Why free-market health care doesn't work ..
With the ink on recent SCOTUS decision on the individual-mandate provision of the Affordable Care Act still not quite dry, it's worth discussing some of the benefits and shortcomings of that measure as well as why it is a good thing for now, but is not a good thing in the long term.
One of the most fundamental aspects of economics is the law of supply and demand, in which supply and demand balance each other to drive pricing of a marketable commodity. For typical commodities, the demand for a product is driven by desirability, the supply is constrained by production capacity, and a consumer of the commodity (for appropriate definitions of "consumer" with regard to the commodity) can choose whether to buy or not buy at any given pricing, and thus incrementally influence the seller's pricing. For most commodities, whether they're tangible products, stock in publicly traded corporations, gold or silver, or what have you, that model tends to produce an equilibrium price for a given set of supply and demand considerations, and that price may fluctuate above and below that equilibrium, but by and large, the opposing pressures of demand driving pricing up and supply driving it down will balance out at some sort of equilibrium somewhere.
This is the fundamental way in which health care does not fit the classic supply/demand model. Health care consumers are not consumers by choice -- the circumstances that create their demand for health care services are dictated by forces mostly beyond their own control, preventive care notwithstanding -- and thus demand is not subject to decision making on the consumer's part, it either exists or does not depending on the consumer's state of health at the moment. It's probabilistic in that the circumstances under which any given individual might need to be a health care consumer are relatively unlikely at any randomly chosen moment, but for those who are in that overall-unlikely situation, the need for medical treatment is not optional. (Granted, this is an extremely simplistic modelling of what is in fact a nearly infinitely complex medical discussion, but for economic purposes, it covers enough of the nature of a health care consumer to suffice for this discussion.)
The fact that being a consumer of health care is not optional changes the entire equation, because it makes the demand side of the supply/demand balance effectively infinite -- there is no price point or scarcity of supply that makes the "oh well, I won't buy that today" decision appropriate, since it means either continued or worsening illness or even death. Thus the only equilibrium in that equation is the point at which consumers literally cannot afford the services at all, because that is the only point at which demand can begin to drop and stop driving the pricing up.
So health care is essentially a captive market -- its consumers have no choice but to seek services if they can afford them -- and this alone completely skews the supply/demand balance.
The other important condition of the supply/demand law is that it depends on a direct coupling of pricing to consumer ability to pay -- the drop in demand as the price rises above a consumer's desire, in the case of ordinary commodities, or ability, in the case of health care, to pay for those services is the pressure that limits pricing. Once pricing increases beyond a certain point, no one can pay for the services and it is no longer profitable to provide them, as they've been priced out of the market.
The widespread availability of health insurance was the last ingredient of the perfect storm.
For a bit of background on how insurance works, let's take an extremely simplistic example: A group of 100 people decide to protect themselves from a relatively rare -- 1 in 100 -- but expensive -- $10,000 cost -- event by each contributing the total cost of the event multiplied by the probability it will happen to them -- $10 in this case -- to a risk pool. If the 1-in-100 event happens to anyone in the pool, they then can use the entire $10,000 pool to pay for the cost of the event and not have to pay out of pocket. The pool as a whole might join up with other pools to protect themselves against the unlikely but expensive possibility of two or more people incurring the $10,000 cost at a given time -- this is called "reinsurance" -- but the overall effect is that under certain defined circumstances any one of the people in the pool could conceivably draw on it to pay a much larger cost than they could out of pocket.
What this does to supply and demand pricing, especially in the extremely asymmetrical case of health care with its anomalous demand side, is vastly increase the ability of any individual consumer to pay for certain costs .. completely decoupling the pricing from the individual's own ability to pay out of pocket, which in the short term makes the costs far more affordable by spreading them out across a large pool of individuals each of whom is relatively unlikely to need services, but can then pay for them when needed, but in the long term, allows providers to charge far more for those services, eventually reaching the point where even with the risk pool, the services cost more than the pool can cover.
At this point, the pool needs to either increase income by having each person contribute more, or reduce costs by reducing its liability for indemnity, in other words, what it's required to pay out for, so some instances of the large cost might be refused coverage (either completely or in part), or the pool may start being selective about who it allows in, since some people may have a higher probability of encountering the cost than others. (And all of these things have happened -- increasing premiums, increasingly restricted treatment coverage, and refusal to cover people with pre-existing conditions who bring more cost into the risk pool than they offset with premiums.)
The compromise in the ACA -- the mandate to obtain health care coverage -- was a necessary offset to the increased cost exposure of requiring coverage with pre-existing conditions, because it offset the costs in a third way, by expanding the pool to include a large number of people with a low probability of needing to use the coverage. This was also the main point of attack for opponents, who knew full well that eliminating the mandate would have made the remainder of the plan so costly to insurance providers that the entire plan would have collapsed and returned us to the same crisis we just escaped.
But the ACA was not a long-term fix, it merely delayed the inevitable and shifted the equilibrium cost point still higher, because costs, as yet, are still following the free-market model, which with captive demand, will only drive pricing higher until it strains even a pool containing every single citizen in the country. The flaw in free-market health care is still the captive demand side of the equation, which only drives pricing up and has no countering force to drive pricing down except the limit of consumers, in this case now insurance and reinsurance risk pools rather than individuals, and already astronomical costs will increase still further until they reach the limit of what that market will bear.
So why are we not looking at the supply side of that equation yet? Why are we not regulating costs at all? "Because it's SOCIALISM!!1!1!" is one answer -- not a particularly helpful one in that tone, but an answer nonetheless. In essence, the free-market model is what got us into this mess, and while it's making a handful of healthcare and medical technology CEO's and upper level management rich beyond the dreams of avarice, and making them very disinterested in changing the game and killing their golden goose, the fact is that as long as the supply side of the system is unregulated and there are no controls on end-delivery-to-patient costs, we're simply going to be going through this cycle of straining increasingly widely distributed resources to their limits until payers start refusing coverage again.
So how do you control costs? By getting out of the free-market mentality, because these services are not really free-market services -- they're captive-market services and need to be treated accordingly. Every single cost point of the chain needs to be analyzed to determine whether it's excessive or whether it covers upstream costs, starting far enough upstream that all of the price-gouging (and I'm certain there is price-gouging) is squeezed out, going back to raw materials suppliers for pharmaceutical companies and medical technology providers, and working forward through the chain to point of delivery to the patient. And a lot of the "fat" in a lot of the pricing throughout the chain is liability insurance -- because malpractice insurance is an ever-present threat at almost every point in the chain that has deep pockets -- so some offset to that may need to include addressing the liability in other ways that don't pass costs through to the patient. Like it or not, that will probably include some form or other of subsidies at various points in the system.
And I'm sorry, but the payer side of the system cannot continue to be for-profit. The runaway price escalation we've seen over the past few decades has been partly due to insurers and providers both taking profit margins off the top of virtually every transaction in the system. For-profit corporations are required to turn profits, every quarter, or face civil liability to their stockholders -- they are not in the charity business. They have to make money everywhere they can find a profit center, and the proliferation and expanding exploitation of profit centers inflates both sides of the equation. Remember, individual consumers are not a part of this pricing game at all anymore -- the costs are far more than the wealthiest of the wealthiest of us could possibly pay out of pocket -- and it's strictly a game between for-profit payers and for-profit providers controlling the price equilibrium. The only way for-profit payers can continue to be part of this system is if the entire structure of transactions between payers and providers is so structured and so regulated that their choice in the pricing equation is minimized or even eliminated.
And it has to be on both sides. Control only the costs, and unregulated payers might inflate their margins and still deny care. Control only the payers, and providers will simply find the point at which the market bleeds and prices will settle there. Create any solution that regulates one but not the other, and the more regulated one will revolt and lobby (most likely successfully) to get the regulation removed and you're back at square one. It has to be a balanced solution that takes the captive-market nature of health care into account, or it won't work long-term at all.
So, ultimately, the long-term workable solution is either to nationalize both sides of the system, to put governments on various levels in both the payer and provider roles, or so thoroughly regulate both sides as to create more or less the same system out of the private payers and providers by strict regulation of both sides. Simply expanding the pool of consumers to offset the cost of including the higher-cost one is nowhere near enough .. it gives us a break for now, but doesn't address the free-market thinking behind it ..
One of the most fundamental aspects of economics is the law of supply and demand, in which supply and demand balance each other to drive pricing of a marketable commodity. For typical commodities, the demand for a product is driven by desirability, the supply is constrained by production capacity, and a consumer of the commodity (for appropriate definitions of "consumer" with regard to the commodity) can choose whether to buy or not buy at any given pricing, and thus incrementally influence the seller's pricing. For most commodities, whether they're tangible products, stock in publicly traded corporations, gold or silver, or what have you, that model tends to produce an equilibrium price for a given set of supply and demand considerations, and that price may fluctuate above and below that equilibrium, but by and large, the opposing pressures of demand driving pricing up and supply driving it down will balance out at some sort of equilibrium somewhere.
This is the fundamental way in which health care does not fit the classic supply/demand model. Health care consumers are not consumers by choice -- the circumstances that create their demand for health care services are dictated by forces mostly beyond their own control, preventive care notwithstanding -- and thus demand is not subject to decision making on the consumer's part, it either exists or does not depending on the consumer's state of health at the moment. It's probabilistic in that the circumstances under which any given individual might need to be a health care consumer are relatively unlikely at any randomly chosen moment, but for those who are in that overall-unlikely situation, the need for medical treatment is not optional. (Granted, this is an extremely simplistic modelling of what is in fact a nearly infinitely complex medical discussion, but for economic purposes, it covers enough of the nature of a health care consumer to suffice for this discussion.)
The fact that being a consumer of health care is not optional changes the entire equation, because it makes the demand side of the supply/demand balance effectively infinite -- there is no price point or scarcity of supply that makes the "oh well, I won't buy that today" decision appropriate, since it means either continued or worsening illness or even death. Thus the only equilibrium in that equation is the point at which consumers literally cannot afford the services at all, because that is the only point at which demand can begin to drop and stop driving the pricing up.
So health care is essentially a captive market -- its consumers have no choice but to seek services if they can afford them -- and this alone completely skews the supply/demand balance.
The other important condition of the supply/demand law is that it depends on a direct coupling of pricing to consumer ability to pay -- the drop in demand as the price rises above a consumer's desire, in the case of ordinary commodities, or ability, in the case of health care, to pay for those services is the pressure that limits pricing. Once pricing increases beyond a certain point, no one can pay for the services and it is no longer profitable to provide them, as they've been priced out of the market.
The widespread availability of health insurance was the last ingredient of the perfect storm.
For a bit of background on how insurance works, let's take an extremely simplistic example: A group of 100 people decide to protect themselves from a relatively rare -- 1 in 100 -- but expensive -- $10,000 cost -- event by each contributing the total cost of the event multiplied by the probability it will happen to them -- $10 in this case -- to a risk pool. If the 1-in-100 event happens to anyone in the pool, they then can use the entire $10,000 pool to pay for the cost of the event and not have to pay out of pocket. The pool as a whole might join up with other pools to protect themselves against the unlikely but expensive possibility of two or more people incurring the $10,000 cost at a given time -- this is called "reinsurance" -- but the overall effect is that under certain defined circumstances any one of the people in the pool could conceivably draw on it to pay a much larger cost than they could out of pocket.
What this does to supply and demand pricing, especially in the extremely asymmetrical case of health care with its anomalous demand side, is vastly increase the ability of any individual consumer to pay for certain costs .. completely decoupling the pricing from the individual's own ability to pay out of pocket, which in the short term makes the costs far more affordable by spreading them out across a large pool of individuals each of whom is relatively unlikely to need services, but can then pay for them when needed, but in the long term, allows providers to charge far more for those services, eventually reaching the point where even with the risk pool, the services cost more than the pool can cover.
At this point, the pool needs to either increase income by having each person contribute more, or reduce costs by reducing its liability for indemnity, in other words, what it's required to pay out for, so some instances of the large cost might be refused coverage (either completely or in part), or the pool may start being selective about who it allows in, since some people may have a higher probability of encountering the cost than others. (And all of these things have happened -- increasing premiums, increasingly restricted treatment coverage, and refusal to cover people with pre-existing conditions who bring more cost into the risk pool than they offset with premiums.)
The compromise in the ACA -- the mandate to obtain health care coverage -- was a necessary offset to the increased cost exposure of requiring coverage with pre-existing conditions, because it offset the costs in a third way, by expanding the pool to include a large number of people with a low probability of needing to use the coverage. This was also the main point of attack for opponents, who knew full well that eliminating the mandate would have made the remainder of the plan so costly to insurance providers that the entire plan would have collapsed and returned us to the same crisis we just escaped.
But the ACA was not a long-term fix, it merely delayed the inevitable and shifted the equilibrium cost point still higher, because costs, as yet, are still following the free-market model, which with captive demand, will only drive pricing higher until it strains even a pool containing every single citizen in the country. The flaw in free-market health care is still the captive demand side of the equation, which only drives pricing up and has no countering force to drive pricing down except the limit of consumers, in this case now insurance and reinsurance risk pools rather than individuals, and already astronomical costs will increase still further until they reach the limit of what that market will bear.
So why are we not looking at the supply side of that equation yet? Why are we not regulating costs at all? "Because it's SOCIALISM!!1!1!" is one answer -- not a particularly helpful one in that tone, but an answer nonetheless. In essence, the free-market model is what got us into this mess, and while it's making a handful of healthcare and medical technology CEO's and upper level management rich beyond the dreams of avarice, and making them very disinterested in changing the game and killing their golden goose, the fact is that as long as the supply side of the system is unregulated and there are no controls on end-delivery-to-patient costs, we're simply going to be going through this cycle of straining increasingly widely distributed resources to their limits until payers start refusing coverage again.
So how do you control costs? By getting out of the free-market mentality, because these services are not really free-market services -- they're captive-market services and need to be treated accordingly. Every single cost point of the chain needs to be analyzed to determine whether it's excessive or whether it covers upstream costs, starting far enough upstream that all of the price-gouging (and I'm certain there is price-gouging) is squeezed out, going back to raw materials suppliers for pharmaceutical companies and medical technology providers, and working forward through the chain to point of delivery to the patient. And a lot of the "fat" in a lot of the pricing throughout the chain is liability insurance -- because malpractice insurance is an ever-present threat at almost every point in the chain that has deep pockets -- so some offset to that may need to include addressing the liability in other ways that don't pass costs through to the patient. Like it or not, that will probably include some form or other of subsidies at various points in the system.
And I'm sorry, but the payer side of the system cannot continue to be for-profit. The runaway price escalation we've seen over the past few decades has been partly due to insurers and providers both taking profit margins off the top of virtually every transaction in the system. For-profit corporations are required to turn profits, every quarter, or face civil liability to their stockholders -- they are not in the charity business. They have to make money everywhere they can find a profit center, and the proliferation and expanding exploitation of profit centers inflates both sides of the equation. Remember, individual consumers are not a part of this pricing game at all anymore -- the costs are far more than the wealthiest of the wealthiest of us could possibly pay out of pocket -- and it's strictly a game between for-profit payers and for-profit providers controlling the price equilibrium. The only way for-profit payers can continue to be part of this system is if the entire structure of transactions between payers and providers is so structured and so regulated that their choice in the pricing equation is minimized or even eliminated.
And it has to be on both sides. Control only the costs, and unregulated payers might inflate their margins and still deny care. Control only the payers, and providers will simply find the point at which the market bleeds and prices will settle there. Create any solution that regulates one but not the other, and the more regulated one will revolt and lobby (most likely successfully) to get the regulation removed and you're back at square one. It has to be a balanced solution that takes the captive-market nature of health care into account, or it won't work long-term at all.
So, ultimately, the long-term workable solution is either to nationalize both sides of the system, to put governments on various levels in both the payer and provider roles, or so thoroughly regulate both sides as to create more or less the same system out of the private payers and providers by strict regulation of both sides. Simply expanding the pool of consumers to offset the cost of including the higher-cost one is nowhere near enough .. it gives us a break for now, but doesn't address the free-market thinking behind it ..