The political left in the United States, and for that matter, throughout the world, only knows two ways to try to control health care costs: (1) squeeze the providers and (2) deny patients care. Since they don’t believe in markets or economic incentives or entrepreneurship (the way costs are controlled in other markets), all that’s left is to take it out on doctors and patients.
Today I will address the doctors. To help our thinking, consider these four questions:
- Since Medicare pays doctors less than private plans, can we lower the cost of care by enrolling everyone in Medicare?
- If through force of law or power of negotiations, we managed to suppress all provider fees, would that lower the cost of care?
- Since nonprofit entities don’t have to earn a profit, could we lower the cost of care by outlawing the profit motive in health care?
- Have other countries lowered their cost of health care by paying providers less than what we pay?
The answer to all these questions is basically “no.” If you are inclined to answer “yes,” you don’t understand the concept of social cost. But don’t feel too bad. That would put you in the company of some very smart people — who I will charitably decline to name.
In thinking about these questions, the only “cost” that really matters is “social cost.” That is the cost to all of us collectively. I can always lower my private cost of care if I can get you to pay part of the bill. And you can always lower your private cost of care if you can find a way to shift some of your health care costs to me. These observations are both true and trivial.
Social cost is society’s opportunity cost. It is what society as a whole must give up in order to be able to consume something. For example, the social cost of one more doctor is what we must forgo in engineering or architecture or accounting or legal services that we could have had if a bright, talented young doctor entered some field other than medicine.
The same concept applies to other providers. For example, the social cost of a hospital is the value of the forgone uses of the labor and materials that made the hospital possible.
We can divide the aggregate social cost into units. Even though we are still thinking very abstractly, we can talk about the social cost of an hour of a doctor’s time or the social cost of a hospital bed day. But the social cost of a doctor’s hour or of a hospital’s bed day is independent of what anybody happens to pay for it, or even whether anyone pays at all.
To take an extreme example, imagine that we enslave all the doctors — paying them only a subsistence level wage. Let us ignore for a moment the difficulty of forcing a mind and assume they keep right on practicing as before. Would we have lowered the social cost of doctor services? Not by one penny. But we would definitely have changed the incidence of that cost. The private cost to payers would have been lowered by shifting much of that cost to doctors.
Suppose we nationalized a hospital. In the process, we cancel all of its outstanding financial obligations, telling the stockholders and creditors and mortgage holders to take a hike. Similarly, suppose we tell the manufacturers that we plan to keep all the hospital’s CT, MRI and PET scanners without making any more monthly installment payments. Would nationalization of this type lower the social cost of the hospital? Not one whit. Again, what I am describing is a mere shifting of costs from the buyers of care to the people and entities that make that care possible.
Even if these actions don’t lower the social cost of care, why not do them anyway? What’s wrong with screwing the providers if it helps the patients? In general, economists think it’s a good thing for people to pay prices that reflect the social cost of the goods and services they consume. On the buyer side, that means we won’t purchase items unless their value to us is at least as great as the social cost of their production. (Note: As explained elsewhere, ideal insurance contracts help us afford high prices without distorting these incentives.) On the seller side, producers are encouraged to supply services so long as their cost of production is at or below the value people place on them.
By contrast, if the price is way below the social cost of production there will be perverse incentives that lead to three bad outcomes. First, since health care is underpriced, buyers will overconsume it. That means too many doctor visits, too many CT scans, etc. Second, potential producers will withhold valuable services. Returning to my examples, there will be runaway slave doctors, as physicians seek more lucrative opportunities in other markets; future talented people will avoid medicine altogether; and nobody will be building any new hospitals. Third, in absence of prices that reflect social value, care will have to be rationed in some other way — for example, by waiting. But waiting uses up real resources, forces people to delay gratification of needs and in other ways adds to the social cost of care. (More on this in a future Alert.)
In most markets, the principles described here are easily grasped. That’s because in a normal competitive market, price reflects the marginal social cost of real resources used to produce the product.
In health care, things are different. Normal market forces have been so completely suppressed that in health care people rarely face a real price for anything. For the most part there are only reimbursement rates; and for each payer, there can be a different rate. Moreover, these rates almost never reflect the real social cost of the resources used to produce the services we get. For example, charts produced by the International Federation of Health Plans show the following wide range of prices paid in the private sector and in Medicare.
So let’s now answer the first three questions:
- Neither Medicare nor private insurers typically pay the real social cost of care. The different fees paid often reflect the results of shifting of costs. An NCPA study by Andrew Rettenmaier and Thomas R. Saving suggests that when Medicare spending is low, private sector spending tends to be high and vice versa — with hospitals at the end of the day managing to cover their outlays.
- Although it is possible to suppress provider fees across the board, doing so only shifts costs. It does not lower the true social cost of care.
- The cost of capital (including the cost of risk-taking) also cannot be avoided. Just because it does not show up on the books of nonprofit and government entities does not mean it goes away. Either taxpayers or some other entity is always bearing this cost.