An initial discussion about healthcare prices

Price Tag
Price Tag

For a while, I’ve been thinking about writing about healthcare prices and why I do think they are not the problem, but a symptom of what is happening in the healthcare systems around the world – it is not only the US that have problems! In order to do so, I will first talk about some aspects related to pricing and then analyze few aspects related to healthcare system itself. Other post will follow this discussion, in order to try to cover some important aspects that will only be mentioned here.

Let’s start our discussion with two different – and unrelated – situations:

  1. How much does a new iPhone cost? Usually, in the basic configuration and with a contract, it costs $199.00. What is the iPhone price? Someone can say the exactly same amount: $199.00. But, I would claim that, for the person who waits in line for days, the price is way higher, even though he/she will be paying only that given value.
  2. Second situation: is it paying $1.00 for a bottle of water cheap or expensive? Someone living in Los Angeles on September 17, 2014 and searching using Google can say that it is expensive because of the price listed in this website http://goo.gl/vfu3Ru where a 28 bottles package is sold by less than $6.00. However, someone in the middle of the Sahara desert might say that $1.00 is a ridiculously low price and it is extremely cheap.

From these examples, it is possible to see that prices establish an exchange relationship between things: iPhone or water for money and/or time. Furthermore, it is possible to see that prices are not necessarily the same for a given product, even for two different people at the exactly same location. The main question is: why?

When I was studying Econ 101, my college professor and my father presented me the definition of prices as feedback mechanisms of the market. In simple terms, prices are ways to understand the desire for something, how that product or service is available in the market, and how to allocate the scarce resources in a given period of time. Furthermore, since prices are not only given by monetary value – currency is also a product in the market that is used to facilitate exchanges and is affected by supply and demand (see inflation) – as they can be expressed especially in time or effort (energy expended) to obtain something, it is also necessary to evaluate other indicators when analyzing a market.

For simplicity, my discussion here will focus on two aspects: prices are not given only by monetary values; and prices are dependent on the scarcity of a given good or service in a given area (city, state, country, continent, even planet). I think these are the key points to start addressing the analysis about the healthcare market and why the monetary values seem so high in the US compared to other locations. In following posts, I will talk about regulations and politics, which are also extremely important to understand the current market status and its problems.

Before starting my analysis, it is important to stress that deeper and detailed studies on healthcare prices should also analyze the amount of taxes charged by government, the relationship between various production factors (costs), the labor costs – also related to scarcity and to regulations -, the subjective value of different products in a given time (someone is willing to pay more for a cancer treatment when he is sick than in a healthy situation, or when gramma is ill than when an unknown homeless is facing the same disease), the moral hazard, the controlling mechanisms imposed by bargaining agents such as governments and unions, etc. Some excellent economists have analysis on this topics, I recommend reading the articles on the George Mason University Mercatus CenterJohn Goodman’s and the Apothecary‘s blogs at Forbes, and the healthcare posts from the Economics 21 at the Manhattan Institute web site.

First fact: prices are not necessary monetary!

Everyone has a story about a person who stayed in line for a long time waiting before a significant promotion took place in a store (or before the tickets of a show/sports event went on sale), kept refreshing the web browser to buy a product with discount, or waited for a healthcare service (surgery, appointment with a specialist, starting of a treatment). This time spent in the sole purpose of waiting is a type of non-monetary price that is paid for a service or good, directly related to rationing. And why is that?

Because this time could be used in other more productive activities like working or studying, or it will increase some of the final costs of the process like in the case of a disease that evolves with time and requires a longer and more difficult treatment after waiting to start the treatment. There is always a trade-off, an opportunity cost associated with the purchase of a good or service, and this cost is not necessarily paid with currency!

DMV Line (source: http://libertydmv.com/)
DMV Line (source: http://libertydmv.com/)

Consider the example of someone receiving the minimum wage in California, which currently is $9.00/hour. For every hour this person spends in a line at the DMV, he/she is losing the chance to make $9.00 working. Of course the time spent in the line can be worth and usually the result of the waiting process is considered more valuable than the amount of money the person would make. However, it is still an associated price even when the person believes he/she is having a profit with the outcome of the waiting. The same analogy is valid for someone who is waiting to purchase the new iPhone and, instead of going to work, stays in the line for days. In this case, it is not necessarily the iPhone that is worth the hours waiting, but the chance of being the first among friends and family to have the new gadget.

In the case of healthcare systems, the price is increased when people have to wait hours or even years for a given treatment. The monetary value of the service or good might be fixed (by a regulator, an insurance company or a contract), however the time/distance/effort values are not, and they sum up to the total final price being paid.

Second fact: prices are related to scarcity

The golden rule is given by: the scarcer the item, the pricier it will be. Items are scarcer when they are difficult or costly to obtain and/or produce, regardless of their importance. Diamonds and platinum are scarce, therefore they are pricy. Air and sunlight are abundant (available almost everywhere), therefore they are extremely cheap or non-priceable at al.

Scarce items are difficult to produce or obtain because they are associated to exploration of a very specific regions (the case of diamonds), to time consuming processes (e.g. formation of a microvascular neurosurgeon), to a highly selective number of people (e.g. lectures of Nobel Prize laureates), to once in an year events (e.g. Super Bowl tickets), etc. Thus, their prices in monetary and/or non-monetary values will be high enough to equilibrate supply and demand (market clearing prices).

In the healthcare system, every single item is scarce due to natural limitations of their production or to governmental imposed regulations (more on this later). In a given city, we only have a limited number of physicians, nurses, dentists, hence, the prices associated to the services of these professionals are higher than in a hypothetical situation where every single resident of a town is a healthcare provider equally trained and capable of providing every single aspect of care. The same is valid to the number of hospitals and clinics that exist in a limited number and may require a certificate of need in order to open.

Furthermore, scarcity can be a temporary or almost permanent. For example, the scarcity of  food due to a flood is temporary and increases the prices of perishable items (like price gouging) until the supply is reestablished. But the scarcity of tropical trees in Alaska is extremely difficult to solve, and would require a really long time to be dealt with. Each situation will present a different implication in the market logic and the price dynamics.

Waiting lines in Haiti during a cholera epidemic. (Source AFP)
Waiting lines in Haiti during a cholera epidemic. (Source AFP)

This idea is also valid for healthcare systems. Consider a city where there is only one hospital providing emergency care. The medical prices might be higher in this location than in another place where there are multiple health centers, in order to accommodate the demand – the non-monetary component might be present with long waiting times -, especially in cases of epidemics. But if another hospital can open at any time – such as a military field hospital -, the prices tend to go down because of the increase in supply.

My comments about the healthcare prices

As I said before, the prices are not the problem, they are symptoms. If the price is too high, we should identify what is driving that amount up. Some people might even find interesting things about the phenomenon high prices, like Dr. David Belk in his criticisms of pharmaceutical industries, but their proposed solution of price control using bargain agents attacks only the symptom not the cause!

I will talk more about Dr. Belk’s example later and explain what I think he gets right and why his proposed solution is completely wrong. The same thing happens with Dr. Aaron Carroll videos on the excellent Youtube channel called Healthcare Triage and his videos about the different healthcare systems in the world. They both focus on the prices and forget to consider what prices represent: a feedback. The American prices can be higher that the European or Australian ones, however this does not necessarily mean anything regarding quality or fairness.

The same logic also applies to medical technology companies, hospitals, clinics, etc. We should not pay attention only to the monetary price and we should not be those jealous people looking at someone else’s garden and complaining about ours. If the prices in the US are higher and they do not reflect quality of the services and goods, the problem exists not because the European prices are lower, but because there is something artificially driving our prices up.

Yes, indeed the monetary values in the US are higher that what they could be and we should focus on the variables that are supposed to lower them down, not capping them. It is the same idea when a patient enters the hospital after a car crash: we do not focus on reducing the scars and doing cosmetic procedures, we try to find if there is internal bleeding, what is the extent of the damage, and later we take care of the appearance – which is probably getting better as we fix the other problems.

However, the president Obama only looked at the external part when proposing the “Affordable” Care Act (aka Obamacare – one of the worst pieces of legislation that I have had contact with, even worse than the Brazilian “Draconian” Labor Regulations), he and other liberal analysts like Paul Krugman did not pay attention to what was driving the prices up and in the process proposed solutions that will increase even more the non-monetary prices – after having increased the monetary prices during the last few years, imposing a cap only on government spending. As result, Dr. John Goodman in a recent articles shows problematic statistics that with the increase of third party payments, especially government payments, the non-monetary prices to see doctors are increasing a lot – reaching Canadian-like levels.

When one understands that prices are both not only monetary and extremely related to scarcity, the person realizes that the only way to really reduce prices is increasing the supply of the services and innovating to create alternative services that will compete with the pre-existing ones. Healthcare is not an exception to this rule! Nevertheless, increasing the supply might take time and is not politically compelling as it is writing a gigantic law that is based only on claims and demagoguery, not on real data and strong economic models. In the eagerness of satisfying every interest group, one usually ignores what is the problem and attacks only the visible symptom.

We should foster competition among health insurance companies and healthcare providers in the same fashion as we have with non-insured treatments such as LASIK surgery and medical tourism, this will drive prices down and quality up. We should reform the FDA to reduce the time needed to approve new drugs and treatments, therefore downgrading regulatory costs in the market and driving down both the monetary and the non-monetary prices. We should get rid of the certificates of need that act only in the interest of already established business and protect those with influence in the government, not the patients. We should let the market act freely, not control prices, because one can only control the monetary prices for a limited amount of time before black markets appear and the non-monetary prices skyrocket.

My the take home lesson is: prices are way to complex to control, since they are not only paid with cash, and reflect various indicators, especially the scarcity of the good or service. If one desires lower prices, this person should foster competition and learn with other markets that the greater the supply, the lower the prices. Furthermore, we cannot ignore what happened in other countries, since it is impossible to determine a “fair price” without violating the market rules and paying the consequences in the future, as Canada, UK, Sweden, Denmark and Brazil – to name only a few – are paying now.

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