Four variables and a theory: an equation for health care.

During the years 1990-91, a series of 10 articles on modem economics were published in The Economist as "Schools Briefs." They were collated into a reprint booklet as "the academic articles of recent years that have done most to shape the way economists now think." One of these articles[1] concerns theories of "rent-seeking," which is defined as "the use of resources to make profits without creating any useful output." The application of this theory to health care economics in the United States is most revealing, but first the theory itself needs clarification. The origins of the "rent-seeking" theory lie in the theory of monopolies and their inefficiency. Four charts graphically show the losses created by monopolies. Figure 1, page 17, shows the demand curve: prices fall and demand increases. The "competitor" point represents a competitive entity. The "monopolist" point represents a monopoly, where production is purposefully reduced to increase price, which harms consumers. The shaded area in figure 2, page 17, indicates the volume of consumer loss. In economic terms, this is known as monopoly rent. The shaded area in figure 3, page 18, represents the monopoly producer's gain. The unshaded triangle in figure 3 is shaded in figure 4, page 18, and represents the volume that consumers lose relative to the producer's gain. This triangle is known, in economic terms, as deadweight loss.

In the scheme described in figure 4, the relatively small triangular area represents the only economic loss from monopoly. In 1967 an economist, Gordon Tullock, showed that this is not the complete picture. He noted that governments must approve monopolies before they can occur, making a gift of monopoly rents by their approval. In obtaining this "gift" from government, the would-be monopolizer is willing to pay for the privilege, the amount limited only by the size of the shaded rectangle in figure 3. Such use of the producer's gain is, economically speaking, waste and actually adds to the total real deadweight loss to the economy. This waste may be manifested through transfers to corrupt politicians or to government lobbyists. Thus, the transfer of the rectangle from the consumer to the monopolizer is not harmless, but actually a significant economic loss.

The concept was expanded by two other economists. In 1974, Anne Krueger coined the term "rent-seeking." She was concerned with the monopoly loss created through government quota restrictions, where the transfer of the monopolizer's gain to "buy" the quota advantage is called a quota rent. She showed that such rents can be very expensive to economies. The most important contribution to the theory was made in 1982 by Jagdish Bhagwati. His study invoked the term "directly unproductive profit-seeking" (DUP) and broadened the scope of activities that could cause economic loss to a society through such rent-seeking creation of deadweight loss. He pointed out that DUP frequently relates to government policy. It includes trade policy, government spending, tax systems, regulation, policy evasion, and bribery. He further pointed out that one of the largest costs results from the efforts of governments and rent-seekers to disguise the sharing of rents.

How does all of this apply to health care economics in this country? It applies on two levels:

* The advantages that have been permitted, if not given, by government to the health care profession since World War II are actually monopoly rents.

* The theory strongly suggests that "the costs of many forms of economic intervention by governments are much greater than was once thought," which portends hazard if health care reform results in increased government control.

We will return to these two aspects of the theory after considering the variables that may provide a cure.

Cost and Use

The first two variables, cost and use, require no explanation. They are the two aspects of health care that have received the most attention in all health care discussions in this nation during the past two years. Cost has been and continues to be the major focus of attention. While it is indeed an important, and the most visible, variable, it may not be the crucial one. The second variable, use, is a topic avoided by politicians and the public whenever possible, because the synonym for its control-rationing--creates all sorts of adverse reactions. After discussing the final two variables, we will return to further consideration of cost and use as they apply to our equation.

The last two variables, productivity and innovation, deserve closer scrutiny, neither necessarily having been familiar concepts in health care before the demand for reforms developed. We will first look at each of these variables in detail, based on the two separate writings that have appeared in the management literature during the past half-decade.

Productivity

Drucker looks at productivity in six sections.[2] "The productivity of the newly dominant groups in the work force, knowledge workers and service workers, will be the biggest and toughest challenge facing managers in the developed countries for decades to come." Knowledge workers and service workers, of course, are the work force in health care, in many instances a given individual being not one or the other, but both.

Drucker points out that capital (money) cannot be substituted for labor (people) in knowledge and service work and that technology by itself does not increase productivity. In industry, capital and technology are "factors of production," whereas in knowledge and service work they are "tools of production." Whether or not these tools increase productivity in knowledge and service work depends on how they are used by people, not on their presence alone. Drucker uses hospitals as the prime example of the nonproductivity of capital intensive investment and makes the point that, because of its dual labor and capital intensity, the hospital is not, from an economic point of view, viable economically. "Only massive increases in hospital productivity can stem the health care cost explosion."

The only solution, Drucker feels, is "working smarter." The way to work smarter, he indicates, is to define the task and discard the unnecessary. This is important in service work but even more important in knowledge work. The salient questions are: "What is the task" and "Why do it?"

Drucker again turns to the hospital as an example of how not to do it, using the burden of paperwork that forces nurses away from patient care. The cure: remove the paperwork, and one has a surplus of nurses. The salient questions: "What do we pay for?" and "What value is this job supposed to add?" He further contrasts industrial jobs with service and knowledge jobs by saying that, in the former, making and moving things focuses on work, while in the latter the focus must be on performance. In knowledge and service work, performance often means quality, such as a surgeon's surgical procedure. In other instances, quality and quantity must be considered concomitantly to judge performance, such as the performance of medical imaging tests. Some jobs in knowledge and service situations are purely qualitative, such as making beds. To increase productivity in knowledge and service jobs, one must first decide just where quality and quantity fit in the desired end product and then determine what needs to be analyzed, improved, and changed.

However, Drucker points out, there is more than task definition, task concentration, and performance definition to knowledge and service work productivity. He feels we do not yet know how to analyze process where quality is the predominate element; we need, he says, to ask "What works?" Where there is a mix of quality and quantity, we need to ask what works and also analyze the process stepwise. Where quantity is predominant after defining quality standards, the usual industrial engineering approach works. While these steps will increase productivity, a single instance of working through them will not suffice in the long run; they must be repeated periodically to maintain effectiveness. In the process of working through these steps, it is crucial that the worker be involved. Such a partnership of management and responsible worker is not just the best way but rather the only way to ensure success. Two further important ingredients in the equation are continuous learning and teaching, with workers as well as management participating in both.

Drucker states: "Developed economies face economic stagnation if they do not raise the productivity of knowledge and service work." If knowledge work and, perhaps even more important, service work productivity are not rapidly improved, he foresees major social problems. Without improved productivity of service work, he sees decline of the social and economic position of the large class of persons who would be employed in such work, persons who are generally poorly educated and poorly skilled. This could result in social upheavals that could include class alienation and even class war.

Such improvement in productivity can be and has been done,. In many instances, it has been accomplished by outside contractors rather than the organization itself Such outsourcing brings into the organization people with knowledge of and pride in their work, which the larger organization itself cannot adequately encourage because of its larger mission and goals as well as its inability to understand or respect such work. "To raise the productivity of service work cannot be done by governmental action or by politics altogether....It is, in fact, the first social responsibility of management in the knowledge society."

It should be obvious how very applicable this topic is for health care economics, particularly because hospitals are the primary examples used by Drucker in his discussion. Health care does indeed exemplify the combination of knowledge and service work. In spite of the evidence given for the importance of labor as opposed to capital investment in the health care industry, we continue to see many examples of the latter. These include extensive building programs and buy-outs, development of complicated and expensive information systems, and amplification of marketing maneuvers. We do not see a focus on people and their jobs and on results before profits. We do not pause to study, but rather frantically grasp for first one possible advantage and then another.

Innovation

Tiesberg et al.[3] note that the immediate political question is whether one-time cost savings from waste and inefficiency elimination will pay for universal coverage. They feel that the really proper question should be how to achieve sustained cost reductions over time. The answer to this important question, they say, lies in competition. The authors go on to analyze what is wrong with competition in health care. They suggest that competition is not failing but that incentives are the problem. Two adverse effects relating to payers' and patients' incentives are delineated, including the potential of the former to make adversaries of patients and providers and the latter to discourage cost sensitivity. Two further problems concern the fragmentation of customers, which leaves little negotiating power and lack of information for all three segments-providers, patients, and payers. Finally, two adverse effects relating to providers' incentives are shown: costs increase and over-investment.

Tiesberg et al. explain how exit barriers protect substandard payers and providers and that piecemeal solutions treat only symptoms. They also state that recent progress on cost reduction is not enough. They believe that reform can cure competition in health care. They highlight four elements of reform:

* Incentives for productive competition, including:

* Avoidance of overconsolidation.

* Maintenance of antitrust laws to

ensure healthy rivalry.

* Allowance of the exit of substandard

providers when regional competition

is not restricted.

* Rejection of price caps because of

their effects on innovation in new

drugs and devices. Steps to accomplish these incentives include:

* Alignment of interests.

* Simplification of health insurance.

* Outlawing of balance billing.

* Increased patient responsibility.

* Insurance coverage for economic efficiency, including universal coverage to make everyone paying customers.

* Information for meaningful choice, including providers, treatments, and insurances.

* Innovation for dynamic improvement to reduce costs and enhance quality.

It is this last step that provides the key word--innovation. It is clear that Tiesberg et al. believe that innovation is meant to be the key solution to the problem of incentives in health care. "Health care reform must build on [cost-reducing innovations] by creating still stronger incentives for both medical and managerial innovation. Reformers must not confuse one-time efficiencies with sustained cost improvement. Innovation, the missing principle in all the contending reform proposals, is the only true, long-term solution for high-quality, affordable health care."

The Equation

How do the four variables and the theory apply to our national dilemma concerning health care reform? The clearest way to consider these relationships is through the following equation:

[V.sub.e] = P + 1/C + U, where

[V.sub.e] = value to the economy

P = productivity

I = innovation

C = cost

U = use The value to the economy, which is what should be the concern of all involved parties, is determined directly by the productivity and innovation of the delivery system and inversely by its, cost and use. If cost and/or use are high, value diminishes. If these variables are low, value increases. If productivity and/or innovation are high, value increases; if they are low, value decreases.

Most of the focus to date in health care reformn has been on cost reduction and on control of use. While some short-term benefit may have been shown, neither approach has accomplished any long-term change. The ultimate control of both variables requires government intervention--price controls and rationing. Neither of these interventions is a politically popular item, and both will be avoided by all lawmakers seeking reelection. However, if the economic value of the system continues to deteriorate, both of these interventions are quite possible in our society. If they were to occur, the adverse effects of government involvement demonstrated in the rent-seeking theory would come into play and the value to the economy would probably worsen. The DUP effect would widen, with resultant loss to the economy coming from not only the deadweight loss shaded area in figure 4, but also an increasing portion of the shaded areas in figures 2 and 3. This DUP would result from government spending, tax systems, regulation, attempts to evade government policy, and attempts by both government and rent-seekers to disguise the sharing of rents.

Inadequate attention has been given to productivity and innovation, and, if the economic value of the health care system is to improve, both deserve close scrutiny and increased implementation. One could say that productivity and innovation equal competition, and that is true. However, the word "competition," like the phrase "price controls" and the word "rationing," is not readily accepted by the health care system. Productivity and innovation are much more acceptable concepts. If their use improves competition, which it no doubt would, improved economic value will be realized. If use of these two management variables is effective, the size of the shaded areas of figures 2-4 will decrease. If these variables increase and the shaded areas decrease, government intervention will be unnecessary and its hazards can be avoided.

How, then, can productivity and innovation become working variables in our nation's health care system? There are no magic formulas. Through sharing of ideas and approaches, the system can improve itself. We must focus on longer term solutions and not on short-term "quick fixes." Labor improvements rather than capital improvements must be our goal. We must replace wasteful costs of marketing and unbridled technology with systems that respond to the customer with efficiencies of time and availability. We need to learn to ask questions about what we do: why we do it, how we do it, and what the results are. We need to learn to work together as a professional team rather than separately as individual providers, compete for improvement of the whole rather than against one another as separate components. A rational and humane form of universal insurance coverage must be designed and implemented, and cumbersome insurance bureaucracies must be replaced with an efficient method of communication for reimbursement. Other improved information procedures to provide consumers with appropriate means of judging providers must be determined. But care must be taken to avoid the potential pitfall of outcomes' becoming an academic grant-seekers paradise, resulting in increased costs to the system.

Innovative approaches to increase the utilization of nurse practitioners and physicians' assistants must be built into the system to further improve productivity. The training and placing of physicians within the framework of our future health care system must be studied carefully. We must be willing to break out of the bounds of our traditional ways of thinking about the physician's position in the system as a whole. The not-for-profit segment of the industry must either be changed to for-profit or be made to pay its way through appropriate reimbursement to the system for its tax advantage. Because the tax advantage is a form of government monopoly gifting, the former approach makes more economic sense than the latter. An argument can be made that existing government programs, such as Medicare and Medicaid. contribute to DUP. A less obvious possible source of DUP is federal funding of research grants.

Conclusion

Health care reform in the United States needs to increase its focus on productivity and innovation within the health care system. Cost and use, while still important, need to be viewed from a broader perspective. It is vital to the economy of the nation that government controls be reduced to avoid the economic hazard of directly unproductive profit seeking that such controls engender. In contrast, improved productivity and energetic innovation can unleash new vistas for the nation's health care system.

References

[1.] "Dear Landlord." In Economics: Ten Modem Classics. New York, N.Y.: Economist Newspaper Group, Nov. 1990-March 1991, pp. 18-9. [2.] Drucker, P. "The New Productivity Challenge." In Managing for the Future. New York, N.Y.: Truman Talley Books/Dutton, 1992, pp. 93-111. [3.] Tiesberg, E., and others. "Making Competition in Health Care Work." Harvard Business Review, July-Aug. 1994, pp. 131-41.