compare them to their competition. I also get a veteran’s discount. Little or no gov interference, save for licensing the practice and veterinarians. Personal story. I had a state of the art hip replacement 4 years ago. 30 minute procedure. The surgeon and hospital billed the insurance company $47,500. The price of the titanium implant was billed for $30,000. They settled at $23,500. $6500 less than the implant. Go figure. I asked the surgeon what the cost to me would be If I were self-insured and hospitals could compete for patient care. He estimated about $15,000 and he would work out a payment plan if necessary. It seems the freer market is veterinary care.
steve
Nov 6 2024 at 4:39pm
I think its pretty notable that no one has tried to engage in free market health care and the the more market mechanisms you incorporate the higher the costs. You can make the case that some non-first world countries have market based health care but the care is poor in those places and very patchy at best. I think it would be great if someone thought of some way to achieve market based health care but no one has been able to do it. On a side note I have had private conversations with several prominent health care economists that would be considered left of center. All would like to see more market influences in health care but acknowledge that to date efforts to do so have largely been ineffective on addressing costs.
Every first world country with decent health care uses insurance. There is probably a good reason(s) for that. Given the way that medical costs actually occur I haven’t seen anyone offer a good alternative.
I was heavily involved in rural medicine and I worked in a state without CON laws. We have had hospitals closing because they were losing money and because the networks that acquired them decided they couldn’t afford them. TBH I wasn’t aware that states were, as apparently your authors claim, being arbitrarily ordered to shut down by their states. What I am aware from reading health care management literature is rural and inner city hospitals are closing due to losing money and especially in the case of rural hospitals having trouble finding staff. **
Fee for service? Yup it has issues, but isn’t it ironic that a libertarian would complain? That’s pretty much how the rest of the world gets paid. You provide a service and you get paid for it. With the knowledge imbalance inherent in the relationship it makes it hard to find a market solution. There are things we could do. For example we could pay Medicare rates for everything since their rates are usually 20%-30% lower than private rates.
** What my team has found over and over when we have gone in and taken over failing rural hospitals is that local residents were avoiding them if they could because they were aware that the quality of care was poor. I have many horror stories.
Steve
Kevin Corcoran
Nov 6 2024 at 4:57pm
This is simply false – as Chapin extensively documents, we used to have something much closer to a free market in health care and costs were substantially lower when that was the case. It was after market mechanisms were expelled that costs began to skyrocket.
Again, that’s simply false. Fee-for-service was the exception, rather than the norm, in health care prior to the government restructuring the market. And there’s nothing ironic about objecting to that – libertarianism isn’t somehow based on a commitment to “fee-for-service”. (Whatever on earth would give you that impression?) Libertarianism is, however, committed to allowing people to peacefully make their own voluntary arrangements on how to organize their affairs. Fee-for-service is one way to do that, but it’s hardly sacrosanct, or some terminal end in itself. The objection here isn’t to “fee-for-service” as such, the objection is that previously existing, voluntary arrangements were forcibly prevented from occurring and a fee-for-service model was mandated, for the explicit purpose of benefiting special interests at the expense of everyone else. This is exactly the kind of thing you should expect libertarians to object to (and, unfortunately, for progressives to cheer for). There were a variety of different arrangements for how health care was provided. They didn’t fade away because the insurance model outcompeted them and there were “probably a good reason(s) for that.” They were displaced because special interests used regulatory capture to advantage insurance companies at the expense of everyone else.
Kevin Corcoran
Nov 6 2024 at 5:15pm
If you don’t want to take the time to read Chapin’s entire book, she does provide a few highlights in this article. Some key points:
So your assertions that nobody has ever tried a market style system in health care, or that the more market oriented health care is the more expensive it becomes, or that third party payment methods became the norm because of “good reasons” are, as matters of historical fact, simply false. The market used to provide all kinds of different and competing arrangements for health care, with lower costs and easier access, and third party payment systems had to be mandated into existence precisely because they weren’t successful on their own.
steve
Nov 6 2024 at 6:52pm
You are using 1930s quality care as your model. OK, I totally agree that if we go back to 1930s level of medical care markets will work much better. Medicine didnt have that much to offer back then, not much that was truly expensive. It was the pre-antibiotic era. No US, MRI or CAT scans so you couldn’t diagnose much until it was terminal. No endoscopes. No ICUs. No ventilators. If you needed the equivalent of critical care you died. No polio vaccine yet. A baby born a couple of weeks early probably died (as opposed to about 100% survival now). The list of useful medicines was tiny compared to today. Lab studies were still in their nascent stage and it wasn’t until the 50s that they became reliable. Chemotherapy didnt start until the 40s. Heck, we didnt even use plastics much in medical care until the 50s or 60s. There wasn’t much specialization as there wasn’t much to specialize about. It’s easy to prepay a group of docs who arent actually going to do much for you.*
So first, it actually is a fact that in the more socialized medical systems, that still have first world quality, are cheaper. The more expensive nations tend to have more market mechanisms built in and we have the Singapore experiment where costs rose when they tried to implement a very market based system. Second, in the modern world with all of the advances in health care no one has figured out how to do market based care while also providing quality. Certainly not with making it widely available. Third, while Chapin cites those group formations there was a lot of fee for service care at that time. It was actually in the 30s that doctors decided to work together to form their own insurance group ie Blue Shield.
I would note that in particular that surgeons have nearly always been paid on a fee for service basis. Same for proceduralists in general. I think, as do others, that it was the growth in surgery numbers and procedures, including diagnostic and imaging tests plus the increase in hospital costs that lead to more broad fee for service payment. Even then, the private insurance companies were largely paying on a fee for service basis.
*There are a number of primary care groups in the country who provide primary care for a set fee. That works pretty well and some of those groups claim to have lowered costs. However, you still need some way ie insurance to cover the large costs of chemo, surgery, chronic illness, trauma, etc. They limit the use of specialists to control costs.
I would suggest reading Paul Starr’s book on the history of medicine. It goes back further in history and gives you a pretty full picture.
Steve
Kevin Corcoran
Nov 6 2024 at 7:03pm
The first part of your comment merely lists a variety of medical techniques and procedures that didn’t exist previously and simply asserts that the market couldn’t work in providing such things, but you merely assert that without providing any substantive argument or evidence for that assertion.
The second half of your comment regarding the relative cost and quality of “socialized” systems and the prevalence of fee for service methods contains several basic factual errors, which I may return to and comment on further if I remember, but that also leaves me unmoved.
Regarding Paul Starr’s book, I’ve read it a couple times already. I’d give it a C- overall.
steve
Nov 6 2024 at 7:33pm
The first part of my statement illustrates that medicine in the 1930s was a different profession than what it is now. It cost less because it didnt do much. I thought I made that pretty clear but maybe I didnt or you dont want to acknowledge it. As I noted, no one has been able to make markets work since the advent of modern medical care. The lack of existence is my evidence. Lots of people talk about it but it doesnt happen. Note that the same thing happened in the rest of the world ie they ended up with insurance financed health care. They did have some advantages in the 30s. Women didnt work as much back then. There was a large population of women available to do volunteer work, part of the reason for the mutual aid societies sort of working.
I will have to think about the Chapin book. I dont find it encouraging that in one place she notes that group practice can lead to rationing then claims shortly after that group practices in the 30s didnt have that problem. Absent incentives getting people to work in a group practice is a recurring issue. Incentives can then lead to over utilization regardless of whether you are not in a fee for service model. It also seems odd that after documenting that it was doctor groups there were responsible for so much of the increase in costs, she then ends up blaming it on Washington DC.
Also, while there were hopes for the DPC model it really hasn’t been very successful in addressing costs. Like a lot of those proposed remedies they work well in the groups that found them but dont move well to other groups.
Steve
Kevin Corcoran
Nov 7 2024 at 6:21am
This is a pretty weak form of reasoning for a couple of different reasons. For one, it completely fails to generalize. Pick virtually any area of economic activity – electronics, for example – and it’s true that it looks very different today from the 1930s, and you could list out a long line of advancements and abilities available today that didn’t exist in the 1930s. But it would be plainly, obviously, comically false to infer that therefore they must be massively more expensive today compared to before and couldn’t operate on a free market. Indeed, in virtually every area where the free market is more allowed to operate, we see the opposite process occur – industries have massively transformed and gained incredible new abilities while becoming far cheaper and more available. As libertarians often point out, it’s just in the areas that government most heavily involves itself, such as health care of the education system, where we don’t see these same cost declines occurring alongside massive improvements in capability. So pointing out that health care has gained far more abilities from the 1930s but is also massively more expensive than back then is a pretty self defeating claim to make – indeed, it’s a central point in the argument libertarians make! So you’re just trying to bash your shoulder into a wide open door there.
Of course, that’s not what she actually said. What she said was “They carefully balanced resource expenditures between rationing and overutilization.” That is, they managed their resources in ways that avoided both rationing and overutilization. So I would suggest you read her book – it would also shed light on a number of other fundamental factual errors among your other assertions I don’t have time to outline at the moment – but I would also recommend you make an effort to read it more carefully, otherwise you’ll continue misunderstanding elementary points like this.
Knut P. Heen
Nov 7 2024 at 8:21am
There is an important distinction between cutting costs and becoming more efficient. Becoming more efficient means holding output (quantity, quality, etc.) constant and reduce costs or increasing output holding costs constant. That requires the type of creativity only competition can produce. Cutting costs is simple. Just close down shop.
Kevin Corcoran
Nov 7 2024 at 10:26am
Very true.
David Seltzer
Nov 7 2024 at 4:42pm
Knut: Your comment is profound in its brevity.