Blame It On The Profits

Steven Pearlstein has a column on the American health care system based on a recent study by the McKinsey Global Institute.  As Mr. Pearlstein reads it, the problem with the American medical system is all about the profit - it's all about the doctor profit stacked on the drug profit stacked on the insurance profit.  If the government would just take over and get rid of all that profit, the system would run smoothly and be much cheaper.  I am flabbergasted that anyone at Cato would remark on such an article with approval.

First, while I worked at McKinsey & Co, I never worked for the global institute.  However, though I have not yet read the study, it would be unusual to the point of uniqueness if their recommendation for the industry was more government control and less profit motive, but I guess it is possible.  More likely, Mr. Pearlstein is reading the study through his own progressive lens.  Anyway, let me deal with a few parts of the article:

Even after adjusting for wealth, population mix and higher levels of
some diseases, McKinsey calculated that we spend $477 billion a year
more on health care than would be expected if the United States fit the
spending pattern of 13 other advanced countries. That staggering waste
of money works out to 3.6 percent of the nation's entire economic
output, or $1,645 per person, every year.

I will agree that for a variety of reasons, there is a lot of waste in the medical system.  We will get to "why" in a minute.  However, note that the author is taking a leap from "we spend more per capita than Europeans" to "staggering waste."  The US spends more per capita on a lot of things than the Europeans, in large part because we are wealthier (by a lot, and more every day).  One man's waste is another man's preference.  However, I would agree that health care is unique, in that it is the one industry where the decision maker(s) on whether to purchase a service is not the same person who is paying the bills.  I think we will find, though, that I and Mr. Pearlstein differ on who the person should be who should do both simultaneously (I say each person for himself, he says Nancy Pelosi and George Bush for everyone).

But let's get into all that money-grubbing.  Mr. Pearlstein reads the study as saying the problem is all that profit.  Because we have layers of profit in the distribution channel, our health care costs more than it does in Europe, where you have the efficiency [sic!] of government management.  Before we get into detail, I would observe that this fails a pretty basic smell test right off:  Nearly every single product and service we Americans buy, all of which are rife with layers of nasty profits in the supply chain, are cheaper than their counterpart services and products in Europe.  If this layering of profit without government management is a problem, why is it only a problem in health care but not a problem in thousands of other industries.  But anyway, to details:

Let's start with one the American Medical Association hopes no one
will notice, which is that American doctors make a lot more money than
doctors elsewhere -- roughly twice as much. The average incomes of
$274,000 for specialists and $173,000 for general practitioners are,
respectively, 6.6 and 4.2 times those of the average patient. The rate
in the other countries is 4 and 3.2.

According to McKinsey, the
difference works out to $58 billion a year. What drives it is not how
much doctors charge per procedure, but how many procedures they perform
and how many patients they see -- a volume of business 60 percent
higher here than elsewhere.

Ooh, those greedy doctors.  They are the problem!  But read carefully, especially the last sentence.  He makes clear doctors in the US are not making more because they charge more, they make more because they see more patients --- ie, they work harder than their European counterparts.  Where have I heard this before?  Again, in every other industry you can name, the fact that our workers work harder than their European counterparts is a good thing, leading to lower costs and higher productivity.  So why is it suddenly bad in medicine?  For this I would instead draw the conclusion that their are perhaps too many procedures (an expected outcome of the screwy incentives in the system) and thus too many doctors.  Doctors, whom Mr. Pearlstein paints as enemy number one in the health care system, are actually its greatest asset, being 60% more productive than their European counterparts, certainly something to build on.

Don't be distracted by arguments that American doctors need to make
more because they have to pay $20 billion a year in malpractice
insurance premiums forced on them by a hostile legal system, or an
equal amount for all the paperwork required by our private insurance
system. The $58 billion in what the study defines as excess physician
income is calculated after those expenses are paid.

Walter Olson, are you listening?  Since Walter is not here, I will say it for him.  Malpractice insurance premiums themselves are only a part of the cost of runaway malpractice.  Defensive medicine, including the overuse of tests, is another big cost.  Malpractice is one big reason doctors prescribe so many more tests and procedures than their European peers.

Proponents of a government-run "single-payer" system will certainly
home in on the $84 billion a year that McKinsey found that Americans
spend to administer the private sector portion of its health system --
a cost that national health plans largely avoid. But as long as
Americans continue to reject a government-run health system, a private
system will require something close to the $30 billion a year in
after-tax profits earned by health insurance companies. What may not be
necessary, McKinsey suggests, is the $32 billion that the industry
spends each year on marketing and figuring out the premium for each
individual or group customer in each state. Insurance-market reform
could eliminate much of that expense.

What freaking planet does this guy live on?  Does he really think administrative costs are going to go down in a single payer system?  That's insane.  I am willing to believe that the number of procedures will go way down, as Congress starts to ration care in favor of building bridges for their constituents  (a savings likely offset as America's world-leading doctor productivity discussed above takes a nosedive).  Does he really think that administrative costs will go down?  Most administrative costs today are for satisfying government paperwork requirements - how is having the government run everything going to reduce these?   I would argue exactly the opposite -- that eliminating government from the equation would reduce private administrative costs substantially.

I won't bore you with any more, but he doesn't miss the chance to blame health care costs on drug and hospital company profits as well.  Just for entertainment value, I urge the reader to look up a few P&L's of some of these companies.  The profit as a percent of sales for Humana is 2.3% of sales.  So if you wiped out all that egregious profit at Humana, you would save all its customers a whopping 2.3% (before, of course, the incentives problems take over and costs bloat for the lack of a profit incentive to manage them). Insurer CIGNA's profit is a bit under 10%.   Merck's profit is a more comfortable 19% of sales, which means that by cutting their profit to zero we could get nearly a 20% discount on drugs.  Of course, new drug development would cease, but the AARP doesn't care about drugs that won't be on the market after their current constituency is dead.

Isn't it more reasonable, as I am sure the McKinsey study actually concludes, that the problem is not in companies making profits or doctors working hard, it is in having a health care system, built the way it is through distortive tax law, that gives neither patient nor doctor any reason to consider costs when deciding on care?  Can you imagine such a screwed up system in any other industry?  How inefficient would retail be in the US, for example, if we all had a "shopping policy" that paid for all our purchases.  Would you give a crap about the price of anything?  Would you hesitate one second buying something you may not need but is covered by your "policy"?

Mr. Pearlstein sortof agrees, but its hard to find this incentives point in the middle of all his blame-it-on-the-profits progressive rhetoric.  Here is our one hint that Mr. Pearlstein understands that the true problem is this mismatch between payer and decision-maker.  Unfortunately (emphasis added) he has a really destructive perspective on the issue:

What we have here is pretty good circumstantial evidence of
Pearlstein's First Law of Health Economics, which holds that if you pay
doctors on the basis of how many procedures they do, and you leave it
to doctors and their insured patients to decide how much health care
they get
, consumption of health services will rise to whatever level is
necessary for doctors to earn as much as the lawyers who sue them.

Mr. medico-fascist Pearlstein thinks the big system problem is leaving it to you, the patient, to decide what health care you get.  The solution for him is to have the person spending the money, preferably the US Congress, decide how much health care you get.  I think a much saner solution, and the only one consistent with a free society, is to get back to a system where the same person who gets the care, pays for the care.  If its a good enough system for 9,999 things we purchase each year, its good enough for health care too.


  1. Myrtle:

    And the "evil" insurance companies are regulated to death by the state departments of insurance. They must show a need and file with their state to get any sort of rate hike approved.

    Interesting that this came up on your blog. In my lovely state of Texas the required cervical cancer vaccination that was supposed to cost about $350 is costing $500 - $900 at the doctor's offices. Why? Transportation, shipping, spoiled vaccination, overhead, their own insurance premiums, etc.

    When cavemen had to use up all their energy to meet their needs for living needs did they consider it an evil conspiracy or a fact of life? Today when living is expensive it's gotta be someone's fault.

    The health care industry isn't even capable of resonding to normal consumer inquiries. Ask, "how much will this procedure cost me?" And they can't pull it up on a computer and tell you, you get transferred to different departments, stuck in voice mail, and in a few weeks somebody might get back with you after they check it out with your insurance company first. What other industry is incapable of quoting a price?

  2. Jim Collins:

    Yesterday,I had to buy two masks for my CPAP machine at a local medical supply store. I was going on a trip and didn't have time to wait on my insurence company's supplier to mail me one. I bought the same make and model mask that I was initially issued when I recieved the machine. Because I hadn't recieved my machine through them and didn't have a prescription for the size and model mask (a prescription isn't required by law) I needed I had to have one of their employees "fit" me with a mask. All this fitting required was for me to put the mask on and have the girl tighten the velcro straps for me and ask "if it felt ok?". Then we released the same straps she had just tightened and put the mask back into it's box. This fitting service cost me $90.00. Funny thing is that I can buy the same mask on the internet for half the cost I paid and no fitting charge. One of the problems with our health care system is as soon as something is designated as a medical item that insurence will pay for it's price is tripled.

  3. ettubloge:

    I just received an e-mail making the rounds that seeks all of us to petition the government to force health insurers to pay for a 48-hour stay for women who receive mastectomies. Apparently, the insurers treat mastecotomies as one day recovery surgery. Knowing that this very close relative has had one mastectomy and may be facing a second, I had a dilemma. Should I have joined in to pressure Congress to coerce insurers to pay for the extra day of recovery?

    I do not approve of running to the government to force any business, even an insurer, to do anything outside of their business choice. Ultimately, all businesses must fulfill their customer's needs or be out of business. So, on principle I refused to petititon whichever politician I was urged to write. But is my free market inclination misdirected in this instance?

    I believe the porblems of health care costs create the very cost-cutting regulations that this petition sought to redress.

  4. TCO:


    1. Is mealey-mouthed on free markets.
    2. Has poor quality and honesty of issue analysis.
    3. has way, way overblown "knowledge development", with Global Institute included.

    Woohoo! Magic three! Ok, 2 and 3 may not be "ME"

  5. The Dirty Mac:

    When someone categorizes profits within the health care system as "waste", that person is simply letting is know that they have no concept of what they are talking about.

  6. Adrian:

    I think the reason it gets praised by Cato is because it blows a hole in the "evil insurance companies" hypothesis of escalating insurance costs. And furthermore, I think that the article is, in fact, right about a number of points. I also don't think the author is showing a whole lot of his socialist side in the article (although perhaps he is one or even worse -- a modern American liberal). It basically *is* true that the *providers* (i.e. doctors, hospitals, labs, etc) are the big benefactors -- the capitalist fat-cats or whatever. And, they *are* fat and not just poor small-business guys struggling under the yoke of government oppression because they are the ones benefiting from the influence of the government subsidizing the hell out of their industry. Governments don't just randomly act -- there is usually some corrupting influence causing them to do so -- and it is the providers of health care services that are the culprit on this particular issue.

    Consider the point about doctors getting rich off of numbers of services. They aren't working harder. It is actually a pseudo-fraudulent unbundling of claims. It is hard to draw the line between fraud and just aggressively gaming the system. Either way, that system is basically all a product of medicare, and they are indeed gaming it -- not providing better services to more people or some such thing as that (i.e. working harder). They're rushing people through a revolving door and over-charging the insurance companies (and, to a usually negligible degree, their patients, for that matter). All of this is true, and it all exists because the government has provided massive subsidy to this sector of the economy and because of large government programs like medicare. But -- make no mistake -- it is the *doctors* making gobs of money for less service that are benefiting the most from it right now. A typical visit to the doctor probably costs something like $150-$200 now. Ten years ago it was more like $100. (Of course, this all depends entirely on location and specialty and so on.) It really should cost more like $50 or even $20, but the cost is so inflated relative to other goods and services because of incredibly high utilization (a combination of consumer response to government subsidy and provider exploitation of widely adopted and highly complicated and bureaucratic government reimbursement methodologies).

    At any rate, it is all a big debacle *because of* the *great deal of* government influence that already exists in it here in America. Is the government as involved in our health care system as the government in Canada is in theirs? I have no idea (which also means that I don't know that it *isn't*). But, health care and health insurance certainly isn't even close to, say, investment banking in terms of being untrammeled capitalism (which given the efficiency of something like the stock exchange is relatively good). And, the major benefactors of the inefficient health care market are the providers of health care. How would it work if the stock market wasn't efficient? Imagine if the government wanted to make sure everyone held some stock (compare to accessibility of health care) and didn't tax the transactions between brokers and consumers (compare to the tax subsidies for employer sponsored health programs and the tax deductible nature of services for individuals). Of course the demand for stocks would sore and the prices would all unilaterally rise. And who would really profit? Companies that sell their $1 shares for $2 which corresponds precisely to the doctors, nurses, etc. (To some extent, insurance companies do, too, just like brokers would in the analogy since their commission is a percentage of a larger pie.)

    So, I think that's why this study is worth noting by libertarians -- it sort of proves that point that it's the *doctors* that are the real bandits here which kind of takes the wind out of the pro-socialized-health-care folks (who see doctors as saintly which is why we should all go see one RIGHT NOW whether we need to or not).

  7. markm:

    Doctors are genuinely working harder in the USA, and it's not hard to find specific cases where American healthcare is much better. E.g., my grandson, born two months premature and weighing 1 lb 13 oz, and now doing fine in first grade. He likely wouldn't have been recorded as a live birth in some countries (thereby helping keep both costs and the infant mortality statistics down). His hospital bill was over $300,000, and his larger and healthier twin brother ran up a $200,000 bill. Medicaid picked up the excess after my daughter's insurance was maxed out.

    Because of cases like this, because of poor immigrants that never saw a doctor until they came here (where emergency rooms will treat them with little expectation of ever collecting their bill), and because of wealthy sick foreigners who come here for procedures that are on a waiting list at home, it's hard to know whether health statistics from other countries can be fairly compared to American statistics at all. So when someone claims that we have worse infant mortality, etc., than Sweden (for instance), I think that's just that neither the population (overfed and underexercised) nor the statistics are entirely comparable, and if we could compare apples to apples, we'd come out a little better. OTOH, it's very clear that we don't get anywhere near 50% better health results for 50% more expenditure. Anyone familiar with how doctor's order tests just to cover their rear against malpractice suits, and how neither patient nor doctor considers the cost of anything insurance covers can see how we've gone far past the point of diminishing returns.

    But substituting some bureaucrat's judgement (whether in government or an insurance company) for the doctor's best judgement is not going to improve health care. It might slash the cost. So does the UK's practice of putting cancer patients on a waiting list - the sooner they die, the less they cost! What we need is:

    1) To return more control of medical spending decisions to the patient and family, along with more of the costs. To begin with, insurance should be only for rare and unusually expensive treatment. Things you know you're likely to need should come out of your pocket - just like your car insurance doesn't pay for a brake job.

    2) To break the link between employment and insurance. You should be able to shop for alternate insurance plans without taking a bath on the cost.

    3) Transparency in insurance coverage, so comparison shopping can become meaningful. That is, plan A costs less but allows only one day of recovery from having several pounds of flesh removed, plan B costs more but gives you more recovery time, which do you want? (If your employer gets to choose, it'll be plan A - and with the present system, won't even know what the problems with it are until they hear from employees that tried to use it...) I'm not sure how this transparency can be achieved, but it's badly needed.

    4) Tort reform, so doctors spend less time covering their rears, and more doing something that is actually likely to be useful. (Including maybe helping you read those insurance plans.)
    a) Damage caps. Rather than having the court go through a grotesque process of trying to figure out what a life is worth based on future earnings, I'd set a fixed value - say $2 million. Then, anything that doesn't kill you must be worth less.
    b) Arbitration process: Put a doctor, a Biology professor, a lawyer, and a couple of laymen on a panel and have them look at all the cases of bad medical outcomes where physician's mistakes might have contributed over an area and a period of time. They will get the experience to assign damages or reject cases consistently - unlike the present system, which is pretty much a lottery.
    c) If someone doesn't like the arbitration verdict, then they can pay all the costs (their own, the other side's, the court's) of taking it to a jury trial, but we'll change the jury selection process. Jurors aren't picked at random - college degrees will be required, technical fields preferred. Lawyers don't get to arbitrarily throw out jurors (maybe because they seem too intelligent or believe in personal responsibility).

  8. bird dog:

    Does McKinsey Global have a wasteful profit too? I hear they do OK.