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Emotions, politics and economics: an introduction to health care.

AS PROFESSIONAL economists, it is our responsibility, as well as our comparative advantage, to see through emotions and politics to obtain a genuine understanding of issues. Health care decisions are some of the most challenging for our profession and the central theme in this issue. Our challenges are doubly difficult because so few of us know the facts about the health care industry. The authors of the special papers in this issue have condensed a vast amount of information and analysis.

Their references are certainly an appropriate place to start if you want to learn more. These few pages present a very brief glimpse of the trade and issues facing it.


Last year, health care consumed and, of course, produced about $839 billion or 14 percent of our gross domestic product, and this year it is forecasted to grow to $940 billion. If the industry's growth, as an even larger share of GDP, were to continue as it has since 1965, all of our GDP would come from and go to health care by about 2053. Obviously, health care will be controlled. The question is by how much, when, and by whom. If no major change occurs, the Congressional Budget Office estimates that total health care cost growth will be proportioned along these lines: general inflation will account for roughly one-third of the nominal increase; population increases, 8 percent; demographic composition, 5 percent; more visits to physicians and more hospital days, 8 percent; and 43 percent of the increase will come from a combination of medical price increases over and above general inflation plus productivity/quality improvements called "intensity." They believe it is not currently possible to separate the inflation component from the quality improvement component. According to another government agency, The Health Care Financing Administration (HCFA, pronounced HICK FA in the trade), on average the ratio is one-third pure medical price inflation and two-thirds intensity increases. Unfortunately, the ratios apparently are not stable over time and differ greatly between inpatient, outpatient, physician, and nursing home care. Thus, in the near term, it may not be technically possible, or at best very difficult, to measure any efficiency improvements derived from regulatory policies.

The market shares of personal health care are: hospital services, 47 percent; physician services, 22 percent (although what they direct or prescribe is about 70 percent); dental services, 6 percent; other professional services and home health care, 5 percent; drugs and medical nondurables, 10 percent; vision products and other medical durables, 2 percent; and nursing home care, 9 percent. The industry is diffuse, with a total of more than 600,000 physicians, of whom 450,000 provide direct patient care, producing about 120 patient visits per week. There are more than 6,000 short-term general hospitals with over 35 million admissions per year. The industry employs 10 million people, and employment is growing at over 9.3 percent per year.


Very few consumers purchase health care directly. More than 75 percent of our $839 billion dollar health care bill is purchased by third parties. Governments purchase over 40 percent of the total, of which approximately 19 percent of the total is Medicare, the federal system for retirees, and 12 percent of the total is Medicaid, the federal/state means-tested subsidy. (The remaining 9 percent is other federal and state aid programs.) Medicare is also a subsidy, because Part B covering physicians' services receives 75 percent of its financing from general tax subsidies and only 25 percent from current user fees. Part A, for inpatient hospital care, is a current period transfer from today's workers to today's retirees, with current period recipients receiving considerably more than the actuarial value of their previous tax payments. There is no means test for these benefits, and they are a very valuable component of any retiree's expected future income stream. Copayments and deductibles impose some cost sharing, and the elderly generally purchase Medicare supplemental insurance to prepay these and noncovered expenses.

The federal organization that administers the program, HCFA, is experimenting in some areas with the equivalent of HMOs, where the cost sharing is mostly borne by the provider. Medicare is the crown jewel of the Johnson era Great Society program and was designed to reduce the amount the elderly had to pay for health care. In 1962, before the program went into operation, the elderly paid 8 percent of their income out-of-pocket for health care. Today the elderly pay 15 percent of their income out-of-pocket for health care. But the pressure for reform does not come from the elderly. In 1988, a bill was passed by an overwhelming majority in Congress to insulate the elderly from the consequences of catastrophic illness. When the elderly learned that they themselves rather than the general taxpayer would fund the system, the law was repealed. The reversal was the first elimination of a major piece of social legislation in the postwar era.

There is some pressure for change from the advocates of the poor. They cite the difficulty of finding physicians and others willing to provide free care, or care to those covered by the Medicaid program. Because Medicaid pays about one-half the going price in many areas, it is not a surprising result. It is also believed that Medicaid patients are more difficult to treat, less compliant, less willing and able to follow treatment instructions, and more likely to litigate in cases of adverse outcomes. Emergency rooms are required, by law, to see virtually all comers and they bear or shift all uncompensated costs. The original idea was that emergency room teams were like fire fighters who mostly waited for an emergency and could see charity cases at zero marginal cost. Because the price is free to the poor, demanders now crowd the halls, and services are rationed by waiting queues. Cost per patient could be reduced by having low-cost paraprofessionals or family practitioners assigned to these clients, rather than the highly specialized trauma and intensive care specialists now employed. However, many government regulators and budgeteers have forbidden this reaction because it would eliminate the single rationing device that is lawfully available. In 1992 the estimate is that Medicaid grew 28 percent, compared to an 11 percent growth in Medicare, and a 3 to 4 percent growth in GDP. But the major pressure for reform does not come from the poor in Medicaid.

The mass media often reports that 37 million people are uninsured. The correct number is probably closer to 34 million, but that is hardly the point. The average person without insurance is not permanently uninsured. Only about 4 percent are uninsured for twenty-eight months or more. The uninsured are apparently a mobile group moving out of and into covered jobs. They often are eligible for coverage under their spouse, relative, or other programs such as those sponsored by universities. The best estimate is that only 1 percent of the population is uninsurable. The cost of the care the uninsured receive, paid by others through what is called "cost shifting," is between $10 and $20 billion. The 14 percent who are uninsured contribute 2 or 3 percent of the cost via cost shifting. They are young, healthy, working, and apparently rationally uninsured. But the pressure for reform does not come from the uninsured, or, in my judgment, those who directly or indirectly pay their bills; the amounts seem too small.

Almost all Americans receive health care as a tax-preference component of total compensation. Only 7 percent buy their primary health insurance independently. This institutional arrangement is the vestige of a World War II scheme that allowed employers to accomplish wage increases through health insurance companies and not have them subject to wage and price controls. Health insurance is tax deductible by the firm but not reported as income by the employee. Today, with marginal income tax rates approaching 50 percent (federal, state, Social Security, and Medicare), the asymmetric tax treatment is why health care is "financed" via employer-purchased coverage. If you buy health insurance yourself you do so with after-tax dollars, and the price effectively doubles. If there were substantial organizational or other efficiencies via economies of scale or scope, we would see auto, fire, and other casualty insurance provided by employers via business purchased policies. This explains why, when you loose your job, you loose your company's American Express expense account card, and your company's Blue Cross health card, and not your AAA card. If the tax treatment were equal across all insurance, all policies would be personal and portable.


The major pressure for health care reform comes from government, the middle class, and business. This is true not only in America; it is a world-wide phenomena. My colleagues and I have looked at over fifty nations, and the pattern is remarkably consistent. As an institution, government tends to seek opportunities. Those opportunities to expand must, of course, be balanced against the costs. Governments in many nations have been overly optimistic as to the net benefits of their activities.

The next pressure group is middle-class workers, who see those above them with no worries economically because their own resources easily purchase care, and they see those below them without worries because of government programs. They see themselves in the middle, being squeezed by a financial vice. Again, a world-wide phenomena is that middle-class workers are an advocacy group for government-provided or subsidized health services. These people tend to believe that the costs are, or will be, small and borne by other taxpayers or business.

Finally, some business executives believe that the incidence of taxes to fund a government health system falls on labor, and not on capital. There is little serious scholarship purporting to demonstrate that health care expenses increase costs of production or reduce international competitiveness. Paying people in kind via health care insurance is economically equivalent to paying them in chickens. However, when health care costs go up by more than labor productivity, there are extraordinary pressures to hold down and reduce money wages and other labor costs. We economists see this as the growing gap between total compensation, and wages and salaries. Business sees it as a big problem.

On an operational level, business executives see health care costs as uncontrollable expenses. Some idea of the dimensions of the future costs of health care can be seen by the requirement of the Financial Accounting Standards Board that companies now must estimate the future costs of retiree health benefits in their financial statements. Last year, firms saw insurance costs increasing from 8 to 60 percent. In many cases, executives need to know more about purchasing health care than selling their own product. There are strong incentives to turn the problem over to government so that individual or corporate leadership is not exposed to the pressure of dealing with an apparently intractable problem. Of course, none of these groups can identify the problem but can list the symptoms -- costs are too high to be affordable and too low to control utilization.


Here is the great meeting of emotionality, politics and economics. Employees have a card guaranteeing that care is virtually free. There are few if any benefits not to consume health care. The system violates what William F. Buckley calls, "Musgrave's Iron Law." The Law is, "The economizers must benefit from the economizing." All of the managed competition and managed care ideas are based on having the benefits of economizing go to the employer, the insurance company, the physician, the hospital or some other third party. Thus, I believe all of these noneconomic solutions are doomed either to be ineffective or considered Draconian by those subjected to the regulations.

With the preceding as a background, what is the situation you face if you were as the president's chief health advisor? If you do nothing, health care is forecasted to increase at 9.7 percent per year throughout the next two terms. Here are the sources of increase: 3.3 percent general inflation, 0.8 percent population, 0.5 percent demographic factors -- all of which are virtually out of your hands. You can expect 0.8 percent increase because of more physician visits and hospital stays for a variety of reasons, including public awareness of beneficial outcomes, as well as easier access to care for all including those in lower socioeconomic groups. About 1.5 percent of the increase will come from pure medical price inflation, due in part because higher valued, less abundant resources are being demanded in the industry. About 2.8 percent of the increase is due to technological advancements, quality improvements, and increases in efficiency.

Do you advise restructuring the industry to obtain a 1.5 percent reduction in cost growth? Do you advise developing the regulatory apparatus to limit scientific advancement and enforce utilization bans on new methods and technology? Do you advise, and if so what is the best way, to stimulate the industry guaranteeing universal access for all? How will the net result of your recommendations allow us to reduce the budget deficit?

The papers that follow give you an extraordinary insight into the complex interaction of emotion, politics, and economics. I write these words as I learn that the President's wife will be in charge of the White House effort to make health care universally available, not impose high costs on the taxpayers nor increase budget deficits -- almost a free lunch.


Politicians have learned three great lessons. They can provide free government services if they run a deficit. They can provide the equivalent of free government services if they mandate that business provide them. They can provide the equivalent of free government services if they fix the private sector prices for them. It takes a lot of economics to disabuse politicians of the wisdom they possess.

To make matters worse, the benefactors of the mandates and price controls are numerous and politically powerful. Those who will, in the short term, pay the costs are relatively few and politically weak. So it has all the earmarks of rent control. However, Americans have a cultural antipathy to bureaucracy and political power. They may think twice about tossing their health into the political arena. With 14 percent of GDP going to, and of course coming from, the health care industry, it is the largest political pie to be divided as spoils of political war in our nation's history.

If the new Administration does not immediately and dramatically diminish public expectations about reform, the conflict is likely to be the bloodiest special interest fight in our recent history. If the reforms are not fundamental and massive, nothing will happen, nothing will change. The administration will be under ever stronger pressures to provide "free" care. Under both of these scenarios, emotions and politics dominate. The third scenario is that economists and others who understand markets will be able to guide policy so that individuals will be at the center of the system controlling cost through something like Medisave Accounts or Health IRAs, or other patient-centered systems.

My near-term forecast is for diminished expectations, more regulation, more practice and professional controls, establishment of price controls, indirect physician and hospital income limits, growing numbers of intervenors, rationing of cures via waiting, and rationing of intellectual development via technology controls. All of this will be done by sympathetic physicians who will accept central guidance and financial control (via the equivalent of global budgets), with the promise of day-to-day professional autonomy, and relief from the current paper work and administrative crush. The system will be flexible enough so that the politically and economically powerful will have access to quality care. There is a small chance that wiser minds will prevail, or that special interests will annihilate one another, leaving the general public and Congress sufficiently disgusted that grid lock will seem to be the second-best alternative.

My twenty-year forecast is that, if we have massive intervention, there will be "medical enterprize zones" within America where a freer market system for health care will be available. If this is prevented, as in some other nations, a new area near America will develop, like Hong Kong or Singapore near China. I am very optimistic about the health care future for those with financial, intellectual and political power. The papers in this issue will give you facts and insights so that you can form your own views. You are certain to agree with some and disagree with others. However, more economics can only help in rationalizing what is now primarily an emotional and political debate.

Gerald L. Musgrave is President of Economics America, Inc., Ann Arbor, MI, a Fellow and Chairman of The Health Care Round Table of NABE, and the Book Review Editor of Business Economics
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Author:Musgrave, Gerald L.
Publication:Business Economics
Date:Apr 1, 1993
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