President Obama made a remarkable statement to John Boehner in the middle of their negotiations leading up to the fiscal cliff. "We don't have a spending problem," the president said. We have "a health care problem."
To put this in perspective, almost every economist familiar with the federal government finances views our national health care problem as a spending problem. In fact, it is THE spending problem. If the federal government were not buying health care, we wouldn't have a long term deficit.
The reason is not hard to understand. For the past four decades health care spending per person in this country has been growing in real terms at twice the rate of growth of our income. Over time, tax revenues at every level of government will tend to grow at the same rate as the economy grows. But if health care spending is growing at twice that rate, the public sector will be running ever larger deficits or raising taxes or cutting spending on every other program or all three.
So what is the president talking about and why is this distinction important? Well, if you view our health care problem as a spending problem, then the follow up questions are fairly obvious. Why are we overspending on health care? What would it take to get people to spend less and keep health care within our means?
The answers to those questions are also fairly straightforward.
We are overspending on health care because when we enter the medical marketplace most of the time we are spending someone else's money rather than our own. On the average, every time we spend a dollar on health care only 13 cents comes out of our own pockets. The remainder is paid by a third party insurance company, an employer or government. If we can buy medical care for 13 cents on the dollar, our incentive as consumers is to buy every test and procedure in sight as long as it's worth at least 13 cents to us.
But if society is spending a dollar and getting 13 cents of value in return, we're wasting a great deal of money.
On the provider side, incentives are also perverse. When third-party payers, rather than patients, are paying the bills providers perversely begin to treat the payers as their customers, rather than the patients. Instead of competing for patients based on price and quality — the way other professionals do the incentive in health care is to maximize against payment formulas doing whatever reaps the most revenue.
What's more and this is important our worst offenders in this regard are Medicare and Medicaid. Low-income patients on Medicaid make almost no out-of- pocket payment when they get medical care and most seniors once they combine Medicare with Medigap and drug coverage insurance face no out-of-pocket-expense either. In our government health programs, people are encouraged to treat heath care as though it were a completely free good.
Loyal readers of my columns already know what needs to be done. Both in the private sector and in the public sector, people need to manage more of their own health care dollars in Health Savings Accounts (HSAs). We need special HSAs tailored for the needs of the chronically ill. And for the big ticket items, health insurance needs to become like casualty insurance which people have for their homes and automobiles.
Changing Medicare and Medicaid, however, would be entitlement reform. And the new mantra on the left is: we don't need entitlement reform. That's basically what Barack Obama was saying to John Boehner. It's the same thing New York Times columnist Paul Krugman routinely says when he writes about health care. Ditto for former Labor Secretary Robert Reich. For example, writing at The Heath Care Blog the other day, Reich called entitlement reform a "hoax," and he went on to say:
We're already spending nearly 18 percent of our entire economy on health care, compared to an average of 9.6 percent in all other rich countries.
So how do we become more like them?
An estimated 30 percent of all health care spending in the United States is pure waste, according to the Institute of Medicine.
What he is really saying without ever coming clean about it is that all we really need to do is to tell doctors how to practice medicine. If they practiced medicine the way Canadian doctors do, for example, we wouldn't have a problem at all!
But in fact, all this is liberal myth. When the accounting is done correctly, we are not spending more than other countries and the idea that other countries have found a way to make socialized medicine efficient is ludicrous. We may indeed be wasting one of every three dollars in health care, but so are the Canadians and so are the British. In fact, the systems of other countries are very probably more wasteful than ours.
There are two fundamentally different ways of thinking about complex social systems: the economic approach and the engineering approach.
The social engineer sees society as disorganized, unplanned and inefficient. Wherever he looks, he sees underperforming people in flawed organizations producing imperfect goods and services. The solution? Let experts study the problem, discover what should be produced and how to produce it, and then follow their advice. This is the approach implicit in the writings of Reich, Krugman and President Obama.
Social engineers invariably believe that a plan devised by people at the top can work, even though everyone at the bottom has a self interest in defeating it. Implicitly, they assume that incentives don't matter. Or, if they do matter, they don't matter very much.
To the economist, by contrast, incentives are everything. Complex social systems display unpredictable spontaneous order, with all kinds of unintended consequences of purposeful action. To have the best chance of good social outcomes, people at the bottom must find that when they pursue their own interests they are meeting the needs of others. Perverse incentives almost always lead to perverse outcomes.
In the 20th century, country after country and regime after regime tried to impose an engineering model on society as a whole. Most of those experiments have thankfully come to a close. By the century's end, the vast majority of the world understood that the economic model, not the engineering model, is where our hopes should lie. Yet health care is still completely dominated by people who steadfastly resist the economic way of thinking.
The Affordable Care Act (ObamaCare) was heavily influenced by the engineering model. Who but a social engineer would think you can control health care costs by running "pilot programs"? What's the purpose of a pilot program if not to find something that appears to work so that you can then order everybody else go copy it? Pilot programs are a prime example of the social engineer's fool's errand.