ADMINISTERED PRICES & HEALTH CARE

A PAST - AND FUTURE - FAILURE

FUTURECASTS online magazine
www.futurecasts.com
Vol. 9, No. 8, 8/1/07

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 Invariable failure:

 

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   As rising prices in health care and pharmaceuticals leads the government ever further into the morass of the health care market, it is well to remind ourselves of why one type of government economic policy - government administered prices - has always failed in the past - and will always fail in the future.
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Much of the intellectual community remains determinedly ignorant of the futility of administered prices. 

   Actually, extensive studies of administered pricing have been conducted by a major government agency. These studies have provided clear and convincing proof of the futility of price controls and other forms of government administered prices. Unfortunately, much of the rest of the government has repeatedly chosen to ignore this proof - to the great cost of the American economy. Much of the intellectual community also remains determinedly ignorant of this proof.
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 The SEC studies:

 

 

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   The U.S. Securities and Exchange Commission ("SEC") during the 1960s and early 1970s was one of the most dedicated, experienced and capable agencies in or out of government. The quality of the men who held the five commissioner positions was traditionally high and had probably never been higher than during that period. The quality and dedication of the staff was unchallenged even by its most severe critics. Enthusiasm and morale within the SEC was always at high levels.
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No amount of conscientiously applied human intellectual effort could come close to duplicating the results that are routinely achieved by competitive markets - even in instances where competition falls far short of being perfect.

  The inescapable conclusion of this agency, however, was that it lacked the ability to arrive at reasonable minimum commission rates for the securities industry, and that no amount of conscientiously applied human intellectual effort could come close to duplicating the results that are routinely achieved by competitive markets - even in instances where competition falls far short of being perfect.
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  What made this administrative retreat even more remarkable was the fact that commission rates had not - for almost two centuries - ever been set by competitive forces. They had been fixed by the industry ever since the establishment of the New York Stock Exchange late in the 18th century. Moreover, the SEC's price control efforts were limited to just one of the many services offered by a single industry with whose operations it was intimately familiar.
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  In May, 1975, the SEC forced the securities industry to abandon fixed commission rates. The reasons for this decision were broadly applicable to just about all government price administration efforts - whether directed at fixing minimum or maximum prices - and are also instructive with respect to some of the many ways in which price controls actually push prices higher and strengthen the forces of inflation.
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 Price controlling agencies never come close to gaining a full appreciation of all of the ramifications of their actions.
   The imposition of price controls or administered prices always seems easier in contemplation than they actually turn out to be in actual practice. This is because of the great diversity of our economic entities and products, and the dynamics of accelerating economic change.
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  The price controlling agencies never come close to gaining a full appreciation of all of the ramifications of their actions, and their procedures never come close to keeping pace with the rate of pertinent economic and technological changes. These disadvantages are serious enough during periods of relative economic stability. They became overwhelming during the inflationary times of the 1970s.
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     One of the SEC's statutory duties is to assure that commission rates charged by brokers are "reasonable." The SEC staff was aware that - under fixed commission rates - several brokerage houses were achieving extremely wide profit margins. However, they were stymied in their effort to reduce commission rates because - due to the vast diversity of broker-dealer operations - many others were operating on narrow profit margins and would have been seriously undermined by any effort to reduce commission rates.
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  The broker-dealer business of that time varied not only with the size of the firm, but also with the mix of firm business. Only a few specialized in serving large numbers of small investors. Others specialized in serving a few large customers, underwriting new issues, servicing institutional or discretionary accounts, and/or executing large "block" trades.
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  Thus, the efficiency with which individual firms could execute a single 100 share order varied greatly. Moreover, the execution of a 10,000 share order cost considerably less than 100 times that of a 100 share order but - with commissions fixed - earned a commission 100 times greater. Further complicating the problem was the widely varying impacts that the frequent sharp increases and decreases in trading volume had on the various types of firms.
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 Fixed and administered prices are invariably inflationary.
   Competition isn't eliminated by the elimination of price competition. It is just perverted.
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  Producers and suppliers always face a wide range of choices in the quantity, variety and quality of goods and services they provide. Price competition assures that - in making these choices - costs and prices will be kept down. Without price competition, producers compete by increasing the quantity, quality and variety they offer - thus increasing costs and providing a constant upward pressure on the fixed price. This happened, for example, before deregulation in the airlines industry - and it happened in the securities industry.
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     As a result of SEC studies of the problem, many members of the SEC staff became convinced during the 1960s that minimum commission rates were fixed at an "umbrella" level capable of sheltering even the most inefficient firms. Moreover, they were convinced that - without the restraints of price competition - other forms of competition resulted in ever-increasing costs which, in turn, were used to justify a continuous succession of increases in the levels of fixed commission rates that were "reasonable" in light of industry costs. Despairing of its ability to control so complex a situation, the SEC decided that the automatic controls of private enterprise competitive market capitalism were the only tools available capable of doing the job.
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  The SEC thus began to foster meaningful price competition that would provide constant pressure to induce broker-dealers to reduce costs. The process culminated in May, 1975, when all fixed commission rates were abolished.
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   Wall Street adamantly opposed the application to its operations of the price competition that is so important a part of the private enterprise market mechanism.
  The results were immediate and massive. Securities industry firms began reevaluating their operations, cutting out marginal services, upgrading other services to make them saleable, and competing vigorously for business. Institutions began receiving commission "discounts" as high as 40 and 50 percent, providing significant savings for their millions of beneficiaries. Even the small individual investor benefited - receiving a variety of offers for novel, low cost investment services from the major retail firms and new upstarts.
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  Wall Street - the financial heart of the private enterprise system - adamantly opposed the application to its operations of the price competition that is so important a part of the private enterprise market mechanism.
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 Price competition is capitalism's disciplinarian.
   Price competition is the disciplinarian of capitalism. It is far more ruthless and thorough than any administrative agency can be without undermining the health of the industry it presides over.
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     It is thus neither inconsistent nor paradoxical that businessmen acknowledge the importance of competition for the general economy while trying - by recourse to private or government restraints on competition - to shield their individual interests from its impact. Professional basketball players recognize the importance of the referee, but still seek to conceal their own transgressions. Even the most valued disciplinarian is disliked and, as expected, the shakeout in the securities industry was rapid and massive.
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  However, those firms that fell or were sold out disappeared for economic reasons, and not because some administrative agency had bungled its price fixing chores.
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 The rest of the government failed to get the message - or chose to ignore it.
   Unfortunately - but not unsurprisingly - the other arms of government ignored what was happening in the SEC. During the 1970s, various price fixing and administered pricing schemes were resorted to - with uniformly disastrous results - in response to the powerful inflationary forces that the government's Keynesian monetary policies were inflicting on the nation.
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 Farm subsidies cause enlarged and wasteful surplus crops.
   It has been over eight decades now since the federal government began trying to influence agricultural prices. One scheme after another has been tried and found wanting. At the turn of the century, government subsidies were paid by the bushel - so wheat farmers hastily switched to corn, which yields 200 bushels per acre as against 40 bushels per acre for wheat. Needless to say, the total of agricultural surpluses soared and farm subsidies rose to 40 percent of gross farm receipts. Now, the government favors inefficient corn ethanol production for political reasons when sugar ethanol could be imported far more efficiently.
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The threat of excess profits taxes and price controls destroys all incentive for farsighted businessmen to take the financial risks of investing in or even maintaining excess capacity or excess inventory in the event of future supply shortages.

   The energy crisis during the 1970s was extended at least four years by the imposition of "excess profits" taxes and by massive and expensive government interference with energy prices. "Excess profits" - realized when some unexpected economic, military or natural disturbance suddenly restricts supply - actually play a very positive role in the economic adjustment process. Excess profits taxes - like price controls - can grossly extend the time and expense of such disturbances.
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  This is what happened during the phony "energy shortage" of the 1970s. Even just the threat of excess profits taxes and price controls destroys all incentive for farsighted businessmen to take the financial risks of investing in or even maintaining excess capacity or excess inventory in the event of future supply shortages. The suddenness and severity of current energy shortages were undoubtedly far worse than they otherwise would have been if past experience with "excess profits" taxes and energy price controls had not deterred all thought of investing in extra capacity or inventory ahead of the easily predictable arrival of the current shortages.
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  The periods of 1970s price controls witnessed a wide array of wasteful absurdities. The substitution of expensive hardwoods for cheaper and more abundant softwoods for use in ordinary shipping pallets was typical of the results.
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 Deregulation occurs after government screws up so badly that there is simply nothing else left to do.
   Even the liberal Carter Administration was ready to throw in the towel by the end of the 1970s. The deregulation bandwagon started rolling, as politicians and bureaucrats faced the economic chaos they were creating and reluctantly loosed the reigns of economic power that they loved. This laudable impulse was continued with vigor by the Reagan Administration, freeing such vital industries as trucking, airlines, telecommunications, and finally energy, from the suffocating tentacles of the federal bureaucracy.
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  In all cases, the market responses were rapid and beneficial to consumers, as prices fell and the services offered were expanded.
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 Everything the government touches turns to stone.
   Nor is this true only for the federal government. Local government price control efforts - especially with respect to rent controls - have experienced similar fates. Invariably, administered efforts to reduce prices result in flights of capital, abandoned and/or deteriorating buildings, and the disappearance of new construction.
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 Health care:

A segment of the intellectual community remains determinedly - indeed intentionally - ignorant of  basic economic realities.

  Undaunted by this record of invariable and catastrophic failure, many of our brilliant political leaders have continued to wrap our vital health care industry in an increasingly smothering blanket of third party payer and administered pricing schemes. They have been cheered on by a segment of the nation's intellectual community that remains determinedly - indeed intentionally - ignorant of the most basic economic realities. The results are inevitable.
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 The inherent absurdities of administered pricing schemes now bring widespread dissatisfaction among patients, doctors, and political leaders alike.
   Health care is far more varied - far more complex - than brokerage services. The health care industry is far more varied and complex than the trucking, airlines, telecommunications, or rental housing industry. Health care services are not fungible. There exists no criterion by which compensation can be administratively set for quality of care and for the different varieties of care available. (The public school system has notoriously been unable to evaluate and compensate excellence among its teachers.)
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  Advances in health care, administrative technology and medicinal drugs proceed at a dizzying pace. Anyone who does not appreciate the chaos that administered pricing is causing - and will cause - in health care - is an idiot.
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  A variety of noxious unintended consequences have flowed from the tax laws and well intentioned initiatives that have broadened access to health care during the last seven decades. Third party payer systems financed by employers and government instead of by the insurance providers and program beneficiaries have slowly short circuited free market pricing disciplines in the health care industry. Costs rising well above the rate of inflation for several decades have forced recourse to administered pricing schemes under Medicare, Medicaid and other public insurance programs as well as under managed care private insurance programs.
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  Managed care seemed to work for a short while as long as there was obvious fat to cut out of the system, but that stage ended before the end of the last decade. The inherent absurdities of administered pricing schemes now bring widespread dissatisfaction among patients, doctors, and political leaders alike.
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 Healthcare will remain the most troublesome sector of our economy.
   Health care has become increasingly expensive, impersonal, and error-prone. Health care continues to benefit from great scientific strides. However, FUTURECASTS has from its beginnings predicted that heavy and increasing government involvement will continue to make health care the most troublesome sector of our economy. See, "Economic Futurecast," at segment "9) Health Care Industry Problems will Worsen." The industry is inevitably becoming increasingly bureaucratized. It is increasingly being forced into a mass medicine mode where patients are dealt with as mere throughput.
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 Reform efforts will fail unless based on market mechanisms:
   The series of health care reform efforts continues, as FUTURECASTS expected. However, except for those reforms based on market mechanisms (like substantial copay requirements and deductible levels and health savings accounts - see, Gratzer, "The Health Care Cure"), FUTURECASTS continues to predict that reform efforts will invariably make matters worse. A widely supported government administered single payer system may appear workable in the short run based on health care assets already in place (see, Richmond & Fine,  "The Health Care Mess."), but will ultimately be a disaster. Application of the forces of competition to generate the delivery of health care "value" to patients will be an essential part of any viable health care reform. (See, Porter & Teisberg, "Redefining Health Care: Creating Value- Based Competition on Results.")
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 Medicare providers are smothering under 130,000 pages of regulations.
   Health care costs keep rising at rates well above the rate of inflation. The Health Care Financing Administration now imposes about 130,000 pages of regulations on health care providers - and one third of all Medicare dollars go for administrative expenses.
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  Private managed care providers experience similar levels of administrative costs. Hospitals, clinics, and private health care providers struggle to comply with the regulations and red tape of public and private managed care third party payers.
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  The General Accountability Office (GAO), a highly competent Congressional watchdog agency, has of course studied these matters. A typical result from a few years ago was GAO: B-285401(Aug. 2000) which examined the problems of Medicare administered pricing efforts. The study found:
  • Different providers have substantial differences in the health status of their enrollees.
  • Different institutions have different cost structures. Teaching hospitals have different costs from major city hospitals which differ from hospitals in small communities.
  • Providers servicing large retirement communities have differing cost structures, too.
  • Payment rates must also accommodate future increases in health care costs. Such forecasts are hardly precise - and usually over estimate costs. (Payment recipients inevitably become expert at gaming the system.)

  Moreover, these relationships are constantly changing. Payment levels that threaten some providers with financial failure thus can generate great profits for others. This is unsurprisingly similar to the findings of the SEC studies on fixed commission rates during the 1960s.
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  Medicare attempts a variety of adjustments based on enrollee age, relative health and sex and location - but is never able to get it right. All of these adjustments require a vast flow of data from providers - which pushes up administrative costs. The HCFA is insatiable in its desire for additional data that it hopes will improve the adjustment process.
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  Indeed, once divorced from market direction, government economic programs generate an insatiable need for data to provide some rational basis for decisions. There are inevitably errors of omission and commission in entering data and compiling it. There are inevitably problems in getting data, understanding it, and using it.
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  Over the decades, GAO analyses repeatedly identify defects in available data as a limiting factor. Program changes repeatedly outdate or even render obsolete the data collected. Complexity quickly reaches frustrating levels. There is nobody who actually knows what is in the 130,000 pages of Medicare regulations.
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  Reports inevitably contain much useless information and omit much that is needed. Forms invariably contain inadequacies and ambiguities. Necessary coordination between different agencies with different information needs and systems create vast additional complexities.
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  Of course, experienced staff learn how to get the information they need despite the weaknesses in the information system. Sometimes they create redundant information systems of their own to meet the particular needs of various levels in the bureaucratic chain. This, too, imposes additional costs on the system.
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  Then there are problems with the various information technology systems in use. Modern information technology systems can have problems with both hardware and software. One GAO report typically found an examined information system "is not providing the timely, accurate, complete and appropriate information needed at the headquarters and district office levels to manage the program." The system is "cumbersome and difficult to use." There is incomplete data and a lack of data on program services that is not quantifiable. The GAO recommended abandonment of this system.
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  Indeed, the wholesale failure and abandonment of vast, expensive state and federal data collection and information technology systems is not uncommon. All schemes for government programs depend on adequate information technology and take it for granted that it will be provided. The reality is much different. The reality is that funding limitations frequently make these systems permanently inadequate and outdated.
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 High paid consultants are hired to mine the Medicare regulations for reimbursements.
   Top hospital executives are paid large salaries and employ substantial administrative staffs to grapple with these problems. One of the most highly paid individuals on the payroll of many hospitals is the consultant who is hired to grapple with the Medicare reimbursement regulations.
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   In spite of all the red tape and regulations - indeed, because of all the red tape and regulations - tens of billions of dollars are admittedly lost to fraud, waste and abuse every year.
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 The employers and the politicians are the customers of these insurance providers - not the employees and patients. Quality of care ceases to be a criterion for reimbursement.

   Rapidly rising health care costs have also forced inevitable responses in private insurance. The traditional employer provided "cost plus" fee-for-service insurance policies short circuited market pricing disciplines and could not be maintained. Managed care seeks to substitute administered pricing for market mechanisms as a restraining force on these rising costs. It should surprise nobody that this is a poor substitute.
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  Those insured through their jobs or through government programs like Medicare must understand that the employers and the politicians are the customers of the insurance providers - not the employees and patients. Quality of care ceases to be a criterion for reimbursement.
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  Legislation that mandates "patients' rights" simply undercut cost restraints and further loose the forces of health care cost inflation. The health care dollar must now also fund a wide array of managed care administrative services, such as sales and brokerage, public relations and advertising, financing, claims handling, and an additional layer of utilization review, information technology, and management of cases and prescription drug benefits. Of course, the cost of liability insurance has risen rapidly.
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Actually, health care costs are declining even though health care spending keeps going up.

  Actually, the real costs of health care are going down. It is health care "spending" that is rising. Most health care procedures and drugs have experienced dramatic increases in effectiveness and efficiency in recent decades - with better outcomes, fewer side effects, and shorter recovery times. However, more health care services are now available, and the administrative costs of delivering health care services and drugs have risen dramatically. Further elaboration of Food and Drug Administration procedures have greatly increased the costs of developing new drugs - and deter even the effort to develop niche drugs.
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 Teaching hospitals are observably withering on the constricted vines of third party payer reimbursement limitations and administered pricing schemes.
   Increasing - and increasingly noxious - administrative requirements can adversely affect the quality of health care services. Many doctors will not take Medicaid patients or limit the numbers they will accept. The Canadian nationalized health care system has widespread shortages of doctors and modern diagnostic equipment. If many Canadians didn't cross the border to get the care they need, the problems of the Canadian system would be much worse.
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  Teaching hospitals worry that third party payer reimbursement limitations and administered pricing schemes will restrict their ability to teach the next generation of health care providers. Current reimbursement schemes that pay fixed amounts per patient according to the diagnosis obviously leave fewer resources for educational purposes and undermine teaching hospitals, which generally receive more of the sickest patients and most difficult cases. The number of doctors and nurses being turned out is woefully short of requirements - mitigated only by the substantial numbers of health care professionals that the U.S. attracts from third world nations that are thus left short of the health care personnel that they desperately need.
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 All too often, doctors are reduced to mere retail outlets for drug company products.
   Teaching hospitals are being forced to turn over increasing parts of their educational responsibilities to the drug companies. All important clinical education suffers for lack of time to teach and learn. Clinical experience is restricted by the emphasis on keeping people out of hospitals or shortening hospital stays and broadening the scope of ambulatory care, as well as by restraints on the time doctors can spend with individual patients. Teaching hospitals are now increasingly being restricted to intensive care and major surgery patients.
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  Students thus see a much narrower segment of the medical care process, have less sustained contact with patients, and receive less personal instruction from experienced faculty. These administered pricing schemes similarly limit the teaching hospital role as a source of clinical research and new clinical knowledge
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  With much less time to give to each patient, doctors have become over-dependent on testing methods that - for all their modern sophistication - are still all too often ambiguous in result. All too often, doctors are reduced to mere retail outlets for drug company products.
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  These are some of the results of government health care efforts that the politicians and advocates of nationalized health care don't want to discuss.
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 Unintended consequences are widely ignored.
   Nevertheless, various administered pricing and subsidized access schemes are a feature of each year's political campaigns. All candidates promise much - but none account for the unintended results of their actions. All of their budget estimates are based on current usage - notoriously inaccurate "static analysis" - which ignores the inevitable impacts of the plans.
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 The inefficiencies of broad coverage third party payer schemes, and the problems of administered pricing schemes, are the inevitable results of proposed health care reforms.
   Plans to help the working poor buy insurance will surely lead many employers - especially small employers - to drop health care benefits for low wage employees - leaving it to the government to pick up much of their employee health care costs. Fixed price, low cost insurance schemes for families or those in the 55 year to 65 year age group will surely lead to higher than expected costs, since it inevitably will be people with poor health who will be the first to buy into the system. Schemes for subsidized drug coverage have now been enacted, and will surely increase drug usage, destroy what limited market restraints there are on drug prices - even for generic drugs - and massively increase program expense.
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  All of these proposed third party payer benefits have the inherent inefficiency of all broad coverage third party payer benefits. The same coverage is offered to all eligible participants, regardless of circumstances, leading to gross inefficiencies. Inevitable efforts to limit cost growth by means of administered pricing schemes - as some politicians already propose - bring all of the problems of administered pricing schemes into play. Ultimately, in one way or another, the only alternative becomes the rationing of care.
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 The United States market subsidizes the development of new drugs for nations all around the world.
   The pipeline of promising new drugs now being developed would be quickly restricted or turned off by efforts to reduce prescription drug prices to levels available in foreign nations. The effect would be to apply foreign price controls to the United States market. Currently, drug prices in the U.S.  market subsidize the development of new drugs for nations all around the world. If prices in the U.S. market are restricted, research and development will die.
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  As for medical care generally - just imagine the costs of extending Medicare pricing regulations over the whole of the health care industry.
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  Of course, there is always the option of a nationalized health care system - towards which we seem to be inevitably heading - with all of the horrors that any complex socialist scheme entails.

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Copyright 2007 Dan Blatt