Social Cost
All over the developed world, the political left only knows two ways to constrain health care spending: (1) squeeze the providers and (2) deny patients care. Since they don't believe in markets or incentives or entrepreneurship — the ways costs are controlled in other markets — there really isn't much left to do but take it out on doctors and patients. Today I want to address the mistaken idea that suppressing provider incomes is a socially good thing to do.
Of all the arguments for national health insurance, the absolute worst one is the idea that a single buyer of health care can lower the social cost of care by exercising strong bargaining power. The Physicians for a National Health Program, for example, argues that a monopsonist (single buyer) will be able pay doctors, nurses, hospital personnel and other providers below market rates. [Doctors who want the government to stick it to doctors? Medicine seems to attract more than its share of masochists. The only thing worse is an economist who hates economics. Read on.]
Paul Krugman, writing in The New York Times, uses a similar argument to advocate a public plan option in President Obama's government-run, government-regulated health insurance exchange. A public plan, he writes, would have the "bargaining power needed to bring down health care costs."
So what's wrong with this way of thinking?
Social cost is the sum of all the individual costs. That is, it's the cost to me plus the cost to you plus….. etc., summing over 300 million people. In doing the summation, we can't omit whole groups of folks. Although this may come as a surprise to some, doctors really are people! So are nurses. So are hospital personnel. Squeezing the incomes of providers shifts costs, but it doesn't lower them. It makes patients better off (in the short run) and providers worse off. But that does not lower cost for society as a whole.
As Gregory Mankiw explained in a recent New York Times editorial, if we want to shift costs, we do not need monopsonistic buying power. We could simply impose a tax on all the providers and use the proceeds to subsidize the health care purchases of patients. Good for patients and bad for doctors, perhaps. But since the gains and losses cancel out, the benefits for society as a whole are nil.
The obverse of a monopsonist is a monopolist. Suppose the federal government awarded a single company exclusive rights to sell domestic wine. The monopolist would certainly raise the price to consumers. But does this mean the social cost of wine would be higher? No. The consumer's loss is the seller's gain. The cost of production remains largely unchanged.
Social cost, in general, is independent of the prices people pay. The social cost of the production of a good or service is the value of the resources used to produce it.
The reason why economists — from Adam Smith to the current day — do not like monopolies and monopsonies is that they misallocate resources. Under monopoly, for example, too little of the monopolized good will be produced. Too much will be produced of other goods and services. The same is true of monopsony.
Another problem with monopsony in health care is that in the long run you get deterioration in quality. Suppressing doctor incomes encourages bright young people to enter professions other than medicine. In Britain, a very high proportion of doctors are immigrants — trained in some other country. Increasingly, that is true in the United States as well.
Brilliant.
John:
Excellent article.
Costs are dynamic, with many underlying variables.
It seems like our government leaders have tunnel vision, not being able to see beyond the current fiscal year.
I guess when you can’t go out of business, you have that luxury!
By the way, great interview on Dennis Prager’s radio show last week.
Don Levit
Excellent post.
Prof. Krugman is back on the case in the NY Times this a.m., without much new to say: More regulation, more subsidies, etc.
Another major error in the appeal for government as monopsonist health plan (we cannot call it an insurer if it accepts all applicants without regard to pre-existing conditions) is that it assumes that the government has some magical power to understand the preferences of all the beneficiaries. If participation is not voluntary, this cannot be true.
There are many examples where individuals or groups band together to exercise purchasing power, but these are voluntary. In return, they trade away some of their independence. Each participant decides whether the trade off is worth it. Co-operatives and franchises are obvious examples. Indeed, at the extreme, a firm is a group of people who have chosen to trade away some (much) of their independence in return for the efficiencies that the firm provides.
If the government decided to exercise monopsony power over housing, automobiles, food, and clothing, I suppose it could get better prices from Beazer Homes, Toyota, General Mills, and Levi’s than I can on my own. However, the other consequences would be horrific: lack of choice and innovation.
I think the last paragraph (“Suppressing doctor incomes encourages bright young people to enter professions other than medicine….”) describes the tangible problem. Fewer young people will become doctors, existing doctors will retire earlier, existing doctors will play a lot more golf, more women doctors (and some men) will decide to become stay-at-home moms (or dads), etc. There simply won’t be enough doctors available at the prices that Krugman, et al, decide that they’re willing to pay.
Supply and demand – it’s the law!
A public plan would have the bargaining power needed to bring down health care costs.
Really, Mr. Krugman?
I thought bargains were struck being a willing seller and a willing buyer.
The government sets the prices, it does not negotiate them.
Why do the American people accept such blatant mischaracterizations?
I think I finally understand why all this media talk is so cheap.
It is because the supply exceeds the demand.
Don Levit
Just who is this Paul Krugman and why does he believe he knows better?
Very interesting article. Netting out the cost of health care cost shifting, you might even argue that it is worse than a net zero. http://www.ilovebenefits.wordpress.com
A letter to the editor of our local suburban paper this week argued for the public option because someone else (perhaps me) would be paying for the writer’s health insurance. I wrote in to say No, he would be paying for mine because I have more political clout. And when rationing comes, I will be at the front of the queue and he will be waaaay back at the end.
Bob Barry, Pittsburgh
I don’t know, Krugman may have a point. Just think of all the money that will no longer be wasted on useless things like research and development.
Yes. research and development of new and more effective drugs to mitigate te infirmities of old age. Why would we want that when rationing will help reduce the marginal olf person who is just a drain on society – meaning Medicare. Marie Antoinette was to have said let them eat cake. Paul Krugman is basically saying let them (old people) get in line. Economists should ration Paul Krugman.
With respect to your last paragraph, it is not a coincidence that a headline in a recent Dallas Morning News says something like “Nation Faces Shortage of Primary Care Physicians” (and I may have seen the same in the New York Times). Primary care physicians, I would guess, have the least bargaining power and are the most vulnerable to mandated price cuts.
John,
For fun you should write about the limitation of market approach in medical care.
The limits of choice for patients in buying medical care from hospitals, doctors, and drug companies.
If you do this I might like to read your Utopian ideas of markets and medical care.
Goodman makes the case for what not to do. John, please give some advice on what to do. Here is a start:
Health care insurance may be the only type of insurance in which three basic criteria for insurable risk do not prevail, namely:
A potential claim should be significant,
A potential claim should be rare,
Both insurer and insured should be committed to
avoidance of claims.
Almost every doctor visit generates a claim for the insured with its attendant overhead cost. Coupled with the common misperception that insurance benefits are free or at least inexpensive to the insured, there results an overutilization of the health care system and unnecessary escalation of the cost of health care.
Reduction in the number of third party payments for health care would address the overutilization problem. Fortunately, consumer driven health care and the tools of Health Savings Accounts and high deductible insurance are available to accomplish this without new legislation and new bureaucracies. Proposals to reduce the cost of health care generally ignore overutilization. I believe that efforts to reduce the cost of health care will fail unless they include major reduction in insurance claims, particularly those that do not satisfy criteria for insurable risk.
You nailed it with this one. I am re-tweeting this and sending a copy through our channels. Your thesis is so plausibly simple it will be overlooked as too simplistic. Maybe if you could make it 1,000+ pages it would fit inside the beltway’s agenda. Let the magic of the market do its magic. Thanks John for a simple elegant solution to the healthcare hairball.
Monopolies are seen as bad these days, unless they are government backed or driven. Why would monopsony be any different in the value being a net negative? Certainly to the economist the notion of a monopoly being unstable over time in a free market is a no brainer. Why did Krugman win the Nobel Prize for Economics? My assessment of the Noble prizes is that it a political prize. We are being tested folks as to how much we are willing to do to peacefully fight for our freedoms. Is it time to ramp this effort up.
If you look at the list of prior names, people like Arrow and Friedman, it’s clear that it hasn’t always been. Maybe an outspoken progressive with a regular column in the Times was just too much for the committee to resist. It’s about what I would have expected for the Peace Prize.
John:
Regarding Krugman’s argument, it’s déjà vu all over again. I agree with yours and Mankiw’s arguments, but I think you are working too hard.
See my editorial – which made the rounds on capital hill in the last health care revolution scare and put an end to alliance language within in days – for a more direct argument to the same effect.
John:
The problem with so-called “market forces” such as private health insurance/HMOs is that it has screwed both doctors and patients, too. Managed care has achieved oligopsonistic power in most big cities. The reality is that political leaders of all persuasions have decided that doctors make too much money and patients get too much care. So they are “fixin” to pass laws to pay doctors less and ration care with a vengeance. It’s going to be great for the insurance execs who do the dirty work for the politicians. As I suggested many years ago, time to read Robert Jay Lifton’s The Genocidal Mentality. The elderly many “ethicists” have concluded lead lives not worth living. There will be plenty of doctors with a lot of medical school debt and political ambition to do their political bidding.
John,
Reducing reimbursement rates will not bring down costs. An accountant may believe that but a good economist knows better.
David Rose: Good column, and good point about the fallacy of composition. Although one could argue that combining small purchasers’ bargaining power (by whatever means) would tend to push costs back onto existing large players.
Take drug prices, for example. Either the British and Canadians would have to begin paying some of the fixed costs, or new drug development would halt completely. I wonder which would happen first?
If we ever get Government healthcare then it MUST apply equally to EVERYONE from the President down with no exceptions. It is about time that government employees join the working class. Then we will see just how anxious our politicians are to pass the legislation.
Jim
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But patients are denied care now. My insurance just denied me the shingles vaccine. Insurance companies routinely deny care. Those without insurance put off (self deny) care because of cost until it becomes much more serious then show up at the ER. The denial of care is not an argument that rings true with the public.
Monopolies are seen as bad these days, unless they are government backed or driven. Why would monopsony be any different in the value being a net negative? Certainly to the economist the notion of a monopoly being unstable over time in a free market is a no brainer. Why did Krugman win the Nobel Prize for Economics? My assessment of the Noble prizes is that it a political prize. We are being tested folks as to how much we are willing to do to peacefully fight for our freedoms. Is it time to ramp this effort up.