Progress often means cheaper, not necessarily better

The best clothing you can get is “bespoke” clothing. Bespoke clothing is sewn by hand to fit each individual and because it is custom made, it can be designed with exactly the kind of cloth, colors, and shape that you want. If a design isn’t quite right, it is altered by hand to fit, feel, and look better.

One of the first big sources of economic development was the industrial revolution which automated this process and mass produced clothing that is much, much cheaper and a little worse. Mass produced clothing rarely fits as well as bespoke clothing and isn’t infinitely customizable. In fact it is worse in every way except that it is way, way cheaper. That is why economic progress has almost entirely wiped out the bespoke clothing industry and replaced it with inferior mass produced clothing. There are many examples of industrial products that are a little worse than the products they replaced except that they cost a lot less. Frozen dinners are worse than restaurant (or home cooked) food, but cost a lot less money (or time). Video on demand is generally worse than a movie theater, except that it is cheaper to watch at home. Ikea furniture is generally worse than custom furniture, but it is really cheap.

There is potential for a similar effect in medicine. Suppose there are numerous technologies that your health system is using that can save a life for under $5million and few people can afford to spend $5million to save one life. One of these common technologies is a drug that can cure a rare cancer that afflicts 1,000 people per year. The drug costs $200,000 per treatment and cures a little more than half of the people with the cancer. Specifically it cures 510 of the 1,000 people who get the cancer. That is a bargain compared with the treatments that cost $5million to save lives.

Then researchers develop a new treatment for the same cancer that isn’t quite as effective because it would only save 500 lives rather than 510 lives, but it costs half as much at $100,000 per treatment. Should the healthcare system adopt the new, inferior treatment because it is cheaper? That would cause 10 more people to die of the cancer per year, but it would actually save more lives than are lost because the resources could save many more lives if they are directed to other kinds of diseases.

The total cost of the first treatment is $200,000,000 because 1,000 people are each getting a treatment that costs $200,000. The total cost of the new treatment is $100,000,000 because it costs half as much to cost each person. Thus, adopting the new treatment would save a total of $100,000,000. The marginal benefit of the new treatment is just ten lives saved, so $100,000,000/10 = $10 million.

Thus, the new drug is so much more cost effective than the old drug, that it would save lives to let ten more people die of cancer so that at least 20 more people can be saved by spending the savings on treating other people with existing technologies that cost less than $5million per life saved.

That is the logic of cost-benefit analysis. A new product can replace an old product even if the new product doesn’t work as well if the new product is a whole lot cheaper.

One of the problems in medicine is that we haven’t been willing enough to look for more cost-effective solutions. Matthew Yglesias argues that medical licensure is another example.

And as Adam Ozimek observers, one reason is that high-wage occupations are using licensing rules to stifle competition from cheaper alternatives. If you’re a good boy like me and go to the dentist regularly to get your teeth cleaned, you’ve probably noticed that the dentist doesn’t actually clean your teeth. A dental hygenist does. So why don’t the hygenists band together and cut out the dentist? Well, they frequently can’t:

For instance, many states have regulations preventing dental hygienists from practicing without the supervision of a dentist. Dentists have an average of six years more schooling than a hygienists, who on average have 2.6 years of post high-school education. In addition, dentists make on average $100 an hour, and are 80% male, whereas hygiensts are 97% female and make around $37 an hour. Kleiner and Park find that these regulations transfer $1.5 billion dollars a year from hygiensts to dentists. This is a highly regressive transfer to a male dominated, higher educated, higher paid job from a female dominated, lower educated, lower paid job. In a very similar vein with likely similar impacts, many states restrict the ability of nurses to practice without the supervision of doctors. In fact these regulations are currently growing as regulators rush to restrict the number nurses working in retail health clinics in a variety of ways to prevent them from competing with doctors.

Not only does forcing hygenists to be “supervised” by a dentist raise the price of routine tooth-cleaning, it also raises the price of dental health services that really do require a dentist’s skill and training since it induces dentists to spend a share of each day shaking hands with patients who don’t need their expertise. This creates artificial scarcity in the supply of high-end dental services.

The bigger issue — though harder to estimate — is the way that these rules stifle potentially enormous gains from organizational innovation. Imagine a world in which in order to make clothes you needed a license from the State Board of Tailors, and the tailor lobby manages to persuade the state to extend the tailor’s monopoly by saying that to sell clothing you need to be under the supervision of a tailor. This set of rules doesn’t just reduce competition in the fields of clothing manufacturing and retailing. It prevents the technological and organizational innovations that have brought us mass-produced clothing, and retail chains. The cartel would justify its existence in the name of high-quality and consumer protection. And it’s even true that if we all went to work in handmade shirts and bespoke suits that we’d be wearing higher-quality clothing. But the impact on overall living standards would be devastating. There’s no H&M; or Ikea of the health care sector, and there never will be without some relaxation of the rules governing who’s allowed to be a provider of health care services.

Progress doesn’t always mean better quality products. Often it means slightly worse products that are a lot less expensive. Less stringent licensure could be worth some reduction in mandated minimum quality because costs would drop and Americans could afford more health care.

As you can see from Imagur’s graph of average salary data in the US, healthcare occupations (in bright pink) have some of the highest incomes.  One reason is the excessive scarcity imposed by licensure regulations.  Lots of Americans resent CEOs for their high salaries (the first green bar below), but the average specialist physician makes more than the average CEO!

(Click to expand the graph.  Note that there are a lot of pinkish occupations near the bottom of the graphic, but that is a slightly more purple shade of pink and represents entertainers and media producers.)

salaries

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Posted in Health, Managerial Micro, Public Finance
One comment on “Progress often means cheaper, not necessarily better
  1. […] PBMs is badly aligned with the interests of society, so it is unlikely that they make the kind of rational cost-benefit analysis in selecting formularies and pricing that would lead to the healthiest population for the amount of spending that we do. […]

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