The Medical Market Place
FEBRUARY 01, 1971 by A.R. PRUIT
Dr. Pruit is a practicing physician at the Hertzler Clinic in Halstead,
What is the state of the market, what are the economic problems of the health industry today? Realistic appraisal of the current situation requires examination of the nature of the market prior to the onset of massive state intervention. So let us review the economic history of organized medicine in the
American medicine was until about 1850 a free-wheeling, highly competitive, free market industry. Like the ministry in some religious denominations today, anyone who "felt the call" was free to hang out a shingle and declare himself available. The only restrictions were those put upon him by the quality and availability of the competition, and by the favor of the customers who dictated his rewards. Similarly, medical schools were easy to start, easy to enter. These schools taught every conceivable approach to health from the orthodox to the mystic. Many of the schools of this time were organized as profit-making institutions. Some were owned by the faculty. Some were privately endowed. Some were hardly more than diploma mills. Their quality and the quality of their products ran the gamut of the quality spectrum from excellence to quackery.
It is easy to understand why many of the finest men in orthodox medicine, those dedicated to the development of medicine as a science, would feel totally dissatisfied with this seemingly chaotic arrangement. One can only applaud their desire to improve the over-all quality of medicine for the public benefit. Their problem was one of implementation. How can this improvement be accomplished? Can the people, through education or any other means, ever have enough special information to be able to recognize and choose quality care out of this hodgepodge of misinformation and charlatanism? Or, is human gullibility so great, and human ability to choose responsibly so frail, that some means must be found to protect individuals from their own folly and insure the delivery of what we know to be the highest quality care? Who is to be responsible: man or the state? That was their basic question. This troublesome but fundamental question lies at the root of every sociopolitical problem which faces us today. The men in medicine did not believe that man could be responsible. Their answer: the state. They believed that orthodox medicine should seek the sanction and protection of the state to help shield the people from their inability to choose responsibly.
Origin of the A.M.A.
The American Medical Association was organized in 1847 and committed itself to two propositions which, when fulfilled, would improve the over-all quality of American medicine. But these same propositions led to sharp restriction of the medical market place. From a free market, it quickly changed to what many economists call a discriminatory monopoly, which simply means a market place which favors, invariably through legislative fiat, one competing group over all others. How did this come about?
The two propositions were (1) that medical students should have acquired by the time they were ready to practice a "suitable education"; and (2) that a "uniform elevated standard of requirements for the degree of M.D. should be adopted by all medical schools in the U. S." What would be "suitable" and "elevated" was to be determined by a consensus of the best minds within the organization.
Certainly, these laudable goals of themselves could have no possible bearing on medical economics. What did bear on the medical market place, however, was the method of implementing those propositions. The method was to exclude, by state intervention, all undesirable or unqualified competition: first, by licensure of only qualified M.D.’s, and second, by control, through the state mechanism, of medical school standards.
These objectives were achieved in two stages. It took the A.M.A. fifty years to convince all state legislatures that licensure was necessary, but by 1900 this goal was accomplished. The states in turn delegated the power of licensure to organized medicine through the State Boards of Medical Examiners, all of whom were members of orthodox medicine. Subsequently, control of standards of medical schools was accomplished comparatively quickly following the now famous Flexner Report in 1910. With licensure already in effect, it was a simple matter to change the rules of the State Examining Boards to consider only graduates of medical schools which were approved by the A.M.A. and/or the Association of American Colleges, whose lists were identical. A short time later, these controls were extended to many of the hospitals of the country by defining standards for hospitals eligible for internship and residency programs. Today, through the efforts of the Joint Accreditation Commission, these controls have been extended to all the hospitals in the country. The delegation of these powers by the state, making A.M.A. a quasi state agency, gave it complete control over entry into the practice of medicine as well as control over access to the nation’s hospitals. It is this control over entry and access that prompts Prof. Milton Friedman of the
Viewed in the light of the current acute shortages of physicians, the successful argument deriving from the Flexner Report is ironical. In brief, the argument held that
Whatever names one may apply to the industry or to the A.M.A., it is a fact that the number of doctors produced by the medical schools has remained relatively static for many years despite a rapidly increasing population. In 1910 when the Flexner Report was published there were 23,300 medical students in the
When Demand Exceeds Supply, Prices Tend to Rise
It is axiomatic that when demand exceeds supply, other factors being equal, the price of the goods or service in demand also increases. It is also true that when standards of quality are elevated, the price of the better quality product is also elevated. A Cadillac necessarily costs more than a Ford. To know that these laws have held true in medical economics, we only need remember that the medical profession has become one of the highest paid of all the professions—thus reflecting the relatively higher costs of medical care to the general public. Ordinarily, however, one would expect, in a market where supply is so severely restricted, a much greater cost differential than there has been. The medical profession has been able to deliver quality medical care to the general public, rich and poor, at prices within the reach of any who needed care.
There were many mitigating factors which made this possible. Once the barriers to entry into the profession were overcome, the individual physician was free to practice when, where, and how he pleased. There was no Board of Directors making decisions for everyone. Competition with his fellow physicians helped to keep his prices down and the quality of his care high. Contract with each patient through "fee for service" demanded his personal involvement with the singular problems of the individual, the essential ingredient in quality medical care. The ancient Hippocratic tradition that care would be provided regardless of ability to pay was an extremely important factor. Freedom of choice by the physician and by the patient, community respect and its derivative, the sense of responsibility to the community, all played important roles. The success of the system depended precisely upon the fact that it was not an organized business entity. There were no police committees like peer review, or utilization review. Competition, contract, and freedom of choice provided all the restraints that were necessary.
This, then, is an economic overview of the American medical system prior to the advent of government inflation of the nation’s supply of money. It was not a perfect system. There are no perfect systems this side of heaven, in spite of the contrary declaration of the planners of the American utopia. But that system functioned brilliantly enough to bring American medicine into world-wide esteem. It is the very nature of this high quality but severely restricted and inelastic supply market and of the control mechanisms which sustain it, as outlined here, which makes the system so vulnerable to massive intervention. At the same time, the system raises almost insurmountable obstacles in the way of those who are totally opposed to this intervention and to the philosophy which prompts it. Whoever controls entry and access has the power to control the economic destiny of every physician in the industry if he chooses to use that power.
The Impact of Inflation
Inflation is one of the most devastating, destructive, and demoralizing forces which can be imposed on a civilized society. The distortions and dislocations which it produces are so numerous and occur in such rapid succession, that the adjustments and rearrangements which society would achieve under normal growth conditions now become impossible of achievement, thus creating permanent dislocations and maladjustments with social disintegration the ultimate result.
Most of the dislocations and maladjustments which are chronic problems in the health industry today are directly or indirectly an aftermath of inflation. The increase of doctors in the cities and their decline in small towns, the growth of specialists and the decline of generalists, the increase in emotional and social problems and the decline and distortion of social values and standards, are but a few of the multitude of distortions and dislocations which are aggravated by, or caused by, a continuing general inflation. I mention here these effects of general inflation because of their bearing on problems to be discussed later.
For discussion purposes, the health industry can be considered as an isolated economic unit which functions within itself in exactly the same way that the national economy does. As such a unit, it is subject to the same laws of the market place. Such an economy tends toward a state of equilibrium between supply and demand, and the prices of goods and services to the consumer are reflected in this equilibrium by remaining fairly stable.
If, in this state of relative equilibrium, there is an intrusion of hitherto unavailable money, there occurs an immediate disequilibrium. In the general economy the increased demand caused by the influx of new money is met (at least for awhile) by an increase in productivity and a rise in prices, which tends to return the market toward a state of equilibrium again.
As long as the producers can profitably increase their productivity by raising their prices, then supply and demand will continue to tend toward equilibrium.
This holds true for the general economy and it holds true for the health industry as long as the inflation is general. But when a massive increase in the supply of money is suddenly injected into the isolated economy of the health industry, there is an entirely different situation. The health industry can cope with general inflation because its internal equilibrium is not greatly disturbed. However, when a secondary inflation is imposed on the industry by a sudden vast increase in the supply of money within its isolated economy, the disequilibrium which occurs between supply and demand has immediate and serious consequences throughout the industry. The medical market cannot react as the general market reacted for the obvious reason that in the general economy, supply has been relatively flexible and could adequately respond to demand; but in the medical economy, supply, particularly in the vital area of physician’s services, is relatively inflexible and cannot respond adequately to great increases in demand.
Subsidies to Medical Schools
The first major intrusion of government into the health industry began with World War II and the subsidization of medical schools. This intrusion did not cause an immediate disequilibrium in the medical market. It was concentrated in the area of what may be termed a producer’s market and had no appreciable direct effect on consumer demand. However, when coupled with some of the consequences of general inflation, it did cause major changes in the distribution of physicians, thus affecting their supply in the vital area of service to the consumer.
The initial effect of the use of fiat money to subsidize medical schools was to cause an inflation of research activity. While this increased activity did serve to increase (inflate) our knowledge and technical ability in many areas, it had other, far-reaching and less salutary, effects. There was, first of all, a great increase in the size of the faculty of medical schools. With continued subsidization, and through the device of tenure, the number of teachers and research fellows tended not only to grow but to become permanent, thus greatly increasing the costs. Since the chief source of funds from the government was earmarked for research purposes, the schools tended to be diverted from their main purpose—to teach students—and to become more and more preoccupied with research. As the research programs grew, more and more physicians were diverted into research, thus adversely affecting the supply available for private practice.
The availability of fiat money in this area, along with the rapid growth of population and the increasing demand for medical services, did increase, very slowly, the number of medical schools and the total number of medical students. In 1944 there were 69 medical schools. By 1969, their number had climbed to 99. Interestingly enough, though hardly surprising, every medical school in
Walter McNerney, writing recently on medical costs, calculated that: "If we double the output of American medical schools today and keep all other factors constant, it will be 30 years before we double the total number of physicians in the country."
Supply in the medical market place is, indeed, inelastic.
Thirty years of war and the continuous mobilization of huge numbers of men in the armed forces; the tremendous growth of bureaucratic health agencies, state and Federal; the mushrooming of research programs in the medical schools and in the so-called "think tanks"; all of these, made economically possible only because of fiat inflation of the money supply, have increased the demand for physicians. The entry of doctors into these artificially created areas of demand has, in terms of the supply available to private practice, negated completely the increased production of physicians by the medical schools.
Controls Upset Balance Between Demand and Supply
The net result of government intervention in medical education has been (1) the Federal government has gained virtual control of medical education; (2) in terms of an increasing demand for services there has been a relative decrease in the supply of physicians available to render services through entry into private practice.
The passage of the Hill-Burton Act initiated the second major intrusion by government into the medical market. The rapid increase in the number of hospitals which resulted, coupled with the growing demand for medical services generally, caused a hyper-acceleration of demand for trained auxiliary medical personnel of all kinds. Supply of personnel has not been adequate to meet the demand, and a spiral of wage increases has resulted throughout the industry. It is significant, as a reflection of this disproportionate increase in cost, that until the advent of Medicare, hospital fees were the only prices throughout the health industry which increased significantly faster than price levels in the general economy.
According to Mr. McNerney, "over 60 per cent of health care costs are attributable directly to manpower." When one considers that nursing salaries have more than quadrupled in the last 25 years, that the salaries of other technicians have risen comparably, and that all wages are still rising, one can see immediately that the effect of special inflation within an industry where all technical help is in short supply is to put an exorbitant price tag on the services demanded.
With the advent of Medicaid and Medicare the already straining health market was immediately forced into a state of marked disequilibrium. In this instance, vast sums of unearned and hitherto unavailable dollars were suddenly poured into the demand side of the ledger.
The immediate effect was not just an increase in demand. There occurred a psychological hyperinflation of demand. The consumer, released from all the restraints imposed by "cost" and "afford," develops, rather quickly, a whole new spectrum of complaints which demand attention. Chronic ailments which were not disabling, with which he had lived and been productive for many years without seeking medical aid, now become more and more emergent. He begins to demand attention for increasingly trivial complaints. His calls upon the physician become more frequent and his hospital admissions more frequent. He demands more sophisticated and more luxurious services and facilities than he was willing and/or able to pay for before. The physician once had difficulty keeping him in the hospital long enough; more and more the problem now is getting him to leave. As we have already proved, with the vast and never-ending expansion of welfare programs over the past 30 years, there is no end to the growth of needs and demands when they are unrestrained.
As long as the government continues to stimulate demand, and supply remains inelastic, acute shortages will continue and wages will continue to rise. Attempts to further improve efficiency by more mechanization and increased paramedical personnel will only increase capital investment and operational costs. Physicians and hospitals, who must pay their bills or close their doors, have no choice but to increase fees and to continue increasing them with each new spiral of wage, price, and tax increases. This, in general, is the situation in the medical market today. As long as inflation continues, this will remain the situation, and no combination of managerial talent under the sun can do anything constructive about it.
Further Intervention No Cure
What happens when the medical market, as seems likely, becomes a government controlled monopoly, administered by a politically oriented bureaucracy? It seems unlikely that the situation will improve under the least competent and least efficient form of administration which man has yet devised.
The only thing that can possibly be achieved by government intervention is a drastic reduction in the over-all quality of medical care at a tremendous increase in cost to the consumer. The program will be entirely dependent on a continuation of inflation in spite of massive increases in taxation for the already overburdened taxpayer, and in spite of wage and price controls which will be applied throughout the industry. The demise of competition, the eradication of "fee for service" contract between the physician and the individual patient, the distortion of freedom of action and freedom of choice, must all have an almost lethal effect on physician motivation and incentive. The art of medicine under these circumstances must degenerate into a sterile and grossly distorted caricature. There may, for awhile, be luxury care but the element of quality will, all too often, be lacking.
Lower the Standards?
The only possible way to adequately increase the supply of physicians under the present circumstances is to lower the standards of qualification. Just as the Registered Nurse shortage of the 1950′s caused the development of Licensed Practical Nurse programs, so will the planners try to meet the physician shortage by the development of what should be, but will not be, called Licensed Practical Physician programs. The imposition of these programs will, in effect, turn the clock back about 70 years, as far as the over-all quality of medical practice is concerned. In the pre-Flexner Report era, however, the consumer had a free choice of quality. In our time the poor quality care will be imposed by the state. The vast majority of Americans will have to accept it. There will be no choice in the matter.
This is not a pleasant report. It is, I believe, an honest one. I cannot here attempt evaluation in depth of the many maladjustments which have accrued, not only from external influence and interferences, but also from our own past errors both of omission and commission in the management of our affairs. Further study and evaluation of these fundamental problems is, in my opinion, imperative. No useful purpose can be served by minimizing a serious situation. Just how serious our situation is becomes immediately apparent when we realize that the problems of medicine are but one set of symptoms of a disease which threatens our entire social structure.
There is no easy solution. Before we can understand effects, the causes in which they are rooted must be explored and identified. Until we understand causes, we cannot hope to find effective solutions.
The situation is by no means hopeless. On the contrary, we have every reason to be hopeful. There is more awareness, more concern, more intensive study, more understanding of fundamental issues today than at any time in the past 30 years. Disillusionment with government policy, its profligate spending, its gross inefficiency, its monumental failure to improve society, is growing rapidly. Inflation cannot last forever. It must end, as historically it always has, in economic and social disaster, but this will not be the end of the world. Our form of government may not survive, but we will. If we know and understand enough, we can, in our turn, and in our sphere, help recapture a heritage which we have somehow lost.
GARRISON, FIELDING H., An Introduction to the History of Medicine, Fourth Edition.
KESSEL, REUBEN A., "Price Discrimination in Medicine," Journal of Law and Economics, 1958.
Journal of the American Medical Association,
GARDNER, JOHN W., "Medical Costs: A Report to the President," Condensed Report—Medical Economics,
MCNERNEY, WALTER J., "Why Does Medical Care Cost So Much?" The
Free Medicine Can Make You Sick
SOCIALIZED MEDICINE includes government care of the sick and support for the family as well. If this support amounts to approximately the same as the man can earn from his own daily labor, he is tempted to be sick continuously. The temptation would be the greatest for people in low income brackets, illness actually being preferable to good health. This may sound strange, but doctors can observe the fact in their daily practice. Many people want to be sick, or sicker than they actually are, because material advantages in the form of compensations and liability payments are involved.
CHARLES G. JONES, M.D.