Root causes of the defects in US Health Care

Some explanations of the problems related to the US health care are listed below. In short, their system is actually not encouraging the customer to discriminate between the different providers, leading to an increase of bad suppliers and services. He thinks that the government will keep under control the market deficiencies such as information asymmetry, conflict of interests, high prices, lower quality and so on. It is not unlikely that the presence of these regulations might have prevented the formation of institutions that would help to reduce market imperfections. This is what we would expect if the fundamentals of a free market economy can be best described by the trial and error process. Economic forces tend to correct for the lack of efficiency in some parts of the economy where the needs of the customer are not fully satisfied because such cases imply some profitable opportunities that capitalists may exploit. Health care is probably not an exception to this rule.

What’s Really Wrong with the Healthcare Industry, by Vijay Boyapati.

The real problem with the American healthcare system is that prices are continually rising, greatly outpacing the rate of inflation, making healthcare unaffordable to an ever-increasing fraction of the population — particularly those without insurance.


If prices in the healthcare market were falling, as they are in other markets such as computers and electronics, the large number of uninsured would be of little concern. Treatments, drugs, and medical technology would become more affordable over time, allowing patients to pay directly for them.

Employer-Provided Health Insurance

The most important economic consequence of the existence of the employer-provided health insurance is that consumers are much less likely to discriminate on cost. Beyond the deductible, the employer pays the cost of medical procedures through an insurance company. As anyone who has gone on a business trip knows, if the company is paying, then the employee is likely to purchase a more expensive ticket and accommodation. Where an economy ticket may have sufficed for a personal budget, a business-class ticket becomes far more attractive.

Not only are consumers less likely to discriminate on cost, but providers of healthcare services have greater incentive to provide medical treatments that are only marginally more effective at much higher cost. This is the opposite of how the price mechanism works in a free market, where consumers (who are paying out of their own pocket) search for the cheapest prices and providers work hard to provide services that are equally efficacious but less costly.

While employer-provided health insurance undermined price sensitivity among consumers, it did not completely destroy it. Businesses, being profit-maximizing organizations, have an incentive to push back when costs increase. However, because of privacy concerns, businesses are less able to push back against rising healthcare than they are for plane tickets. An employer is less likely to pry into the cost effectiveness of a particular surgical procedure undertaken by an employee than they would be to pry into the purchase of a substantially more expensive first-class plane ticket.

In 1965, Medicare was passed as part of the Social Security Act, essentially supplying employer-provided health insurance to all citizens above the age of 65. However, the “employer” in this case was the US government, which does not have the same economic incentives as a business, but rather has political incentives. Elected officials have a strong incentive to promise their elderly constituents an expansion in the range of treatments covered by Medicare, as well as to lower the deductible that Medicare consumers pay out of their own pocket. Both these factors further undermine a consumer’s desire to discriminate on cost when seeking medical treatments.

us-healthcare-spending-percent-of-gdpIn 1960, the government covered 21 percent of total medical expenditures with 55 percent coming out of consumer pockets. In 2000, 43 percent were covered by the government with 17 percent coming out of pocket. Unsurprisingly, the passing of Medicare in 1965 almost immediately lead to a precipitous rise in US healthcare spending as a fraction of GDP.

… The first example was the LASIK corrective-vision procedure, which has become very popular over the last decade. LASIK is an elective procedure that is not covered by standard insurance, and consumers must pay directly for the service — which means that they are much more likely to discriminate between providers both on cost and reported quality of the surgeon. With these incentives in place, the LASIK procedure has been reported to have fallen in cost by over 30 percent during the last decade. [6]

Even more importantly, the quality of the procedure has improved dramatically in that period as providers competed to deliver the most efficacious treatment. According to Erik Gross, an expert in the field of LASIK technology,

Early procedures were not LASIK at all, but uncomfortable surface ablations with no astigmatism correction. Subsequent generations of the procedure increased the treatable range, added correction for astigmatism, correction for hyperopia, the lasikflap to increase stability and comfort, accuracy and safety features, and finally moved to true custom wavefront analysis and correction. [7]

The second example I gave the students was from a personal experience, when I wanted to have a small epidermoid cyst removed from my back. The first practice I visited was a dermatologist’s office, which deals primarily with insured customers and can afford to charge exorbitant rates. I explained to the assistant on my first consulting visit that I didn’t have health insurance — I choose not to — and asked how much the procedure would cost if I paid cash. She quoted me $700 for a riskless procedure that takes about 15 to 20 minutes to perform, and would not in this instance be performed by the dermatologist, but by the assistant herself. As I explained to the students in the public-health-policy class, the fact that there are very basic procedures that cost the equivalent of $2,100 an hour is a glaring sign that the market’s normal price mechanism has been broken.

On the recommendation of a friend, I decided to visit another medical practice, Country Doctor, which deals mostly with lower-income patients who do not have health insurance. Because its customers pay out of pocket, Country Doctor has a much stronger incentive to charge prices that its customers are willing to pay up front. When I had the procedure to remove the cyst done at Country Doctor, it was performed by an actual doctor, and it cost less than $50.

The moral of the story is that price sensitivity is a crucial factor in driving prices down over time. Government policy has undermined price sensitivity, and this has been a very important cause in the rising costs of the American healthcare system.


Licensure is the practice of restricting entry into a market by forcing practitioners and providers to seek permission before doing so. A common fallacy is that medical licensure protects consumers — yet having a license is no assurance of the ability of a person to practice medicine. Some who have received their license decades ago may no longer be fit to practice, demonstrated either by incompetence or lack of continued education.

… The restriction of supply and the attendant rise in prices faced by consumers is not the only detrimental factor that can be attributed to the actions of the AMA. As Milton Friedman pointed out,

It is clear that licensure is the key to the medical profession’s ability to restrict the number of physicians who practice medicine. It is also the key to its ability to restrict technological and organizational changes in the way medicine is conducted. [9]

In other words, the AMA has sought not only to limit supply, but also to regulate who can practice various aspects of medicine. For instance, many medical procedures and decisions about prescriptions could be handled by nurses or medical technicians rather than doctors, whose labor is more expensive. Licensure limits the extent to which market forces — that is, forces that lead to the cheapest and most effective results for consumers — may determine the most efficient use of doctors, nurses, and technicians.

Intellectual Property

A patent is a government-granted monopoly on production. Holders of pharmaceutical patents are free of the strictures of competition when deciding the price at which to sell the drugs they produce. In practice this means that drug companies are able to charge significantly higher prices than they could in a market free of government intervention. Kesselheim et al. estimate that for three drugs alone (amoxicillin, metformin, and omeprazole), the delayed availability of generic alternatives cost Medicaid 1.5 billion dollars between 2000 and 2004. [18]

The following chart illustrates the effect of generic competition on the price of a cocktail of antiretroviral drugs, used to treat HIV, between 2000 and 2001. [19]


Before the availability of a generic competitor the brand cocktail cost over $10,000. Once generic competition was introduced, the price rapidly dropped to $712. The dramatic difference in cost hardly covers the human cost of government-granted monopolies on drug production — namely, the tens of thousands infected with HIV who died for want of affordable treatment.

One common myth in the economics profession is that intellectual-property rights are necessary to foster innovation in the production of ideas. Recent work by Boldrin and Levine [20] and Stephan Kinsella [21] has exploded the fallacies underpinning this widely believed economic shibboleth.

In particular, Boldrin and Levine devote a chapter of their book, Against Intellectual Monopoly, to the pharmaceutical industry. They argue that the actual cost of bringing drugs to market is substantially lower than the estimates produced by the pharmaceutical industry — a group with a vested interest in lobbying for strong patent protections. They also provide evidence that in many instances the existence of patents hinders research in drug production.

The Economics of US Healthcare, by Gilbert G. Berdine, M.D.

A tornado is an insurable event. Tornadoes are devastating, but they only affect a small number of people. Rather than each homeowner having to set aside capital to rebuild his or her home after a tornado, large numbers of people can pool their risk by each setting aside a smaller amount in the form of premium payments. The payments are called premiums because the amount paid is a premium to the actuarial risk. The excess of premium payments over damage claims pays administrative costs plus the cost of capital required to handle claims in the current time frame. The insured willingly pay a premium to their actuarial risk for peace of mind and to free up their capital for other uses.

Unlike the tornado, not all healthcare costs are insurable events. There is a current recommendation for people aged 50 years or more to have a screening colonoscopy every ten years. This leads to earlier detection of colon cancer and greater likelihood of curative therapy. While a screening colonoscopy might be a very good idea, the age of 50 is not an insurable event. There is no risk to share. If one desires a colonoscopy at age 50, one must save the required funds before the 50th birthday. Any attempts to cover screening procedures by insurance are schemes to socialize cost.

The promotion of Medicare as health insurance for the elderly has led many Americans to expect that health insurance should cover all their healthcare costs including costs that are not insurable. The only way existing beneficiaries profit by inclusion of noninsurable costs is to force people with lower risks to join their insurance pool. The end result of this process is the demand for universal coverage that covers everything related to healthcare.


A free-market insurance industry would be allowed to sell policies against the treatment of leukemia. This treatment is catastrophically expensive, but because the condition is very rare, large numbers of people can pool their risk and make the premiums very inexpensive. No insurer is going to sell a policy against leukemia to somebody who has leukemia for the same premium as it would sell it to the general population. Any attempt by government to force insurers to cover preexisting conditions is a socialization of cost rather than an insurance.

Many disease conditions require therapy for long periods of time. Anyone who purchases insurance for the next year becomes vulnerable to losing insurability after the policy expires. The solution is to have insurance policies for many years or life. With a condition such as leukemia, there is no reason that insurers could not and would not offer policies covering people for their entire lives as long as they had no signs of leukemia at the time they enroll. The main reason we do not have health-insurance policies for life is that insurers are forced by government to cover conditions that are not insurable, such as the example of screening colonoscopies I gave earlier. The costs required to cover these uninsurable conditions for life make the policies so expensive that nobody will purchase them.


Doctors and nurses are both cartels. It should come as no surprise that these cartels are resistant to competition. As with all cartels, barriers to entry increase over time, reducing competition. And as with all cartels, barriers to competition are disguised as assurances of quality. Quality is subjective; different consumers have different priorities. Licensing requirements are attempts to objectify what is purely subjective.

Standards used as points of information, on the other hand, are objective and can be used by consumers to determine their choice of provider. A truly free market in healthcare would have no licensing requirements, and assurances of quality would be handled via ratings agencies or certification boards. Decisions about which quality standards were important would be determined by consumers rather than providers.

Would anyone be able to set himself up to perform open-heart surgery? No! Open-heart surgery is a complicated procedure requiring many skilled people working together and a huge capital outlay for facilities. Neither the anesthesiologists, nor the technicians, nor the nurses, nor the hospitals are going to work with a quack heart surgeon; they have no desire to share liability with the quack.

Many doctors have the misconception that without licensure there would be no standards. Hospitals have credentialing processes. It is very likely that the process of credentialing would have little or no change in a free market. Hospitals would demand letters of reference and would continue to inquire where a heart surgeon received training.

Healthcare is not a single entity. There is a continuum of services with a continuum of expertise. The market is best suited to match expertise with complexity of service. Consumers would demand considerable expertise of heart surgeons. They would not likely demand the same expertise for the treatment of a sore throat. Certification of expertise would remain an important source of information, but consumers would decide what value to attach to any certificate, rather than certificates barring entry into any given service. Certifiers, including the educational institutions that grant degrees, would either be attentive to consumer demands or lose their prestige.

… A bone-marrow-transplant team would serve a much larger community. Teams would compete on the basis of quality of service. Consumers would purchase insurance against the need for a bone-marrow transplant. The insurers would set standards of quality for teams they would work with. Any attempt by insurers to compromise quality for cost on such a high-end service would likely lose insurance customers because the effect on premiums would be small. Cost would not be limitless, however. The market would determine the optimal price of quality rather than some government committee.

Obviously, as we have seen, moral hazard leads to a higher level of prices than what would have prevailed otherwise and also to a lower quality of services (including the quality of information) since bad behaviors drive out the good ones. It would be curious if health care is now becoming less accessible as we are becoming more and more rich since GDP per capita keeps growing. Egalitarians believe that technology would drive up health care costs. But in any other sectors, technology decreases prices by reducing costs. If prices decline in the other sectors, people will have more money to spend in health care (Reisman, 1994). The cost of health care for american people increases because of the peculiar way they pay for health care in an economy of moral hazard. A point worth noting is that, as Gottfredson (2002) pointed out,

Chronic diseases are the major illnesses in developed nations today, and their major risk factors are health habits and lifestyle.

… chronic diseases therefore require constant judgment in applying old knowledge and the need to spot and solve new problems.

“Today most illnesses are chronic diseases — slow-acting, long-term killers that can be treated but not cured” (Strauss, 1998, p. 108). They begin developing long before any symptoms appear, which puts a premium on foresight and prevention.

If chronic diseases arise from poor lifestyle due to a low IQ (Gottfredson, 2002), free market should not be blamed for the intellectual inability of those people to protect themselves even on the basis of new information. Again, the fact that obesity-related illness accounts for 20.6 percent of U.S. health care expenditure (Cawley & Meyerhoefer, 2012) explains why a low IQ is a liability in an advanced and complex economy.

Cawley, J., & Meyerhoefer, C. (2012). The medical care costs of obesity: an instrumental variables approach. Journal of health economics, 31(1), 219-230.

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