I recently reviewed Steven Horowitz’s excellent “The Price System and Distributive Justice” (link.) In this article, Horowitz considers the effect of price shocks in healthcare, and in the setting of natural disasters. He makes a good argument that the price system works in the case of natural disasters. His argument on healthcare costs is less compelling.
Missing is a discussion of two key mathematical concepts: variance, and cumulative risk of ruin.
Previously we discussed what inflation is, and whether fiscal policy can cause inflation. We looked at the Bennett hypothesis, which lays out the case (as yet unproven) that federal policy might be causing inflation in the education sector.
The federal government borrows 43% of what it spends, and it spent some 1.2 trillion on healthcare in 2019. CMS estimates the total market for healthcare was 3.8 trillion that year. So over 13% of all healthcare dollars come from federal borrowing. Is this inflationary?
It could be, just depends on where the government gets the money. Who is buying those bonds?
In Part 1, I narrowly defined inflation as an increase in money supply. An increase in the number of dollars chasing a limited supply of goods and services, all other things being equal, will cause the price of those goods to be bid up. “Inflation” thus defined is historically a result of monetary debasement, although in modern times, in civilized countries, it typically comes about through expansion of credit.
Federal spending currently accounts for about a quarter of the GDP, about a third of that borrowed. The portion that is borrowed consists of newly-printed dollars, some of which are chasing targeted goods and services. Can fiscal policy thus result in inflation?
William Bennett, former secretary of education, suggested as much in a 1987 NYT editorial entitled “Our Greedy Colleges.”
If anything, increases in financial aid in recent years have enabled colleges and universities blithely to raise their tuitions, confident that Federal loan subsidies would help cushion the increase. In 1978, subsidies became available to a greatly expanded number of students. In 1980, college tuitions began rising year after year at a rate that exceeded inflation. Federal student aid policies do not cause college price inflation, but there is little doubt that they help make it possible.
William Bennett, NYT 1987
Here, he seems to be using the term “inflation” to refer to higher prices, a phenomenon he admits is multifactorial. But there seems little doubt he hypothesizes that throwing a great deal of money at a limited supply of services has a tendency to drive prices higher.
Sense then, there have been several studies seeking to disprove his hypothesis. All have limitations. A typical study seeks to correlate volume of Pell grants with tuition, showing inconsistent results. Such studies disregard the fact that colleges have several sources of income other than Pell grants and cash-on-the-barrel tuition fees. And invariably, these studies seem ignorant of the fact that loans are, by nature, inflationary.
To the extent these two lines are correlated, tuition increases are being funded by debt. Which is, by definition, inflationary.
Remember, there are only three ways to bid up the price of something:
To dip into your savings for extra cash.
To forego buying something else.
To borrow money.
The tight correlation between borrowing and tuition suggests that the first two things are, to a great extent, not in play. To be clear, people do save for college, and their parents do make sacrifices. But that’s not what is driving tuition inflation in recent years. (One might hypothesize that real income, and real savings have been flat during this time period; and one would not be far from the truth.)
Hold on, you might say. What about all the extra people clamoring for college education these days? Doesn’t that affect the price of tuition?
That’s partially why I am comparing per-student debt with per-student tuition; but in a larger sense, you’re right. Of course it does. But you have to understand how the system works.
As more and more people demand education, they bid up prices and profits. This encourages new entrants, people starting up their own colleges to get in on the action. This tends to hold prices and profits down. Even so, prices may rise to the point where people figure it’s not worth it, and start looking to spend their education dollars elsewhere, for example in technical school. That reduces demand, thus putting further downward pressure on prices and profits.
So, you form a cartel and first approach the government about passing laws to keep the competition out. That helps. Then you beg the government for grants. And when that goodwill runs out, you lobby for lending. And once the lending starts, you’re dealing with pure inflation.
The key is, to keep the rate of education inflation above the rate of inflation for things college administrators want to buy. And of course it’s not all about the champagne and foie gras. It’s also about buying buildings and professors and such. They do have a business to run, after all. And you’re going to pay for it, one way or another.
This is no different than saying inflation in the housing market is being driven by the mortgage debt market, or that stock values are being driven up by companies borrowing money to re-purchase their own stock.
Where you see inflation, is where you are allowed to spend borrowed money. When banks are holding the strings, they tend to approve loans for specific things, like cars and houses. We can expect those prices to be bid up when loans are readily available.
When the government is holding the strings, it will tend to promote spending with borrowed money on certain things. The government itself will borrow money to buy jet fighters and tanks, and it should come as no surprise, those things are expensive. Here, the government is encouraging people to borrow their own money for education, with predictable results.
To be clear, fiscal policy and monetary policy are working hand-in-hand. The Fed is working to keep the cost of borrowing abnormally low (in other words, has set the price of money below the market-clearing price) thus resulting in inflation. Which sectors see that inflation is a matter of policy, and that’s true regardless of who is setting that policy: the Congress, the Fed, or both.
People worry about the cost of healthcare, which takes up a fair amount of the national pocketbook. This is particularly true in the United States, where we feel we are paying more than we should, based on the cost of healthcare in other civilized nations.
My question is, to what extent can inflation explain rising healthcare costs?
Note, inflation does not result from rising prices. Inflation is one cause, among several, that can cause some prices to increase.
Here, we are using a narrow definition of “inflation.” Specifically, an increase in the money supply. An increase in the supply of money doesn’t always cause an increase in prices. But, all other things being equal, it should.
Came across this article, a thoughtful and balanced argument in favor of “Personalized Medicine,” in other words treatment customized to the individual. The author emphasizes the role of genetic testing, which is an established practice for cancer chemotherapy, and an emerging discipline elsewhere. But there are other aspects to personalization, among them (as the author notes) the particular range of symptoms a patient might express, a combination that is unique to each individual. Herbalists might add intangibles like temperament. Someone with an economic viewpoint like myself might add assessment of risk tolerance, which is different for different people.
I’ve had the pleasure of working with medical and nursing students lately, and I can assure you, they believe in the personalized approach. Unfortunately, they are entering a field that is increasingly becoming depersonalized. This depersonalization is being driven by a combination of technology and policy.
In Part 1, we discussed price theory in general. In Part 2, we defined the market-clearing price, and discussed how this affects price-fixing schemes like Medicare uses.
In some respects, “price” and “cost” are two sides of the same coin. If I am able to sell an bottle of vitamins at a price of ten bucks, the guy who buys that is going to say it “cost” $10. By that he is specifically referring to something called “opportunity cost.” Meaning, he had to give up the opportunity to spend $10 on something else, or to just hang on to his money.
Likewise, the producer is looking at opportunity costs also. If it costs him $8 to produce something, he is giving up the opportunity to spend eight bucks producing something else, or else just spending the eight bucks on himself.
While price and cost are related, believe it or not, they are not always the same number. In health care, they are almost never the same number. Because there is an intermediary between the producer and the consumer. This intermediary — an insurance company, or the government — pays one price to the producer, and charges a different price to the consumer.
Previously we discussed basic cost theory. The “market price” of something happens when a producer and consumer find alignment in their opportunity costs.
There’s a special kind of price that happens when production is in equilibrium with supply. It’s difficult to tell exactly what that price is — and impossible to predict — but still, we can imagine a situation where price is stable, and inventories are neither increasing nor decreasing. Let’s call that the “market-clearing price.”
The market-clearing price is not an intrinsic property of a good or service. Just depends on what consumers are demanding these days, and whether or not producers feel like satisfying that demand (they may or may not, depending on what it costs to produce, and what consumers are willing to pay).
Price theory is going to be a central basis of most of what I write on healthcare economics — and is a key source of error on the part of policymakers and voters alike — so I’ll take a few moments to discuss how we arrive at prices in general.
First, a quiz. Let’s say I’m planning to buy transportation in the near future. These are the vehicles I’m thinking about buying, in order of preference:
A Harley-Davidson motorcycle.
A Vespa scooter.
Assume the price of a Porsche is $80,000. How much should I pay for the Harley-Davidson?
Interesting article from Harvard Business Review looking at the current state of computer technology in healthcare. The COVID epidemic has highlighted the promise of healthcare tech. For example, utilization of telehealth services has skyrocketed. Yet healthcare technology rates an “F” on facility of use by doctors, contributing to burnout. “Put patient care first,” advises Marchalik.
In healthcare, maximizing shareholder value boils down to a throughput problem. Sick people go in at one end of the assembly line, and well people come out the other. Healthcare is highly labor-intensive, so productivity is the name of the game.
In every other business in the world, computer technology has improved productivity. But not in healthcare. Quite the opposite, in fact.