Saturday, August 01, 2009

Wow, he said.

In response to yesterday's post about health care, one anonymous commenter (but I think I know who it is) begins with the words "wow Rick wow." What could cause that type of incredulity?

The commenter argues that a monopsonistic buyer will lower prices for everyone. Not necessarily. Medicare and Medicaid pay below market rates but there seems to be general agreement that they have raised - not lowered - prices for everyone else. They are a "public option" that we all subsidize.

Of course, one of the reasons that may happen is that the rest of us can't migrate to Medicare or Medicaid. In the case of a public option that is available to all, it is possible that providers will be unable to maintain higher prices for private plans because, if they do, patients (or, more accurately, their employers) will simply move into the public plan. If that happens, the public option may reduce but not eliminate private coverage.

But lowering prices below what they are in today's current market - in which insurers or administrators compete - can only be the product of government's monopsonistic power. And that price decrease is, at best, a mixed blessing.

Let's illustrate the point with the commenter's claim that the current system is immoral because some people can't afford the $40 pills that they need.

I agree that this is a problem. How does a public option fix it? It can't reduce the cost of making the pill. It can't reduce the amount of money that it cost to develop it. As we have seen, the price for the pill has been set in a competitive market. The company's bargaining power may have been enhanced by a patent, but we generally regard that a price worth paying for innovation. So the public option can't wring out "excess" profit, defined as that which could not be earned in a competitive market.

What the public option does is simply refuse to pay the market price. Then, one of two things happen. As do service providers with Medicare and Medicaid, the drug company may sell at the lower price to the public plan and increase its price to private plans. But, as our commenter suggests, that might not work if people migrate to the public plan in response to that and other costs shifted from the public option to private plans. The drug company, if it can, might refuse to do business with the public plan. But if it is legally required to do so or, if the public option by undercutting private plans, has become the only game in town, then it may be forced to take the lower price or withdraw the product.

In many cases, it may do the former because the cost of a drug is generally in its development and not in its production. Development costs are sunk. The company may not recoup its costs or make a "sufficient" profit at $10/pill, but it will cut its losses by selling it for that.

All good? Maybe not.

We have now changed the economic environment in which new medical technology is developed. We have reduced incentives for development, so we will get less development. This creates hidden victims. We can congratulate ourselves that the $40 pill now costs $10. But we don't know who has suffered and died because the next pill was never invented. The only thing that we can be sure of is that it has happened.

This is why the "cheaper drugs in Canada" story is a canard. The problem isn't that the drug companies don't recoup their minimal marginal costs of production due to Candadian price controls. It's that they wouldn't have the same incentives for development if the whole world was Canada. In that sense, Canada's drug consumers are free riders. They enjoy what they don't pay for.

A "public option" is not the answer to unaffordable drug prices because it can't change the difficulty in developing new drugs. If we want people to have drugs that they can't pay for (and, at least for some drugs, we do), then we should help them pay for them.


Anonymous said...

Wow - as much as I may want to jump into the crying hate debate I have to respond here. Have I been singled out for calling some of your original points unassailable?

Again, you're right, a monopsonistic buyer won't necessarily lower prices for everyone or to the same level. Some price discrimination will occur and may even be a good thing. But private insurers will gain a good bargaining chip to attempt to negotiate lower their prices and good incentive (staying competitive) to do so.

On to lower costs as a mixed blessing. If I were an Objectivist I might imagine all the health care provides in America fleeing for some medical version of Galt's Gulch and the gears of R&D, unlubricated by massive profits, grinding to a halt. But my faith in the market lets me sleep soundly at night even when faced with the prospect of a meddlesome public option. No matter what the public option shapes up to be, there will still be money to made in health care. People will still go to med school and drug companies will still develop new drugs. I've no doubt there will be some effect (maybe even negative) on the rate at which new drugs are brought to the market but I seriously doubt that a public option will squeeze so much of the profit out of the proposition as to make it unattractive for businesses to develop new drugs.

A public option could ameliorate the problem of costly medications by capping profit margins or some other form of market regulation. It might not keep drugs from being expensive but it could help. It might not solve the speculative problem of slower development but it would solve the all too apparent problem of those the current system ignores.

What I find immoral are those who ceaselessly attack the public option as though the status quo were acceptable. If an insurance company (or two) goes under or a share of Merck loses a few points, so be it. The system is broken and a good plan today beats a perfect plan tomorrow. Inaction on this issue comes only at the price of those the system currently fails and it's immoral to pay it.

Rick Esenberg said...

You were "singled out" for saying something worth reponding to. Your point now seems to be that I am right but it won't be so bad. You want to sacrifice care for equality. I'd rather subsidize care as needed.