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What do we mean by "health costs?"

3/31/2014 11:02:00 AM
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A women's AIDS clinic in Malawi. While the Ryan White Care Act and Medicaid help poor Americans afford patent-protected HIV medications, it is worth reflecting on the fact that the costs of our economic policies fall not just on Americans, but the whole world.
Peter Dorman makes an excellent point: the high "cost" of healthcare does not necessarily mean we are providing an inefficiently high level of healthcare. Dorman makes this point in terms of costs versus transfers: the socially optimal level of care is determined by the actual resources used (ie "social cost"), which may bear little relation to the pecuniary "cost" of care, which generally involves some amount of transfers from patients to providers above and beyond the true social cost.

There are two different ways in which healthcare over-spending can be economically inefficient. The way most people think about it, inefficiency arises because we use too much care, such that the marginal cost of care exceeds its true marginal benefit, which is what we'd expect to happen when insurance reduces patient's exposure to the true prices of treatment. However, often the price patients pay for care vastly exceeds the marginal cost because of massive producer markups. Excessive markups are an essential feature of the US healthcare system: laws protect the AMA's monopoly on the supply of doctors, and drug makers' monopolies over the patents they own, for example, which have lead various commentators to decry the fact that "doctors are overpaid" and "drug companies make excessive profits," which are often touted as examples of "wasteful spending."

Circling back to Dorman's point, however, shows that paying these possibly excessive salaries to doctors and profits to drug makers doesn't cause inefficient overuse of medicine--quite the opposite, they are inefficient because they cause under use of medicine. By charging $80 for an HIV pill that has a marginal cost of only $4 to produce means that a lot of HIV positive patients will forgo treatment because they can't afford it. Overpaying doctors means that many people won't get check-ups because they can't afford a visit to the doctors office. When it comes to transfers, the economic inefficiency is not one of overuse but under use; it's not an issue of "cost" but of access to care.

The mere fact that doctors are overpaid or drug makers get excessive profits needn't cause economic inefficiency. To see why, just consider the case where the government pays for the treatments financed by lump-sum taxation, and then charges patients the social marginal cost of those treatments. Drug companies and doctors would make just as much money, but we'd be using the efficient level of healthcare (provided people make rational self-interested choices). In a general sense, any level of "healthcare spending" can be consistent with economic efficiency if we have guaranteed access to care (a necessary but not sufficient condition of efficiency).

This issue is why I'm always a bit surprised there isn't more political movement on things like HIV drugs. It's true that the patent holders make obscene profits, sure, but the far more pressing issue is that treatments can be financially ruinous for patients. Since the drugs have been proven enormously successful at keeping HIV patients healthy and driving transmission rates down towards zero, why doesn't the government just buy out the patent? If we just offered the drug company a sum equal to the present discounted value of their future profits from HIV, they'd be willing to sell the patent. Thereafter, competing drug makers would all be able to sell the drug, driving the price down to marginal cost. I guess some people would object to the government handing such a large chunk of change to a drug company, but from my perspective, that's what we are already doing by paying their patent-protected prices anyway. At least my way, everyone would have access to HIV treatment.