On Health-care Pt. 2.7: Reform is not inherently evil

Health-care reform has been a BigDeal(tm) lately, and I wanted to express some thoughts about it, the way it works and my general gripes about what is decidedly not real progress in my mind. In this series I will explore the benefits and failures of the current path of health-care reform in the United States. I will talk about insurance companies and risk pools; the difference between moral, political and economic decisions; and (in)efficiencies of scale in different levels of the industry.

On the April 17th, 2010 edition of The Economist, packed between an article about how we shouldn't eat our vegetables (seriously) and something about that slowly disintegrating Mediterranean economy, there was an article about dialysis. Most of the content matter was nothing new. Dialysis is expensive, sometimes up to $80,000 per person per year; many people die; the drugs and equipment are expensive. Basically, the same old "is it worth $x to keep this person alive?" question that is guaranteed to get everyone to scream over each other and not much else. But, while cruising through snooze-ville, I came across these little gems:

... running dialysis clinics and administering drugs, which account for 80% of the cost of dialysis. The two biggest operators of dialysis clinics are Fresenius and DaVita ...  Each of them runs almost a third of America’s dialysis clinics.

American dialysis clinics are paid on a “cost-plus” basis for the drugs they use ... American clinics used to favour an injected drug costing $4,100 a year over an identical oral one which was introduced to the market at a cost of $450 a year. After languishing unused, the oral drug now costs more than the injected one.

In case you didn't follow, here's how I understand this: Some pharma company came up with a drug that could be administered orally instead of intravenously and cost 11% of the original drug. Wow, that seems both convenient and economical! The maker couldn't sell this new, cheaper substitute because what clinics are paid is based on the cost of the drugs, therefore cheaper drugs meant less profits. In order to sell their new drug, the drug maker increased the price to a level above the injected substitute and the clinics, lured by higher profits, switched to it too. Clinics were able to do this because they could just bill it to the insurers. Patients didn't care because they were too worried about not dying, and because the insurer is paying anyways. This is big money! The government alone spends "$24 billion a year," and private insurers spend even more, although no exact figure was given. In any case, that's $48+ billion.

That, my (few) readers, is what we call "negative price elasticity of demand," resulting from the presence of a "perverse incentive."

Your friendly neighborhood tea-partier might be pointing to this as proof that the evil socialist health-care reform is going to bankrupt this once-great, once-capitalist nation, but he/she would be wrong:

The reforms will introduce a “bundled price”, whereby clinics receive a set rate for providing treatment. Analysts expect drug costs to fall by at least 10% soon after the change, as clinics use fewer or cheaper drugs.

Take that reactionaries!