Theory of the health care firm

This article by Atul Gawande on Medicare abuse in McAllen,TX has been discussed elsewhere, and it's no wonder that it has created such a stir, it is very thourough and mostly right on. One excerpt:

The core tenet of the Mayo Clinic is “The needs of the patient come first”—not the convenience of the doctors, not their revenues. The doctors and nurses, and even the janitors, sat in meetings almost weekly, working on ideas to make the service and the care better, not to get more money out of patients. I asked Cortese how the Mayo Clinic made this possible.

“It’s not easy,” he said. But decades ago Mayo recognized that the first thing it needed to do was eliminate the financial barriers. It pooled all the money the doctors and the hospital system received and began paying everyone a salary, so that the doctors’ goal in patient care couldn’t be increasing their income. Mayo promoted leaders who focussed first on what was best for patients, and then on how to make this financially possible.

No one there actually intends to do fewer expensive scans and procedures than is done elsewhere in the country. The aim is to raise quality and to help doctors and other staff members work as a team. But, almost by happenstance, the result has been lower costs. “When doctors put their heads together in a room, when they share expertise, you get more thinking and less testing,” Cortese told me.

Skeptics saw the Mayo model as a local phenomenon that wouldn’t carry beyond the hay fields of northern Minnesota. But in 1986 the Mayo Clinic opened a campus in Florida, one of our most expensive states for health care, and, in 1987, another one in Arizona. It was difficult to recruit staff members who would accept a salary and the Mayo’s collaborative way of practicing. Leaders were working against the dominant medical culture and incentives. The expansion sites took at least a decade to get properly established. But eventually they achieved the same high-quality, low-cost results as Rochester. Indeed, Cortese says that the Florida site has become, in some respects, the most efficient one in the system.

...

Providing health care is like building a house. The task requires experts, expensive equipment and materials, and a huge amount of coördination. Imagine that, instead of paying a contractor to pull a team together and keep them on track, you paid an electrician for every outlet he recommends, a plumber for every faucet, and a carpenter for every cabinet. Would you be surprised if you got a house with a thousand outlets, faucets, and cabinets, at three times the cost you expected, and the whole thing fell apart a couple of years later? Getting the country’s best electrician on the job (he trained at Harvard, somebody tells you) isn’t going to solve this problem. Nor will changing the person who writes him the check.

What he's talking about here is the well known issue of assymetric information, where the doctor knows technology and the patient knows only that he's in pain. There are many examples of this besides the housing industry, and generally the free market solution is incorporation. Take computers. Most consumers have no idea what's in their computer and would be lost if they had to construct a computer from its components. So the market solution is to put the assembly of these components under one firm, so that the consumer than has an easier informational challenge in which he need only compare and contrast complete computers rather than all the combinations of components. The analogy with health care is that consumers can't easily distinguish and judge individual procedures but they can easily distinguish and judge health care companies based on their reputation and record of performance.

I believe this is what the HMO revolution was about in part, but we all know it ultimately failed when the consumer got pissed off that someone told them "no". My question is why does the Mayo Clinic apparently succeed at this? Not answered.

And he concludes:

Something even more worrisome is going on as well. In the war over the culture of medicine—the war over whether our country’s anchor model will be Mayo or McAllen—the Mayo model is losing. In the sharpest economic downturn that our health system has faced in half a century, many people in medicine don’t see why they should do the hard work of organizing themselves in ways that reduce waste and improve quality if it means sacrificing revenue.

In El Paso, the for-profit health-care executive told me, a few leading physicians recently followed McAllen’s lead and opened their own centers for surgery and imaging. When I was in Tulsa a few months ago, a fellow-surgeon explained how he had made up for lost revenue by shifting his operations for well-insured patients to a specialty hospital that he partially owned while keeping his poor and uninsured patients at a nonprofit hospital in town. Even in Grand Junction, Michael Pramenko told me, “some of the doctors are beginning to complain about ‘leaving money on the table.’ ”

As America struggles to extend health-care coverage while curbing health-care costs, we face a decision that is more important than whether we have a public-insurance option, more important than whether we will have a single-payer system in the long run or a mixture of public and private insurance, as we do now. The decision is whether we are going to reward the leaders who are trying to build a new generation of Mayos and Grand Junctions. If we don’t, McAllen won’t be an outlier. It will be our future.

One clear way to tip the balance in favor of Mayo and other private providers is to eliminate Medicare as the personal piggy bank of profligate doctors.

Addendum: My brother the healthcare exec emailed me an answer to my question about Mayo v. HMO:

HMOs aren't a single concept. They are at least 2 different concepts.

The first one, which is the one that failed pretty significantly over the last 15 years, is the concept of steering patients into a particular group of providers, and the providers have loose to no other affiliation with one another and close to no ability to "manage" the costs, quality, or service of the system they are a part of.

The second concept is similar to the first, except the providers are significantly integrated and have the ability to collaborate to take costs out of the system and improve quality and service. They also generally have a shared financial incentive through capitation and benefit collectively and individually from costs coming down.

Most of the U.S. experience with HMOs was the first concept, and it left a bad taste in people's mouths. Patients felt restricted in their choices of providers and providers felt they had lost control over decisions and blamed someone else for this, mainly HMOs. The delivery system was essentially a group of individuals with individual interests, some of which were competing and most of which were disconnected from one another, both finanically and from an information perspective. This is largely the system we have in the U.S. today.

There are pockets of the second concept across the country. The article refers to these delivery systems as "accountable care organizations," a term coined in the following article (I have a subscription to Health Affairs if you want me to track down the full article):

http://content.healthaffairs.org/cgi/content/abstract/26/1/w44

It's really just a new term for the original concept of HMOs (NOT the sham HMOs in the first concept above), Mayo Clinic, and other organizations that have come together to organize the delivery of care, including sharing information and financial rewards collectively. It's a great concept with proven results as noted in the article in The New Yorker. However, it's going to be difficult to move our current system to this model on a dramatically larger scale because it requires a whole lot more Mayo Clinic-types with an organized approach rather than individual providers providing individual segments of a patient's care. The lack of naturally occuring such organizations is why the good HMO concept slipped into more of a sham HMO reality that most of us think of when we hear "HMO."

Deluded socialists and health care

Tyler Cowen spells it out beautifully:

The "poorest" people are not those with low incomes but rather those with low human capital endowments. That includes the elderly because, even if they are very talented, on average they will die sooner. A typical 23-year-old lower-middle-class immigrant has a higher real endowment than does Warren Buffett.

Through Medicare, the U.S. government subsidizes the health care of the elderly. Given the embedded incentives in the system, the subsidy is especially large for people in the last year of life or so, namely the very poorest.

Western European welfare states may be more efficient, because they do more to expand routine health care access for the relatively young and this may have a higher rate of return. But those same systems are in critical regards less egalitarian. Bravo to them.

Many people do not look at the contrast this way. They wish to think they believe in egalitarianism, they wish to be skeptical of the United States, they wish to condemn the U.S. for its inequality, and they wish to raise the relative status of people who are not very successful under capitalism. When you put all those wishes together, those people will be deeply allergic to my argument.

A few of these people also confuse "high social status" with "well off." Since old, high-bank-account white males have lots of social status and power, these onlookers cannot bring themselves to regard those males as holding very poor overall endowments. They substitute in assessments of social status for assessments of absolute endowments (another sign of the claim that "politics is not about policy" but rather it is about whom we should admire and condemn).

I am amazed (but not surprised) by how frequently people think of egalitarianism in terms of social markers of status rather than actual forward-looking endowments.

It is common for more egalitarian policies to be less efficient.

Tyler is saying that socialists sell nationalized health care as egalitarian when in fact it is efficiency enhancing. Oh, the tangled web we weave. I believe he is right for the most part, but if you look at the dynamics of a policy of nationalized health care I think you will find that, yes, initially it is unegalitarian in that it takes away from the old and feeble and gives to the young and healthy but over time I think it becomes more egalitarian in that it takes from the young and healthy and gives to the young and feeble. However, all of this ignores the role of education, which I believe is the main determinant of health outcomes.

Real economics of quality health care

Paul McBride, VP at Wellpoint (and my brother!), speaks here about health care at the Milken Instistute Global Conference (he's third from the left on the panel).  He says the core problem is that as a society we've been too concerned about the incentives of producers while we largely absolve consumers of their responsibility.  I couldn't agree more.  

I would also add that medicine is probably doomed to inefficiency in this country and around the world.  The main problem is that cost-benefit analysis has very real limits when applied to life and death issues.  What's the price of life?  This is a moral question more than an economic question.  Hence, we have the hippocratic oath, the inability to let go of granny, the need to show that we care and that our care does not depend on price, and a good deal of religious belief in the power of medicine.  Yes, we can make progress on certain margins, such as breaking up the AMA's monopoly of labor supply, but overall it's a tough row to hoe.  Good luck, brother.

Addendum: The LA Times wrote a piece about it, particularly discussing how health care tourism is going mainstream.  A bunch of commenters think this is somehow unjust.  These are my comments:

It's called competition. It highlights how non-competitive the medical industry in the US has become. Blame the AMA, and their government enablers, for limiting the supply of doctors. Blame the FDA for limiting the supply of drugs. Don't blame capitalism, or competition.

Nation's Bachelors Demand Health-Care Coverage For All Their Buddies

That's today's Onion Radio News. Which of the candidate's would find this funny? When are we going to see an Onion debate?

Why do we invest in useless health care?

Robin stumped us with this in health econ class. Here's a first cut:

Investing in health care is inefficient ex post, but ex ante the uncertainty is so great that trading $ for health care makes sense. The uncertainty arises from the mystery of the human body, and from rapid, and eratic medical innovation. Thus, there is some chance, however slim, that the average benefit will increase in the future. If someone values 1 year of additional life at $100M, and the average benefit of $1M of health care is zero, but there is a 1% chance that the average benefit will become 1 year of additional life, then the costs are $1M and the benefits are 0.01*1 year=0.01 year=3.65 days=$1M. Thus, assuming risk neutrality, it makes sense to invest because this someone is betting on innovation. Further, it makes sense to spend more money as time goes on, since medical technology is always improving. And this is what we see, that the bulk of health care $ are spent in the last 6 months of life. Also, there's little incentive to save up for the future at that point.

These are small numbers, and if they're realistic, that may partly explain why the RAND Study showed zero marginal benefit of health care. But even if there truly was zero marginal benefit over this period of time (seven years, 1975-1882), I think it was not irrational to expect innovation. Using the numbers above, that would mean an innovation occurs only once every 100 years, and so maybe no significant innovations were picked up during the RAND Study.

Correction: Here is the other first cut.

Lying liars

Robin lists 10 ways to detect lies. I think he knows this is a lie, that it is of no use. Those who read the list, already know it. Those who skip it are not interested in finding the truth anyway. I think all of us live on lies to some extent, and some more than others. I fancy myself as a truth seeker, and I think Robin does too (just look at the names of our blogs, for God's sake). Libertarians generally see themselves as crusaders. And it turns a lot of people off. My mother says I sound like Jesus, and she doesn't mean that as a complement.

But I know I couldn't live without lies. For instance, when I was taking economics at Lund in Sweden, they treated me like royalty, I suppose just because I'm American. One young Swede once blurted out in class, "But you're brilliant!", referring to me. I didn't take him too seriously, since he barely knew me, but it's something I'll not soon forget either. It feeds the ego, even if it is a lie.

Last night a friend told me some horrible stories about her on-again, off-again relationship with a pathological liar. She seemed to truly wonder how she could swallow so many lies. I suspect they served a purpose. He's a salesman who knows what the customer wants. Or, alternatively, we can blame him, via a kind of Say's Law of lies, ie the supply creates the demand. Regardless, it is clear that both sides gained something. At least in the short term, the lies expanded the opportunity set.

The same kind of self-deception is behind many of our most cherished institutions. You atheists will immediately think of religion. Indeed, Larry Iannaccone has used this same language, claiming that religion exists in large part because it expands the opportunity set, from the mundane to the transcendent. He does not, however, call it self-deception, since we simply have no evidence one way or the other as to the existence of God.

Another example is democracy and the whole notion of the State. We all know the politicians are lying to us, and yet many of us continue to vote for them. It is a kind of religion for the voter, since he is basically ignorant of the evidence on government effectiveness. For libertarians, of course, this whole arrangement is appalling, because we've seen the evidence and it doesn't look good.

The same applies to health care. The best evidence indicates that, on average, doctors really don't help much at all. Yet, we treat them as experts, and insist on policies which subsidize health care and health insurance.

As Robin pointed out in class this week, this is essentially no different than our faith in financial "experts." We gladly fork over millions of dollars in fees to pay for actively managed mutual funds, when, on average, they do worse than index funds.

The list goes on and on, from academia to the main stream media.

So why do we believe experts, even when the preponderance of evidence contradicts them? Why do we believe lies? And why do lying institutions prosper in prosperous economies? Do lies somehow make the world go round? Or are they just the baggage of civilization, an unfortunate and unavoidable human condition? Perhaps, just as Fischer Black's noise traders provide liquidity in financial markets, lies and those who trade in them provide a kind of liquidity in the extended order.

Addendum: Women, you're in trouble. Apparently, only criminals are good at detecting lies.

Auf wiedersehen Herr Professor Doctor

Tyler points to a NY times story on how Germans, especially doctors, are voting with their feet and moving to places like Canada, Switzerland, Brittain, and the US.

And here is more on medical tourism.

Modern Drunkard

So, Robin Hanson again shocked us with the facts last night in health econ class. Most compelling to me, and all the undergrads who were there, is the apparent health benefits of drinking. This is different than all those reports about "one glass of wine per night turns out to be healthy." The statistical evidence indicates there is no upper limit on the health benefits of drinking, ie the more you drink, the healthier you are. Why does this not make the news? Well, you may have guessed that government and other paternalistic organizations don't like the message.

And I would agree, based on the reaction of the undergrads. I certainly didn't need this information in college. I almost wish someone had told me "drinking makes your stomach hurt, because everytime you take a drink I'm going to punch you in the stomach."

One wine hangover will convince anyone that drinking cannot possibly cause health benefits. So, Robin offered up an alternative explanation: drinking signals health. At least in part, people drink to signal their health. The last guy standing is the alpha male. Maybe that was my problem, I never figured out the standing part.

So this may explain why drinking is so prevalent on college campuses. Young'ns have a comparative advantage at drinking a tremendous amount without taking on that evil, drink-sodden look. Does this mean we should consider moving the drinking age up to 22, or 25? After all, it does appear to be a market failure, of the kind Robin was referring to in his signaling example.

At Sewanee, Max will remember the university banned kegs during our second semester freshmen year. The first semester was truly a drunkard's dream. Free beer everywhere. The ban made drinking beer a little more expensive. So we switched to whiskey. It was more fitting anyway, since Sewanee is located in the hills of East Tennessee, surrounded by distilleries. My point is that I doubt there is any good way to actively suppress such an effective signaling equilibrium.

In Europe, as we know, youth drinking laws are less restrictive. And youth drinking appears to be less of a problem. I speculate that this has more to do with alternatives to drinking, while the laws are of little consequence. Being surrounded by castles and art museums, as opposed to hillbillies and 'stills, the signaling in Europe occurs along more refined cultural dimensions. This factor alone may explain why K-12 produces better results in Europe, as I wondered in a previous post.

This illustrates another of Jane Jacob's major themes, which she focused on in The Death and Life of Great American Cities. It is that cities, as the highest form of human civilization, offer many more benefits than costs. In economic terms, the positive externalities, e.g. networking, far exceed the negative externalities, e.g. pollution. See more on this here.

I wonder if she knew about Robin's health stats that indicate city living takes 15 years off your life. Smoking only takes 3.

Bottomline: I'm not really sure where this leaves us. But it's happy hour at the Big Hunt.

Bush's healthcare proposal

If you haven't been following the healthcare discussion over at MR, you should. Either that, or just stop voting or paying any attention to politics. I'm almost there myself. First, Krugman succinctly describes the two sides of the issue in economic terms. Next, Alex shows why Joan Robinson's quote, like a fine wine, is getting better everyday.

This is another example where knowing a little history can be more useful than having a PhD in economics. Healthcare spending was roughly 4% of GDP between 1925 and 1955. Then it began a steady growth rate and today it is 16% of GDP. The only blip occured in the 1990's, when the HMO revolution briefly reduced the growth rate to zero. So, what happened in 1955 to start this madness?

That's what I asked Robin Hanson last night in health economics class, and I didn't get a satisfactory answer. He mentioned something about FDR's price and wage controls. Indeed, according to this article, that caused employers to offer other benefits, including health insurance. Then, in 1942 the federal government started subsidizing employer sponsored health insurance. What do you think happened? As the article mentions, the number of people insured by employers went up 12 fold between 1946 and 1957, to roughly 32 million. That must have been a significant part of the insurance market, and likely big enough to effect prices. That is, those 32 million got the gold-plated ball rolling. The law of unintended consequences strikes again.

I have to say Bush is right on this one: out of control health care costs do seem to be linked to employer sponsored health insurance. Unfortunately, his proposal is an arcane bunch of exemptions which can be spun in any direction the pundits choose. Why can't he just propose banning all exemptions, deductions, subsidies, and loopholes, and "level the playing field" that way? Oh, that's right, because without the lobbyists' money, the Republican party would go broke.