How Much Should Health Care Cost in America?

Many believe that health care in America is very expensive. But few Americans actually know what health care costs them, because they don’t pay for it in the same way that they pay for food or other things they need.

It’s actually a good question: How much should health care cost in America? At the rate we’re going, we’ll never know.

How much should anything cost? How much, for example, should shoes cost? Should shoes be cheap, so people can spend their hard-earned money on other things? Or should they be expensive, so the shoemaker earns a good living?

Fortunately, in the case of shoes, car repair, and so many other things, we know how much they should cost, thanks to free markets.

Free markets are practically miraculous. Wherever human want can be satisfied by human talent, it will be, for the right price. Consider transportation and the incredible array of products and services available, from roller skates to airliners. It’s astonishing, but also entirely accurate to say that every possible transportation device that anyone in the world wants and can afford is available for purchase. Luxury cars that cruise over 200 miles per hour? Thousands own them. Star Trek-like teleportation?  Not possible, not yet. A lunar shuttle?  Bill Gates might be able to afford it, but apparently he doesn’t want one badly enough. If he did, someone would build one and sell it to him.

Adam Smith’s famous invisible hand really works. In a free economy resources automatically move to where they are put to the most efficient use, based on supply and demand. A free economy rewards innovation and efficiency. It punishes stagnation and inefficiency. A key element is information. When people have good information, prices find their correct level, through a process called price discovery. Of course, not everyone discovers the right price at the same time. Sharp traders with the best information score bargains. Uninformed traders get hammered.

Good information allows price discovery to work properly. Except, of course, when fraud or coercion intervene. Fraud is a common crime, but fortunately you can protect yourself against it in a number of ways, through expert knowledge, inspections, certifications, warranties, testimonials, etc. Coercion by definition removes the “free” from a free market. Coercion should be a crime, and it generally is, except when committed by governments.

Lack of information is one reason we don’t know what health care should cost. Although fraud is surely a factor, coercion is the main reason health care costs a lot more than many think it should.

A study by McKinsey & Company concluded that health care in America costs approximately 30% more than it should. How did they determine this? They compared the per capita cost of care versus the per capita GDP of several dozen countries. Richer countries, they found, tend to spend more on health care. That’s not surprising. But the data for all countries, save one, showed a close correlation between the two per capita GDP and health care spending. The outlier was, of course, the United States (see illustration).

Today, the per capita GDP in America is $53,000 per year. The per capita cost of health care is almost $10,000 per year, about 18% of GDP, and rising. (Fifteen years ago, America spent 13% of GDP on health care.) If McKinsey and Co. are right, the per capita cost of health care should be closer to $7,000 per year.

Still, it’s not really possible to know in advance what health care should cost. The only way to find out for sure would be to extend the free economy to health care, an industry that is very far from being a free marketplace, and unfortunately moving in the wrong direction.

Health care in America has been heavily distorted for years by government intervention. Federal and state government mandates on insurance coverage drive up costs and reduce availability. Government subsidies, including Medicare, push up demand, and therefore costs. The new Obamacare mandate that everyone buy insurance is an artificial boon to insurance companies directly, and the rest of the industry indirectly. Government licensing of health care providers restricts supply, also increasing costs. The tax-exempt status of employer-provided insurance is another distortion that stimulates demand.

Employer-provided medical insurance is unique to America. Why is this? Blame another government distortion: During World War 2, the federal government controlled wages and prices in a misguided attempt to contain wartime inflation. With few other ways to attract new employees, firms turned to fringe benefits which the government did not control. Employer-provided medical insurance became popular, lasting to this day, seven decades after the original wage and price controls were phased out.

Another problem is the way health insurance is used. Insurance is a risk management tool. You use it to protect yourself against rare events. If only one car in a 100,000 is stolen, the risk of one car being stolen, and the cost of replacing it, is spread across 100,000 policy holders. Each person pays as theft insurance a tiny fraction of the cost of a car. But health insurance policies generally cover routine care. That’s like using car insurance to pay for oil changes and gasoline.

Copays and deductibles adjust the math a little, but they don’t change the fundamentals—if health insurance covers routine visits to the doctor and everyday medication, the insurance company must charge more than what it pays out, if it’s going to stay in business. That means expensive insurance.

Lost to history is the once-common situation where an individual or family saved money for a medical procedure. The exception is elective surgery, such as lasik eye surgery or breast augmentation surgery, where people do spend their own money. The market for these procedures is open and competitive. But other medical procedures, many no more complex than these, cost many times more. Would they if the free market were allowed to operate?

Some blame the high cost of health care on business profits. They say that nobody should profit from another person’s need for health care. By this argument, no one who satisfies a human need should be allowed to make a profit. Food is a human need—does that mean farmers, food manufacturers, food transporters and grocers shouldn’t make a profit? People need water—so plumbers and water companies shouldn’t profit? Home builders provide shelter—no profits there either? And who decides what is and is not a human need? Cellphones satisfy the human need for communications—they even save lives in case of emergencies. Should cellphone providers forego profits too?

Remember that profits motivate people to provide goods and services in the first place. Without profits there wouldn’t be cellphones at all. Profits are usually small—most successful businesses earn just a few cents on every dollar’s worth of sales. But health care doesn’t cost a little bit more than it should, it costs a lot more than it should.

How about eliminating profits by putting government in charge? It's been done often enough for us to safely predict disaster. The worst examples of health care come from government-run monopolies: the Soviet Union and Cuba. According to Dr. Yuri Maltsev, a Soviet economist who defected to the US in 1989, health care in the Soviet Union was free and worth every penny. A majority of Soviet hospitals had no running water—and this was in the 1980’s. Cuba may well be worse. Maltsev calls the false reputation Cuba has for good health care “the best kept lie” about the country. Cuba has avoided the problem of obesity through a chronic shortage of food. Infant mortality is low, because the government registers newborns only after they reach six months of age. Hospitals have no pharmaceuticals beyond aspirin and a few topical ointments, although some medicines, mostly herbal remedies, are available on the black market. The widespread belief that Cubans enjoy excellent health care is a triumph of propaganda, sold to those who fervently wish it to be so.

Of course, we are told, those examples are too extreme. Great Britain is cited as having excellent state-run medical care. But we hear plenty to the contrary about poor care and long delays. One example: The long waiting time for emergency care became a popular issue not long ago. Politicians pledged to solve the problem. New regulations were issued. The result? Hospitals developed an elaborate queuing system for ambulances, stacking them like airplanes in a holding pattern until rooms and doctors were available. That’s because the wait time for emergency care did not start, legally, until the patient was unloaded.

Government-run health care may be great politics, but it’s poor health care. Decisions are dominated by politics, not by economics nor by medicine.

Suppose the health care industry had evolved without government distortion. How might it look today? In general, the supply of health care would match the demand, and prices would be determined by the free market. The specifics are hard to predict, as free markets can and often do produce creative, unexpected innovations—that is the nature of entrepreneurism. But here are a few of the more likely features:

• Health care insurance would be true insurance—it would spread risk of relatively rare events across a large pool of policy holders.
• Insurance would be purchased directly by consumers, not through employers.
• Parents would purchase insurance for children before they were born, as a safeguard against the risk of birth defects (the ultimate “pre-existing condition”).
• Routine doctor visits and medication would be paid directly by the patient, not through insurance.
• Information about the efficacy of medications, procedures, doctors and hospitals would become an important factor in decisions made by patients and insurers.
• People who could not afford health care on their own would be assisted by charitable individuals and organizations.

Some people cannot tolerate the idea that voluntary charity would provide the final health care “safety net” for poor people. I suggest that the poor would actually enjoy better health under this system than today’s system of politically-rationed care at prices inflated by government-driven bureaucracies. And it would have the advantage of morality-based funding, that is, voluntary funding, versus government’s immoral confiscation of property through taxation. Walter Williams has this to say about the subject: “Charity is one of the nobler human motivations. The act of reaching into one's own pockets to help a fellow man in need is praiseworthy and laudable. Reaching into someone else's pocket is despicable and worthy of condemnation.”

Patients today don’t have much information about the effectiveness of specific medicines, procedures, or practitioners. In a free market they would need and therefore demand information, which would become available from a variety of sources. Health care information and certification organizations analogous to United Laboratories would spring up. These would be funded by patients and insurers. Since their livelihood would depend upon it, these organizations would develop and carefully guard their reputations for accuracy and independence. (They would render obsolete today’s pseudo-governmental licensing boards, such as the American Medical Association.)

How would free markets handle care for seniors, who need more and more medicines and procedures as they age? The market would promote development of treatments that truly improve and extend life, and would weed out ineffective treatments. It would do so without distortions from government subsidy and regulation. The decisions to employ or refuse an expensive, risky, and potentially ineffective treatment in order to extend life would rest with the patient and his family, where it belongs.

There is no question that wealthy individuals would be able to afford the most advanced and expensive medical treatments. This is true today. It’s also true in many areas of economic life, not just health care, where initially expensive innovations consumed by a few become more and more affordable over time.

Thanks to the comprehensive distortion caused by government subsidies, mandates, and regulations, there’s no question that health care in America costs much more than it should. How much should it cost? Let’s make it a free market and find out.