Sunday, September 13, 2009

What is a Waste of Resources?

Obama promises to cut $500B of waste, fraud, and abuse out of Medicare and Medicaid over 10 years. To say that this claim has been met with skepticism would be an understatement.

I am not nearly so skeptical because what Obama and the left wing are really demanding from Congress is more power to ration government provided health care, as well as to pay drug companies, medical equipment companies, doctors, and hospitals less for their products and services (which will of course lead to more rationing).

I think the savings in terms of money could easily materialize. The problem I have is that saving the government little green pieces of paper is not a worthy goal in and of itself. After all, the government can create little green pieces of paper almost for free.

If the government were to save $50B/yr in Medicare costs by cutting Medicare reimbursement rates and by raising the eligibility age from 65 to 67 years, would anybody think that is real savings? How about if the government mandated that no doctor be allowed to make more than $100K per year? Or that all drugs currently on the market are deemed no longer on patent? All of these changes would dramatically lower the cost of government provided health care, but would they actually prevent the waste of or increase the supply of health care resources?

Resources are tangible things -- valuable services, goods, products, information, trained people -- and not little green pieces of paper. Tackling waste means freeing up or increasing the amount, quality, and availability of resources. Paying people less doesn't do that.

Consider the following paired examples:

(A) A drug company wins a patent extension which allows it to keep charging high prices for a successful and effective cancer drug;

(B) A drug company realizes that its new cancer drug provides essentially no benefit over existing ones, but decides to spend $1B developing and promoting it anyway because it calculates that it can capture a significant share of the market and generate a net profit;

(A) a health insurance company CEO is granted a bonus that exceeds the industry average by $10MM even though by most measures he is doing a mediocre job;

(B) a health insurance company with an antiquated billing and reimbursement system spends $10MM more than it should this year on administration costs;

(A) a doctor submits fraudulent claims to Medicare for services he never performed;

(B) a doctor orders unnecessary MRI tests for most of his patients because he has an equity interest in the MRI facility;

(A) a doctor has to pay $150K/yr in malpractice insurance;

(B) a doctor orders a wide range of unnecessary tests for a patient, in order to protect himself from a potential malpractice suit in case of an adverse outcome;

I believe that to first order the (A) examples are merely (possibly unfair) transfers of money from one entity to another, but not a waste of resources.

The (B) examples represent true waste. Real (mostly human) resources are being used which could have been deployed better elsewhere.

It is not surprising that the focus of politicans is on the (A) examples. Perceived unfair transfers of money get people riled up, and being natural demogogues, our politicans cater to that anger.

Ironically, putting in place policies that curtail the (A) examples will, if anything, decrease the supply of health care resources (which is not necessarily a bad thing - see further down).

Reducing the amount of money transferred to the health care industry in the aggegate (even including outrageous examples of overpayment, abuse, and fraud) will not encourage an increase in supply.

When Obama and his speechwriters make the mistake of lumping corporate profits in with overhead (as they do repeatedly), it is clear that they don't understand any of this at all.

Now I am not claiming that we should tolerate overpayment and fraud. Far from it. A distortion in favor of the health care industry is just as bad as a distortion against it. As only one part of a complex economy, the health care industry should have no stronger claim on aggregate resources than any other area. Too many people becoming doctors, for instance, is as bad as too few. [How we could know how many is the right number is something that the free market is best at determining, by the way.]

Finally, here's a trio of hypothetical examples. Which of these represent a waste of resources?

(A) a drug company spends $100MM on a public and doctor-focused advertising campaign to introduce its new product;

(B) a drug company spends $100MM in litigation defending itself against claims that its product causes serious problems in approximately 1% of patients;

(C) a drug company spends $2B developing a new cancer drug that gives terminal patients a 25% probability of living an extra 2 months;

I am inclined to believe that (A) and (B) are wasteful, but (C) is not.

Advertising is a complex subject. Some economists consider marketing expense a dead weight loss to the economy. I have always felt that it has some informational value for consumers, but it also appears to be necessary for free market competition.

The competition hypothesis seems less convincing in the case of drug companies, however, since they only compete directly in those rare instances when they have identical drugs on the market.

The benefits of litigation are difficult to quantify as well. Obviously, one way that the sanctity of contracts is upheld and consumers are protected is through litigation. But our system has gone awry, and you probably couldn't find one serious economist today who didn't think that the US is an overly litigious society and that the costs of litigation are excessive.

As for example 5.(C), the drug company would be wasting resources only if its prospects for making a profit depended upon the market price for the drug being anomalously high. It is in the nature of our 3rd party payer system for medical care to create such inefficiencies. Since consumers don't see the true cost, they make inefficient cost benefit decisions.

Still, my sense is that the medical community has generally made sound choices when it comes to approving expensive new drugs. My evidence is that hundreds of miraculous drugs have been invented over the last 30 years, and yet drug companies account for only about 1.5% of world GDP (in the US, it's about 2%). I would be willing to spend that fraction of my income on Claritin. Fortunately, it's much cheaper than that.