Medical Economics and Medical Ethics

A lengthy op-ed in The New York Times the other day typifies the way quite a few doctors think. Written by Gilbert Welch (Dartmouth Institute), the article acknowledges that there are perverse economic incentives in the practice of medicine. But these incentives play second fiddle to a much bigger problem: the failure of providers to act ethically and the lack of moral outrage in the face of such lapses.

What are the ethical lapses Welch has in mind? They include:

• Hospitals charging outrageously high prices that have nothing to do with real costs (“highway robbery”);
• Hospitals acquiring doctors so that they can charge Medicare two to four times what the doctor was previously getting in private practice;
• Over-testing (too many colonoscopies and echocardiograms); and
• Too much expensive equipment of questionable value (a proton beam in every facility).

He goes on to ask, “At what point, does it become crime?” and answers:

The word “crime” is awfully strong. Many prefer to call all this a problem of perverse incentives: good people, working in a bad system.

We could make the system better…But the incentives will never be perfect. Ultimately, society needs individuals to be guided by ethical standards. And in medical care, those standards are getting pretty darn low.

Too many of us have passively accepted the situation as being beyond our control. Medical care in America could use a dose of moral outrage. It would be best for all if it was self-administered.

But why separate ethics and economics? That’s foolish.

Economists have long known and long established that if you want more of something, you subsidize it; if you want less of something you tax it. People respond to economic incentives. And this principle applies just as much to ethical behavior and even criminal behavior as it does to any other activity.

Did you know that the fraud rate for credit card transactions is much less than 1%? But the fraud rate for Medicare and Medicaid is estimated to be ten times higher than that. In principle it should be immeasurably easier to steal with someone else’s credit card that to steal from a government health care program. Think about how many times you hand a credit card to someone you don’t even know. Think about how many times it is out of your sight. Given the opportunities for abuse, it is remarkable how rarely credit card theft occurs.

Why is that? It’s because the credit card issuing businesses, in cooperation with each other, have set up systems to greatly reduce the expected gain from fraud and substantially increase the cost to the potential criminal. If we unleashed the marketplace (contract Medicare collections to VISA?) and allowed similar incentives to prevail in health care, about nine in ten dollars of Medicare fraud would go away.

Or, let’s think more broadly. Suppose we had a health care system in which the incentives were all correct. Imagine that every doctor, every patient and every hospital administrator faced financial incentives to make optimal decisions with respect to the difficult tradeoffs between money and medical care. There might still be unethical behavior. But it would be a tiny fraction of what Welch is complaining about in today’s system.

Some may be surprised to learn that Adam Smith was a moral philosopher as well as the father of economics. His book the Theory of Moral Sentiments is less well known than The Wealth of Nations, but is a nice complement to it. One of his enduring insights was that in competitive markets pursuit of self-interest on the part of producers and sellers is consistent with maximizing the welfare of the buyers.

Contrast Smith’s insight with what happened in the Soviet Union. Under communism, every price consumers and producers encountered was the wrong price. So everyone had perverse economic incentives to do the wrong things (over-consume, over-produce, etc.). From time to time the Soviet government would exhort people to ignore incentives and do what was good for society as a whole.

We know how well that worked. And it reminds me very much of Welch’s editorial.

Like the Soviet consumer, patients in our health care system pay nothing for basic services, or at least far below the social cost of those services. To see the magnitude of the perverse incentives on the provider side, consider the following from a Wall Street Journal editorial I wrote:

Medicare is potentially setting about 6 billion prices across the country at any one time…

Is there any chance that Medicare can set prices and approve transactions in a way that does not cause serious problems? Not likely.

What happens when Medicare gets it wrong? One result is that doctors face perverse incentives to provide care that is costlier and less appropriate than the care they should be providing. Another result is that the skill set of our nation’s doctors becomes misallocated, as medical students and practicing doctors respond to the fact that Medicare is over-paying for some skills and under-paying for others.

Like the Soviet experience, we are not going to get very far encouraging patients not to over-consume care and encouraging doctors and hospital administrators to ignore the financial incentives created by 6 billion incorrect prices. (BTW, my casual impression is that the vast majority of people ― both buyers and sellers ― in health care believe they are being taken advantage of by impersonal bureaucracies and feel no moral qualms about “getting theirs.”)

Are there heath care markets that come closer to the ideal? Yes. Cosmetic surgery, Lasik surgery, walk-in clinics, other retail medical outlets, online mail order drug houses, telephone and email consultation services, domestic medical tourism, international medical tourism ― in short, wherever patients are primarily spending their own money and third-party payers are relatively unimportant, economic incentives and medical ethics seem to be very much aligned. I have written about those markets elsewhere.

Can we transform the entire health care system into one that aligns ethics and economic incentives? Yes. That is the subject of my book, Priceless.

[Cross-posted at Psychology Today and John Goodman’s Health Policy Blog]