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Price, Volume, Mix

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The health care debate seems to center on fixing two important problems. The first is the people who do not have any insurance, and the second is the rising cost of insurance premiums, which have been going up over 10% a year for a number of years. The latter issue is a very important one, and one I am very familiar with. When I owned a couple of businesses, I had to deal with 10%+ increases each year and finally had to stop absorbing the increases and pass them on to the employees, either through taking the money out of their pay or reducing the benefits. The politicians are promising us the reform will reduce cost and improve the quality of health care. As a person with a lot of business and academic experience, this one is a little strange because there are few examples of reducing cost and improving quality in any industry. The one question I have always had is: what is really driving the increase in health care cost? Because once you understand what is driving the increase, then it might be possible to figure out how to reduce the cost.

Simple cost accounting will tell you that an increase in total cost is attributable to a combination of increases in the price per unit, increase in the number of units, or a change in the mix of products to those that are more expensive to provide. The question becomes, which of these (or combination of the three) is driving the increases in health care costs? Increases in the price per unit would suggest that seeing a doctor for the same procedure is going up each year, but that does not seem to be the case. There are tight controls on the cost of a procedure by both the government (for Medicare and Medicaid) and the insurance companies. The cost of new medical devices and technology may be driving some of the increase in health care costs, but labor costs do not seem to be increasing enough to make a difference. This is one area the government can have significant influence on, but not without unintended consequences. Squeezing doctors to lower fees (which is what the government does with Medicaid and Medicare) may help in the short term, but eventually doctors cannot make enough money to make it worth their time. In a previous post I debunked that insurance companies are making millions, they have low margins and cannot get much lower and stay in business. The government can certainly reduce the cost for procedures, but only at the expense of poor quality of service.

The second is the quantity of procedures, and whether each person is seeing the doctor more than they did in previous years. It makes sense that this is at least a partial driver in the increase in costs, but fixing it becomes difficult. People are living longer, which comes with more medical expenses to facilitate a longer life, and our lifestyle is not known for reducing the need for medical help. The only way to fix an increase in quantity is to force people to see the doctor less, which in turn will decrease the total cost of health care. This is also why people are concerned about more health care rationing than exists today.

The third is more people are having health care issues that cost more money to fix. If cancer, heart disease and other medical issues that cost a lot of money to fix are on the rise, then this will also increase the cost of health care, even if people are not seeing the doctor more or the cost of a procedure is not going up. Again, how do you solve this one from a public policy standpoint? You cannot tell people not to get cancer or heart disease. Intuitively, this also seems to be one of the bigger drivers in the increase of health care costs.

It is unlikely any law passed would have a meaningful effect on either the price, quantity, or mix of health care unless you ration care more than it is now, which is supposedly off the table. In fact, if you look at industries that have had significant cost reductions, there are usually unintended consequences which may be worse. Consumer products have reduced the cost of most things we buy, but that has been done by outsourcing overseas at the expense of US manufacturing jobs. And Wal-Mart may be known for low prices, but quality is not part of the equation. The cost of food has been forced down over time, but at the expense of the commercialization of food, which brings with it low wages, lots of fertilizer, and a compromised food system. Computers are one industry that has seen a reduction in price and improvement in quality, but it is driven by technology and innovation. Technology and innovation are expensive and the computer industry has the benefit of being able to spread those costs over millions of computers and one breakthrough can help every computer system. Health care also has technology and innovation, but each one is for a particular disease or procedure and therefore the costs are spread across fewer units and therefore cause the price to increase not decrease.

Anytime a politician says we can reform the system to lower the cost and improve the quality, the public has a right to be skeptical. How exactly is cost going to be lowered, and are we reducing price, quantity or mix? I have yet to hear a politician coherently articulate how costs are going to be lowered. Everyone should be cynical of the pledge because frankly it is a promise no politician can deliver. It is virtually impossible to meaningfully reduce the cost of health care in America, while maintaining the quality of care and not ration people’s access to treatment, at least not without major lifestyle changes.

About Craig Mayberry

Closed Account • Member since Jan 17, 2008

While writing his articles from 2008 to 2011, Craig lived near Lynden and taught at both Whatcom Community College and Western Washington University. He was active in politics and ran for public [...]

Comments by Readers

John Servais

Aug 11, 2009

Craig,

While I follow your line of thought - and agree that in an ideal market place these principles would prevail, I think health care is different.  One big reason is we do not choose when to use it - its use is forced on us.  As such, the insurance industry is a regulated business and what is being proposed is the regulations be changed.  The question is - can we all benefit from a change.

I also take issue with some of your suggested facts, especially that the insurance industry is not making enough.  With the public choice, the private agencies would have some competition and we may well see improvements in cost.  Further, it is a well proven fact that universal health care lowers the administrative overhead - primarily because there is not so much wasted effort to game the system for higher profits.

Bottom line - the USA was founded on principles of serving the common good and over the two hundred years we have extended what is the common good to include basic education, safety regulations, many other public processes and now we are where we feel basic health care is a common benefit to living is this country.  We need to fashion a system that is the most fair and that covers everyone.  It should no longer be a question of if but rather how.

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Craig Mayberry

Aug 11, 2009

John,

I appreciate your comments and I think if you look back over all of my health care posts you would see that we agree on every point.  I have stated elsewhere that everyone should have access to health care without concerns about how to pay for it or doing long term damage to their credit.  I have also stated that one of the reasons health care is different from many items is we do not have a choice whether we get sick or not, therefore using a market system may not always be appropriate. 

The point of this particular post was to address one particular fallacy of the health care debate and that is we can have our cake and eat it to.  You cannot have complete access to high quality health care and reduce total costs at the same time.  Our government officials are being disingenuous every time they make that claim.

In terms of the health insurance industry, my point was not that they are not making enough money, only that they make very little and therefore there is not a lot of savings by squeezing their profits further.  By the way, I also believe that I am on record on this very site as saying if I were king for a day and was reforming health care I would eliminate the health insurance industry in a heart beat.

I do believe there is a critical discussion on health care rationing that we need to have.  You used the term “fair” which is always an interesting term because fair is in the eye of the beholder.  I agree that many aspects of the current system are not “fair” to many people, but it is also not possible to design a system that is “fair” to everyone.  I think it is important to understand what is “fair” and “not fair” in the current system and what would be “fair” and “not fair” based on what Congress wants to pass.  I am not sure at the end of the day that the proposal is any more “fair” then the current system, but it is hard to say because there is not a lot of transparency in the details of the proposal.  Congress would be better served if they talked about what was “fair” and what was “not fair” under their proposals and stop with the Utopian claims that everyone will be better off if we pass HR 3200 (the reality is some will be better off and some will be worse off).

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