Economies of Scale vs. Monopoly Power

The Wall Street Journal (behind subscription paywall) says that hospitals are rapidly buying up small physician's practices because hospitals can negotiate a higher price from insurers for exactly the same services that the the doctors had been doing.  The title of the story is Same Doctor Visit, Double the Cost, and it tells about David Hubbard who, "underwent a routine echocardiogram at his cardiologist's office last year, [and] was surprised to learn that the heart scan cost his insurer $1,605. That was more than four times the $373 it paid when the 61-year-old optometrist from Reno, Nev., had the same procedure at the same office just six months earlier."  The reason was that his doctor's practice had been acquired by a hospital that was better at negotiating a higher price from insurers because of its economies of scale in bargaining clout! David was upset that he had to pay the extra thousand dollars himself because of his high-deductible health plan.  And it isn't just private insurance.  Big hospitals are also able to negotiate higher payment from Medicare too.  
This is kind of like an economy of scale.  Walmart has been able to lower its average costs as it has grown bigger simply because a larger buyer has more leverage to squeeze down supplier prices through monopsony power.  Monopsony power is not the textbooks example of an economy of scale because it is a market failure and economists usually think of economies of scale as being efficient, but monopsony power does meet the textbook definition.   In the above case, doctors offices are able to increase their seller power (monopoly power) by getting larger.  This has the same effect as an economy of scale: It increases the size of organizations because smaller organizations cannot compete. 

Value of a Life

A Life’s Value

As U.S. Agencies Put More Value on a Life, Businesses Fret

As the players here remake the nation’s vast regulatory system, they have been grappling with a subject that is more the province of poets and philosophers than bureaucrats: what is the value of a human life? The answer determines how much spending the government should require to prevent a single death.

To protests from business and praise from unions, environmentalists and consumer groups, one agency after another has ratcheted up the price of life, justifying tougher — and more costly — standards.
The Environmental Protection Agency set the value of a life at $9.1 million last year in proposing tighter restrictions on air pollution. The agency used numbers as low as $6.8 million during the George W. Bush administration. The Food and Drug Administration declared that life was worth $7.9 million last year, up from $5 million in 2008, in proposing warning labels on cigarette packages featuring images of cancer victims.
The Transportation Department has used values of around $6 million to justify recent decisions to impose regulations that the Bush administration had rejected as too expensive, like requiring stronger roofs on cars.

And the numbers may keep climbing. In December, the E.P.A. said it might set the value of preventing cancer deaths 50 percent higher than other deaths, because cancer kills slowly. A report last year financed by the Department of Homeland Security suggested that the value of preventing deaths from terrorism might be 100 percent higher than other deaths.

...“Agencies have been using numbers that I thought were just too low,” said W. Kip Viscusi, a professor of economics at Vanderbilt University whose research is cited by most of the federal agencies as the basis for their calculations.

...some industry representatives said assigning a value to life was inherently subjective, and that the recent changes were driven by the administration’s pursuit of its regulatory agenda rather than scientific considerations.

“It looks like they just cooked the books — they just doubled the numbers,” said Todd Spencer, executive vice president of the Owner-Operator Independent Drivers Association, a trade group for the trucking industry, which faces higher costs under some of the Transportation Department’s new rules.

...The current rise in the value of life is based on the work of Professor Viscusi, who wrote his first paper on cost-benefit analysis as a Harvard undergraduate in the early 1970s. ...

The idea he and others have since developed in a long string of studies is that differences in wages show the value that workers place on avoiding the risk of death. Say that companies must pay lumberjacks an additional $1,000 a year to perform work that generally kills one in 1,000 workers. It follows that most Americans would forgo $1,000 a year to avoid that risk — and that 1,000 Americans will collectively forgo $1 million to avoid the same risk entirely. That number is said to be the “statistical value of life.”
Professor Viscusi’s work pegs it at around $8.7 million in current dollars.  Before the current administration, only the E.P.A. had fully embraced this methodology. Other agencies relied instead on the results of surveys asking Americans how much they would spend to avoid a given risk. This technique tends to produce significantly lower results. An even older technique, which yields even lower numbers, is to sum the wages lost when a worker dies.

Here is a comedian's take on the reductions in the value of a life that the government uses for regulations: Colbert Report. Time magazine reported that several foreign governments had been using yet another value per year:

In theory, a year of human life is priceless. In reality, it's worth $50,000. That's the international standard most private and government-run health insurance plans worldwide use to determine whether to cover a new medical procedure. More simply, insurance companies calculate that to make a treatment worth its cost, it must guarantee one year of 'quality life' for $50,000 or less. New research, however, would argue that that figure is far too low. Stanford economists have demonstrated that the average value of a year of quality human life is actually closer to about $129,000.

These Stanford economists used cost effectiveness analysis for determining that $129,000 is the best value of a year of life, but their . They basically looked at how costly kidney dialysis is and simply declared that to the the benchmark value of a life.  But nobody put much thought into the cost effectivness of kidney dialysis.  It is just a longstanding US tradition to pay for that.  

The Value of a Human Life for government agencies -  Mother Jones:

Though calculating the "value of a statistical life" (VSL) may sound callous or morbid, it can lead to stronger safety and environmental regulations. For example, auto safety rules that would cost $100 million to implement but might protect $500 million worth of lives (say, 100 people at $5 million a pop) are seen as a good deal, cost-benefit-wise. VSLs can vary widely, depending on the agency crunching the numbers and the administration in office. As this chart shows, the feds currently think each of us is worth somewhere between $5 million and $9.1 million.

Competitive Bidding and Lower Costs?

Kevin Drum says, "There's good evidence that competitive bidding is a useful part of the healthcare discussion and can indeed help control medical costs. But how much?" There are two studies I have seen on this, but that I do not understand and they both say that competitive bidding could reduce costs by about 8%.  However, two real-world caveats:
1. Medicare Advantage was supposed to do this and it has ended up costing taxpayers more than regular Medicare.  That is a pretty big strike against competitive bidding.  In theory it could work, but the only example of it in practice is a complete failure. 
2. One of the reasons that competition works poorly with Seniors is that a significant fraction of Seniors have some form of dementia or low literacy or depression, or some other difficulty shopping for something as complex as health insurance which is hard enough for an Economics PhD to sort out. 
3. Outsourced to Kevin:

...just focus on private insurance. When a corporation provides health insurance for its employees, what does it do? Answer: it sets some minimum requirements and then solicits competitive bids from insurance companies. After it gets the bids, it chooses one of the low bidders. This is competitive bidding in its purest form.

So how has that done at holding down healthcare costs? In case you need a hint, the charts on the right tell the story. Since 1999, according to the Kaiser Family Foundation, group insurance premiums have gone up 168%. And CBPP reportsthat private insurance costs have risen faster than Medicare costs consistently over the past four decades.

Private corporations all rely on competitive bidding, and it just hasn't done much to hold down costs. That's because the real source of America's high medical costs is the fact that we simply pay more than other countries for everything we get: more for doctors, more for procedures, more for hospital stays, more for drugs, and — yes — more for insurance.

The mechanism for competitive bidding is a voucher program or "premium support".  The major way that Paul Ryan's plan cuts the government's costs is by just capping government expenditures and letting more of the burden of paying increasing health costs fall upon senior citizens as health costs rise.  Ironically, this plan would eventually turn Medicare into something similar to Obamacare, but Ryan opposes Obamacare. 

5% lower quality for 50% lower price?

Healthcare is an area in which Americans are overly obsessed with getting the highest possible quality.  Many technological revolutions have produced new products that were initially at least of lower quality than the good that they replaced, but of much cheaper price.  For example, recorded music is still generally worse than live music, but it is much cheaper.  Mass-produced clothing is worse than custom tailored clothing, but much cheaper.  Many of our plastic consumer goods are a bit less durable, but much cheaper than what our parents used. 
Healthcare innovations are almost never this kind of advancement and that is one reason why technological change produces cost increases in healthcare whereas technological change often reduces costs in other industries. But there are many ways we could use existing technologies and institutions to reduce costs right now.  For example:
1. medical licensing is too strict and we need to expand the supply of doctors, particularly for primary care.
2. Expand the ability of nurse practitioners and physician's assistants to practice medicine independently.  They are much cheaper than doctors, but they charge the same amount because they can only work under the supervision of a doctor who gets the profits from their lower salaries. 
3. Increase telephone and online consultations.  There is telephone and online support for nearly every other industry, so why not in medicine?  It could replace a lot of office visits if doctors would answer questions more readily via telephone. People with low ability to pay for American doctors could even be allowed to use foreign doctors too. 
4.  Use more generic drugs.  We have already done a lot with this. 
5. Allow pharmacists to dispense more drugs without a prescription.  There could be an intermediary step between OTC and prescription in which pharmacists are required to do some basic education and patient screening before despensing medication.  Birth control pills are an excellent candidate for this and they are already available over the counter in most countries in the world. 

AMA: Good or Bad?

The American Medical Association is like a union for doctors.  The AMA is typically given the kind of respect that the public gives to doctors, but it is a lobbying organization that has always profited from selling its influence.  Its entire history, the AMA has behaved more like a greedy, for-profit corporation than like a public-interest group and it has promoted drugs and even tobacco in exchange for corporate cash. 

[T]he AMA eventually decided to sell advertising space for its medical journal JAMA to drug companies. Expanding on this business model, AMA President George Simmons decided to create the “AMA seal-of-approval” for favored drugs in 1899, resulting in a five-fold increase in advertising revenue by 1909. Simmons, it turned out, had no credible medical credentials and the AMA did no drug testing for the products given the seal-of-approval.
...Simmons’ focus on molding public opinion also became one of the greatest weapons of the AMA – his “Propaganda Department” would soon expand to communicate the AMA’s views through a column syndicated published in over 200 newspapers, a weekly radio program, and various books about how homeopathic practices and non-AMA approved drugs were “quackery.”
Through the 1930s to 1950s ...the tobacco industry leaned on the AMA to substantiate its dubious health claims. Beginning in 1933, JAMA published tobacco advertisements, stating that it had done so only “after careful consideration of the extent to which cigarettes were used by physicians in practice.” The tobacco industry became the AMA’s largest advertiser, and its implicit endorsement of tobacco products allowed companies like Camel to proclaim slogans such as, “More doctors smoke Camels than any other cigarette.”

...[Today the] AMA derives at least a fifth of its budget from drug companies through an arrangement known as “licensure.” The program consists of AMA selling drug companies its “Masterfile” of doctor profiles, spanning everything from detailed biographic information to an individual doctor’s prescription-writing history. The program is extremely controversial since drug companies in turn use the information to aggressively market their products to doctors. Controversial drugs Vioxx and Avandia, which have subsequently been found to pose significant risks to patients, have been marketed to doctors, in some cases, using information obtained from the AMA.
After an uproar in 2007, the AMA, through a policy of self-regulation, claimed to have stopped selling doctor prescription-writing information. But that pledge must be viewed with skepticism given the AMA’s track record.
During a Senate investigation of abuses of the licensure practice in 1990, the Boston Globe reported that AMA and PhRMA lobbyists came to Capitol Hill to promise Sen. Ted Kennedy (D-MA) that the program was not part of any effort to convince doctors to prescribe PhRMA drugs. This promise to self-regulate was never kept. In 2001 the New York Times reported that the AMA generated $20 million dollars a year from licensure sales to drug companies in a complex scheme to market drugs like Baycol to doctors. In 2006, that number climbed to $40 million, and in 2007 it was reported to be $45 million.
So while the AMA projects an image of representing doctors ...it is actually financially tethered to the drug industry. Unless there are major structural changes to the AMA and its sources of revenue, it is difficult to view the group as an honest broker in the reform dialogue.

And when the AMA isn't promoting drugs for pay, it has been acting like a union that tries to raise the incomes of doctors at the expense of the rest of society. It also has its good side, but that is usually all the public thinks about it.  

Health Care Spending Growth Slowing?

Washington Post:

The New England Journal of Medicine published a paper this week titled “When the Cost Curve Bent,” where researchers from the Center for Sustainable Health Costs suggest that the slowdown happened way before the recession. Their analysis shows — and you can see it in this chart — that excess health-care spending growth (any spending above and beyond potential gross domestic product) began to moderate in the early 2000s:
Most of the difference is that gray bar, the one that represents “non-personal health care.” That pretty much includes the cost of private health insurance, alongside the cost of administering government health-care programs and medical equipment — most of the stuff that isn’t a doctor seeing a patient, or a prescription.
“The most important factor in 2003 was the net cost of private insurance (roughly the difference between premium revenues and payments to health care providers), which rose sharply,” the researchers write. “In 2008 and 2009, that net cost dropped sharply, which, combined with reduced spending on structures and equipment, drove down overall excess spending.”

Cost Benefit/Effectiveness Analysis and Innovation

The Institute of Medicine produced a book entitled, Medical Innovation in the Changing Healthcare Marketplace.  The following selection shows how important cost effectiveness is. We have a limited budget and we should spend on things that get us the greatest value and that is what cost benefit analysis and cost benefit/effectiveness analysis tries to do. Even though most research is a failure that produces nothing useful, a few breakthroughs have had a tremendous impact and so research has had tremendous value.

Cost-benefit analysis translates the benefits (health and saving lives) into dollars:

p. 17: University of Chicago economists Kevin Murphy and Robert Topel sought to evaluate the social benefits of medical research by placing a value on aggregate improvements in longevity … The first task was to estimate what an average American would agree to pay for a reduction in mortality risk that would add a year to his/her life. Murphy and Topel used data on what workers are paid in occupations with differing risks of job-related death to estimate the value of an additional life-year to be about $150,000, a figure that varies with age.

Over the period 1970–1990 increases in the life span of an average American have been significant. For example, the increase in the life span of a typical 40-year-old person is more than three years. Using age-dependent values of an additional life-year and the increases in life expectancy over this period, Murphy and Topel attribute a value of roughly $57 trillion or about $2.8 trillion per year to the increased life expectancy, indicating the public values improvements in health very highly. To put these figures in perspective, improvements in life expectancy over the period 1970–1990 contributed about as much to overall welfare as did improvements in material wealth.

p. 18: Kevin Murphy pointed out that investment in medical research has brought significant returns. In 1995, according to NSF calculations there were about $35 billion in investments in medical research. The gain in health, as measured by the value of added longevity, is about 50-100 times what we spend on research, even taking into account the fact that health improvements are due to a variety of factors.

Looking forward, Murphy said that potential future gains will also be very large. For example, eliminating cancer is worth roughly $47 trillion. Further, the economic value of disease reduction is increasing significantly over time… as the wealth of the population increases. In addition, the value of progress against any one disease rises as we make progress against other diseases. For example, as we have made progress against heart disease and, hopefully, make progress against cancer, the value of curing/mitigating Alzheimer’s disease increases. The reverse is also true. Progress against Alzheimer’s disease makes further progress against cancer or heart diseases much more attractive because of a better life in those later years as well as more years to live.

MAJOR RETURNS ON INVESTMENT IN MEDICAL TECHNOLOGY FOR CARDIOVASCULAR DISEASE :  David Cutler, a Harvard University economist, explained that life expectancy has increased 9 years since 1950 with about half of this increase resulting from reduced mortality from cardiovascular disease. These successes in treating/preventing cardiovascular disease can be attributed to developments in the intensive treatment of heart attacks, new medications for chronic heart disease (hypertension, cholesterol, angina), and behavioral changes (less smoking, reduced fat intake, decline in heavy drinking). These developments, including the behavioral changes, are products of medical research.

To determine the return on medical care and basic research (Cutler, Forthcoming), Cutler attributed roughly one-third of the benefits to developments in intensive treatment, roughly one-third to new medications, and the remaining third to behavioral changes. For someone 45 years old the total increase in longevity is about 5 years since 1950, of which about 41/2 years is a result of reduced cardiovascular disease mortality, with 3 years from medical treatments and 11/2 years from behavioral changes. For someone 45 years old the average cost of medical treatment on cardiovascular disease is $30,000 in present value terms. The costs of providing behavioral advice are much less—David Cutler estimated about $1,000 to cover the costs of research and consultation with health care professionals. For the purpose of estimating benefits, Cutler assumed an extra year of life to be worth $100,000.

p. 19: For the return on medical care [for cardiovascular disease], there is a cost of $30,000 in exchange for three extra years. These three extra years are [only valued at]... $120,000 [total] because the benefits occur in the future and need to be discounted. Even so, the return for medical care is very large, on the order of 4 to 1. For the return on behavioral changes, there is a cost of $1,000 in exchange for just over an extra year. [The additional year is discounted more than for medical care because it is farther in the future on average and so the value is only] $30,000. Thus, the return on behavioral changes (30:1) is much higher than the return for medical care.

Cost-effectiveness analysis only measures the costs of treatment in dollars and sees which is cheaper for accomplishing the same goal of reducing mortality or morbidity.  This is less controversial because of the difficulties and subjectivities involved in estimating the dollar value of a life, but both methods generally lead to exactly the same policy conclusions.   

SIGNIFICANT POTENTIAL BENEFITS FROM MELANOMA PREVENTION PROGRAMS

As Cutler pointed out… life style changes have brought about significant reductions in cardiovascular deaths. Life style changes can also have an impact on the incidence of melanoma. Margaret Tucker of the National Cancer Institute said that although the incidence of melanoma is increasing, it is a disease that can be prevented by decreasing sun exposure. To achieve this, major cultural issues need to be addressed since having a tan is an important part of “looking healthy” in American culture. These cultural problems have been successfully addressed in Australia where considerable investment in a prevention program has resulted in melanoma incidence rates leveling off, possibly even decreasing. The Australian program taught the need for sunscreens and protective clothing and led governments to provide shade at nearly all outdoor pools and school playgrounds.

Tucker also said that secondary prevention/early detection is practicable. In Australia, it has been estimated that a family practitioner doing a 2-year screening for adults over 50 costs about $12,000 per male life-year saved, and $21,000 per female life year saved (Carter et al., 1999). In America, it has been estimated that a one-time screen by a dermatologist with treatment would cost $29,000 per life year saved (see below). These costs would decrease for targeted screening.

p. 20: …The issue of whether screening is cost-effective was addressed in a recent study by Freedberg et al (1999). This study examined whether no screening or a single one-time screen by a dermatologist could be cost effective for high-risk patients. The study found that it is cost-effective but highly dependent on the initial cost. If the screen costs $30 then the cost per life year saved is $29,170. However, if the screen costs $120 then the cost per life year saved is $110,000, a considerably higher figure whose acceptability is debatable.