The Political Vine

It now appears a “prescription drug benefit” for Medicare recipients is on the way in the form of what some have called the “largest entitlement program ever,” and others have called it “the first overhaul of the Medicare system in nearly 40 years.”

This is a good thing – in the sense it may put an end to the political cacophony surrounding this issue for the last five years, at a minimum. But, as this writer hopes to demonstrate below, the reduction in the noise level may only be the calm before the storm, the likes of which have not been seen for many years.

And while the takeover (co-opting?) of this issue on the part of President Bush may be cause for celebration on the part of Republican strategists and loyalists with respect to re-election chances and continued control of Congress, those of us with more conservative views in terms of economic policy, feel it is critical to see this in a more practical and fundamental light, steering clear of the euphoria seen in liberals with the creation of nearly all forms of government entitlement programs. Certain inherent dangers and failures in the prescription drug benefit plan (and any other insurance-based solution) will become painfully clear (pardon the pun) upon a more complete analysis.

To accomplish this, it is unfortunately necessary to revisit the curriculum many of you found painfully boring, if not a complete waste of time – that being basic economics, and consumer behavior.

Let us begin with a brief discussion of “elasticity of demand” (Remember this stuff? It wasn’t very fun back then, so I’ll try to liven it up a bit). In simple terms, elasticity refers to the variation in demand for a product or service given variation in price. Inelasticity of demand, not surprisingly, refers to the lack of variation in demand for a product or service given a variation in price.

When it comes to health care, few would argue the demand for health care is not inelastic. That is, given the choice between suffering with an illness or painful condition, and paying more for its cure or treatment, nearly all will opt for paying more, in one form or another, to receive treatment, at least up to their economic ability to do so. In other words, we value our health, and the ability of our society to deliver heath care, very highly – and our demand for this is highly inelastic.

Responding to this, certainly based on a profit motive, hospitals, doctors, insurance companies, pharmaceutical firms, and medical device manufacturers, amongst many others in this Country, have all combined to offer the most advanced, dynamic, innovative, and expensive health care in the world. Our lives are now longer, less impacted by disease (many of which less than a generation ago were potentially life-threatening), and definitely less painful, thanks to the exponential progress in development of medications and therapies.

Yet we continue to demand more.

And to do so, we have become reliant upon health insurance to defray the cost of our individual demand for good health and treatment for the lack thereof across all wage earners and insured individuals. What started as the equivalent of a “signing bonus” some fifty-plus years ago to attract employees to larger companies, has turned into the largest non-cash component in employee compensation for nearly all employers and government entities in this country.

Until roughly 10 years ago, that was just fine, as our economy absorbed this cost reasonably well. Inflationary pressures, driven by both demand and cost components, were expected and managed. Increasing health care costs to employers, both private and public, were just a part of the overall mix that increasing revenues would cover. Since then, however, the additional demand for health care has increasingly outstripped supply. This has been caused by numerous factors, not the least of which are 1) insurance plans with minimal “co-payments”, 2) the aging of the baby-boom “bubble”, and 3) the expectation of complete health care and cures on the part of consumers thanks to the radical success of pharmaceutical, therapy, and device manufacturing companies.

Adding all this up, including the elasticity stuff from above, yields the following practical, and very simplified example:

Joe and Josephine Q. Public, and their two children Jessica and Jack, are the holders of health insurance policies, courtesy of their employers, which offer a $10 co-payment benefit for all visits to the family doctor. In addition, all visits to specialists are covered at an 80% level, with the same condition applying to admitted hospital stays up to an out-of-pocket cost to the Public Family of $5,000 per year, after which the policy will pay 100% of hospital costs. (Both Jessica and Jack were born with the help of the insurance policies.)

Whenever Jessica and Jack have a sore throat for more than a day, Josephine carts them off to the family doctor, just to make sure their ailment is not something “serious.” The Public Family shells out $10, and all is well, except for the lost productivity of their 1-hour waiting room delay thanks to the 9 others ahead of them needing a nurse to look down their throat just to say, “you have a cold.” In the meantime, Dr. Finkelbean, happily accepts the Public’s $10, even though his cost of delivering his service to the Publics approaches $90 in rent, payroll, equipment, malpractice insurance, and a myriad of disposable supplies, not to mention, he will only receive $70 from the Public’s insurance carrier in about 3 months.

The Publics are perfectly content in demanding an ever-increasing amount of health care delivery, particularly when the apparent cost to them is only $10. Dr. Finkelbean is not quite as happy, but as long as the patients continue to flood his waiting room, he can make enough money. However, family doctors like the good Dr. Finkelbean, are not increasing in numbers large enough to handle the demand. Soon, Dr. Finkelbean, and others like him, will be able to make a sustainable case with insurance carriers that their costs have increased; hence, visits to his office must now be reimbursed at a rate of $100 per visit. Insurance carriers stall as long as they can (by slowing their rate of reimbursement), but eventually they cave in and increase their rates to employers, which in turn adjust the co-payment requirement to $25.

The Publics complain bitterly to their friends, and their elected representatives, about the outrageous increase in their health care costs. Their comments include assaults on “The” insurance companies, and “The” doctors, and “The” pharmaceutical companies. In the coming year, however, the Publics happily continue to demand their health care in increasing doses. Josephine produces Johnny, another low-cost baby thanks to the maternity coverage they enjoy. (Happily, thanks in part to fully covered pre-natal care, Johnny joined this world in very healthy shape.) And the cycle continues….

So, what do we have here? Quite simply we have “insurance-induced” and highly inelastic demand, which is increasing, and a less than commensurate growth in supply, at best. It is not necessary to have read “The Wealth of Nations” by Adam Smith, to understand what will happen to prices in this scenario.

Obviously prices will rise. And, this price rise will be continuously exacerbated by the inelastic character of the driving demand, and the incessant political “solution” of additional insurance coverage or government assistance (which as we all have seen, is NOT a solution).

Finally, we can begin to tie all these pieces together: Although since the New Deal it has been politically expedient to provide something for nothing to the masses, this use of what I call “political heroin” is much more complicated and extremely dangerous, economically speaking, when it comes to goods and services, the demand for which is highly inelastic.

Yes, adding prescription drug coverage to Medicare will generate additional votes and power for the party and members identified as being a champion of the issue. But, the failure of this program to even recognize the central cause of increasing health care costs will yield nothing more than fuel for the fire of ever-growing insurance induced demand. With no attention paid to the supply side of this equation by anyone in politics, the general public, or even well-respected public authors and spokespersons, the cycle of continuously higher health care costs will not end. Granted, technological breakthroughs have increased the efficiency of health care, and thus essentially improved supply. But this, in turn, has for all intents and purposes increased the expectations for complete health care, and thus effectively increased demand, again due to the inelastic nature of this demand. (This increased demand can be easily seen in the growth of specialty medicine, and the so-called “gatekeeper” system, which in turn has been the industry reaction to insurance requirements and liability issues, but that is a topic for another article completely.)

Taken together, 1) our failure to properly analyze the components of supply and demand in this critical aspect of our society, 2) our inability to understand the demand characteristics of health care, and 3) our continued reliance upon insurance-oriented short-run solutions, will eventually cause the downfall of the most advanced health care delivery in the world. “Socialized” health care for this Country becomes one step closer, replete with all the misallocations of resources, renowned Medicare inefficiency, bureaucratic red-tape, and multi-month waiting times for what are now routine procedures. (Insert your Hillary-Care comments here.)

When I hear Senators and U.S. Representatives (of both parties, unfortunately) saying foolish comments like, “We’ve got to do something about health care costs….” then proposing additional insurance coverage paid for by employers, or yet another government program, I cringe, then realize the person(s) making those less-than- intelligent comments were obviously not listening in those oh-so-boring economics classes.

Be careful, President Bush. This one will get you some votes, but may metastasize just a year or two down the road. And the cure for this ailment may be very difficult.

Author’s Note: The “Public” family, and “Dr. Finkelbean” are fictional characters. Any relationship to real persons, living or dead, is unintentional.

Copyright© 2003 All Rights Reserved, Tom LaBarge

Tom LaBarge is a commercial and residential real estate agent, and holds an MBA from the University of Chicago. If you wish to correspond with him on his article, you can write him directly at Tom LaBarge. Or, send a letter to the editor at PV Editor.