The Economics of Government Health Care

A short explanation of how government health care would quickly lead to rising costs, rationed care and overcrowding
by Joe
(libertarian)
Wednesday, September 23, 2009

Washington has recently made a number of lofty claims about what a government-provided insurance plan could generate, despite lacking a single straightforward example of any government-run program actually reducing costs or improving efficiency. Fortunately, simple economic principles quickly prove how many of these claims are false and makes a clear case for free markets rather than government intervention. At first glance, it may seem logical that in the case of insurance, a government plan would be far less expensive, since profits would be essentially nonexistent. Absent the necessity for profits, the government could simply use these funds to provide additional insurance at discounted rates. Yet when scrutinized, it becomes apparent that the proposed government plan would actually lead to higher costs, overcrowding and longer waiting lines, and limited or rationed care.

In this case, the government has said that the insurance would provide nearly all forms of care, to include preventative care and medications. In exchange, consumers would be required to pay a flat fee, based on their annual income, and a co-pay which would be restricted by a maximum out-of-pocket limit. According to the government estimates, the insurance program would be "deficit neutral," once fully initiated, and would essentially be funded by consumer premiums and tax penalties the government would collect from uninsured Americans and businesses that did provide insurance for their employees. Unfortunately, for multiple economic reasons, such a program is simply not feasible; in order to understand why, it is necessary to understand economic principles.

Normal Pricing Mechanism: Supply and Demand

Almost all economic models are based upon the theory of supply and demand. In order to evaluate products and services, economists look at the effects of changes in prices in order to observe the resulting effect on the number of goods that the public consumes, or the quantity demanded, and the number of goods produced, or the quantity supplied. In almost all circumstances, as the price of a good or service increases, there are fewer buyers able or willing to pay the price for the good, and the quantity demanded decreases. Likewise, as the price of the good or service decreases, more buyers are able and willing to pay the price for the good or service and the quantity demanded increases.

With free markets and competition, prices are set at the level where supply is equal to demand, or at the point of equilibrium, which is beneficial to both consumers and producers. For the consumer, prices are lower than they would be without competition; for the producer, all of their production is purchased without waste. While economists disagree over whether or not it is possible to actually achieve equilibrium, all economists agree that markets naturally move toward the point of equilibrium. If there is a sudden increase in the demand for the product, the increased demand will cause the price to rise and either reduce the number of buyers willing to purchase the good at the new (higher) price, or incentivize other business to begin manufacturing the good. Likewise, if an excessive number of producers enter a market, the price of the good will fall to a level at which some of the businesses cannot profitably produce the good or service and those businesses will be forced to discontinue production, or leave the market. Under these conditions, markets are naturally self-regulating, that is the market naturally incentivizes both producers and consumers to enter and leave the market based on the market price set for a good.

Unknowingly, consumers naturally analyze goods and prices using logical comparisons in order to decide whether or not to purchase a product, or how much of a certain product to purchase. This evaluation may be different depending on the consumer and the product being purchased, but nevertheless, the consumer will still normally arrive at a logical decision of when and how much of a good or service to purchase. Consumers may make decisions based on personal preferences or tastes; they may evaluate the marginal benefits and costs associated with purchasing a good; or they may decide between consuming a certain amount of product "A" or a certain amount of product "B" or a combination of both goods, all of which happens almost naturally. Unfortunately, under a government-run insurance program, all of these naturally occurring judgments are distorted.

Marginal Benefits v. Marginal Costs

Consumers often decided whether or not to purchase a good, and how much of a good to purchase based on the marginal costs and benefits associated with product. The benefit derived from purchasing a good is measured in the usefulness, or utility derived from the decision to purchase an additional unit of the good. Take for instance a situation in which a very thirsty runner has just completed a long race. The runner may gladly pay the $2.00 charged for a sports drink, since the runner values the utility he derives from the first drink at $5.01. After finishing the first drink, the runner is still thirsty and chooses to purchase a second drink, yet this time his utility is only worth $4.01, since he is less thirsty after drinking the first sports drink. The rest of his choices are shown below.

Even thoughthe runner's total utility continues to increase with each sports drink he consumes,he chooses to stop purchasing the drinks after his fourth bottle, since the cost of the fifth sports drink is greater than the utility he receives from consuming the additional drink. The decision of how many sports drinks to consume is based on the price of the drink and the utility derived from its consumption. If the sports drinks were free, the runner would continue to consume additional bottles of sports drinks until he had maximized his total utility- six bottles. The change in the utility between each quantity is known as the marginal utility. For nearly every good, the marginal utility decreases as the quantity increases; this is known as the law of diminishing marginal utility.

Unlike the model above, under a government program, consumers would have no reason to consider marginal benefits in relation to the price of health care once they had reached their annual out-of-pocket limit. While the runner above chose to stop purchasing sports drinks after he had consumed the fourth bottle, a government-provided health care recipient would choose to continue to consume additional units of health care, whether in the form of medications or services, until they had maximized their total utility (6 bottles), rather than stopping at the point where the marginal benefit equal to, or greater than the marginal cost (4 bottles). Since the recipient would no longer consider the price of the services or medications that he or she would consume, the cost would have to be evaluated by a different unit of measure, such as time. In this case, unless the time it took to receive the needed or desired medical treatment was greater than the perceived benefit, the consumer would always choose to continue to consume additional units of health care, such as medication or services. While time is extremely valuable, when it comes to one's health, many people would gladly choose to wait for treatment, even if it was for an extended period, if they believed that receiving the care would result in making their cold better, or their headache go away.

While it may seem calloused to "ration" care using price as a barrier, without proper pricing, the healthcare system would quickly be overburdened. Patients with minor illnesses, such as coughs and colds, would crowd hospitals and clinics, forcing others with more urgent needs, such as a patient with a fractured arm or a severe fever to wait while others received treatment. In reality, price is the only "fair" rationing device. Under dire circumstances, people gladly part with their money or are willing to go into debt in order to receive treatment. Without price rationing, other rationing criteria would be required, since the government would be unable to provide every recipient with all of the service that they chose to consume. Unlike the current system which allows for individual patients to make personal decisions about the costs and benefits of certain treatments, the proposed plan would necessarily set criteria on the societal benefits of certain procedures. For example, while an individual may benefit from a knee surgery that increases the patient's mobility, such a procedure could be considered an unnecessary luxury from society's point of view, when compared to radiation therapy for a cancer patient.

Due to the difficulty of objectively evaluating the true value of medical procedures with regards to an entire society, it would become necessary for the government to begin to evaluate and arrange both patients and medical treatments according to some specified criteria that the government would define. This process, which is already accounted for under the current system by a consumer's willingness and ability to pay, would require both bureaucratic oversight and regulation, and thus remove the ability of consumers to make their own value judgments on the true costs and benefits of such services.

An additional problem faced by a system in which decisions must be made with regard to an entire society is that not only is it necessary to regulate goods and services, but it would also be necessary to control the actions of individuals in order to "protect" the rest of society. A society in which individuals are free to make their own decisions and are personally responsible for their actions has no need to regulate such behaviors, as long as they do not infringe upon or damage others. Yet in a culture where the entire society is responsible for paying for the actions of each individual, the individual must now be subject to the decisions of the entire society. For instance, a person's choice not to exercise, or to overeat, is a personal decision only if that person is solely responsible for their own actions. Yet, if the society were held responsible for paying for that person's healthcare, they would rationally have a reason to prevent that person from becoming overweight. In fact, many would argue that since society must pay for that person's health care, then the society should have the right to determine or to dictate what that person eats and how often they exercise.

Using economic principles, it is easy to see how a program in which the government distorts normal pricing mechanisms and alters consumers' normal cost-benefit analysis could easily further decimate the health care industry. Once instigated, such a program would quickly become extremely costly for all Americans, both in taxes and in lost health care. While the health care system is in need of drastic reform, government intervention is not the cure. A plan such as the one recently proposed by Congress would only add to escalating health care costs. Consumers would gladly switch from higher priced plans to a government plan under which they were no longer charged for the services that they would receive.

Rather than subsidizing health care consumption, the government should incentivize consumers to properly evaluate their own medical care. By offering tax-free health savings accounts and by allowing health insurance providers to compete across state lines, the government could reduce total health care costs virtually overnight. As has been shown in the market for laser eye surgery, where consumers are largely forced to pay for the operation on their own, when consumers are allowed shop multiple providers, and producers are forced to compete for business, prices naturally fall as innovation and competition increases, even as demand increases. Sadly though, government bureaucrats seem more intent on squabbling over the different ways that the government can "fix" health care in America, rather than relinquishing their control over the health care markets and allowing the market to naturally generate positive solutions.

Did you like this article?
If you did, Thumb It!
8 thumbs so far

Facebook Share: Share

Share on Twitter

©2009 Joe, all rights reserved. You must have written permission from the author in order to republish this work.
Published: Wednesday, September 23, 2009
Last modified: Wednesday, September 23, 2009

The views expressed in this article are those of Joe only and do not represent the views of Nolan Chart, LLC or its affiliates. Joe is solely responsible for the contents of this article and is not an employee or otherwise affiliated with Nolan Chart, LLC in his/her role as a columnist.

Report violation by Joe of Nolan Chart LLC's terms of use policy.