Health care prices and costs

Many years ago I decided not to go into health policy research because it looked too hard for me, intellectually and especially psychologically – I didn’t have the chops to deal with the personality types in the medical system nor with the long history of misogynistic arrogance that pervaded it. I never understood why the phrase “doctor’s orders” should be so easily used; I never heard of “engineer’s orders” or even “lawyer’s orders”. Anyway, I’m glad others have stepped in, especially as my judgment looks good in retrospect.

Governor Schwarzenegger’s admirable assault on the current mess (I don’t mean his plan is wonderful, I mean I admire him for wading into it the way a political leader should) has generated a lot of published discussion that seems to me confusing in a familiar way: the concepts of price and cost are being muddled, a confusion fatal to clear thinking about any important decision, especially a public policy decision. What follows is an attempt to sort out the basic questions about health care from a citizen’s perspective, offered because the stuff I read is not doing the job.

Just to clarify these two central ideas: a cost is incurred when an economic resource is consumed, and not otherwise. Economic resources include the labor of a doctor, the labor of the lawyers in his malpractice case, a day’s use of an operating room or a waiting room, medicine, the computer printing checks at the insurance company, your time and comfort taken from you by an illness, etc. A price is the ratio at which two economic resources are traded in a marketplace, and more generally, the ratio of values of two things for purposes of deciding on some action. Because we use money as an intermediate good to trade everything else with, prices are usually cited in dollars: when we say a stethoscope’s price is $50, we are using shorthand to say making it and getting it to the store used up various other resources that everyone has agreed to trade for $50. Cost is what we should compare to benefits in order to decide whether to use this or that economic resource: when you have a bad headache, you use up a couple of aspirins because the pain relief is worth more to you than the cost (shown to you by the price) of the pills. Note, importantly, that a big malpractice award is not a cost, it’s a transfer. No economic resources are used when A pays B money; if there was a cost, it was in the injury the doctor may or may not have done to the patient.

Prices generally match costs but the exceptions are important. For example, we have decided to give some things away to anyone who wants them, like city parks, at a zero price, but this doesn’t mean parks don’t have a cost (land, gardening, policing, sweeping up, etc.). Where this gets especially confusing is where we have arranged for some people to bear the costs of the behavior of others. For example, if you have health insurance, and get really sick, everyone else in the same insurance plan pays the costs of your illness: next year, their premiums are a little higher than they would have been if you had stayed healthy, and they consume less of everything else. None of this changes the cost of your care. It’s a lot less costly to you, but not less costly overall. If you don’t have health insurance and you’re poor and you get sick, the cost of your care is shared through the tax system that pays for charitable care; if you don’t get care, you and your family bear the cost of your death or disability. [UPDATE: I can’t believe I left the average/marginal cost issue on the tree for Mark to pick and run with, but I did, so read the post above.]

Gov. Schwarzenegger says he plans to reduce the costs of health care, but he’s not at all clear about what he really means. He’s going to reduce the price of insurance for people who buy it by forcing healthy people into the pool that pays premiums, and the price of health care for many people who get sick (the currently uninsured) by forcing others to share their costs. This is all well and good, but it has nothing to do with reducing “the cost of health care”; it’s just rearranging who pays for it.

The cost of health care can only be reduced in a few ways:

1. Provide less (for example: terminating desperate end-of-life treatments sooner; doing less aesthetic plastic surgery; doing less “defensive medicine” that only serves to protect the doctor from a lawsuit)

2. Provide less by not needing it as much (for example: consumers getting exercise, not smoking, and being happier)

3. Provide it more efficiently (for example: treat slightly sick people before they get very sick; stop wasting cheap antibiotics by misusing them for sniffles and in animal feed)

4. Provide it with less overhead (for example: reduce the bookkeeping and bureaucratic labor associated with getting providers paid for what they do, and getting malpractice suits tried)

Universal health insurance can induce some of these cost reductions, by improving the incentives facing patients and everyone else making decisions in the system. It may produce real cost reductions in category 4 above. But it will also increase costs because the currently uninsured will start consuming medical services they now forgo, and this is probably a good deal for society as a whole, not because they “save money in the long run”, but because keeping people healthier is often worth what it costs even though the benefits of happiness and longevity do not have a money price.

Anyway, the cost of health care is not something that “should be lower” even if some important savings are on the table to pick up; it’s just as reasonable that a society whose income goes from $100 to $200 should increase its health spending from $5 to $12 (more in both absolute and proportional terms) as that it should spend a larger proportion of its resources on art. What’s uncontroversial is that the cost of health care should get us as big a package of benefits as it can, and if health becomes a better deal in this way, why shouldn’t we buy more of it?

Health care reform will reduce the cost of health care to some of us and increase its cost to others. It may well reduce the total cost of the system below what it will grow to if we don’t attend to the issue. But no-one should be promising that it will reduce the cost of health care, because at some point the only savings will be in category 1, and (i) saying “no” to a really costly treatment that might possibly help the particular, named, individual in room 322 who is the dear grandmother of particular individuals gathered around the bed (and that will get the people who provide it closer to a ski condo or a yacht) is not an easy thing to do; (ii) there is no stopping the technological growth in things that might possibly help. It’s so hard to do this that we take refuge in language designed to obscure the decision as much as possible, like “making medical decisions for medical reasons” and “health care needs”. Making medical decisions for medical reasons is like demanding that only one blade of a scissors cut; the word “need” is a device to stop discussion. Desperate end-of-life measures (for example) need to be confronted and discussed honestly before someone’s Nana is hooked up to the machinery. They are neither obviously wasteful nor obviously worth it; maybe we’d all have a better life if we spent it sure the system will spend a fortune on us in our last week, and having less stuff to play with while we’re healthy to assure that. I don’t know; but that’s the kind of debate that health care costs demands that it’s not getting.

[Afterthought: See if you can say this in front of a mirror with a straight face: “Health insurance should be provided by employers. This is true for fundamental reasons of principle and theory, namely (i) sixty years ago, government wage regulation during the war forced employers to compete for labor with fringe benefits, and health insurance was one of those, (ii) countries that have better health outcomes than we do, spend less on health care, and aren’t as rich, don’t do it that way. They are foreign (in fact, one is known to be French, and has admitted it publicly!) so they must be wrong.”]

Author: Michael O'Hare

Professor of Public Policy at the Goldman School of Public Policy, University of California, Berkeley, Michael O'Hare was raised in New York City and trained at Harvard as an architect and structural engineer. Diverted from an honest career designing buildings by the offer of a job in which he could think about anything he wanted to and spend his time with very smart and curious young people, he fell among economists and such like, and continues to benefit from their generosity with on-the-job social science training. He has followed the process and principles of design into "nonphysical environments" such as production processes in organizations, regulation, and information management and published a variety of research in environmental policy, government policy towards the arts, and management, with special interests in energy, facility siting, information and perceptions in public choice and work environments, and policy design. His current research is focused on transportation biofuels and their effects on global land use, food security, and international trade; regulatory policy in the face of scientific uncertainty; and, after a three-decade hiatus, on NIMBY conflicts afflicting high speed rail right-of-way and nuclear waste disposal sites. He is also a regular writer on pedagogy, especially teaching in professional education, and co-edited the "Curriculum and Case Notes" section of the Journal of Policy Analysis and Management. Between faculty appointments at the MIT Department of Urban Studies and Planning and the John F. Kennedy School of Government at Harvard, he was director of policy analysis at the Massachusetts Executive Office of Environmental Affairs. He has had visiting appointments at Università Bocconi in Milan and the National University of Singapore and teaches regularly in the Goldman School's executive (mid-career) programs. At GSPP, O'Hare has taught a studio course in Program and Policy Design, Arts and Cultural Policy, Public Management, the pedagogy course for graduate student instructors, Quantitative Methods, Environmental Policy, and the introduction to public policy for its undergraduate minor, which he supervises. Generally, he considers himself the school's resident expert in any subject in which there is no such thing as real expertise (a recent project concerned the governance and design of California county fairs), but is secure in the distinction of being the only faculty member with a metal lathe in his basement and a 4×5 Ebony view camera. At the moment, he would rather be making something with his hands than writing this blurb.