Wednesday, July 22, 2009

Profits and the Health Care Industry

There has been a lot of talk lately about the morality of profit-seeking behavior in the health care industry. Many advocates for a single-payer system have argued that it is fundamentally unethical for doctors and insurance companies to profit off of illness, while so many cannot afford to pay for care.

During the Democratic primary, presidential hopeful John Edwards basically endorsed this argument -- though he ultimately opposed a single-payer system.

Edwards explained:

I looked hard at single-payer. Proponents of single-payer have some very strong arguments, particularly the elimination of profit motive in a health care system. Medicare, for example, runs at 3 to 4 percent overhead compared to some insurance companies charging 30 to 40 percent profit and overhead, so I thought that there was a legitimate and strong argument for it.

This is a fair ethical consideration, regardless of its policy implications. Is it moral for individuals and businesses to profit off of illness? It seems to me that this question should be vigorously debated.

But many advocates for single-payer go further, arguing that removing the profit motive from health care will ultimately reduce costs. This is the logic behind the public option -- that, ceteris paribus, not-for-profit insurance companies will offer lower rates than for-profit insurance companies.

Is this sound economic theory?

Some advocate for single-payer, like Paul Krugman, have argued that a market-based approach to health insurance is economically irrational "because private markets for health insurance suffer from a severe case of the economic problem known as 'adverse selection,' in which bad risks drive out good." This argument -- while controversial -- is economically sensible.

Krugman was careful to note:

I'm not an opponent of markets. On the contrary, I've spent a lot of my career defending their virtues. But the fact is that the free market doesn't work for health insurance, and never did. All we ever had was a patchwork, semiprivate system supported by large government subsidies.

Krugman believes that the only way to correct the problem of adverse selection is to create a single-payer system. Unfortunately, this is not the argument employed by most advocates for single-payer. Many who support a larger role for government argue that profit-seeking behavior is the primary cost driver in the health care industry.

The Obama administration, for example, has insisted that a public plan will "force waste out of the system," making the health insurance market more efficient. The clear implication is that for-profit companies are more wasteful, and that this waste drives up health care costs.

Does this argument make economic sense?

The real question in terms of economic theory is not whether certain companies are motivated by profit, but whether the market structure allows those companies to become "price makers." A single-payer system would create a new kind of market structure in the health care industry -- a government monopsony, with the power to dictate prices.

But this is not the case with the public option. Unless the public plan is given some advantage over private plans, it will not have the market power to dictate prices -- even if its motives are more altruistic.

This is the reason so many opponents of government-sponsored health care fear that the public option is a backdoor to single-payer. The argument that a public option without any financial advantages can reduce costs does not rest on sound economic principles.

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