Econ Lesson: The Rationing of Medical Care

 Like most things, the use of medical services must be
rationed. But who should do the rationing?

All things that are desired and cannot be provided without
cost (as we used to say about air) must be rationed. This is exactly what
markets do by discovering the price at which buyers are not willing to pay more
for more and producers/sellers are not willing to provide more at that price.
This market-clearing price has the interesting property of maximizing the value
(utility) of each person’s income because a reallocation of that person’s
spending would result in having more of things less valued and less of things
more valued. If you spend more on one thing you will have less income with
which to buy other things (what economists call the budget constraint). Each
person’s tastes and choices are different but each person can satisfy this
utility maximization goal in a free market by tailoring the mix of her
purchases to her own tastes. In short, the market-clearing (equilibrium) price
maximizes the value of each person’s income for each person. Why in the world
do they call this the dismal science?

While I know very little about the health industry, it is
obvious that the necessary rationing of medical services if we are to get the
best value from our incomes faces some challenges. The share of GDP going to
medical care in the U.S. has reached over 16% and is still climbing. This is at
least twice the level of spending of other developed countries, but the result
is not healthier Americans on average. For example, infant mortality rates in
the U.S. are about 40% higher than those in other high-income OECD countries
(World Bank data).

If medical care is provided to users free of charge (i.e. if
someone else pays the actual cost of producing it), those users will consume
medical services until the marginal value of an additional amount is zero (even
though the actual cost is far from zero).
Such users have no need and thus no incentive to restrict (ration) the
medical services they consume in order to save the income for something else
they value more. If insurance pays the full cost of all medical services, the
consumer, at the margin, is getting them free. This is why co-payments are now
usually required and serve the useful purpose of returning some incentive to
the consumer to ration services more carefully (e.g., should you ask for a
simple blood test or a much more expensive comprehensive one?).

If consumers don’t pay, other mechanisms for rationing are
required if gross over provision of medical services is to be avoided and it is
obvious that the escalating costs of such services (without a commensurate
increase in benefits) arise in part for this reason. Insurance companies
themselves ration by establishing what they will pay for and how much they will
pay for it. Ideally consumers would choose insurance plans that ration in ways
that match their own preferences as closely as possible. However, competition
among insurance providers over such cost/benefit decisions is limited by the
fact that since World War II employers have generally provided health insurance
to their employees (because the government subsidizes employer provided
insurance by exempting that form of employee remuneration from taxation). Thus
the employers rather than the actual consumers of medical services decide which
insurance plans to provide. This restricts competition among insurance
companies to provide the mix desired by consumers. Employer provided health
insurance also makes it harder for workers to change jobs and increases the
hardship of unemployment because it also result results in the loss of
insurance coverage.[1]  A national Insurance Exchange through
which everyone could chose competing insurance programs, as is now being
considered, would also increase competition for insurance plans.[2]

One problem with insurance (including Medicare) deciding how
to ration services is that they often do not know as well as trained and
experienced doctors which services (treatments, medications, and technology)
are most cost effective for each situation. So if consumers have little
incentive to ration, maybe doctors should make such decisions for them. Indeed
they are surely the most knowledgeable for making good judgments about the medical
services that are most appropriate and cost effective and in fact we rely
heavily on their judgments in this area. Unfortunately, doctors have several
strong incentives to over supply expensive services. Most doctors in the United
States are paid on the basis of the tasks performed (fee for service) rather
than on the basis of the services rendered (treating pneumonia, or setting a
broken bone) or the results of their efforts (curing a back pain). The more
they do the more they are paid whether they make the best choices or not. Some
medical practices, such as the Mayo Clinic have obtained good cost containment
with high quality service by making their doctors employees rather than paying
them fees for services. If the Mayo Clinic, or Doctors Inc. charge a fixed fee
for treating a particular ailment, they have an incentive to find the most cost
effective ways of doing so for each patient. But then they might have an
incentive to cut too many corners to save money.  HMO’s are another approach to rationing in an effort to deliver
good service at a reasonable cost. They have been unpopular with many people,
but might be the best choose for some if offered as one of many options.

The oversupply of services by doctors has another cause as
well. American malpractice liability laws encourage lawsuits by offering very
large damages, sometimes in cases of reasonable judgments that proved wrong.
Malpractice insurance, often costing individual doctors several hundred
thousand dollars per year, has added considerably to medical costs directly. But
the threat of such suits has also added considerably to such costs indirectly
(with no real benefit) through the defensive, over use of extensive diagnostic
tests by doctors to ensure that they are protected from nuisance lawsuits. Most
professional practitioners (lawyers, engineers, directors, etc.) are protected
from such suits if they have adhered to established norms (protocols) of
decision making even if in retrospect their decision was wrong or not the best.
Reform of malpractice law for medicine along similar lines is needed.

Individual doctors rely on medical boards to establish
protocols for what is best practice in treating each disease and condition.
President Obama wants to establish professional boards to set such standards
for insurance coverage and to evaluate and propose the most cost effective
treatments. It is clear that individual doctors do not have the time and
resources with which to do so and still practice medicine. The American Medical
Association develops such protocols, but it also restricts medical practice in
ways that limit competition among doctors and techniques (e.g., phone or
internet consultations across state lines). As with other services, progress
comes from competition and experimentation. If doctors can never try new
techniques or technologies because they are dealing with human beings, medicine
would be frozen where it is (or where it was).

All of the above reflect failures or weaknesses in
traditional market rationing of medical services. They have contributed to the
high cost of these services in the United States in relation to the quality of
these services. In some cases services are expensive but produce superior
results (new medicines and machines) but in many cases they are wastefully
expensive without providing better results. As in other areas of providing
goods and services, financial and other incentives need to be properly aligned
to provide the best serve at the least cost, which is the level of service and
related cost desired by each consumer from the offered options. And all
services need to be competitively provided (insurance, doctors, labs,
hospitals, etc.). Currently medical services are not being properly rationed. I
wish I knew the answer to the best way forward. Generally the best approaches
result for experimentation and the survival of the best in the market place.
Medical care to too regulated for this traditional approach to work well, but
keeping in mind the importance of getting the incentives right will be part of
improving our system of delivering medical services in the U.S.


[1] Ruth Marcus,
Bipartisan Plan on Health Care? Try Two”
, The Washington Post, July 29, 2009, page A17.

[2] Ezra Klein, “A
Market for Health Reform”
, The
Washington Post
, July 29, 2009, page A17.

Author: Warren Coats

I specialize in advising central banks on monetary policy and the development of the capacity to formulate and implement monetary policy.  I joined the International Monetary Fund in 1975 from which I retired in 2003 as Assistant Director of the Monetary and Financial Systems Department. While at the IMF I led or participated in missions to the central banks of over twenty countries (including Afghanistan, Bosnia, Croatia, Egypt, Iraq, Israel, Kazakhstan, Kenya, Kosovo, Kyrgystan, Moldova, Serbia, Turkey, West Bank and Gaza Strip, and Zimbabwe) and was seconded as a visiting economist to the Board of Governors of the Federal Reserve System (1979-80), and to the World Bank's World Development Report team in 1989.  After retirement from the IMF I was a member of the Board of the Cayman Islands Monetary Authority from 2003-10 and of the editorial board of the Cayman Financial Review from 2010-2017.  Prior to joining the IMF I was Assistant Prof of Economics at UVa from 1970-75.  I am currently a fellow of Johns Hopkins Krieger School of Arts and Sciences, Institute for Applied Economics, Global Health, and the Study of Business Enterprise.  In March 2019 Central Banking Journal awarded me for my “Outstanding Contribution for Capacity Building.”  My recent books are One Currency for Bosnia: Creating the Central Bank of Bosnia and Herzegovina; My Travels in the Former Soviet Union; My Travels to Afghanistan; My Travels to Jerusalem; and My Travels to Baghdad. I have a BA in Economics from the UC Berkeley and a PhD in Economics from the University of Chicago. My dissertation committee was chaired by Milton Friedman and included Robert J. Gordon.

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