How Price Control Raises Healthcare Costs: A Case Study from Karnataka
This article explores the proposed amendments to the Karnataka Private Medical Establishments Act of 2007 that was tabled before the Karnataka Assembly on June 13, and argues that these amendments will adversely affect the booming healthcare sector within the state.
The author, while applauding the noble intentions of the bill, laments at the lack of insight and understanding of the healthcare market showcased by the legislators; offering first hand statistical data to further augment his arguments.
In 1936, Robert K Merton, a Professor of sociology from Columbia University published a seminal paper titled, “The Unanticipated Consequences of Purposive Social Action”. In the paper, he wrote of the ‘imperious immediacy of interest’, wherein government legislations that desperately seek one outcome, are prone to overlook the unintended consequences of said outcome. The foremost example of these ‘unintended consequences’ is that of the US Food & Drug Administration (FDA), which has become stagnant due to several years’ worth of backlog regarding new drug approvals. The FDA, originally created to protect consumers has, through its own regulatory inefficiencies, resulted in the death of a thousands of patients. This loss of life could have been prevented, had these lifesaving medications been approved on time. Also as a result, costs of drug discovery has been raised significantly for billions of people around the world.
In 2016, the government of Karnataka created a committee of health experts, chaired by Retd. Chief Justice Vikramajit Sen, to propose amendments to the Karnataka Private Medical Establishments Act of 2007. The committee was formed with the hope of reducing healthcare costs for patients. On the 13th of June, the government tabled a bill before the Karnataka Assembly that bore little resemblance to the Justice Sen proposal. The biggest impact of the tabled bill on future healthcare in Karnataka lies in 2 key provisions — “It is considered necessary to … have effective control over Private Medical Establishments”[1], and “Every Private Medical Establishment shall follow the rates as fixed by the Government”[2].
There are a host of other amendments in the bill that will reduce the freedom of doctors to manage their respective establishments, increase penalties for violations, reduce the duration of licenses, but I won’t focus on those. I also won’t delve into the hypocrisy of not holding government hospitals to the same standards as private hospitals. The focus of the article will instead be on the unintended consequences that are a direct result of the aforementioned provisions i.e. increased regulatory burden and price control. The argument put forth in the article is that these burdens and controls will raise prices for patients in the long run, reduce their choice of healthcare providers, and lower the quality of healthcare that they receive.
At this point, it would be noteworthy to point out that I applaud the noble objectives of this bill. It will encrust a first-world regulatory structure on top of our inadequate third-world infrastructure. Since the public believes that doctors are not to be trusted, the government will create multiple layers of oversight through ad-hoc inspection committees. These committees will be able to define the standards of infrastructure, staffing levels, or “any other function”. These same committees will also have the right to inspect every single department of the hospital. And because the government believes in efficiency, the same committees will also have the power of a civil court, thus playing the role of judge, jury and executioner.
I shall choose to believe that this new cadre of inspectors will discharge their functions honestly and will not invoke their power to arrest any hospital owner on arbitrary non-compliance charges for six months to three years[3] as a means to seek rents. I shall focus, instead, on the rising costs of compliance, highlighted brilliantly by William Baumol in his ‘theory of cost disease’[4]. He showed that over time, technological progress lowers the costs of manufactured goods, but the costs of labour-intensive services like healthcare and education increase, often far in excess of wage inflation. There are many reasons for this, but the most important is the increasing need for labour that is required to deal with compliance issues brought about by overzealous regulations.
Most private healthcare establishments are operated by individual practitioners and small nursing homes. These mom-and-pop establishments operate within low margins, collect cash, pay no taxes and make do with low overheads. The facilities they operate in wouldn’t pass an NABH[5] audit but they serve a valuable role in the delivery of affordable secondary care, especially in small towns. There’s no way they can afford the software needed to track clinical outcomes, nor pay for quality control specialists. When the inspectors come, they will have to make a choice between spending money they don’t have on facility upgrades or simply closing down. There’s a third choice, but I’m confident that no reasonable person would even dream of asking the honest inspector to overlook the non-compliances in exchange for some kind of, gasp, benefit. The nursing homes that end up spending money on electronic medical records, ETO sterilizers, finance managers, fire protection, auditors, will survive, but all those additional overheads will be borne by, you guessed it, the patients. The tragedy in all of this, is that the facilities that are best equipped to handle these regulations are those old rascals — large multispecialty hospital groups. They will benefit the most when the government eliminates their competition — small nursing homes and private practitioners. Remember, regulation always raises barriers to entry with incumbents benefiting the most.
Finally, the article would like the establish the essential role played by price control in raising overall costs and lowering quality in healthcare. Public health activists choose to ignore decades of research[6] that show price controls don’t work, and so shall I. Instead, I will share a slice of reality.
The chart above shows the revenue mix for different categories of patients that walk into NH Hospital (Bangalore). 18% will benefit from cashless government schemes that pay for the procedures. An unpublished costing study conducted by a leading business school, found that Karnataka schemes pay only between 30% and 60% of the actual costs incurred by private hospitals. The chart below shows the discrepancy for surgical oncology.
So how does it make sense to operate on a large chunk of patients at well-below operating costs? Cross-subsidization. Hospitals use the margins from private rooms and complex surgeries to compensate for patients who can’t afford surgeries; this classic price discrimination works to everyone’s benefit. The rich get a better room and faster service, and the poor get an operation they couldn’t otherwise have afforded. Now what happens when you control all the prices in a hospital? Let’s also assume that hospitals will no longer make any profits[7] but will be paid an equilibrium price that accounts for actual costs incurred. In this alternate reality, a farmer from Mandya and Vijay Mallya might pull into my hospital for the same operation. The farmer would end up paying well over what he could afford, and Vijay Mallya will have to stay in the general ward but will get a great deal on his operation. The farmer has subsidized the tycoon and nobody is happy.
To conclude, India has the most vibrant free market for healthcare services in the world. A free market spawns intense competition- a primary reason for why Indian healthcare sector has grown at double digits and reduced the cost of medical procedures to the lowest in the world[8]. Indian hospitals have pioneered process innovations like factory-line operating rooms, and minimally invasive surgeries that are the envy of the developed world. However, healthcare is still unaffordable for most Indians- this can be attributed to extremely high input costs. For instance, there is a prevalence of high real estate costs due to the scarcity of land that is zoned for hospitals. Specialists are paid tremendously high salaries because there is a greater production of doctors as compared to that of specialists. Medical equipment is imported at dollar prices due to the lack of an adequate domestic market for equipment manufacturers. This doesn’t grab headlines the way, “Hospitals cheat patients” does, but anyone who spends ten minutes on a root-cause analysis will come to the same conclusions that I’ve outlined. There is a proper role for regulation, and that is to create an enabling environment for market forces to move in the direction that benefits most people. It will be a tragedy to reverse two decades of gains if the Karnataka government uses a short term fix to solve a long-term problem.
Footnotes:
[1] Section 1, The Karnataka Private Medical Establishments (Amendments) Bill, 2017
[2] Section 10(3), The Karnataka Private Medical Establishments (Amendments) Bill, 2017
[3] Section 19(4a), The Karnataka Private Medical Establishments (Amendments) Bill, 2017
[4] Peforming Arts: The Economic Dilemma, 1966
[5] National Accreditation Body for Hospitals and Healthcare Providers
[6] But if you’re interested, please read this excellent summary — The Problems of Price Controls, from the Cato Institute
[7] The average PAT for Indian healthcare industry is around 4%. This isn’t a profitable business
[8] WHO, McKinsey, Harvard, take your pick. Everyone agree with this
