Pascal Bedard
Jul 21, 2017 · 6 min read

The Economics of Health Care

There are some markets that have special characteristics and complexities that warrant special thought and require special policy knowledge to fully grasp. Healthcare, education, and a few others are such “markets” in which special economic and social phenomena arise that need full understanding so that we don’t mess it up “too badly.”

https://med.stanford.edu/news/all-news/2014/10/competition-keeps-health-care-costs-low--researchers-find.html

What is so special about healthcare?

On the face of it, healthcare is NOT “that important” relative to food, shelter or clothing, to name a few. After all, we all die if we don’t eat and we can’t really go without shelter of clothes and there are no mega universal programs for these items of modern living, notwithstanding focused food stamps and other such programs of “redistribution” for the needy and hopelessly-stuck-in-the-shit-hole. So what is so special about healthcare?

Healthcare has a demand. I promise that even if you eliminated ALL state intervention, there would be demand for health insurance coverage, just like there is a market for car theft, house theft, fire, and life insurance. With that demand, there would be a good helping of supply, i.e., “production” of healthcare, and probably many shades of grey in that supply, catering to the various needs of health problems, from very severe to aesthetic luxuries like hair removal. In general, MOST people could afford the cost of these insurance contracts and the various associated costs of becoming seriously ill… but it gets a bit tricky… read on…

Supply problems

Supplying all that healthcare is hard and requires a LOT of highly sophisticated tools, highly trained and expensive professionals, and a host of costs. The supply is generally “inelastic” (limited by all kinds of things)… when demand is strong and supply is faced with constraints, the market naturally goes to a high price, right? This would leave out a LOT of people who would simply be priced out and ignored by the market.

This would leave the market with a smaller-yet-big-enough pool of higher-income earners who could afford decent health insurance, while the rest would just get by “as best they can”, and too bad if they get cancer or have metabolic problems or heart problems or one of the many other issues that require healthcare — they would have to just suck it up and tough it out or die. That is indeed the equilibrium that is reached by this market. It creates situations in which people pile on debt as much as lenders allow to get the healthcare they need to get over their problem and move on with their lives.

Still, we could argue that all-in-all, this is a “fair” setup, because those who supply more market value to the market get more purchasing power from the market, and they naturally get the goods and services that others don’t, both in quantity and quality: better and bigger houses, cars, education, clothes, food, traveling, and… healthcare… and we could further say that this cruel “system” generates more prosperity and healthcare which eventually become accessible to all in aggregate and in the long run than any other system, hence it is the best of all imperfect worlds… I could write a book based on pure logic that would refute this logic, but I will grant this logic to Libertarians — fair enough.

The insurance principle and adverse selection

Health insurance is an insurance market. The principle of insurance works like this:

  1. I am fearful that something bad will happen. It could be a robbery, my death that leaves close family in difficulty, my condo catching fire, having cancer, major heart problems, or any other health problem, and many more. It could even be losing my job.
  2. Due to the possibility of this bad event happening and the cost that it would impose on myself, I am willing and able to pay a certain sum of money per month (suppose 100$ per month) so that “the insurer” would pay my bills to cover the costs of the bad event.
  3. There will be insurers IF AND ONLY IF i) the “bad outcome” has a relatively low probability of occurring (try to get travel insurance for a “vacation” in Damascus or Caracas!) and 2) there are enough people willing to pay 100$ per month to cover all expenses, including staff and all production costs, along with the insurance payments to those unlucky enough to be hit by the bad event (illness in the case of health insurance). This is called the “pooling principle”: a risk is “polled” when it is spread over as many people as possible.

Insurers in the health insurance market have a problem: they may get stuck with a “costly client” (a person who is severely sick and requires lots of expenses) and the “risky person” will not SAY IT openly… there is asymmetric information between the insured and the insurer. Knowing this in advance, the company will raise the price to cover the potential extra costs… the higher price will discourage healthy people, who will “opt out” of the market if they can by Law. This will create a long run effect: the market will gradually “auto select” sick and expensive people, and the price of insurance will skyrocket, while a large portion of the population will not have health insurance. The market will suffer “adverse selection” due to special characteristics, which will be exacerbated by special cost and supply structures that render it especially complex and “touchy.”

This is why there is state intervention in this special market in almost ALL industrialized economies and why this market is complex and NOT like any other market…

The USA spends LOTS of public and private money on healthcare, but President Trump seems oblivious to the public policy considerations and complexities of this special market. You CAN tell a person “too bad you are too poor to have a car or to own a house”… you CAN’T say to a person in a rich country “well tough luck for you, good luck with that million-dollar-total-cost cancer.” It’s not acceptable and it does NOT have to be that way, even in pure efficiency terms.

The extra complexity of tying health coverage with a job

In the USA, a major part of your “employment income” is in the form of the “health package” your job offers you. This makes actual pay lower than it otherwise would be (like corporate taxes), but it is part of the pay package. The issue is that the person loses the coverage when they change jobs, which makes things quite risky and complex. This setup adds to the general complexity of the health insurance market and it only tells us that it requires lots of policy analysis and thought to properly grasp, which seems far from what President Trump seems to want to do — it requires to sit down and really think hard… without tweeting or pointing fingers…

Is Canada “the answer”?

No. Canada has a super centralized universal health coverage that will indeed save you if you are close to dying, but has quite a bit of issues of inefficiency with very long waiting lists and waiting times in typical ERs. It is very costly and not necessarily efficient, with overpaid doctors and specialists.

Health care policy also generally encompasses drug policy, which is a whole other beast with considerable complexities of its own due to information problems and powerful lobbies.

As you can see, there is more to health policy than sexy sound bites about spending and budgets. There are also issues of insurance company behaviour, where the company can deny coverage ex post for some reason covered with a small asterisk in the contract, thus adding a layer of information asymmetry, now going the other way, causing heavy consequences for the lone consumer facing a well-organized insurance company.

The ultimate goal is to have all people covered in case of serious health problems at a reasonable cost. The way countries go about it may vary, but it all requires curiosity and the will to learn about it. Keep that in mind, mr. Trump. Regards.

Pascal Bedard

pbedard@yourpersonaleconomist.com

www.yourpersonaleconomist.com

Street Smart

Money, business, and life lessons to be street smart and book smart. Presented by http://www.yourpersonaleconomist.com/

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Pascal Bedard

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Sharing thoughts on economics, finance, business, trading, and life lessons. Founder of www.PascalBedard.com

Street Smart

Money, business, and life lessons to be street smart and book smart. Presented by http://www.yourpersonaleconomist.com/

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