/Health care prices and quantities, by Scott Sumner

Health care prices and quantities, by Scott Sumner

A couple of years ago, Mark Perry did an excellent post about prices in the health care industry. He presented a table that suggests the price of plastic surgery has risen much less rapidly than other medical costs:

I’m surprised by these results.  To see why, consider the two big distortions in health care:

1. The government imposes onerous regulations on health care, which one would expect to sharply boost prices.

2.  The government massively subsidizes health care, which one would expect to sharply boost quantity.

Because expenditure equals price times quantity, these distortions would be expected to dramatically boost total spending on health care.  Perhaps they do.  So why am I surprised by the plastic surgery data?

As far as I know, plastic surgery is heavily regulated in ways similar to other forms of health care.  There are tight limits on the ability of health care practitioners to migrate to the US from places where costs are far lower.  And doctors in the US must undergo training far beyond the needs of the job.  In addition, certain tasks that could be done by nurses are restricted to doctors.

Where plastic surgery differs from traditional health care is in the payment system.  Plastic surgery is far less subsidized than other forms of health care, rarely covered by insurance.  So if you think in terms of two distortions—subsidy and regulation—then it’s mostly in the area of subsidy where plastic surgery differs from other forms of medical care.

A priori, I would expect plastic surgery to cost about the same as other forms of surgery.  I’d expect the biggest difference to occur in quantity, where plastic surgery would be done at close to the optimal level, while other forms of health care get provided at levels far beyond the optimum due to subsidies.  In fact, it seems like the subsidies also impact price, indeed quite dramatically.  This means that our health care regime might well be even more inefficient than it appears, with government subsidies boosting both price and quantity, while regulation further boosts price.

In other words, while the 32% boost in the price of plastic surgery trails the 47% rise in the CPI, and is far below the overall rise in medical costs, it seems plausible that even this modest price increase is excessive due to government regulation.  In a truly free market in plastic surgery it is likely that prices would be far lower.

Bryan Caplan has a new post that discusses a recent book by Eric Helland and Alex Tabarrok.  Bryan is not persuaded by their argument that the cost disease in health care and education is largely driven by the “Baumol effect” (rising wages in industries where productivity is stagnant):

So while Helland and Tabarrok are not wrong to invoke the Baumol effect, they are wrong to fail to blame government for dramatically amplifying it.  If paying customers bore the full financial burden of education and health care, prices could easily fall by 50% or more.

In conversation, Alex objected that the growth rate of health care prices did not dramatically increase after Medicare was adopted.  This would be a reasonable objection if my story were speculative.  But “spending hundreds of billions of extra dollars a year on anything will make it much more expensive” is anything but speculative.  Indeed, it’s virtually bulletproof; are we really supposed to imagine that the supply of health care is perfectly elastic despite a thicket of licensing requirements?!  If prices did not grow more rapidly after the adoption of Medicare, the sensible inference is that price growth would have slowed if Medicare hadn’t happened.  “Unfalsifiable”?  No, but it is an application of a general principle so well-established that it’s crazy to doubt it now.

I haven’t yet had a chance to read their book, so I’ll reserve judgment on the relative importance of the Baumol effect.  (I suspect they are broadly correct for the service sector as a whole.)  Here I’d like to comment on the adoption of Medicare in 1965.  The following graph in Mark Perry’s post suggests that Medicare’s impact was less significant than one might have suspected:

Private health insurance is heavily subsidized by our tax system.  Once people are pushed into using insurance (by any means) to pay for expenditures, they have far less incentive to economize on purchases.  This was already a problem even before Medicare was adopted in 1965.  In my own life and the lives of people I know I see frequent examples of large health care expenditures that only occur only because private insurance, Medicare, or Medicaid are picking up the bill.  That fact doesn’t mean these government subsidies increase prices, merely that they boost quantity (and hence expenditures.)  But if we combine the gradually increasingly level of government subsidies with the data on plastic surgery prices, I suspect that subsidies are increasing both prices and quantity in the health care industry.

I suspect that health care is the single biggest factor explaining mediocre wage growth, with education subsidies a close second.  The left focuses on redistributing wealth from the rich to the other 99%, but the biggest need is to reduce the bloated spending levels in health care and education, which is massively inflated by subsidies and regulations.  This would free up enormous resources to produce more housing, tourism services, and other goods of real value to average Americans.  To conclude:

1. Basic economic theory predicts that our system of subsidy and regulation would produce vastly excessive spending on health and education.  If not, then much of the EC101 taught in principles textbooks is flat out wrong.

2.  All of the empirical studies I’ve seen suggest that there is little or no evidence that this extra spending produces significant gains.

The burden of proof is on those who favor trillions of dollars in government subsidies for health care and education.  So far they are not even close to meeting that burden.