The Economist, Schumpeter, March 15, 2018
Every year America spends about $5,000 more per person on health care than other rich countries do. Yet its people are not any healthier. Where does all the money go? One explanation is waste, with patients wolfing down too many pills and administrators churning out red tape. There is also the cost of services that may be popular and legitimate but do nothing to improve medical outcomes.
The most controversial source of excess spending, though, is rent-seeking by health-care firms. This is when companies extract outsize profits relative to the capital they deploy and risks they take. Schumpeter has estimated the scale of gouging across the health-care system. Although it does not explain the vast bulk of America’s overspending, the sums are big by any other standard, with health-care firms making excess profits of $65bn a year. Surprisingly, the worst offenders are not pharmaceutical firms but an army of corporate health-care middlemen.
In crude terms, the health-care labyrinth comprises six layers, each involving the state, mutual organisations and private firms. People and employers pay insurance companies, which pay opaque aggregators known as pharmacy-benefit managers and preferred provider organisers. They in turn pay doctors, hospitals and pharmacies, which in turn pay wholesalers, who pay the manufacturers of equipment and drugs. Some conglomerates span several layers.
To work out who is stiffing whom, Schumpeter has examined the top 200 American listed health-care firms. Excess profits are calculated as those earned above a 10% return on capital (excluding goodwill), a yardstick of the maximum that should be possible in any perfectly competitive industry.
Total excess profits amount to only about 4% of America’s health-care overspending. But this still makes health care the second biggest of the giant rent-seeking industries that have come to dominate parts of the economy. The excess profits of the health-care firms are equivalent to $200 per American per year, compared with $69 for the telecoms and cable TV industry and $25 captured by the airline oligopoly. Only the five big tech “platform” firms, with a figure of $250, are more brazen gougers.
Everyone hates pharmaceutical firms, but their share of health-care rent-seeking is relatively trivial, especially once you include the many midsized and small firms that are investing heavily. Across the economy, average prices received by drug manufacturers have risen by about 5% per year, net of the rebates. But their costs have risen, too. As a result, even for the 15 biggest global drugs firms, returns on capital have halved since the glory days of the late 1990s, and are now barely above the cost of capital.
As the drug industry has come back down to earth, the returns of the 46 middlemen on the list have soared. Fifteen years ago they accounted for a fifth of industry profits; now their share is 41%. Health-insurance companies generate abnormally high returns, but so do the wholesalers, the benefit managers and the pharmacies. In total middlemen capture $126 of excess profits a year per American, or about two-thirds of the whole industry’s excess profits.
The dark view is that pockets of rent-seeking have become endemic in America’s economy. Wherever products are too complex for customers to understand, and where subsidies and complex regulation add to the muddle, huge profits can opaquely be made.
The Price of Inequality
By Joseph E. Stiglitz
Our political system has increasingly been working in ways that increase the inequality of outcomes and reduce equality of opportunity. This should not came as a surprise: we have a political system that gives inordinate power to those at the top, and they have used that power not only to limit the extent of redistribution but also to shape the rules on the game in their favor, and to extract from the public what can only be called large “gifts.” Economists have a name for these activities: they call them rent seeking, getting income not as a reward to creating wealth but by trapping a larger share of the wealth that would otherwise have been produced without their effort. Those at the top have learned to suck out money from the rest in ways that the rest are hardly aware of – that is their true innovation.
By Don McCanne, M.D.
Joseph Stiglitz defines rent seeking as “getting income not as a reward to creating wealth but by trapping a larger share of the wealth that would otherwise have been produced without their effort.” Investopedia defines it as “obtaining economic gain from others without reciprocating any benefits to society through wealth creation.” Rent seeking is an important phenomenon to understand because it has been a major contributor to the injustices of increasing income and wealth inequality, especially in the United States.
The Economist’s Schumpeter column discusses the middlemen in the U.S. health care system – insurance companies, pharmacy benefit managers, preferred provider organizers, etc. – and describes as rent seeking their all-too-prevalent profits in excess of a 10 percent return on capital. Their share has now grown to 41 percent of industry profits. “In total middlemen capture $126 of excess profits a year per American, or about two-thirds of the whole industry’s excess profits.”
Although this egregious spending is particularly offensive, it is still relatively small compared to the wasted expenditures on high prices and profound administrative excesses in our health care system. But these middlemen add to our high health care costs without providing any additional health care services. If we changed to a well designed single payer national health program – an improved Medicare for all – not only would health care finally be priced fairly and administrate waste dramatically reduced, we would also get rid of these rent seeking leeches.
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