So When Are We Going To Get That Free-Market Health Care Everyone's Complaining About?

My colleague Nick adds to my post on health care. His goal is to examine how free market our health care system in the US really is:

In debates about health care it is often assumed by all sides that the US has the least socialist, most free-market health care system of any modern developed country. Advocates of market provision of health care point to the US system’s advantages as evidence of the advantages of markets; proponents of socialized medicine point to our problems as evidence of market failure. Both will concede that our system is not really a completely free market, but say that despite some significant deviations from the ideal, we still have the closest approximation to a market health system in the First World.

But is that premise true? I want to argue that it may well be false– that there may be other countries whose health care systems are more free-market than ours in most significant ways. This requires that I talk about what “more free-market” means and what it does not mean; I’m going to claim that the metrics by which it seems that the US is the most free-market are bad ones, and that the right metrics are inconclusive at best. Warning: geekery ahead.

He concludes:

One thing I do know is that health care here has become much more regulated over time and continues to do so. In the recent past we have the various acronymic acts– ERISA, COBRA, HIPAA, etc– and in the near future we’ll have the Medicare prescription drug bill (which will vitiate one of the few respects in which the US has hitherto been clearly freer than elsewhere, namely that drug companies don’t have to deal with the federal government as a near-monopsonic purchaser). So from the point of view of our “US is the most free-market” premise, not only does the present look murky at best, but the future is dark indeed.

Nick likely does not know this but I tried to answer this very question he brings up - namely when looking at our health care from an honest point of view, and not just looking at total government and private expenditures, but also at the costs of government mandates and regualtions - last year at my old website, The Proximal Tubule. What follows is the original post in its entirety:


Ask many people how to fix the mess that is our health care system, and they'll have a surprisingly easy answer - institute a nationalized health care system. Ask them if a free-market system of health care delivery would not be better, and you'll generally hear two things: 1) the market for health care is fundamentally different than any other market, and 2) look what our free-market health care system has gotten us into. I don't want to address #1 today, but I would like to focus on #2. The first question we need to answer is "How do we define and measure the types of health care systems?" The second is "What type of system do we really have at the present time?"

How do we define and measure the types of health care systems?
I think this is the easy question to answer in a way that all in the debate can agree. I would define it such that a perfectly nationalized health care system would be one in which the government (at any level) paid for 100% of total health care expenditures. Anything above 50% is marginally nationalized. Conversely a perfectly free-market system would be one in which this figure was 0%. Anything below 50% is marginally free-market. Anyone have a problem so far? Good, I didn't think so.

What type of system do we really have at the present time?
This is where it might get a little bit hairy. According to the OECD, in 2001 total US health care expenditure equaled $1.4 trillion. 44.4% of these expenditures were paid by public systems such as Medicare, Medicaid, the VA and other military care, public heath clinics, and various other programs. So it seems an open and shut case that we currently have a marginally free-market health care system.

But not so fast.

The WHO defines total health expenditures as public expenditures plus private expenditures, where private expenditures are out-of-pocket costs plus insurance premiums. That is the definition I used to calculate the figures above. But there is a fundamental problem with this definition. Some private expenditure can be counted, in my estimation, as public expenditures. Think of it this way - if the government, through the FDA, imposes a regulation on a drug, the drug company includes the cost of the regulation in its price, and I pay the price out of my own pocket, this is equivalent to me paying a tax to the government and the government subsidizing the drug purchase. It only cuts out the middle man. So while a majority of the price of the drug is a private expenditure, the part that goes to paying for the regulatory cost is most definitely a public expenditure. If the regulation did not exist, 100% of the drug could be characterized as privately-purchased, but the expenditure would be much lower, the total expenditure for health care would be lower, and thus, the percentage of public expenditure would be increased.

To restate this another way, the equivalent regulation could be paid for through increasing taxes and fully funding the regulatory compliance If it was done in this way, we would have to count it as public expenditure. That it is done in a way so our beloved members of Congress can hide tax impositions doesn't get the public side off the hook. What I have done is valid because the regulatory taxes have the force of law, the consumer has no choice, and it is antithetical to the free market. That is why we should not count it in the "free-market" column.

Note that this has nothing to do with a judgment on the regulation itself. I am only stating that the cost of regulation that the consumer pays from private funds are miscounted as such. They should be accounted for as public expenditures and change the balance of the above equation.

Unfortunately, the government has a lot of regulations that impose private expenditures that should be counted on the public side:

  • The various FDA regulations mentioned previously. US citizens spend 12.4% of their health care dollar on pharmaceuticals, and 88% of that is funded privately, yielding ~11% from private expenditures. I could not find data estimating what percent of this went to cover regulatory compliance, but I can safely estimate it's enough to say that a few percent of total health care expenditures can be transferred from the private side to the public side.
  • The relatively new HIPAA regulations. These have enforced new privacy laws that have placed a cost burden on health care. Hiring compliance personnel, changing infrastructure, etc. - these have all increased the prices we pay from our "private" stocks. It is difficult for me to estimate what these costs are due to the paucity of data from these relatively new laws. It is safe to assume they are not insignificant.
  • CLIA. These regulations affect all lab tests performed by or for a physician. Laboratories rival pharmaceutical as the most heavily regulated sector of health care. Lab tests make up a significant portion of health care expenditures. Again, the burden is not insignificant.
  • Private health insurance regulations. Private insurance premiums make up a large portion of total private expenditures, but they are not all "private." There are numerous regulations and laws that dictate certain things that private insurers have to cover that they may not otherwise. These increase premiums. But you have to count them as public expenditures for the same reasons as above, and I would guess (though am not sure) that these represent the largest number on this list.
  • Physician licensure requirements. Med students, residents, and physicians have to undergo rigorous and expensive testing and review for licensure. These costs are passed along to consumers in fees and are not insignificant.
  • Finally, all similar state regulations that work above and beyond federal regulations. This number may be insignificant.
  • Oh yeah, I almost forgot, compulsory prescription requirements. This number may be small, but I have to bring it up, well, just because.

Again, I want to make it clear. These have nothing to do with the merits of the regulations themselves. Certainly they have some, or even a lot of, benefit. It's just that these costs, imposed by the rule of law, have to counted as "public" even though they come from "private" pockets.

So where am I going with this? That's a lot of regulations, or to rephrase, a lot of indirect taxes paying for public expenditures. A few percent here and a few there, and we are talking about public expenditures that fly past 50% and lookin' for more. So now we have in my estimation a marginally nationalized health care system. Looking toward the future, we have a $50 billion/year (and quite possibly much more) Medicare drug entitlement that will add a few more percentage points to the "public" ledger. Increased spending on public health to battle obesity and smoking will no doubt be "public" expenditures that could be shrouded in a "private" cloak. There's no doubt which direction we're headed.

If I had to make a wild guess, our health care system will be paid for by explicit or implicit public funds at a rate of 65-70%. My question is this: if we have a nationalized health care system now, and that system is by your estimation broken, is more nationalization the way to go? Especially when every other sector or industry in this country is privately funded and avoids this problem. Except, that is, for education and the military. Oh, yeah, they're publically funded, too. (The problem of getting health care to the poor is independent of this - there is a big difference between publically funding for those who can't pay for themselves and publically funding those that can.)

I, if you didn't figure it out, think a totally free-market health care system is the way to solve our health care problems. But many may be surprised to learn that I almost think we should nationalize it. Why? Because, as I have shown above, it wouldn't be that much different than what we have now. It can't hurt much (but it certainly won't help). But at least we would have gained the knowledge once and for all that nationalized health care does not work and is a bad idea.

Now, is the market for health care fundamentally different than other markets? We'll leave that one for later.


Later I updated this based on new info:


Back in April, I tried to calculate the amount of socialization of the US health care system by adding implicit costs of regulation to explicit costs of public funds:

If I had to make a wild guess, our health care system will be paid for by explicit or implicit public funds at a rate of 65-70%. My question is this: if we have a nationalized health care system now, and that system is by your estimation broken, is more nationalization the way to go? Especially when every other sector or industry in this country is privately funded and avoids this problem. Except, that is, for education and the military. Oh, yeah, they're publically funded, too.

Today, Arnold Kling points to a study that tries to be more precise.  Christopher Conover's conclusion:

A far more accurate "bottom-up" approach suggests that the total cost of health services regulation exceeds $339.2 billion. This figure takes into account regulation of health facilities, health professionals, health insurance, drugs and medical devices, and the medical tort system, including the costs of defensive medicine. Moreover, this approach allows for a calculation of some important tangible benefits of regulation. Yet even after subtracting $170.1 billion in benefits, considerable, amounting to $169.1 billion annually. In other words, the costs of health services regulation outweigh benefits by two-to-one and cost the average household over $1,500 per year.

Kling adds:

More specific papers are linked to here. Looking at those papers, my guess is that the authors have under-estimated the cost of regulation. For example, I do not think that the work on professional accreditation and licensure captures the rigidities in the system imposed by regulation (prohibiting substitution), or the cost of rent-seeking as professional associations lobby for special favors.

So I should update my post.  The $339.2 billion is approximately 28% of the $1.4 trillion in health care expenditures.  Add that to the 44% of health care that is totally funded by the public yields 72%.  I was close.

But maybe it's fair to only add the costs that are in excess of the benenfits.  That brings the total down to 56%, which is a little under my estimation.  However, tack on the $500+ billion Medicare drug benefit and the underestimations Arnold points out, you get back to about 65%.  Nearly two thirds of every health care dollar is paid for or mandated by all forms of government.

So I'll ask the question again:  When are we going to get that free-market health care everyone's been complaining about?

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