Tuesday, November 2, 2010

Antos: Confessions of a Price Controller

Joseph Antos explains how government price controls have distorted the market for medical services in Medicare, leading to many of its current problems.

One key quote:
Medicare's experience demonstrates how hard it is for a government agency to set physician payment rates that clear the market. Some prices are too low, requiring patients to wait for treatment or even go without as the demand for those services exceeds the supply. Some prices are too high, unnecessarily raising the cost of Medicare to the taxpayer as physicians respond to the incentive to use more expensive services—even when those services do not produce better outcomes for patients. If the prices are not right, the consequences are unavoidable.

The problem for a government price controller is that he can never know when the price structure is "right." He can know when physicians are unhappy with their prices because they will complain, but that does not necessarily mean that those prices should be raised. He cannot know when prices are too high, because physicians benefiting from that mistaken generosity will not complain. The bias is always to raise prices, not lower them.

Medicare tries to solve that problem by limiting how much average prices may rise using the infamous sustainable growth rate (SGR) formula. That formula sets an arbitrary limit, unrelated to conditions in the market for physician services, on year-to-year increases in physician payment rates. Just as the price controller cannot know the "right" structure of relative prices, he also cannot know the "right" average price or its rate of growth. Again, the only signals come from those who want more, not less.

The inevitable result is that Congress breaks its own price control rules. In an annual rite of political contrition, Congress overrides the cuts in Medicare physician payment called for by the SGR. To maintain the fiction that someday we will take those reductions, they are pushed off to the next year -- compounding both the amount to be cut and the political problem.
(Read the full text of "Confessions of a Price Controller".)

Basically, when government fiat replaces the marketplace, there no longer is any "right" price.

No bureaucrat can possibly know what would have been the price settled upon by thousands (or millions) of actors seeking their own best values in a free market. Hence, all he can rely on is some combination of guesswork, whim, and political favoritism. The current Medicare mess is the inevitable consequence of such government price setting.

(Via @MatthewBowdish and WolfFiles.)