Understanding the Costs of Healthcare

By: D_W_MacKenzie

Rising costs are the main issue in the debate over healthcare reform. Most everybody thinks of healthcare as expensive, but there is much confusion over these costs. On September 9, President Obama attempted to clarify cost issues concerning the medical industry. The federal government will supposedly reduce costs, curtail abuses, and make healthcare services more affordable.

The president proposes creating a low-cost market for health insurance. Previously uninsured people would be required, with some exemptions, to buy health insurance — so as to avoid high-cost emergency-room visits. Businesses would be compelled to provide insurance, with some exemptions for the smallest businesses. The federal government would also promote preventative care and nonprofit health clinics.

Senator Baucus has proposed a new plan whereby people who do not buy health insurance will be fined $3,800. These fines will force people to buy insurance, and this will spread costs more broadly.

Economist Paul Craig Roberts criticizes proposals for forcing people to buy insurance. He argues that fining people who cannot afford health insurance is like "solving the homeless problem by requiring the homeless to purchase houses." Roberts recognizes that fines forcing more people to buy health insurance are the equivalent of a new tax. He objects to this new tax on the grounds that it is imposed on those who cannot afford it.

Roberts believes that taxes for healthcare should be apportioned according to the "ability-to-pay" principle. He favors a "single-payer, not-for-profit healthcare system." According to him, private healthcare does not work because of expensive medical technology, malpractice suits, bureaucratic third-party-payer costs, and the "cost" of shareholder returns.

The remarks that the president, Senator Baucus, and Paul Roberts have made regarding profits and executive compensation reveal problems with their understanding of economics. The president, for instance, sees profits and high executive salaries in insurance companies as unnecessary costs, fat that can be cut from the health industry. In economic terms, however, profits represent success in satisfying consumers of particular products at relatively low costs.

Successful executives keep revenues high by gaining market share and satisfying customers in large numbers. They also keep financial costs low by cutting waste in the use of labor, capital, and supplies. High profits are often a sign that companies are serving their consumers at a low cost.

The president's remarks regarding profits and executive salaries likely derive from the hostility towards all profits characteristic of many people on the Left (such as Michael Moore), rather than from sound economic reasoning. Executives earn high salaries by delivering high profits to owners, and high profits derive in part from keeping costs under control. Would a nonprofit, single-payer (i.e., taxpayer-funded) system also be run on a cost-minimizing basis?

The basic choice we have to make is between healthcare based on the profit motive and healthcare based on some kind of service principle. On the one hand, corporations do make profit by developing new drugs for consumers, and by manufacturing medical supplies and equipment. On the other hand, nonprofit clinics do exist, medical professionals do perform pro bono services, and some companies do donate medical supplies and equipment. But what serves the public best: private profit seeking, or the desire to do public service?

Of course, we don't want to assume that all profits and executive salaries derive from efficient management. Some executives increase the profitability of their operations through lobbying the government to secure state-granted privileges and subsidies.

Roberts recognizes such problems with special interests. Senator Baucus proposes that people be pressured into buying more insurance, but Roberts notes that Baucus has taken large campaign contributions from insurance companies. Lobbying by special-corporate interests generates profits that are "fat in the system" and should be cut.

But will increased government involvement in the healthcare industry cause more or less corporate lobbying? Both mandated-private and single-payer, nonprofit insurance proposals will likely increase wasteful lobbying by corporate interests.

The real question is, how far can we replace legitimate profit seeking with public service? Some people donate time and goods to healthcare. It is also true that some people work at Medicare or the Center for Disease Control because they want to do public service. But how much more of this conscientious public service can we expect? Other people seek federal jobs for an easy path to early retirement, or for power. The president is assuming a ready supply of capable and conscientious public servants, as well as effective means of managing and organizing healthcare along bureaucratic lines.

In the absence of market prices and profits, large-scale organization requires central planning. The idea of such planning scares many people, and rightly so. The planning of entire national economies during the 20th century ended in disaster. Large public bureaucracies have also exhibited significant problems with waste and rigidity.

These problems exist for specific reasons: central planning suffers from the defect that small groups of leaders or officials cannot possibly understand local conditions in modern industries like healthcare. The modern world is simply too complex to be planned. Of course, the private system of profit and loss also has defects, but we must be careful in identifying the source of the worst problems with profit seeking.

President Obama wants to further politicize the medical industry. He seems to assume that private profit seeking is wasteful. The president would be right if he specifically criticized profiteering through the manipulation of public policies. Since the medical industry is heavily regulated, we should expect that part of its profits serves special interests rather than consumers.

But the president's complaint about executive pay and profits in general is more in line with the socialist idea that profits necessarily serve a particular interest group — capitalists — at the expense of everybody else.

There are, of course, other sources of waste in the current healthcare system. Laws that mandate coverage of minor and routine healthcare services increase private administrative costs. For that matter, income taxes create a bias in favor of healthcare funding through insurance, rather than through per-service fees charged directly to consumers.

Third-party administrative costs could be slashed simply by removing the current bias towards healthcare financing through so-called insurance (as opposed to through true insurance for high-cost/low-probability health events). Frivolous and fraudulent lawsuits have also imposed high costs through inflated malpractice-insurance rates. Would either single-payer or mandated-insurance proposals decrease these costs?

We have three options: our current system, permeated by ill-gotten politicized profits and wasteful special-interest lobbying; a largely untried privatized system, based on private profits and limited private charity; and a system of centralized, single-payer healthcare through public bureaucracies. The type of compromises that the president proposed in his September 9 speech have already been tried and failed. We already have regulation by bureaucratic agencies.

Public bureaucracies have well-known and well-deserved reputations for rigidity, waste, and, at times, abuse. The private sector has a bad reputation in the healthcare industry, but that is largely due to the fact that healthcare has already been politicized.

Obama's plan for healthcare amounts to a self-fulfilling prophecy: if we further politicize the healthcare industry its profits will be even less justifiable, and public options will gain legitimacy. Paul Craig Roberts has seen ahead of this curve, and recognizes that a centralized, single-payer system might have some advantages over a politicized system of government mandates favoring private-corporate interests.

But the idea that we must choose between public healthcare and politicized-private healthcare is false. We can also move to depoliticize the healthcare industry. A depoliticized, free market in healthcare would be run on the basis of profits that are for the most part earned through cost efficiency and customer service.

A truly competitive health industry of this kind would best serve American consumers. Unfortunately, we are as far from approaching this situation as President Obama is from comprehending its merits.

D.W. MacKenzie teaches economics at the Coast Guard Academy. (The contents of this paper do not reflect official views of The U.S. Coast Guard Academy.) Send him mail. See D.W. MacKenzie's article archives. Comment on the blog.

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