Hoover Digest

Why Health Care Reform May Be Bad for Your Health

Sunday, April 30, 2000

Creeping Socialism

Consider the trends in health care over the last thirty or so years. The pendulum swings first in the direction of greater government control. After it pauses—it continues further in that same direction. The Health Security Act, the Clinton health care initiative of the early 1990s, sought to socialize the health care system in one fell swoop. But once it failed, the administration did not remain idle. As its next line of attack, it adopted a consistent, somewhat covert, strategy to introduce what I like to call salami socialism.

Comprehensive programs and their inflated rhetoric were replaced by narrower initiatives that were intended to move us in the long run to the same resting place contemplated under the failed HSA initiative. American politics knows no finality—no matter how shattering a political defeat, the defeated forces can regroup to refight or relegislate or relitigate in the future. Clearly this prospect is a two-edged sword, but on health care the blade today is pointed in the wrong direction.

Now let us consider what we mean by socialism. The simplest and perhaps most accurate definition of socialism is the Marxist account of the collective ownership of the means of production. That said, it is perhaps too easy to posit that we can identify a sharp dichotomy between the socialist state on the one hand and the capitalist or free market state on the other. In truth, we can detect all sorts of gradations and continuities between pure socialism and pure market capitalism. In fact, most short-term legislative reforms fall somewhere in the gray middle area.

American politics knows no finality—no matter how shattering a political defeat, the defeated forces can regroup to refight or relegislate or relitigate in the future.

It is commonplace to say that the United States prides itself on taking the middle course: Socialism is rejected, and so too unregulated capitalism. In lieu of either, we embraced some mixed system that combines the best of both in a well-regulated economy. But to hold that middle ground we have to make and defend an absolute and categorical distinction between government regulation and state ownership of the means of production. But that distinction founders when we break down the term ownership. Lawyers never tire of saying that ownership is a "bundle of rights," or "a group of sticks," over some asset, tangible or intangible. One key stick in the bundle is the exclusive right to keep and use the asset. Most critically, ownership normally entails the right to dispose of (that is, to sell, lease, mortgage, give, etc.) the asset to whomever you please under whatever terms and conditions you see fit. The crudest form of socialism just gives that full bundle of rights over productive assets to the state. The state decides how these things are to be used and by whom. It decides the prices, if any, that will be paid when resources are transferred. We know enough about the operation of centralized economies to predict with complete confidence the long-term disintegration of these systems. The economist would call socialism suboptimal. The rest of us would describe it as a corrupt mess. Both seek to avoid its consequences by opposing its adoption.

The smart person armed with this definition, however, will then realize that if the state cannot snatch the bundle of rights at once, it can take the bundle one stick at a time. Regulation is then proclaimed as the prudent middle way between markets and socialism. But in reality regulation is nothing more or less than the partial transfer of sticks within the bundle of ownership rights to the state. Price controls, for example, prevent owners from selling certain commodities above a certain price (assuming, of course, they could find a willing buyer). But under the standard definition of ownership, when the ability to price goods and services is snatched away, both buyers and sellers have yielded part ownership to the state over their money and their asset, respectively. In this light, regulation presumptively looks like a form of creeping socialism.

Rationales for Regulation

It is possible to advance several rationales for regulation. Sometimes partial government ownership may be justified, as in an effort to respond to the monopoly or choke-hold position held by a particular owner. This issue arises with private utilities and telecommunications networks. Placing some affirmative duties on certain monopolists may be a restriction on ownership that is consistent with sound market institutions.

But when we use the word monopoly or network with health care, we're not speaking descriptively. Rather, we're speaking metaphorically. The health care industry is one that could be marked by ease of entry from physicians and hospitals, especially if we remove many of the license restrictions that block, for example, the movement of medical personnel across state boundaries. So the standard justifications for state regulation are not available.

What might take its place? One common suggestion is that state regulation is needed to overcome the enormous information deficits associated with providing medical service to ordinary consumers. This rationale is hardly unassailable. First, consumers today have multiple, cheap sources of medical information. Second, too much state regulation mistakenly removes information from the markets. Let me explain these two points.

Individuals often need help in making health care decisions. Some may be able to obtain needed information through voluntary groups and associations. More important, the market itself helps to provide information to consumers. Employer-based health plans need not be driven by some misguided government tax subsidy. Employers may have a comparative advantage in seeking out solid group coverage plans appropriate for their respective workforces and in monitoring their performance. Wholly independent of government regulation of this sector, firms constantly experiment to determine, for example, the ideal mix between price and choice in health care plans. Several years ago, the rage was for strict capitation plans, whereby the employer paid a certain sum per patient, independent of the amount of care eventually utilized. But the stringent restrictions on access resulted in a worker rebellion that led to greater flexibility in physician choice. This benefit does not come for free but only in exchange for higher premiums. Employers who wish to retain key people respond to complaints about service. Price/quality trade-offs are everywhere. Incentives matter.

In contrast, one systematic effect of government regulation is to keep information relevant to health care from the market. One strong collective impulse holds that anybody in need of medical care ought to receive it. An equally strong impulse reminds us that cross-subsidies between individuals breed inefficiencies in health care markets just as they do everywhere else. People who are forced to pay health care subsidies may withdraw from their plans because they get back less than they put in. On the other side, the subsidy recipients will overconsume medical resources precisely because somebody else is paying for them.

Socialism in health care has the same effects as it does everywhere else: It leads to systematic shortages.

In order to cope with this risk, the typical private plan tries to learn about its enrollees in order to calibrate the premiums to reflect its anticipated costs. In pooling risks, an employer plan tries to function as an insurance system rather than a transfer system. This effort to block subsidies will often exclude high-cost individuals from the system or reduce their available coverage. Many people respond to this problem with the moral imperative that everybody has a right to health care—that is, the right to predetermined coverage, not the right to purchase coverage at a mutually agreeable price in a voluntary transaction. Yet the only way to preserve the cross-subsidy is to prevent the gathering of information—through regulation, of course. This regulation is not meant to make markets more efficient by giving accurate information to consumers. Its goal is to make them less efficient so that health care providers cannot differentiate between one class of consumers and another. Thus community rating prohibits a health care provider from

taking age into account in giving or pricing coverage. Likewise, the health and disability laws prohibit an employer or insurer from inquiring into a preexisting condition when determining coverages or setting rates. We burn information to preserve cross-subsidies.

The enormous political durability of Medicare, as it teeters on the edge of bankruptcy, is a tribute to the role of self-interest in American politics.

Is this a legitimate role for state intervention? Here are two possible replies. The first says "no," on the ground that state suppression of the truth is tantamount to a government fraud that makes it impossible to run an efficient system at low cost. In the long run some insurers and employers at least will exit the market entirely to avoid these mandated losses, leading to the unwanted increase in the number of uninsured individuals. Socialism in health care thus has the same effects as it does everywhere else: It leads to systematic shortages, for which it is easier to blame the provider than the regulator.

A somewhat less uncompromising argument tolerates subsidies, but not cross-subsidies. Quite simply, the need for democratic accountability requires all subsidies to be funded from general revenues. It is far more difficult to implement the system of subsidies when it is "on budget" for all to see. Indeed one reason why we should be leery of service mandates imposed by regulation is that they block the needed social feedback on the probable worth of the proposed transfer. No one can state the dollar cost of mandates because it is hard to price the state manipulation of private contracts. So political resistance is effectively curtailed when cross-subsidies are hidden from public view. Worse still, politics tends to bring out the extremists who can whip up the crowd without fear of contradiction. Deliberative democracy is thus rendered less effective than it might otherwise be precisely because the public lacks the information to resist the blandishments of indignant reformers. But the declining share prices of the regulated health care companies give a far better sense of the anticipated costs of the new mandated reforms.

For these reasons, then, neither the monopoly nor the information argument justifies the regulatory initiatives used to advance today's creeping socialism.

The Political Dynamic

Thus far I have developed the normative case against the socialist experiment as applied to health care. It remains to be asked as a positive matter—What propels the growth of quasi-socialized programs like Medicare and Medicaid? Here we do have general revenues that go to partisan causes, so that placing these programs on budget has not succeeded in slowing down expansion of the government sector. The internal coherence and power of the coalition for more-extensive health care programs are able to win the battle over general appropriations. The enormous political durability of Medicare, as it teeters on the edge of bankruptcy, is a tribute to the role of self-interest in politics. It is still more remarkable that the current administration is determined to invest more money in programs whose warts are there for all to see.

Part of the underlying difficulty lies, I think, in cognitive breakdown. Consider the Clinton administration's program to cover prescription drugs under Medicare. Its explanation is that the expanded coverage will rationalize the system, by which it means, of course, reduce cost. It is easy to find situations in which state coverage for prescription drugs could reduce the demand for expensive treatments covered by Medicare and thus save the system money. But that's not the only scenario. Drug subsidies will also make desirable certain kinds of treatments that are otherwise not worth having. Stated otherwise, drugs are both a substitute for some covered treatments and a complement to others. As a complement, the new subsidy will increase the private demand for subsidized treatments and therapies and thus exacerbate the problem of overconsumption.

But, as a first approximation, our political system relies on votes, not dollars, to allocate resources. And voters take us ever farther from market solutions. That difficulty is compounded by the political demand for regulation brought about by a variation of the law of large numbers. In the United States today, roughly one hundred million people have coverage under different kinds of HMOs or private plans. Let us assume optimistically that a representative plan now works at 99 percent efficiency-that is, "correct" treatment and coverage decisions are made in 99 percent of cases. This system should be the envy of us all. Yet with the modest assumption of one interaction per patient per year, we can generate a million horror stories of medical misconduct and insurer callousness, all ripe for press coverage. Just looking at the sample of cases in the public eye, you would be hard-pressed to describe HMOs as anything other than instruments of mass slaughter. Yet that judgment conveniently ignores all the cases in which tough HMO decisions turned out to be correct, saving not only large systemwide expenses but also needless individual treatment. Successful cases do not receive political attention—success is not salient to the political process.

The second related phenomenon concerns the problem of ex post regret. The amount of health care needed is highly uncertain. Yet when individuals buy health care coverage either directly or through employers, they have to decide ex ante how much care they want to purchase for how much cash. Hidden behind the veil of ignorance, buyers have to place fair bets. Most people think that 99 percent of the time they'll be just fine, so they trim their coverage levels to preserve their day-to-day comfort and convenience. They might also recognize that deferring the purchase of a new car could increase the risk of accident, so that spending less on health care increases the prospects for good health by keeping them out of the hospital.

Media coverage is so distorted it is no wonder so many people see HMOs as instruments of mass slaughter. The media ignore all the cases in which tough HMO decisions turned out to be correct.

Ex post, some people who opted for limited coverage will regret that choice once they are saddled with serious health difficulties. In this ex post world, no amount of expenditures is too much. There is a built-in demand for high expenditures in areas in which treatment outcomes are uncertain. Does the insurance plan supply a bone marrow transplant? To all comers? Only to those whose treatment promises special benefits? Maybe $50,000—$100,000 is at stake in that kind of decision. Yet no person who is seriously ill has the requisite level of philosophical detachment to turn down that last fleeting hope. The reason we need health care plans is to cope with the love-hate relationship between our ex ante and ex post selves. The former want health plans to act both as gatekeepers and providers. The latter want to fire the gatekeepers and double the number of providers, no matter what the systemic effects. This system will only work if courts, in enforcing contracts, give full weight to the gatekeeper function. They must be prepared to slam doors shut as well as pry them open. They need to have the courage to say, "This is not covered." "This is experimental." "This is unwise." "This is not cost-justified." But too often they say, "This is unclear, so we resolve all ambiguities in favor of the insured." Too often they say that courts are needed to offset the deleterious conditions of HMOs. Too often, they look at exceptional cases and then ignore the influence of their decisions on the overall operation of the plan.

When it comes to controversial public policy issues, anecdotes and hard data often run in opposite directions.

A Balanced Assessment?

Hence my final plea. In looking at social situations, always remember that anecdotes and data may run in opposite directions. The anecdotes are carefully collected. They are very dramatic. They certainly matter. But thousands of other, successful cases are simply recorded on tables somewhere. These are of equal importance and must be measured as well. Litigation brings failures to the fore, as do congressional hearings. Movies make it clear that HMOs are as bad as it gets. The greatest impediment to sound public policy is the inability to step back from those dramatic incidents to understand this institution on a systemwide basis, where success stories have equal billing with horror stories.

Here's the irony. The systematic accounting of HMO successes and failures shows that some firms do well and others poorly, just as with individual physicians on fee-for-service plans. The overall level of treatment is sometimes better and sometimes worse than individual care. But in terms of price, the HMO does better. From the ex ante perspective, this combination of quality and price explains why rational individuals choose to enroll in these plans. The greatest problem with respect to regulation in the United States is that in political markets, failures always dominate. In economic markets, successes count equally well. The political market turns on scandal and failure. Economic markets function in an ex ante world that rewards the honest revelation of preferences. If you are in the ex ante mode, you'll opt for markets. If you're in the ex post mode, you'll opt for socialism. Too many people live in the ex post world. My great fear is that they will engineer the failure of markets, which will only increase the demand for increased government regulation (and ownership) of the health care system. It would be tragic indeed if a system of central planning that has failed everywhere it has been tried becomes the treatment of choice for our health care ills.