Markets Work For Health?
by John Goodman

Perhaps you have heard that health markets work reasonably well when patients pay with their own money.  LAZIK surgery and cosmetic surgery are two examples.  Yet, the authors of a new study dispute this claim.

The article is called "Self-Pay Markets in Health Care: Consumer Nirvana or Caveat Emptor?" It was funded by the Center for Studying Health Systems Change (an RJR outfit) and appears at the Health Affairs web site. http://www.mckinsey.com/mgi/rp/healthcare/accounting_
cost_healthcare.asp.  The authors (both non-economists) focus mainly on LAZIK surgery, but also include in vitro fertilization, cosmetic rhinoplasty and dental crowns.  They do not find nirvana.

But first things first.  Buried in the middle of the article, in the middle of a paragraph, with no bold heading and no mention in the Abstract, as though it were only of passing interest, is this amazing factoid: over the past decade, the real price of LAZIK surgery has decline by 30 percent.  Equally buried, is another startler: The satisfaction rate among patients is 93 percent.  And we can all be thankful the editor's shears did not expunge this tidbit: unlike every other kind of surgery, in LAZIK surgery higher quality service routinely commands premium fees.

Is there some relationship between falling prices, high patient satisfaction, higher pay for superior quality and the fact that patients are paying out of pocket?  The authors never ask this question.

Given that the rest of the world is apoplectic over rising health care costs and people everywhere are telling pollsters how much they dislike their third-party payer systems, you have to wonder.  Either a) the authors are remarkably uncurious, or b) their world view is several standard deviations away from the mean.

The authors did find many blemishes, however, causing them to conclude that self-pay markets don't work, or don't work very well. Although they never talked to any actual patients, interviews with people on the supply side revealed a market with inconsistent pricing and inconsistent bundling.  (Some quoted prices include initial screening and follow up procedures; others do not).  Worst of all: the primary source of patient information is word of mouth! Alas.

Here's a personal confession.  Before I go to the supermarket I do not know the price of bread. Nor do I know the bundles (is the sales price per loaf?  Or is it buy one, get one free?)  I would not be surprised to learn that most shoppers are just like me.  But prices are not determined by what most buyers do. They are determined by the buyers at the margin.

It's economics 101.

A new report from McKinsey claims that the United States spends $477 billion a year - $1,645 per person - more on health care than other OECD countries do, after adjusting for differences in income and wealth.  To make matters worse, we do not get better care. Paul Krugman of the New York Times is going gaga over the report.

However, the study makes a fundamental economic error, surprising for McKinsey.  The real social cost of any good or service is not the amount of money spent on it.  It is the real resources used to produce it.  This is especially important in health care, where the suppression of market forces in every country makes cash flows an unreliable indicator of real resource use.

Surprisingly, there are fewer practicing physicians, nurses and acute care bed days per capita in the United States than the average OECD country.  We do use 54 percent more medical devices - defibrillators, pace makers, coronary stints, hip implants, knee implants, etc.  But our consumption of drugs is 20 percent lower than in other countries.  If health outcomes among developed countries are pretty much the same, the United States does not look so bad in terms of resources used to produce those outcomes.

In the McKinsey study, almost 60 percent of the higher U.S. cost of care stems from high prices paid for inputs.  However, in other developed countries, governments use their buying power to force providers to accept below-market reimbursement, just as Medicaid and Medicare do in the United States.  For instance, the income of a physician is 5.5 times that of the average worker in the United States, on average.  The ratio for Germany and Canada is 3.4 and 3.2 respectively.  The comparable ratio is 1.5 in Sweden and 1.4 in the United Kingdom.

Monopolistic buying power - however, does not lower the real social cost of health care; it shifts those costs.  A different way of achieving the same result would be to pay doctors market-determined fees and then impose a special tax on them, leaving their net income where it is today.  The virtue of this alternative is that it would be clearer that social costs have not been lowered; they have merely been shifted to the providers of care.

A few other economic errors in the McKinsey report are worth noting.  They treat the profit of for-profit hospitals as a cost not borne by public hospitals - as though capital used by government has no opportunity cost.  And they treat the taxes paid by for-profits as a cost not born by public hospitals - as though real social costs were affected by whom the government chooses to tax.

I'll save the quality discussion for another day, but leave you with this thought.  If the United States performs far more knee replacements than other countries then one of two things must be true: either 1) we are increasing the quality of life for our seniors relative to seniors in other countries, or 2) we are subjecting our old folks to a lot of unnecessary (and painful) operations.

Read the full report: http://content.healthaffairs.org/cgi/content/full/hlthaff.26.2.w217v1/DC1

John C. Goodman is President of the National Center for Policy Analysis