Looks Like Someone Could Stand to Lose a Few Pounds
I am a Capitalist Pig. I believe Milton Friedman was far cooler than Ashton Kutcher, and I believe the free market when left alone can fix anything. In the much ballyhooed debate on healthcare the free market has taken a beating by politicians and talking heads as not sufficiently regulated to control cost but these are all people who do not understand the free market has not existed in healthcare since 1965 when Medicare was established.
Before we dig into how Medicare destroyed the free market let’s first look at how the free market actually works. Milton Friedman in his outstanding book “Free the Choose” used the manufacturing of pencils to explain how the marketplace works when left alone but I am going to use a more contemporary example in flat screen televisions. I will try to avoid using charts if possible.
First and foremost we have two television manufacturers in Wholesaler ABC and Wholesaler XYZ and they seek to sell their products to Electronic Store A and Electronic Store B.
Electronic Store A recently bought 25 50 inch plasma televisions from Wholesaler ABC at $500 a piece and Store A intends to sell these to you, the consumer, at $750 each. Conversely Store B recently bought 25 50 inch televisions from Wholesaler XYZ for $525 a piece which they intend to sell to the consumer for $775 a piece.
Since Store A is selling it’s televisions at $25 cheaper than Store B they get the bulk of the business. Store B naturally does not want to lose business to their competitor so in an effort to lower prices Store B begins buying from Wholesaler ABC so they can get a lower wholesale price and pass those savings on to the consumer.
At this point Wholesaler XYZ begins looking for a way to win back the business of Store B so they streamline their manufacturing process and buy new equipment to make themselves more efficient and by the time their efforts are done they are able to offer Store B 25 50 inch plasma televisions at $475 a piece.
Store B jumps on this offer and are now able to sell their 50 inch plasma televisions $25 cheaper than their competitor, Store A, at $725 a piece.
Now Store A is looking at moving their wholesale business from Wholesaler ABC to Wholesaler XYZ so they can compete with Store B which initiates a “pricing war” between not only Store A and Store B but also between Wholesaler ABC and Wholesaler XYZ as they all look to undersell their competitor.
It is the motivation of profit via increased business and revenue that controls pricing in the free market. Profit is the ultimate, unbiased motivator. Profit has no ulterior motive and every company wants profit unless the government gets involved and alters the dynamic.
If healthcare worked like the traditional free market then we would not be having the pricing crisis we are currently having. With that said let’s take a look at how the market currently functions in healthcare.
In healthcare the medical provider (Hospitals, Doctors, Clinics, etc) function as the wholesaler of medical services so for the sake of simplicity we will refer to them as Dr. Wholesale. Health insurance carriers are the purchasers of wholesale medical services much as the electronics stores are wholesale purchasers of televisions and obviously you and I are still the consumers.
Now let’s look at a simple medical procedure like X-rays and let’s also assume, for the sake of nice round numbers, that the current price of an X-ray is $100.
Rather than Dr. Wholesale bidding against other doctors to lower the price of his X-rays from $100 to $90, so he can lure more business, we get a different dynamic because of an 800 pound gorilla in the room named Medicare.
What Medicare does when it enters the equation is tell Dr. Wholesale “no matter what I will give you $100 for an X-ray” this is what in the medical world is called a “fee schedule” where a set price is assigned to a medical service and it is the basis of our current healthcare system which is referred to as a “Fee for Service System”.
Due to Medicare’s intervention in the market Dr. Wholesale and his competitors have no incentive to lower his X-ray prices from the $100 value because regardless of what happens Medicare will give them all $100 for their X-rays. The effect this has on the free market dynamic is this, rather than the wholesalers (the medical providers) lowering their prices to attract more wholesale consumers (the insurance carriers) the insurance carriers now find themselves in the unique position of having to outbid Medicare in order to get the medical providers to agree to do business with them. It is for this reasons that when most private insurance carriers add a hospital or provider to their network they do so by agreeing to pay 110%, 120%, or more of the Medicare fee schedule (what Medicare would pay for the same service). It goes without saying that the more your health insurance carrier is paying out the more they are charging you as the insured. In any other part of the market this would be considered price fixing.
This has had a ripple effect that extends well beyond the doctor’s office and your insurance premiums. Medical equipment providers, such as companies that make MRI machines, have had little to no incentive to make more efficient and cheaper machines because medical providers have had no reason to pressure them into doing so since they have had no market pressure to lower their pricing to be competitive. Combine this with a handful of other perfectly preventable and controllable factors and not only has healthcare not gotten cheaper it has increased in price at more than five times the rate of inflation and has moved from being 4% of our GDP in 1960 to more than 16% of our GDP as of 2007.
One last thing I want to do to prove my point is look at an area of healthcare where the free market has been allowed to work completely unhindered and that is LASIK eye surgery.
A decade ago the average price for the LASIK eye procedure was hovering around $6,000 an eye but today it averages right around $700 an eye, it is worth mentioning at this point that Medicare does not cover LASIK eye surgery.
The market dynamic differs only slightly on LASIK eye surgery in that since insurance carriers, who again generally function as the wholesale purchaser, do not cover LASIK eye surgery you, the consumer, become the wholesale purchaser. LASIK providers quickly figured out that consumers were not very willing to pay $6,000 an eye so LASIK doctors were forced to find ways to make the procedure cheaper.
In order to do this most providers began working with medical equipment providers to create lasers to do the surgery quicker and more efficiently and with an easier recovery time for the patient. This technological innovation allowed the procedure to become cheaper to lure in more customers.
It was at this point that the free market really began to work its magic. LASIK providers began to lower prices to compete against other LASIK doctors and the success of the procedure began to bring more doctors into the field which continued to drive down the price as competition increased.
By simply allowing the market to work not only did it make the procedure more affordable for you and I as consumers it also stimulated innovation which created jobs in research and development to discover ways to make the procedure more efficient and stimulated jobs in the production and technology sectors to produce the devices to perform the LASIK eye procedure. This is how our healthcare system should function.
I realize how a statement that appears to be blaming Medicare and government intervention for our healthcare cost crisis could be considered inflammatory because it is an emotional subject for many but there are two things I want you to consider. First and foremost there is no financial model from any organization that shows Medicare as being financially sustainable for future generations and obviously we know the cost of healthcare cannot continue on its current track and be sustainable either. Second, any industry that receives subsidies from the government immediately disconnects from the free market and has a cost that rapidly increases well beyond the rate of inflation. If you would like another example of what government intervention does look no further than the cost of college education which also received government subsidies in an effort to make it more affordable but has instead seen its tuition increase unchecked more than 400% in the last 25 years. I challenge you to look at any service or industry that has seen their cost to the consumer be lowered due to government subsidizing and intervention.
Clearly we need answers to the cost of healthcare but as of now no one in the healthcare debate seems to have the political will to ask the right questions but hopefully they will have the political will to scream from the mountain tops that more government is not the answer.
I personally watched this example play out when I worked in a drug store in 1972.
the company pricing policy was cost plus profit. Prescription “xyz” cost .10 per pill so the consumer price for 30 pills was $3.00 plus $3.00 profit, total $6.00. Medicare at time had set a national price for “xyz” at $10 for 30 pills. Why sell for less when someone sets a price that is more than normal profit.
We charged the customers who paid themselves the $6 and the ones who were Medicare patients $10. I don’t know if the suppliers and stores have that option now.
One easy way to fix this is have the medicare checks made out directly to the patient. When the cost is their money, they will shop for service. Then the corruption would be theft and come under the jurisdiction of the city, county, state courts and not the congress.
Good point about sending the check directly to the recipient, Kent. But this government won’t trust them with the money. They’ll think they’ll spend it on beer. Some will, of course, but the end result would be lower prices. And those not spending the money where it should will become a self-correcting problem.
The reason the only bailout plan that had some semblence of success was the Clunker program, because that money went almost directly to the taxpayers.
G-Man,
The clunkers money was borrowed from China and most of it went to foreign auto companies in Japan, Germany and South Korea.
Don’t forget that guvment watchdogs showed that the $4500 tax credit cost $24,000 a pop once you figured in administrative cost and other nonsense.
Love the graphic.
We insure our houses in the event of a fire or another destructive event. These are unlikely to happen, but just in case we purchase security for piece of mind. When it comes to health insurance we are insuring for something that WILL happen. We won’t all face horrible diseases or injuries, but we will get sick, and we will go to the doctor.
And now we are poised to allow a massive 4th party to enter the healthcare business.
“Piece” of mind??? I wish I proofread more…
My next big article that I’m working on is a solution to this problem. The direction I think would work best is completely abolishing the “fee schedule” from healthcare and putting physicians in control of their pricing. As it is now a physician has no say in what he charges for his own services and healthcare is the only industry this occurs in. My idea would see physicians bidding to insurance carriers their pricing for services and the insurance carrier determining rather that amount is acceptable. For example:
Dr. Smith in Nashville TN is charging $100 for Xrays and approaches Cigna with his pricing on services but Cigna rejects his pricing because 3 miles away Dr. Johnson is charging $85 for xrays. This leaves Dr. Smith two choices, lower his pricing to compete or not be able to see Cigna patients. This would rapidly drive down the cost of healthcare as physicians were forced to compete.
Also it would open up the opportunity for “cash value” health insurance where you could buy a set dollar value of coverage (just like getting $25,000 of liability on your auto coverage). Since patients would now know the pricing of medical services at the various providers they would be able to make informed decisions and utilize their coverage more budget minded, basically go to doctors who were the most affordable. The set coverage amount would also greatly reduce the risk to insurance carriers and reduced risk means reduced cost to the consumer.
Ultimately the keys are: physicians need to control their pricing and patients need to control the purse strings. Problem solved.
Ultimately the keys are the federal government should control it all. Then it will run as smoothly as everything run by the federal government.
An attorney buddy who works in the health care industry told me tales about the hey-day of contact lens salespeople. At one point, he said, the Medicare fee schedule was so far out of whack with the actual cost of producing contacts (which had dropped dramatically) that contact lens manufacturers were making enormous – ungodly – profits. All you had to do was find a hospital or doctor willing to buy from you. No negotiation required – for Medicare eliminated the need. There was so much money to be had, the tale goes, that some manufacturers took to hiring lovely young women who were willing to do anything (and I do mean ANYTHING) to make a sale.
Great explanation V. This post should be required reading for every one of our Representatives and Senators.
Medical equipment and pharmaceutical sales reps are notorious for being hot, young and female.
Trzupr,
I’d heard about the boom in contact lenses but didn’t personally witness it. The one I hear about most now is prosthetic limbs which is apparently a gold mine.
Absolutely. I’m on my fourth arm and am awaiting my fifth leg. The demand is so high it’s on back-order.