Code Red: Two Economists Examine the U.S. Healthcare System

November 2, 2012

Setting the Record Straight on Medicaid’s “Success”

Filed under: Uncategorized — David Dranove and Craig Garthwaite (from Oct 11, 2013) @ 8:32 am

In last Sunday’s New York Times, Paul Krugman extolled the virtues of Medicaid. Here are some excerpts from this astonishing column:

“Medicaid has been more successful at controlling costs than any other major part of the nation’s health care system.”

“How does Medicaid achieve these lower costs? Partly by having much lower administrative costs than private insurers.”

“Medicaid is much more effective at bargaining with the medical-industrial complex.”

“Consider, for example, drug prices. Last year a government study compared the prices that Medicaid paid for brand-name drugs with those paid by Medicare Part D — also a government program, but one run through private insurance companies, and explicitly forbidden from using its power in the market to bargain for lower prices. The conclusion: Medicaid pays almost a third less on average?”

In the days since this column was published, I have spoken with many experts on Medicaid who are uniformly appalled by it. While my blog may not reach the same audience as the New York Times (at least not yet!), I feel compelled to set the record straight on Medicaid’s “successes.”

Let’s start by considering Medicaid’s exemplary administrative costs. When a program does little monitoring for fraud and abuse, nor attempt to limit unnecessary care, and when a program monopolizes the customer segment is serves, it is going to have lower administrative costs. I am not sure why this is a virtue.

As for drug prices, Congress has given Medicaid effective most-favored nation status for prescription drugs. This all but guarantees that Medicaid will have the lowest drug costs. This accomplishment is no credit to Medicaid; it is the natural result of legislative fiat. The irony is that by granting MFN status to Medicaid, Congress gave drug makers incentives to raise prices to everyone else (in order to simultaneously raise the MFN price given to Medicaid.) Widely cited research by Fiona Scott Morton and Mark Duggan has shown that Medicaid’s MFNs raise all of our drug costs by 5-10 percent or more (depending on the drug.) So the overall impact of the law granting MFN status to Medicaid is to drive up total U.S. drug spending. This is nothing to brag about.

The situation with drug pricing helps us better understand the secret of Medicaid’s “success.” Unlike private insurers, which do have to “bargain with the medical-industrial complex,” Medicaid can dictate prices through legislative fiat. So does Medicare. Both Medicaid and Medicare routinely set prices below those “bargained” by the private sector, but Medicaid is especially “effective” because states know that they can abuse their power without serious repercussions. States do not care that “quite a few doctors are reluctant to see Medicaid patients,” as Krugman modestly states. (It might be more accurate to say that “most doctors, hospitals, and other medical providers treat Medicaid patients as second class citizens” or even “low Medicaid payments have created a two-tiered system in which Medicaid patients have inferior access to the best providers and the latest technologies.”) Congress could not get away with this for Medicare without incurring the wrath of millions of seniors. When states slash Medicaid payments, the most vocal opponents are providers, not patients, and the voices of providers are usually drowned out by the voices of taxpayers. Private insurers could not get away with this either. Thanks to the HMO backlash of the 1990s (led by liberal Democrats), insurers seem to have given up on offering narrow network health plans.

Any monopolist – and Medicaid is a monopolist — can reduce its costs by choosing to pay low prices to its suppliers. Not only does this keep down the price of supplies, it also limits the monopolist’s production, as few suppliers will want to do business with it. This further holds down the monopolist’s total spending. These basic concepts, understood by any first year economics student, help explain the great “successes” of Medicaid, as well as most nationalized healthcare systems, which contain costs largely by limiting the prices they pay for medical services.

Surely there is more to judging a healthcare system than looking at how much it spends. What about access and quality? Does the system pay providers enough to attract new entrants? (I am especially concerned about doctors and nurses who may find more lucrative options in other sectors.) Are prices high enough to stimulate technological change? Are regulations so rigid as to hinder process innovation? I don’t mean to give carte blanche to higher medical spending, but only to suggest that it is shortsighted to heap praise on Medicaid because Congress and the states have chosen to abuse their monopoly powers.

1 Comment

  1. Good and thoughtful discussion, as usual.

    Comment by Herm Stonitsch — November 2, 2012 @ 8:46 am

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