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Why Obamacare Can't Work: The Calculation Argument

Tags Big GovernmentHealthInterventionismOther Schools of Thought

07/17/2009Gabriel E. Vidal

In his speech to the AMA in Chicago June 15, 2009, Obama shared his diagnosis, solutions, and justification for healthcare reform: health costs are spiraling out of control and are a threat to the economy, families, businesses, and the federal government. The current system is unsustainable. Costs are increasing faster than they should because we spend money on things that don't make us healthier. We equate expensive care with better care. We overuse and reimburse for treatments that are not needed and we pay for quantity instead of quality.

We can categorize Obama's major solutions to the healthcare crisis as follows:

  1. Payment reform. Change how providers are paid by bundling payments so they team up to treat episode of care or illness. Pay for quality outcomes.

  2. Knowledge reform. Invest in examining and disseminating knowledge of what treatments are more cost effective and clinically effective to cut costs.

  3. Information-technology reform. Upgrade medical records from paper to electronic. This will avoid duplication of tests, track information from doctor to doctor, lower administrative costs, improve doctors' productivity, and reduce medical errors.

  4. Insurance reform. Make the purchase of health insurance mandatory for everyone. Eliminate preexisting-condition waivers and insurance companies' ability to "cherry-pick" whom to cover. Introduce an affordable public option for individuals in order to inject competition into the marketplace to keep private insurance companies honest.

Obama assures us that this is not government-run healthcare, that this is not a single-payer system, that the only consequence to these reforms is that healthcare will cost less and that anybody who denies this is misleading or does not understand the facts. Without his reform, he insists, costs will grow unsustainably, which will threaten reimbursements and the stability of the healthcare system.

Unfortunately, since Obama uses faulty logic to diagnose the problem, his solutions will only make matters worse faster. The correct framework within which to diagnose the problem is to admit that costs are out of control because they do not reflect prices created by the voluntary exchange between patients and providers, between customers and producers, like every well-functioning industry.

Instead, health costs reflect the distortions that government regulators have introduced through reimbursement mechanisms created by command-and-control bureaucracies at federal and state levels.

Simply put, Medicare, Medicaid, workers compensation, HMOs and even private health-insurance firms that follow Medicare rates, rely on cost reports submitted by providers. This cost data is then pushed through mathematical models and additional data generated by government, such as inflation and regional-labor-cost modifiers, to unilaterally (or in agreement with lobbyists and industry groups) determine what the prices for services should be.

But it is theoretically and practically impossible for a bureaucrat — no matter how accurate the cost data, how well intentioned and how sophisticated his computer program — to come up with the correct and just price. The just price of a health service can only be determined by the voluntary exchange of a patient with his hospital, physician, and pharmacist. The relationship between the patient and his private provider has been corrupted by the intrusion of government and its intermediaries (HMOs, for example) to such an extent that we can no longer speak of a relationship that can produce meaningful pricing information.

Given the level of technological advance and capital investment in healthcare of the past 40 years, one would expect quality to increase and prices to come down relative to other goods and services. This is true of other capital-intensive industries like consumer electronics and air travel. But in healthcare we have the opposite phenomenon: higher prices and, at best, equal or slightly improved quality in some locations or, at worst, lower quality in other locations, particularly government owned institutions. And too few consider that perhaps government participation is to blame.

Obama suggests that Medicare and Medicaid are responsible for the cost spiral because they pay for quantity rather than quality, because they do not differentiate between services that make people healthier and those that do not, because they pay for services that are not needed, etc. But he is stating the obvious. Government bureaucrats, physicians, patients, and hospitals have known that for as long as these federal programs have existed. In fact, these reimbursement mechanisms have been modified over the years to attempt to resolve these very deficiencies in the same way that Soviet and Cuban planners attempted to cure the weaknesses of their resource-allocation formulas.

Contrary to Obama's suggestion that knowledge of clinical effectiveness and cost effectiveness can be obtained and disseminated, there is no rational way to evaluate cost effectiveness outside of the free market. Central health planners cannot compare and recommend the best option between two different combinations of drugs, hospitals, and physicians to treat a particular ailment. It is not just a matter of figuring out which combination offers better outcomes and lower costs. In fact, the bureaucrat actually needs prices to make that comparison! This is also why Obama's ideas on payment reform to change how Medicare pays providers, and knowledge reform to investigate which treatments are most cost effective will never work and will increase costs and reduce quality. We have explored this argument in detail here.

Obama also proposes to reduce the cost of health care by upgrading medical records from paper to electronic. While the benefits of health information technology (HIT) are undeniable, the industry is nowhere near the level of development required to have a material impact in productivity and quality of care. It is truly in its infancy. We have different manufacturers with different systems, and different silos of solutions to particular problems even within the same manufacturer — silos that at best communicate clumsily with each other and at worst make the physician's access to meaningful timely clinical information a nightmare.

Billions of dollars have already been invested in HIT. Some systems have worked, while others have not. Billions more will need to be allocated until the best systems are adopted. But the idea that somehow a government agency with no shareholders at risk will help us better coordinate the allocation of capital and the experimentation necessary to develop these solutions is laughable, especially when one of its agents, the Department of Veterans Affairs, in all likelihood has the record for the most expensive failed HIT experiment to date, the $467 million computer system at its Bay Pines hospital in Florida.

The true drive behind government's interest in electronic medical records is the desire to acquire as much clinical and cost information as possible to further control care delivery and health resources. But this is a futile effort as we have seen above. In addition, the effort runs counter to the logical problem that computer systems at millions of local provider-patient levels are capable of generating more data than can be processed expeditiously and meaningfully by a central control agency and its computer system. Any information produced by this central planner will be erroneous and old by the time it is used to guide central bureaucratic decision making.

Obama's plan also includes a reform of our private health-insurance market. He would like, first, to make health insurance mandatory for all Americans, second, to offer an affordable public option, and third, to eliminate the ability of insurance companies to "cherry-pick" which services to cover and which to deny. These changes, he believes, will reduce cost shifting — the practice that providers use to subsidize charity, bad debt, and unprofitable government programs by charging more to insurance companies and private payers and patients — and will spread the risks of the insurance company to healthy individuals, thereby reducing the costs to everyone.

These insurance reforms ideas are flawed. They are based on the assumption that health insurance companies can charge premiums to a pool of policyholders, predict and pay for a large loss triggered by an event outside the control of the policyholder, and make a profit. But sickness combines risks that are uncontrollable with risks that are indeed controllable by the policyholder (eating, exercise, preventative habits, and adherence to treatment plans, for example) and the provider (selection of diagnostic tests, specialists and hospitals, for example). As a result, insurance companies are left with tools of rationing via higher premiums, deductibles, copayments and utilization controls placed on providers, which have a tendency to create nonrandom groups of policyholders and providers. Health insurance companies are more instruments of income redistribution than risk managers, and they are left with only one option: to charge healthy individuals enough to subsidize sick individuals. Eventually, when the impact of the redistribution on individuals is high enough, many either opt out or are priced out of the market, creating the 50 million uninsured individuals.[1]

Obama explicitly states that he wants to force the redistribution of income from healthy to unhealthy individuals but with the illogical belief that somehow this scheme will reduce the costs to everyone. But we have seen that even if the size of the risk pool is extended to the whole population of the United States by mandating every American to have health insurance and hence fixing the size and selection of the risk pool to the whole population, this does not address the fundamental flaw of mixing controllable with uncontrollable risks. Any sensible insurance reform should separate these risks and only cover uncontrollable risks, allow individual underwriting (the practice of insurance companies assessing each individual's pricing and eligibility) move away from community rating (the practice of offering the same price to large groups of individuals regardless of each individual's age, sex, health status, and risk level) so that healthy people pay lower premiums and sick people pay higher premiums, exactly the current model for life insurance. In other words, we should allow and encourage "cherry-picking," not ban it.

The logical tendency of Obama's insurance reforms, despite his explicit denial, will be an inexorable movement towards a single-payer system as his reforms will not control costs or utilization, and the only alternative left will be to enhance the control of the plan via explicit rationing, by a bureaucrat, of the care delivered. The central authority must then decide which health services are provided and which denied, who should receive them and who should not, when they should be given, all in addition to its current function of attempting to determine prices. Such a centralized system must logically retrograde into chaos because pricing signals to patients, doctors, and hospitals will be so distorted that they cannot guide resource allocation.

Obama concludes his speech by stating,

we're a nation that cares for its citizens. We look out for one another. That's what makes us the United States of America. We need to get this done.

Besides the obvious demagoguery to justify accelerating further control of healthcare by the federal government, we should ask ourselves how we have devolved from a collection of independent states founded by a war of secession from a central government power into one nation with a powerful central state. The justification for independence from the rule of King George III that these states gave was based on the doctrine of natural human rights,

that all men are created equally free & independent, & have certain inherent natural Rights, of which they cannot, by any Compact, deprive or divest their posterity; among which are the Enjoyment of Life & Liberty, with the Means of acquiring & possessing property, & pursuing & obtaining Happiness & Safety.

These words are from the original draft written by George Mason for the Virginia Declaration of Rights. Nowhere in this document or in successive drafts by Mason and Thomas Jefferson do we read words that could lead the reader to conclude that the federal government ought to care for its citizens or that we ought to look out for one another or that a central government ought to violate our individual natural rights to freedom, independence, and property to achieve the absurdity of mandatory equal access, equal price, equal quantity, and equal quality of health care for all.


[1] For a detailed Misesian analysis of insurance, see Hans-Herman Hoppe's "Uncertainty and Its Exigencies: The Critical Role of Insurance in the Free Market."


Contact Gabriel E. Vidal

Gabriel E. Vidal is the chief operating officer of a hospital system in the United States. He has a BA in politics, philosophy, and economics and an MBA in finance.