Very Quick Thoughts on (Chinese) Healthcare

The problems consumers face in the Chinese health care system may suggest that the information asymmetries and uncertainties in the provision of health care are much more difficult that we think.

In China, a significant issue that I hear complaints about is that there never is enough capacity. Hospitals are crowded, and it's hard to get adequate care. Instead, doctors spend minimal time with the patient, medicate them to the maximal extent, and then send the patient on his way.

Even when you do get medicines, there's no guarantee that they are the best value for the patient. Many Chinese doctors get commission from companies based on the prescriptions they push forward to their patients, and are thus incentivized to recommend the more expensive imported medicines.

Why does this persist? I suspect it is a combination of both government failure and market failures.

Let us start with the market failures. First, it seems clear that the market is not competitive. Otherwise, perhaps more hospitals could be built to help mitigate the overcapacity. But the most obvious solution -- encouraging more entry by lowering regulatory barriers -- may not be the most effective. In such a world, there would be two tiers of health care, the first being the traditional system that we have now, the second being the new deregulated system.

In the second system, I fear that it may become dominated with fraudulent medicines and unscrupulous doctors. In China, it's already a common frustration that goods that you buy never seem to be real, and whenever there is a profit opportunity, fake goods appear. At best, this wastes money. At worst, this wastes lives. As a result, I have a hard time imagining that deregulation would go off without a hitch.

I also doubt word of mouth would do much to solve these information problems in the second tier. It's hard to tell the differences between charlatans, and as such it would be much easier for consumers (who are predominantly old) to group the entire second tier collectively as ineffective. The difficulty consumers face in evaluating the quality of care also makes it harder for the market to converge on a fraud-free equilibrium. Moreover, if consumers need relatively limited amounts of healthcare, then it's hard for them to learn from experience.

As such, while deregulating the provision of health care in this way could improve health care by giving much more choice to consumers, it does not seem sufficient. The lack of competition seems to be the result of these information asymmetries, and to address the lack of competition you have to first address the problems in getting information.

Yet this story of market failures may instead be a story of government failures. In the case of overmedication, the government does have laws on the book in order to mitigate it. Their solution is to control the prices of individual drugs as well as limit the total monetary value of drugs that a doctor can prescribe in a single visit. However, doctors then respond to this by reducing the length of prescriptions, and then having patients come to the hospital more often. This contributes to the capacity issue because patients are forced to come to the hospital more often.

Also, because prices are controlled, patients have to "walk the back door" (走后门) and pay additional bribes to doctors to get care. This exacerbates the imported drug problem, because if doctors cannot earn as much money through conventional means, it is natural that they find ways to work around the system to make the money.

Price controls are also problematic because they make investing in new medicines very risky. Even if a given company can create a drug, it's always uncertain how the government will regulate it.

Based on these competing narratives, I draw two broad conclusions.

First, crude price regulation is rarely an answer. In such a world, it's too easy for people to work outside the system (in the case of bribes) or for doctors to subtly change their work inside the system (in the case of overmedication). Instead, if regulation is to work, it needs to address reasons, like asymmetric information, why health care provision hasn't been working like in a regular market.

Second, consumer choice is insufficient. As healthcare consumption becomes dominated more and more by the elderly, it strikes me as very odd that the most feeble in society are now tasked with identifying the best form of healthcare in an environment that is growing increasingly complex. There is just too much uncertainty, both ex-ante and ex-post, about the quality of care, for the standard word of mouth and experienced buyer mechanisms to work.

Voter and Consumer Irrationality: An Extension

Questioning rational choice is not a sufficient basis for arguing for government intervention. But my past few posts questioning standard market propositions in the case of health care are not meant to promote every single government regulation. Rather, I wonder if we can try to further the study of economics and public policy by reversing the typical way public choice economics is applied.

When I think of public choice economics, I think of papers about how the marginal costs and benefits of lobbying lead to poor government policies or how decentralizing the functions of governments leads to a competitive equilibrium with better governmental policies. At its core, I interpret this line of analysis as using the success of markets to explain why governments fail. Markets succeed because marginal costs line up with marginal benefits, and thus governments fail because these costs and benefits are distorted. Markets succeed because there is competition between firms, and thus governments fail because there is no competition. What I want to propose is that we change the direction of this line of thought, and start from the vast literature on why governments fail, and see if that can teach us about why certain markets fail. 

This is why I think behavioral economics is so important. By reducing biases down to core psychological first principles, it highlights the connection between government and market failure. But we should also make sure to avoid thinking that policy makers themselves are perfectly rational. As John Papula pithily points out:

Why in the world do behavioral economists who study our flaws and irrational quirks advocate centralized power in the hands of a small group of flawed overlords? If people are irrational, so are government regulators, only they have corrupting monopoly power.

As such, I agree that it is important that behavioral economists grasp the concept of public choice, but also for public choice to grasp the concept of behavioral economics. There exist reasons for why the market often overcomes behavioral biases, but then there also exist markets in which those mechanisms don't function well. And most likely, we can trace these mechanism failures to arguments past public choice economists have made about the failure of government. That is my conjecture, and I hope to be able to pursue further analysis of health care under this framework.

Voter and Consumer Irrationality: Two Sides of the Same Coin

One strong argument against the government provision of services is that democracy is a very imperfect substitute for markets. As noted by Bryan Caplan, voters have a hard time rationally evaluating policy options, and thus the public choice economy may be a very bad one. The natural conclusion of this argument is that, to the greatest extent possible, the provision of goods should be pulled away from government and the responsibility should instead be allocated to the market. Yet this line of logic contains its own contradiction: if voters cannot rationally choose the right public policy, how can they be expected to make the right private choice?

Now, I don't mean to say markets never work. I am very happy with the way capitalism has treated me, both in terms of the large historic liberalizations that brought me to this country as well as in the small conveniences that improve my everyday life. I don't mean to reject this. But what I want to suggest is that the acceptance of the irrational voter hypothesis suggests that we should take a closer look at our acceptance of the perfect market equilibrium in many different sectors, in particular health care.

Bryan Caplan, in his work on voter irrationality, outlines four main biases: the anti-market bias, anti-foreign bias, make-work bias, and pessimistic bias. 

Anti-market bias refers to the public's systematic bias towards policies that interfere with prices and profits, such as farm subsidies or rent control. I like to think of it as the public's bias against simple supply and demand explanations of the market. 

Anti-foreign bias refers to the way the public tends to see people from other countries as fundamentally different from itself, and thus the bias causes people to under-estimate the benefit of free trade and immigration. People focus on the auto jobs outsourced by free trade and the native fast food restaurant replaced by immigrants, while paying little attention to the new opportunities and technologies granted by interaction with foreigners.

Make-work bias refers to the way the public confuses productivity with having a job. As Caplan cleverly states, "For an individual to prosper, he only needs to have a job. But society can prosper only if individuals  do a job, if they create goods and services that someone else wants." People tend to make the classic luddite fallacy, that new technology destroys more jobs than it creates, and that, as a result, technological growth actually worsens the standard of living.

The fourth and final bias, pessimistic bias, refers to the way the public tends to overemphasize the things the get worse over time, and forget the ways that life improves. Recession is confused for regression, and the massive technological advances of the markets, such as improvements in information technology and energy infrastructure, are forgotten.

Yet when I think about these biases, I would argue that they all are manifestations of a more fundamental psychological bias: a bias towards salience.

Salience refers to the way certain effects or phenomenon are more apparent and more obvious. We should be familiar with this idea of salience in our everyday lives. It's easy for me to enjoy the concentrated fun of watching old episodes of scrubs, it takes more effort to remind myself of the dispersed benefits of working hard on math homework. It's easy for me to catch up on the extra hour of sleep, it takes more effort to remind myself of the long-term benefits of exercising in the morning. As Katherine Baicker, Sendhil Mullainathan, and Joshua Schwartzstein like to joke, "Our research has definitively determined that running is unpleasant and donuts are tasty," and as such, people tend to choose the salient joy of tasty donuts and the immediate avoidance of hard running instead of the long term benefits of consistent exercise. Or as Thaler and Sunstein put it in their book Nudge, very rarely do people ever make new years resolutions to smoke more cigarettes or drink more alcohol.

I would argue that salience forms the basis of Caplan's irrational voter biases. Salience means that people tend to see the direct negative impacts of market liberalization, and neglect the role of the fallacy of composition in hiding the harms that arise from government intervention. In the case of the anti-market bias, the benefit from paying farmers is salient, whereas the cost of higher food prices are dispersed and not as apparent. In the case of the anti-foreign bias, the closed steel mills down the street are immediately visible, whereas the newly created jobs in the software industry and management consulting are not as visible. In the case of the make-work bias, people directly observe the seamstresses fired and don't see the new women, who on count of greater general prosperity, are then given the chance to go to college for a better life. And finally, in the context of the pessimistic bias, people tend to worry about the bad changes more than the good. People complain more about the rising price of gas and food, which they buy everyday, and not the fall in computer prices, which they rarely have the chance to purchase.

Re-framing the issue in terms of fundamental psychological first principles adds to the way we should interpret the irrational voter hypothesis. Rather than seeing the phenomenon of the irrational voter as an isolated problem that makes government policy ineffectual, we should see the irrational voter as a more general irrational person. As such, there may be certain (not all) markets, such as health care, that do not liberalize in the way other markets do. In the case of health care, because certain differences between doctors, such as bedside manner, are more salient than others, such as improved recovery times, a simple market liberalization may not always promote the best health outcomes. We need to think again, again, about why we need reform. Promoting price disclosure makes the costs consumers pay more salient. Moving away from an employer provided health care system towards individual insurance with an individual mandate makes the costs of choosing bad insurance more salient. But just kicking back and "letting the market (not) work", and treating healthcare just like "consumer electronics, telecommunications, computers" or cars is not a sufficient answer. And if we can move away from fiery rhetoric about socialism and capitalism and towards a grounded and pragmatic analysis of psychology and behavioral economics, only then can a meaningful dialogue on healthcare can occur.

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Update 11/18: I extended some of my thoughts on public choice and health care here.

Healthcare and Cars are Not Isomorphic

I've recently been doing some thinking about health care, and my thoughts aren't yet complete. However, when reading many of the conservative commentaries on health care, I was very peeved by their treatment of the market for health care just like the market for any other good or service, and this was aggravated by the fact that I agreed with most of their other arguments. As a result, I wrote the following NextGen article to collect my thoughts on this issue before I move on to more substantive analyses of some recent posts.

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"Healthcare and Cars: Why They're Not the Same"


How is the market for health care different from that for cars? And how does this difference change our understanding of health care policy?

Let us start from the basics: health care is a service, while a car is a good. While this does not prevent market competition from improving society's welfare on the margin, it does mean that there are fundamental limits to how far the market can improve. In particular, it means that one productive hospital cannot simply “export” its health care services across the country. And as we know from the car industry and international trade theory, that lack of export markets and distant competitors can impede the creative destruction that makes markets work.

But this is an incomplete justification. Haircuts are also services, but few people think barbershops require regulation. Yet, they differ in one key respect. While it is easy for me  to determine the quality of my haircut, it is much more difficult for me to determine what counts as “good” health care. A large part of this is linked to the uncertainty inherent in any kind of biological process. How does one determine if one is receiving sufficient care? Of course, if there is any gross negligence, it can be detected. Yet if the care is just slightly worse than it should be, there's no real way for the consumer to know. The problem is compounded by the fact that most people rarely get sick. If you go to get a haircut every month, you can quickly determine which barbershop is the best. Unfortunately for neoclassical economists but fortunately for society as a whole, people need catastrophic care substantially less often than they need haircuts, thereby impeding the market from finding the most efficient solution.

Chronic care does change the calculation, but it introduces other factors that again prevent the market for health care from functioning like the market for cars. To take a concrete example, consider the 40 million elderly individuals who suffer from arthritis. Does it make sense to ask them to “shop around” to find the perfect hospital? Does it make sense to ask them to trust in an online service like Yelp to decide where to get care? And when they are fatigued by chronic pain, does it make sense to think they can make the “optimal” choice, and not just the most convenient?

Other problems make it difficult for the market for health care insurance to function like a regular competitive market. Again, a parallel to the market for cars, in particular used cars, is helpful. A problem with used car markets is that it's not entirely clear whether the car you wish to purchase is good or bad. This depresses the market value of used cars, both good and bad. But then producers of the more expensive good cars exit the market, further lowering the average quality of a used car until the market spirals out of existence. The market for health care is subject to similar pressures, but in the opposite direction. For insurers, they cannot easily tell whether an applicant is healthy or not. As a result, they charge the same premium to all individuals, which leads to healthy individuals dropping out of the market because they value the insurance less. This process repeats itself until premiums spiral upwards and no market for health care insurance exists.

This describes what economists call adverse selection, and although it is a market failure, it doesn't mean the government always needs to step in. However, understanding how the market circumvents the problem helps us understand why a simple solution for the health insurance does not exist. For example, markets for used cars can exist because the salesmen can offer warranties, so that if the car does break down you can “turn back the clock” on the purchase and return the car. This reduces the incentive for used car salesmen to trick you into buying lemons, because if the car does turn out to be a lemon you can always return it.

But what would a similar system mean for health care insurance? In that market, it's the consumer who has the private knowledge, therefore it falls to the consumer to make the “warranty”. This would mean the consumer would have to be able to guarantee that he or she won't become more unhealthy in the future – an impossible task. Alternatively, insurance companies can “turn back the clock” and refuse to pay for the consumer on the ground that the consumer was unhealthier than was expected. This hardly seems like an efficient or moral outcome, and is precisely the reason why the protections for preexisting conditions is so popular in the ACA.

With these stylized facts, it should be abundantly clear that the markets for health care and insurance are very different from what the standard competitive model predicts. Hence, we need to be very cautious when we draw glib analogies from health care to cars. However, the implications for policy are mixed. On one hand, certain regulatory reforms such as cutting the employer health care deduction, reducing occupational licensing barriers, and relaxing privacy laws can result in substantial advances towards improving health care. Yet the presence of these government failures does not mean that there is no role for the government to ameliorate the market pathologies that I have listed above.

A notable example of this is the individual mandate. The individual mandate, by forcing people to purchase insurance, massively expands the market for health care. In doing so, this increases the incentive for firms to pursue innovative new projects to increase productivity. And even though consumers still rarely need catastrophic care, the larger market allows transparency and reputation to have an effect as hospitals are at greater risk to lose customers. For the insurance market, an individual mandate can help pull us away from the adverse selection death spiral by preventing self selection and thereby keeping most of the population insured.

In other words, the government is not perfect, but neither is the market. By noting that the market for health care is fundamentally different from that for other goods such as cars, we can recognize why the standard assumptions for regular markets may not apply in the case for health care. As such, we must move forward with caution, with an understanding that true reform lies not with complete liberalization or complete regulation, but rather with a judicious mix of the two.
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Update 10/24/12 -- I was pleasantly surprised to find that this post was heavily discussed in Reddit. I just wanted to put a few points to defend myself from a series of very informative critiques.

• I never oppose market reforms like HSA's or cutting the employer healthcare tax deduction. That's not in my post at all.
• The point of the post is to highlight some frictions in the healthcare market that justify some sort of intervention -- market based (preferably) or command and control (not ideal).

Notes on a Healthcare Talk

Yesterday at the Ross School of Business, there was a panel discussion on health care in the United States. Jonathan Gruber and  Katherine Baicker, two well known health economists, in addition to David Leonhardt, a New York Times reporter who has reported extensively the health care debate, gave their perspectives on health care in the United States.

What I found was quite interesting was how much of a consensus there was among health care economists. Yes, the health care market fails for the 46 million uninsured Americans. No, providing more health care for people doesn't reduce spending on health care. But yes, there are major tax and market reforms that the government can do to increase the value of health care delivered in the United States.

Gruber was the first speaker, and I found his defense of the ACA quite witty. He characterized health care reform as a three legged stool that depends on three parts -- coverage expansion, individual mandate, and subsidies -- to fully function. Because pre-existing conditions can cause people to be kicked off the rolls when they need it most, it's important to reform coverage laws to allow more people to buy insurance. But then if there's no individual mandate, the market is subject to adverse selection. It is, as Gruber joked, "like forcing sports bookies to take bets at half-time". And to make sure that people can afford to purchase insurance, the government has to provide subsidies to increase affordability.

Something else that Gruber emphasized during the talk was that the health care debate is highly nuanced, and that talk of reform shouldn't be on partisan lines. The Affordable Care Act is not a government takeover of health care -- it merely creates a new market in which private insurers can innovate and thrive. Nor is it a federal takeover of health care delivery -- states are allowed large levels of discretion in how they implement their health care exchanges. Something that both Gruber and Baicker seemed excited about was the possible policy innovations the ACA may stimulate. The ACA, while it is certain in the coverage expansion, is much less certain on how to control costs. It is hoped that the variety of reforms -- capping the employer tax deduction, pilot programs for alternative health care delivery, and comparative effectiveness research -- can eventually discover something that the market will find valuable and later deploy.

We already see some of this innovation in the reform of fee-for-service payments. For two years, Blue Cross and Blue Shield of Massachusetts has already been trying out an alternative payment structure that focuses on patient wellness rather than the number of office visits. And then in the past week, Medicare took its first step away from fee-for-service by penalizing readmission and rewarding hospitals that deliver better care with higher payments. Later during the Q and A session, Baicker mentioned other possibilities, such as integrated health care units or even simple emails from your doctor, in order to improve health care effectiveness.

Gruber and Baicker were both optimistic that these kinds of reforms would be critical in bringing costs down. Baicker often mentioned that increasing coverage is easy -- the question is how to control costs. Yet, for both Gruber and Baicker, this ignorance about cost control was just a better reason to expand coverage first. We know how to expand coverage, we don't know how to expand costs. So, as Leonhardt noted, let's expand coverage to save lives now, and use what we learn from the new practices in the health care market to try to reduce costs on a national level.

I find this approach eminently sensible. As mentioned above, reform is critical to creating a larger market for health care, and it seems to be a natural result that the resulting market will have a greater variety of business models and payment structure innovations. Given that ideas can quickly spread, the efficiency of the system will ultimately be determined by the efficiency of the best, not the average. As such, increasing the number of health care consumers seems to be the first step towards discovering a solution to rising health care costs. Gruber also argued that this would help solve the primary care doctor shortage by changing the incentives for medical students. By changing the way insurers reimburse for services, this would reduce the demand for specialty medicine, and thus push more doctors out of specialty disciplines and into primary care.

Baicker made a statement that I feel is very important in framing discussions in health economics: "Health ≠ Health Care ≠ Health Insurance". From all the above analysis, we know this to be true. Just because something is a health care service, such as proton beam therapy, doesn't mean it improves health. And just because something improves health, such as phone calls from a physician, doesn't mean we think of it as "health care". And to properly fund all of this, we need a robust system of insurance that requires incentives and cost structures that are not directly related to a person's biological condition, but nonetheless change the way health care is delivered. The fact that this is true means that when we move forward with the health care system, we need to consider each of those three related, but distinct, parts.