Milton Friedman on Health Care

The other day I came across a superb article by economist and Nobel laureate Milton Friedman on how to cure health care (H/T Swiss Economist who originally linked to the article, and who posted a comment about it on Enjoyment and Contemplation). The article is somewhat long but definitely worth reading, especially in light of the recent Supreme Court ruling on the Patient Neglect and Unaffordable Care Act (known as the Patient Protection and Affordable Care Act in Newspeak, or as “Obamacare”). The government naturally ignored all of Friedman’s advice in the Patient Neglect and Unaffordable Care Act, and Friedman hints at why the government’s health care reform will fail (despite the fact that Friedman died even before “Obamacare” was written).

First, Friedman explains why health insurance — unlike many other forms of insurance — is bought through one’s employer:

We have become so accustomed to employer-provided medical care that we regard it as part of the natural order. Yet it is thoroughly illogical. Why single out medical care? Food is more essential to life than medical care. Why not exempt the cost of food from taxes if provided by the employer? Why not return to the much-reviled company store when workers were in effect paid in kind rather than in cash?

The revival of the company store for medicine has less to do with logic than pure chance. It is a wonderful example of how one bad government policy leads to another. During World War II, the government financed much wartime spending by printing money while, at the same time, imposing wage and price controls. The resulting repressed inflation produced shortages of many goods and services, including labor. Firms competing to acquire labor at government-controlled wages started to offer medical care as a fringe benefit. That benefit proved particularly attractive to workers and spread rapidly.

Initially, employers did not report the value of the fringe benefit to the Internal Revenue Service as part of their workers’ wages. It took some time before the IRS realized what was going on. When it did, it issued regulations requiring employers to include the value of medical care as part of reported employees’ wages. By this time, workers had become accustomed to the tax exemption of that particular fringe benefit and made a big fuss. Congress responded by legislating that medical care provided by employers should be tax-exempt.

I had always wondered why health insurance was bought through one’s employer. It is indeed “thoroughly illogical”. Next, Friedman explains that the meaning of insurance has undergone a drastic change in the context of health insurance:

Employer financing of medical care has caused the term insurance to acquire a rather different meaning in medicine than in most other contexts. We generally rely on insurance to protect us against events that are highly unlikely to occur but that involve large losses if they do occur—major catastrophes, not minor, regularly recurring expenses. We insure our houses against loss from fire, not against the cost of having to cut the lawn. We insure our cars against liability to others or major damage, not against having to pay for gasoline. Yet in medicine, it has become common to rely on insurance to pay for regular medical examinations and often for prescriptions.

This is exactly what I was explaining in my argument against health insurance mandates. The problem with using insurance to cover regular medical expenses like examinations is that a third party (the insurance company or government) needlessly interferes with normal economic transactions between caregiver and patient, and the patient has no incentive to pay attention to costs since the insurance company is paying for the care (i.e. the costs are hidden from the patient). As Friedman puts it:

Third-party payment has required the bureaucratization of medical care and, in the process, has changed the character of the relation between physicians (or other caregivers) and patients. A medical transaction is not simply between a caregiver and a patient; it has to be approved as “covered” by a bureaucrat and the appropriate payment authorized. The patient—the recipient of the medical care—has little or no incentive to be concerned about the cost since it’s somebody else’s money. The caregiver has become, in effect, an employee of the insurance company or, in the case of Medicare and Medicaid, of the government. The patient is no longer the one, and the only one, the caregiver has to serve. An inescapable result is that the interest of the patient is often in direct conflict with the interest of the caregiver’s ultimate employer. That has been manifest in public dissatisfaction with the increasingly impersonal character of medical care.

This system results in high costs for health care due to the fact that

nobody spends somebody else’s money as wisely or as frugally as he spends his own.

This principle is the ultimate basis for conservative arguments against such heavy government involvement as created and perpetuated in the most recent health care reform — government cannot and does not spend money as wisely or frugally on health care as patients themselves, who are also most familiar with their health care needs.

Friedman gives a solution to reducing the high cost of health care:

A cure requires reversing course, reprivatizing medical care by eliminating most third-party payment, and restoring the role of insurance to providing protection against major medical catastrophes.

The ideal way to do that would be to reverse past actions: repeal the tax exemption of employer-provided medical care; terminate Medicare and Medicaid; deregulate most insurance; and restrict the role of the government, preferably state and local rather than federal, to financing care for the hard cases. However, the vested interests that have grown up around the existing system, and the tyranny of the status quo, clearly make that solution not feasible politically.

Note that Friedman’s solution does call for some government involvement, particularly for the “hard cases” (individuals with pre-existing conditions, the poor, etc.). The conservative approach to health care does not mean the poor and unhealthy must be neglected or that government has no role in health care — despite what many leftists think and would have you believe — but it does limit the government to its proper role.

A politically feasible approach to Friedman’s solution (that actually exists to some degree already) is a medical savings account:

A medical savings account enables individuals to deposit tax-free funds in an account usable only for medical expense, provided they have a high-deductible insurance policy that limits the maximum out-of-pocket expense…it eliminates third-party payment except for major medical expenses and is thus a movement very much in the right direction. By extending tax exemption to all medical expenses whether paid by the employer or not, it eliminates the present bias in favor of employer-provided medical care.

This solution not only restores the true meaning of health insurance as insurance against major, unexpected, and catastrophic health expenses, but it weakens the current model of employer-based health insurance. With employers paying less for high deductible health insurance plans than for low deductible plans, employees can receive more of their compensation in the form of wages rather than health insurance. Cash is more flexible than insurance, so employees can choose to either spend their extra wages on health care (their out-of-pocket expenses would be higher) or on whatever else they want to spend it on (for example, if they are healthy and don’t need much health care).

Given the clear benefits of medical savings accounts, can you guess what the Patient Neglect and Unaffordable Care Act does? Although the law does allow such accounts, it restricts what they can be used to purchase (non-prescription medications cannot be paid for with funds from such accounts) and limits the amount of tax-free contributions that can be made to the accounts.

For completeness, Friedman does briefly mention the leftist approach to health care and its benefits and drawbacks:

In terms of holding down cost, one-payer directly administered government systems, such as exist in Canada and Great Britain, have a real advantage over our mixed system. As the direct purchaser of all or nearly all medical services, they are in a monopoly position in hiring physicians and can hold down their remuneration, so that physicians earn much less in those countries than in the United States. In addition, they can ration care more directly—at the cost of long waiting lists and much dissatisfaction.

The reason why this government approach to health care leads to rationing and long wait times is, of course, explained by basic economics:

Legislation cannot repeal the nonlegislated law of demand and supply: the lower the price, the greater the quantity demanded; at a zero price, the quantity demanded becomes infinite. Some method of rationing must be substituted for price, which invariably means administrative rationing.

With artificially low prices due to insurance mandates (like the “free contraceptives” mandate) demand rises and the low or zero price product is over-utilized. Furthermore, although the government can use its monopoly position to hold down physicians’ compensation, doing so reduces supply in a system of rising demand so that even more rationing is required. There are obvious reasons why monopolies should be avoided, so the leftist desire for a government monopoly (which, unlike a private monopoly, also has the authority of law and armed force to coerce) is “thoroughly illogical”.

Developing a good system of health care is certainly a difficult problem that requires much serious thought and debate, especially when dealing with the “hard cases” like the poor and individuals with pre-existing medical conditions. Both the left and the right have solutions to this problem, although as Milton Friedman has shown the left’s solution has serious logical and practical conflicts with the laws of economics. The conservative approach outlined by Friedman, on the other hand, takes into account the laws of economics and gives patients the power to choose how best to spend their money — on health care as well as other expenses — rather than impose an “individual mandate” tax.

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7 thoughts on “Milton Friedman on Health Care

  1. Thanks for including me in the links!

    I loved Friedman’s re-framing of employer-provided health insurance:

    Food is more essential to life than medical care. Why not exempt the cost of food from taxes if provided by the employer? Why not return to the much-reviled company store when workers were in effect paid in kind rather than in cash?

    The revival of the company store for medicine has less to do with logic than pure chance.

    Maybe appropriate pro-liberty reforms would have more political success if we explained them like that more?

    • Of course, you were part of the reason I found that great article!

      Friedman does an excellent job framing any economic issue. Everything of his that I’ve read or any video of him that I’ve watched has been great. The food parallel is a good one, and I alluded to it briefly in my post on health insurance mandates (though I was making an argument on the re-definition of health insurance). I think that it would have political success, but on the other hand the leftists might get the idea to start lobbying for employer-provided tax-free food!

  2. Friedman’s approach certainly seems more likely to succeed than Obamacare. I’m not looking forward to the next few years…

    • Hopefully we can repeal it — in full or at least in part — after the elections. I’m hoping the fact that the individual mandate is constitutional only as a tax will allow the Republicans to hammer Obama and his fellow Democrats on the untenable position that they effectively raised taxes (which explicitly broke Obama’s campaign promise not to raise taxes on anyone earning less than $250,000).

  3. Pingback: How Did It Ever Come To Be That You Get Your Healthcare Through Your Employer? | Economics For Morons

  4. Pingback: The Null Space Blog Milton Friedman on Health Care | The Daily Hatch

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