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Saturday, August 7, 2010

Health care in a generally deflationary environment

The health care debate has been accompanied by numbers which can best be characterized as unreal...gazillions of dollars and the prospect of consuming the entire economy. The major focus on health care spending has been on health care inflation. Only yesterday I was watching a presentation of the Chief actuary of the Medicare Advisory Panel. Despite all attempts to paint a rosy picture about costs, virtually all plausible scenarios point to costs that will consume the economy as a whole.

In contrast to the health care economy, the fear rippling through much of the remainder of the economy is that of deflation. We are faced with limited demand and excess supply and an environment where we have moved to out of control spending to fearful savers who will not aid the recovery by either consumption or investment. This strikes me as an amazing disconnect. Why are production, consumption, and prices all but collapsing in many sectors of the economy while health care inflation continues on, minimally abated.  Maybe I am missing something but the message I get from these simultaneous but discordant phenomena is these world are operating with very different incentive structures and there is something to be learned if we are clever enough with our powers of observation.

My take on this is that the divergence is due to two major factors:

1. We see continued robust spending in health care because those receiving services are insulated from their actual costs and they do their purchases with what can be viewed as someone else's assets. This may not be universal but it is common enough to continue to drive up costs.
2. There is a drive to keep costs down in the broader economy while it is quite the opposite in the health care economy. Substitution seeks lower cost alternatives in the broader economy while it is quite the opposite in health care economies. Substitution in health care generally is driven by the search for higher margins which is almost always associated with higher costs. In other words, in health care you make more money not by driving down costs, but by driving up costs.

If these are the major drivers of the divergence, the question arises as to what tools the states and Federal government have to reverse the effects of these incentives? The recently passed reforms do nothing to change these two elements. If anything the push is to have less skin in the game from those with health care coverage. Higher copays are viewed with prejudice as barriers to care and it seems reasonable that removal of these barriers will result in greater overall demand and consumption.

You might think that better information directing consumers as to what interventions are most effective might influence consumers be wiser in terms of spending their health care dollars. Consumers are likely to value different metrics than those which are studied, particularly when they are not spending their own money.  Efforts to study actual effectiveness and bang for the health care buck with comparative  effectiveness research are laudable. Unfortuantely the track record for being able to actually do the volume of studies needed to develop a robust database and to also develop a political consensus to actually abide by the conclusions of any unambiguous studies which call into question lucrative books of health care business is essentially non-existent. It amounts to wishful thinking coming to the defense of fantasy to believe this can serve any any basis to reign in costs spiraling out of control. It is not going to happen.

Assuming that we will face a general deflationary environment outside of health care, what will happen if health care cost continue to increase at a pace of 5-10% per year in such an environment? In an relatively unfettered market, this simply would not happen. People with a shrinking resource pool would cut back on their consumption and reallocate their spending to other areas. However, health care dollars are simply different since for a large segment of the population, it is use it lose it and because of this the pool of dollars chasing after health care services keeps growing. It cannot continue growing at the present or even close to present rates of growth. A general deflationary environment where health care activity is immune to deflationary pressures will only aggravate the distortions and result in even larger fractions of expenditures being directed to the health care economy. The debt generated by borrowing to pay for present expenditures will loom even larger in the future in a deflationary environment. One can only hope that we can borrow boatloads of money right now at virtually zero interest and hope that the deflationary scenario rapidly transitions to inflation to devalue the debts we have incurred them.

It is no wonder why no one seems keen on any long term investment in anything.

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