I was reading a WSJ opinion piece on medical reform, and while I agree with a number of topics, there is one comment, despite the writer's credentials, with which I simply disagree.

The bottom line is that our health care is costly because it is costly, not because we deliver more care, better care or special care. Alas, a solution that does not address the cost of care, and negotiate new prices for the services offered will not work; a solution that does not put caps on spending and that instead projects cost-savings here and there also won’t cut it. Leaders have to make tough and unpopular decisions, and if he is to be the first President to successfully accomplish reform there does not seem to be much choice: cut costs.

The problem is, the author touched on the cause of many of these costs earlier, yet failed to notice it. The costs are not simply "corruption" or self-serving doctors. In fact, if I were forced to put a number on it, I would guess not even 10% of costs are doctors ordering needless tests.

No, our costs are of six types.

First, there is defensive medicine. Because of the bizarre way we have defined malpractice, the courts have made it almost inevitable that needless tests, or tests of dubious necessity will be ordered. For example, even the lightest bump to the head routinely gets imaging done. Why? Because a tap to the skull can cause brain damage? Because brain damage is likely? No, but because the 1 in 1000 where it does can cost the doctor tens of millions of dollars. So, to avoid a risk likely to strike 1 in 10,000 or fewer, he orders thousands of dollars of tests per patient, because he doesn't have to pay for it (and neither do most patients), but if he does not order such tests, he could very well be bankrupted.

Second, we have the phenomenon I described in "Government Efficiency". By limiting competing hospital services, restricting access to equipment, and generally preventing competition, the government drives up costs for everyone. Were it not for the explosion of the much abused "imaging centers" MRI, CT, PET and other imagining systems would be even more expensive. Only because of the slightly larger economies of scale imaging centers make possible have costs come down at all. Were we still limited by government certificates of need with only hospitals providing imaging, MRIs would probably cost $10,000 a series or more.

Third, we have the costs imposed because of the government insurance, the DRG system which encourages massive throughput, favored diagnoses, and the related workups and tests. The writer mentioned these, but did not go into it sufficiently. Government insurance, by favoring cookie cutter medicine with huge volume, tends to encourage doctors to treat all patients identically, including ordering unneeded tests simply because everyone gets them. And, HMOs, being basically the private sector version of DRGs tend to encourage the same treatment, spreading the government problems beyond the realm of those getting government care.

Fourth, we have the unreimbursed losses. Some of this is related to government care, as DRGs for some conditions pay much less than real care costs. A patient who has a heart attack, gets admitted and dies is a gold mine for a hospital, but one who lingers in ICU with no additional diagnoses is a money loser. Add to this the costs borne for the indigent, illegal aliens, and those simply unwilling or unable to pay, and you get some pretty hefty losses that need to be covered. And, yes, hospitals do turn a profit, but that does not mean they are covering their losses. Think of it this way, if hospitals have a 5% profit and the market is returning 9% on investments, then hospitals will be unable to attract investors or get loans easily. Just turning a profit is not enough, they must turn a profit equal to the market. So, if losses just drop them below the prevailing rate of return it can be enough to make it hard for hospitals to operate or expand.

Fifth, we have the problems associated with near universal insurance. I know "universal insurance" is supposed to be a good thing, but in practice it is not. When insurance pays for everything, there is no incentive to economize. Think of it this way, those people who comparison shop, who clip coupons, who buy generic, who shop around for the cheapest food, would they do the same if someone else paid for all their food? Well the same is true in health care. By making most Americans insured, the WWII era plan of tying insurance to employment made cost competition vanish. Customers no longer have an interest in shopping for cheaper services, and they do not have to decide whether or not to undergo a procedure based on cost. When we have to pay out of pocket, we may decide a $10,000 procedure to correct a trivial problem is too costly, when insurance covers all but $100 we do not. And so, by making insurance universal, or nearly so, we have caused prices to balloon, and eliminated what little competition there was after the government's anti-competitive policies.

Finally, we have a set of costs that I am surprised the author missed. These are costs because, despite his claims, we do get better care. I have had tests that did not exist 10 years ago. I have had treatments that were unthinkable a few years ago. When my grandfather had his gall bladder removed, he was in bed for a week, and that was only 30 years ago. When my wife had her gall bladder out, she would have spent one night in the hospital had she not suffered complications. That is a real improvement, and, as in any field, improvements, for a time, drive up costs. And, as medicine is constantly improving, so too are costs for the newest treatments always high.

The problem is, in any other field, not everyone gets the newest and most costly. I may buy a top of the line computer as it is useful for my job, you may buy one which was top of the line a year ago, and someone else may buy one that was substandard three years ago. We each buy by balancing costs and benefits. In health care, that is not true. As insurance pays for almost everything, we all tend to develop caviar tastes. We all buy the top of the line health care, and so the costs continue to rise, as everyone is buying the cutting edge, top of the line treatment.

Which brings me to the solution. Or rather solutions.

First, we need to get rid of the idea of universal insurance. Insurance should receive no tax benefits, nor should it be mandated to cover anything. It should be a purely private contract between insurer and insured, with cost relating to coverage, and coverage negotiated by the two parties. If the cost of insurance truly reflected the price of services, people may be inclined to carry less, to use less, and to shop around more.

Second, we need to get the government out. Allow more competition, allow hospitals to offer whatever services they see fit. if that means one city has five trauma centers, so be it. Having a coffee house on every corner has not priced coffee out of reach, it reduces prices. The same will happen with health care. (You do not need to go as far as I did in "Medical Regulation II" and argue for ending medical licensing and prescription laws, but I do think that would truly allow competition and have beneficial effects, but I know I am in a very small minority on that point.)

Third, once we have corrected the anti-competitive government laws and fixed private insurance, we need to eliminate government insurance. As so many rely on these programs, we will probably need to grandfather existing users and those close to retirement, but beyond that we need to end both retirement medical coverage and medical coverage for the indigent. These programs seem sympathetic, but in the end they provide fewer benefits than private charity while causing tremendous harm.

Finally, after all else, we need to address malpractice and the tort system as a whole. They are a factor in rising medical costs, but one so inferior to the others that they can wait for the last step. We do need to stop demanding omniscience and perfection of our doctors, and should not imagine a standard of care that borders on impossible. However, the simple solution is also the most effective. if we can restore power to contracts, and allow doctors and patients to both establish expectations and assign liability in a binding contract, then we have no need for most malpractice reform. After all, torts only went wild after the law of contracts was destroyed by the courts, so, logically, restoring the right to contract could undo all the damage done by its loss.

I am sure along the way other issues will arise which will need to be addressed. The losses run up by those who don't pay. Those who use the emergency room as primary care and so on. But by and large, these four steps will resolve the vast majority of problems. If they were carried out, I doubt that any of the remaining problems would be insurmountable.

Of course I expect none of this to be done in the near future. The concept of "universal health care", and the even more harmful idea of "universal insurance", have taken hold too firmly, so we are probably destined to suffer through some sort of ill-conceived socialized medicine before real reform can take place. But hopefully, once we have worked our way through that purgatory, we will finally see the wisdom of keeping the state out of our most important decisions, including our own medical care.

POSTSCRIPT

I would recommend readers check out "A Passing Thought on ObamaCare" for a look at more specific issues. I would also recommend "Misunderstanding Profits", as it explains the mistake behind claims that socialized medicine or some other "single payer system" would reduce inefficiencies.

UPDATE (06/23/2009)

I forgot that I had proposed some of these solutions in an earlier post. So I feel I should add a link for "Almost Right".