The Economics of Healthcare
A Brief Memorandum from the Virginia Institute for Public Policy
An extremely brief history of American healthcare
Over the last 10 years, the healthcare market has been among the most important issues for Americans, almost singular in it’s significance. The public’s obsession can largely be attributed to the considerable increase in health insurance costs which have followed the implementation of the Affordable Care Act (ACA) in 2010. Public memory is short, however, as the ACA was itself a response to the increasing costs of medical services, much of which has stemmed from the Medicaid/Medicare programs of 1965.
The issue with both Medicaid and the ACA has always been a fundamental misunderstanding of the Laws of Supply and Demand. Robert Graboyes, Senior Research Fellow with the Mercatus Center and co-creator of the Healthcare Openness and Access Project, has said that the biggest issue with the ACA and Medicaid has been that it inadvertently increased demand for healthcare without providing any mechanism by which to increase supply. In fact, with the added regulatory burdens of Medicaid alongside further ill-advised measures such as the Certificate of Public Need policy, it might be reasoned that the growth in the supply of medical services was obstructed over the same period. The effect according to the Centers for Medicare and Medicaid Services (CMS): healthcare spending has increased an average of 9.16% annually from 1965 to 2015; a substantial growth rate considering that GDP has advanced an average of only 3% per annum over the same period.
Economics 101 and Medicaid
As designed, Medicaid has redistributed a considerable percentage of each American’s wages into the healthcare system. Currently, in Virginia an estimated 30% of the state budget, approximately $34.5 billion, will be spent on healthcare alone. As this money makes its way into the market, demand for medical services increases. Whether an increase in demand is natural or policy driven means little to the market; without a coinciding increase in supply, prices must also increase.1 Unlike consumer monies, however, Medicaid funds have always come with considerable strings attached and cannot (easily) be used for any substitute or complimentary treatments, and, most significantly, cannot be entirely removed from the healthcare market (i.e. to be spent on food, housing, or entertainment). Market actors on both sides of the equation (service providers, and Medicaid recipients) see this inflexibility and find ways to engage the system to their benefit. This additionally introduces two costly problems for the Medicaid system: the open access problem, often called the tragedy of the commons, and moral hazard. These problems, among others, create ancillary costs by effectively decreasing the total welfare benefit received in the Medicaid system, currently estimated at 20 to 50 cents per dollar spent, according to a 2016 study out of MIT.2
Further unintended consequences of Medicaid
Increased costs are not where the effects of Medicaid, and its reforms end. Each new spending-based reform supplies new ripples, leading to new and different “market mutations” which themselves must be reformed. Below is a short list of ripples with a brief explanation.
Expansion as a solution for Medicaid: Seriously?
As marginal service costs increase, some states have taken advantage of the option to expand Medicaid eligibility through the ACA. It should be noted that the negative economic effects of Medicaid will expand alongside eligibility. As Brian Blase has noted, state expenditures have increased dramatically due to a woodwork effect which sees Medicaid roles expand far more dramatically than program projections have expected. By 2016, initial CBO enrollment projections were adjusted 50% higher than their 2010 counterparts, and health officials from states which have already expanded Medicaid have warned some advocates and legislators in Virginia to realistically expect double the current estimates. The breakdown: whereas current public/private estimates run from 400,000 to 506,000 new enrollees, the Commonwealth might be better served to expect between 800,000 and 1.12 million newly eligible Medicaid recipients. This would roughly increase the current number of Medicaid recipients twofold in the state, and Virginia has already experienced complications with wait-listing, consistent increases in service costs, budget short-falls, and deaths attributable to inadequate availability of services. More money does not necessarily equate to better outcomes; a sentiment which is particularly true of Medicaid. However, the expansion of consumer choice and responsibility in healthcare will create the kind of outcomes that Virginia really needs.
1 The use of the word “prices” is important as opposed to the word “costs.” I use this word to specifically indicate marginal costs borne by the consumer (i.e. cost per service or good). It is important to also note that due to the design of Medicaid the government has also become a consumer in the healthcare market and must bear these increasing marginal costs as well.
2 Dependent on analytical methodology.
3 Cut and paste link: econweb.ucsd.edu/~rogordon/growth.218.doc