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Karl Smith Responds to Critics on Healthcare

Karl Smith responds to his critics regarding his contention that the higher (money) costs in healthcare do not increase the economy costs:

…There are lots of ways more money could flow to health care entities:

  1. People could value health care services extremely highly and want to purchase more of them
  2. Moral Hazard could lead people to purchase health care through insurance that they do not value very much
  3. The regulatory system could cause people to purchase more health care than they would want
  4. The regulatory system could cause health care to be produced inefficiently
  5. Information asymmetries between patients and doctors could lead people to be misinformed about the value of health care and purchase more than they would want under perfect information
  6. The desire to signal that we care could cause us to purchase the most advanced forms of health care available, leading to an arms race in the production of advanced care
  7. Cartelization by health care providers could raises prices
  8. Health care entities may rent seek for higher payments from the government
  9. Health care entities may engage in outright fraud to increase payments from insurance carriers and consumers

While all of these things increase the amount of money flowing to health care entities they are very different issues, with different economic implications.

For example, I’m not sure if (1) is something anyone should be concerned about, nor would we even use the phrase high cost in other contexts. Lots more money is flowing to the makers of smartphones, but we don’t think usually think of high smartphone cost as something we are facing.

Indeed we commonly say that smartphone costs are falling. This is because the value proposition is increasing.

On the other hand (4) could just be a pure economic loss. If good treatments for example can’t pass FDA approval it might be the case that not a single person in America is better off and many people are worse off. As economists we might consider that pretty costly.

Lastly, its not immediately clear that (9) involves any measurable economic loss at all. If it is extremely easy for some types of fraud to be committed and it doesn’t alter incentives then it could more or less a pure transfer from the victim to the perpetrator…

This is an interesting argument, and I actually buy most of it. I don’t concede point (9), though. Here’s the response I left:

Here’s my thinking:
You would be right in a partial equilibrium setting that the distribution of rents is not even evidence for an inefficiency. But consider this classic example: Costco charges me an entry fee to buy its junk at price equal to marginal cost. The entry fee captures my entire surplus. So efficient right? This particular trade could be viewed as efficient, but economy-wide there is an inefficiency: overproduction of (for example) giant vats of mayonnaise. The real sticking point, then, is your assertion that #9 not alter incentives at all. It can’t NOT alter incentives somewhere in the system.

Nor does it matter for efficiency whether the distortion is “beneficial” or not (as in your Dr DoGood example… although you can certainly argue that efficiency need not be the goal). If we knew for certain that there was a beneficial distortion than we could treat the “fraud” as we would positive externalities. But we don’t, so we shouldn’t.

So here’s what I’ll concede: maybe “fraud” need not be an economic cost in and of itself… but it is always and everywhere evidence in favor of an economic cost somewhere. Hence, we should try to stamp it out (as efficiently as possible, of course).

One more thing. Going back to the Tricor example which began this thread, the economic costs induced are pretty clear (to me): the lawyers hired by Abbot labs to defend their monopoly and the patients who go without treatment because the drug is more expensive than it has to be.

To be clear, giant vats of mayonnaise are inefficient since–because most mayonnaise is sold in smaller jars, but at a markup–some people will buy these vats and then not finish them. Wasted mayonnaise is a pure economic loss.

Economic efficient is a bit of a strange concept, when you come right down to it–it is “efficient” for one person to have all the wealth and the other nothing. still, whenever I encounter these kinds of “counterintuitive” arguments, my first reaction–and I think this is a good heuristic that’s served me well–is that someone is making a mistake. This is one of those times.

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