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Brooks Wilson's Economics Blog: Candis on Health Care Reform

Monday, June 22, 2009

Candis on Health Care Reform

Candis made an excellent comment to my post, "Samuelson and Health Care Reform."  She mentions that the supply curve for doctors' services is inelastic and that the demand from medical services will increase as more people are covered.  I wish to address several points she makes.  I quote Candis.
Universal healthcare would cause an upward shift in demand for healthcare. In the short term, 8 years or more, the supply of doctors would be more inelastic than the demand for them since training to be a doctor is such a long time consuming process. This will result in physicians valuing their time more highly and increasing the cost of a doctor visit in accordance with what is demanded of them. Some thought needs to be given to building up the infrastructure of the healthcare system to accommodate the 45 million now uninsured who would be accessing healthcare if universal healthcare is enacted.
The short run supply of doctors services should be inelastic, and demand should increase are points understood by those who helped design the Obama administration's health care reform plan.  David Cutler, a Harvard University professor, one of the nation's leading economic scholars on the economics of health care, and an election advisor to candidate Obama, outlines the international history of health care reform ("Equality, Efficiency, and Market Fundamentals: The Dynamics of International Medical-Care Reform," Journal of Economic Literature, Vol. XL, September 2002).  Cutler addressed one aspect of the supply of medical services, physicians' salaries.  European governments have been successful at limiting the income of physicians over time but not other health care workers.  Cutler writes,
When there are quasi-rents [producer surplus] in medical-care provision, as there are in the return to past investments by physicians, price reductions need not be accompanied by reduced supply.

Empirical evidence shows that regulation affected both prices and quantities of care provided.  Providers earn less in regulated systems than they do in unconstrained systems.  Real earnings of physicians in the United States increased by 35 percent between 1970 and 1990.  In countries with expenditure limits, by contrast, real earnings were flat.  As a result, doctors in the United States now earn twice what their counterparts earn in other countries...

There may be savings in other factor payments from cost controls, but these will be smaller.  The opportunities for nurses, orderlies, and other personnel to move to other industries prevents a large income reduction for these groups.  Physicians, in contrast, have much more profession-specific human capital.
As a technical note, quasi-rents and producer surplus are the same.  They are pure profit, the repayment of fixed costs, or both.  The Obama plan would deal with the inelastic supply of doctors' services by extracting quasi-rents or producer surplus from doctors by using the government's position as a large supplier of medical coverage to lower payments to doctors.  Economists refer to this type of action as holdup.  Holdup occurs when one party to a contract alters it to his or her advantage after the other party has taken an irreversible action called for by the contract; it reduces producer surplus.  My argument is that doctors have an implicit contact through markets.  If a person completes the grueling process required to become a physician, they will earn a good salary.  I do not like the idea of using holdup to change the agreement between the government and existing physicians for normative and positive reasons.  Normatively, changing agreements after they have been formed is wrong as the term holdup implies.  Positively, holdup will reduce the quality or quantity of care at some time in the future, a point I believe that Cutler glosses over when he writes,
Price reductions are, in the short term, a transfer from medical-care providers to consumers.  There may be long-term effects on the quantity or quality of medical-care personnel, but these effects will not occur for some time. 
Becoming a physician is expensive, time consuming and grueling.  I believe that compassion for suffering of their fellow beings motivates most who enter medical school, but so does future income.  Stagnating income will drive away many potential physicians and increase the cost of medical care in the long run.

To limit the demand of medical services, the Obama administration will attempt to pass more costs onto the consumer, introduce competition through a government plan, and ration medical care by using information technology to identify valuable and non-valuable procedures.  Passing costs onto consumers violates the notion that the Obama administration supports of medical care being a right and not a traditional service like haircuts.  Furthermore, the goal of passing costs onto consumers can be achieved at lower costs by modifying tax laws to make all medical payments tax deductible, or by taxing all medical payments.  Currently, private markets produce thousands of private insurance plans.  Introduction of a government plan would not be as effective as reducing state level restrictions on the provision of health insurance at introducing new competition.  Finally, I support increased use of information technology in health care, but I don't understand why some argue that the government is needed.  Compare Google, Inc. to your state's department of transportation, or UPS to the US Postal Service and ask yourself who is more technologically efficient. 

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