Monday, March 23, 2015

Hospital Supply

In my view, health care supply restrictions are more important than the insurance or demand features that dominate public discussion. If you are spending your own money, yes, you shop for a good deal. But spending your own money in the face of restricted supply is like hailing a cab to LaGuardia at 5 o'clock on a rainy pre-Uber Friday afternoon. We need to free up innovative, disruptive health-care supply. Let the Southwest Airlines, Walmarts, Amazons and Apples in.

But where are the supply restrictions? Alas it's not as simple as the NY taxi commission. Supply restrictions are spread all over Federal, state and local law and regulation, and usually hidden.

So, I was interested to discover an interesting supply restriction in this editorial in the Wall Street Journal last week.
Last year the Daughters of Charity Health System sought to sell its six insolvent hospitals in California to Prime for $843 million including debt and pension liabilities. State law requires the AG [California Attorney General Kamala Harris] to approve nonprofit hospital acquisitions. Ms. Harris attached several poison pills at the urging of the SEIU [Service Employees International Union], which forced Prime last week to withdraw its offer.
State law requires the AG [Attorney General] to approve nonprofit hospital acquisitions. How could this go wrong?

Since 2010 operating losses at Daughters hospitals have tripled to $146 million. High pay scales, inflexible work rules and rich pension benefits have swelled labor costs to 74% of revenues compared to the nationwide average of 58% at nonprofit systems.... 
... Of six bidders, only Prime agreed to assume the $300 million liability for worker pensions. Prime also scored high on 10 of Daughters’s 11 bidding criteria including financial wherewithal and historical service quality. 
Prime’s problem was the SEIU’s  opposition owing to the company’s rejection of a so-called neutrality agreement, which would facilitate unionization at all of its hospitals. Only four of Prime’s 15 hospitals in California are unionized. Since 2009 the SEIU has run a public campaign against Prime, leveling accusations of Medicare fraud and unchecked sepsis. 
Ms. Harris has taken up the union cause. In 2011 the AG vetoed Prime’s acquisition of the bankrupt Victor Valley Community Hospital as “not in the public interest” though a report produced for her own office concluded that Prime’s “capital investment over the next five years should lead to substantial improvement to facilities, infrastructure, and certain services at the Hospital.”
Now you may say, how nice. The Attorney General is stalwartly backing the union cause, trying to raise wages and employment for struggling "middle class" Americans. Except, it's the same people who pay the higher health-care costs and suffer worse service.

Regulation from the top is supposed to "bend down the cost curve" in medicine. But true cost reductions, efficiency improvements,  and quality improvements are painful. Ask United's pilots union, Walmart's competitors, or Kodak's employees.

The tone of the Journal's editorial suggests a morality play. I think not. I can't imagine any regulator, attorney general, HHS secretary, or politician, given the power to approve or disapprove hospital acquisitions, doing so in a way that truly lowers costs and improves quality following the only path we know that actually works, allowing disruptive competition. You only cut costs by, well, cutting costs. And disruptive competitors only enter if they have the right to do so, not the discretionary approval of any politician or political appointee.

Update in response to comments: "After the ACA" has a long list of supply impediments. I'm trying to learn about additional ones.


  1. The Journal's editorial is right about one thing: it mostly is a morality play.

    There two separate issues: efficiency and fairness. Over-priced healthcare involves both, but people, including this post, care mostly about the latter. We can decide that healthcare workers are underpaid and deserve more--that is a valid social choice. Or we can decide--as you have--they are overpaid and it would be fairer if we lowered prices for healthcare. Also a valid social choice.

    "High health costs" is only an efficiency concern insofar as it results in fewer than the efficient number of people seeking care. Especially considering that most care is paid through insurance, that is a much smaller concern than it's usually made out to be. It's the fairness issue that you and everyone cares most about.

    1. It's pretty clear that neither efficieny nor fairness were served. Letting a failed hospital model continue indefinitely?

      I've never seen the claim that high health care costs don't matter on this subject.

    2. Matthew, who says that healthcare is over-priced? I think John's point is that it's probably priced appropriately given the supply restrictions. I also think you set up a false choice: over-paid workers versus lower cost healthcare. John is definitely talking about efficiency in entry and exit with lower regulatory burdens in order to expand supply. All things equal, an expansion of supply could lead to higher wages for workers (increased demand for labor) and overall cost reductions coming from bureaucratic and regulatory cost reductions and increased competition.

  2. Great post, John.

    You might enjoy historian David Beito's book "From Mutual Aid to the Welfare State."

    Here's a review:

    And a synopsis:

  3. Good point about supply constraints. One very important supply constraint:

    Medical residencies are payed for by Medicare, which caps the number of medical residencies.

  4. You can reduce costs by allowing immigration of doctors and increasing supply. But for some reason wage competition is only allowed at the lower end of the pay scale.

  5. In my N. Chicago neighborhood the supply of immediate care facilites is going up significantly. 2 new ones added to 3 existing ones, all within less than 2 miles of each other. I'm not sure of the reasons, perhaps a consequence of high deductible plans within Obamacare.

  6. Hidden regulations? Look no further than your own state's certificate-of-need-program [not sure if I posted this twice, had to re-enter my name]

    1. I know about those. I'm on the lookout for more and less obvious ones.

    2. ??

  7. Below are some thoughts and references that look at the supply of physicians. I don't have the time or training to turn this into a concise case but it looks like physicians artificially, with the assistance of government of course, limit the supply of competitors (more physicians) by limiting medical students and residencies:

    “who decides how many medical students accepted each year?”

    Basically, States limit the supply of physicians through centralized accreditation controlled by physicians. Licensing of medical doctors in the United States is coordinated at the state level. Most states require that prospective licensees complete the following requirements:
    • Graduation from an accredited medical school granting the degree of DO or MD
    o United States and Canada schools must be accredited by the American Association of Colleges of Osteopathic Medicine or the Liaison Committee on Medical Education.
    [The LCME website led me to a list of 17 people who decide how many medical schools exist in the US & Canada. All but 2 of the members are doctors or med students.]
    o Foreign medical school graduates generally must complete some training within the United States.
    • Satisfactory completion of at least one year of an AOA- or ACGME-approved residency.
    • Passage of the United States Medical Licensing Examination or the Comprehensive Osteopathic Medical Licensing Examination (USMLE, COMLEX, or simply "the boards").
    In addition to accreditation, residency requirements for board certification create another possible limit on the supply of physicians.

    Quote from Yale study (Sean Nicholson) entitled, “Barriers to entering medical specialties”:
    “Entry barriers exist due to cartel behavior by residency review committees”

    “less than half of medical school applicants (48,000 in 2012/13) get accepted” -

    “Since some programs may have up to 500 (or even 1,000) applications for only 100 interview slots..”

    “The first Main Residency Match® ("the Match") was conducted in 1952 when 10,400 internship positions were available for 6,000 U.S. graduating seniors. By 1973, there were 19,000 positions for just over 10,000 U.S. graduating seniors. Following the demise of internships in 1975, the number of first-year post-graduate (PGY-1) positions dropped to 15,700. The number of PGY-1 positions offered gradually increased through 1994 and then began to decline slowly until 1998. This year saw a record-high 26,678 PGY-1 positions offered (Figure 1), marking the twelfth consecutive annual increase in such positions. The trend in the total number of applicants since 1952 is more dramatic, starting with 6,000 in 1952 and rising to a high of 36,056 in 1999. After a decline of 5,052 applicants from 1999 to 2003, the number of applicants has increased each year since the 2004 Match. Applicants
    registered for the 2014 Match reached an all time high of 40,394, an increase of 59 applicants over 2013.” -

    There were 50% more first-year medical students per capita in 1980 than currently (7.5 vs 5/100,000).

    1. These are good and important. But the bigger void in my understanding are the restrictions on businesses. If you can figure out how to run a specialty clinic effectively, or buying up and revamping an older hospital, what are the restrictions on you opening up this business?

  8. First off, we need a true marketplace in healthcare services. There are no clear and transparent prices, and therefore no competition and no market.

    A great way to do this is to actually enforce antitrust laws, even price gouging laws if necessary. Hospitals, insurer and physicians collude to fix prices. How they've escaped the reach of the Sherman act is a shocking violation of black-letter law.

    Price fixing, bid rigging, and market allocation schemes in healthcare -- its all there. Enforce the law, eh?

    1. I'm less persuaded. In fact, we now have HHS under ACA pushing ACOs -- a big force towards less competition -- and the FTC and DOJ pursuing hospital antitrust. Both sets of regulators operating with little in the way of transparent rule books, means just that the poor hospital operator in between just has to curry favor with two sets of regulators.

      We didn't get cheap airlines and airplane tickets quoted on websites from andti trust or disclosure laws. We didn't get cheap stuff at Walmart from anti trust and price disclosures laws. We sure didn't get cheap computers and smartphones from antittrust and price disclosure laws.

      No business that is not protected by the government from competition can get away with lack of clear and transprent pricing. Let's fix the source, not add a second set of regulators.

    2. The ACA is an abomination, full stop. But if the government is pushing centralization/regulation model with one hand and decentralization/competition with the other, then that's as good a sign that an incompetent government has too much power over process and outcomes & needs to exit almost entirely.

      And yes, we do get cheap stuff because antitrust law threatens monopolies/monopsonies, and outlaws oligopolistic price fixing. The point is not another level of regulators, the point is to break up cozy pricing.

      There is no way that a medical supply firm can charge $100 for a box of $5 gauze without price fixing, collusion, and violation of anti-trust and consumer-protection laws. You cannot price-gouge as a corner gas station, why can you if you are "medical"?!

      Hospitals don't tell you that you're being charged $100 for a pad of gauze; and you cannot price-check when you're wheeled in having a heart attack.

      Yet these relationships are essential commercial, and are already satisfactorily governed by commonplace commercial rules. Exploiting customers is already unlawful, whether its walmart, gas, or buying a car. Most procedures are done thousands of times a day, but there are no clear prices. No prices, no market.

      To create a market, the already-commonplace commercial rules and laws simply need to be enforced throughout the healthcare industry.

      Enjoy your $83,000 scorpion venom!

  9. your link to "after the aca" is broken (it has two links run together)

  10. The majority of healthcare consumers don't spend their own money (one reason for the $100 gauze). Nor is there a shortage of hospital beds, by any measure I have seen. However, I agree that Ms. Harris offered Prime a deal they had to refuse, possibly for political reasons. DoC will most likely have to file and some, if not all, the facilities will be sold outside the purview of Ms. Harris on terms far more favorable to the purchaser.

  11. This is a really interesting post. However, I think that the alternative story of how the Prime deal fell apart makes the analysis more interesting (and opens you up to a snide "relying on a WSJ could this go wrong" retort). Harris approved the deal with conditions. You could argue that Kamala's conditions are a nefarious plan to drive Prime away thereby serving her labor overlords, but there was a concern that Prime did not intend to continue providing existing hospital services at more cost-efficient/profitable rates, but instead were just going to provide the profitable services and stop providing the others. It's possible that Prime has superior management and could offering existing services more cost effectively, but past practice suggests the former was more likely.
    This raises the thornier question of whether to analyze supply of hospital services as a bundle or individually. Would supply of the bundle of hospital services increase if hospitals are able to debundle the services offered? Presumably, you would get strong competition in the areas of service that are more profitable and that could drive down cost and improve quality for those services. But allowing companies to sever the less profitable services (emergency, etc.) might make offering those services even less financially feasible, and dramatically reduce the participants in those areas. Worse, by allowing a few companies to grab all the low hanging profit fruit, it would make it even harder for a new participant to try to use those profit centers to subsidize the other necessary services while developing more cost-effective ways to provide them.
    One could argue that requiring Prime to continue providing the less profitable services in order to gain market access to the profitable ones is necessary to ensure that disruption occurs in the unprofitable areas that need it most. Look forward to your thoughts on this and love the blog. - Patrick

    1. Cross-subsidies will not stand competition. I think the desire to enforce cross-subsidies is at the heart of the benevolent part of anti-competitive regulation. So, if you want to subsidize emergency rooms do so, on budget, and explicitly. Don't strangle the innovation genie. This lesson is learned time and again. Airlines, telephones, package delivery were all regulated to preserve cross-subsidies. And the result was lack of competition and horrible service for everyone .

  12. I don't know that I would classify what I was describing as cross-subsidizing. There's no suggestion that the parts of the hospital business that Prime prefers to shed are unprofitable, just less profitable. It appears that Prime's business model is to provide the highest margin services in multiple markets and thereby maximize its own profits. This orphans many of the other less profitable services. To me, this creates its own supply restriction. Other vendors interested in providing these less profitable services have less (not no) incentive to do so than they would if they would also be the primary provider of the more profitable ones. The result in my mind would be either that we get worse service in these health services or, even worse from a cost reduction perspective at least, the providers might just address the profit gap by charging more for them.


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