Sunday, January 18, 2009

Healthcare: A Diseconomy of Scale

Economic recessions offer the benefit of making inefficiency more costly. During times of plenty, we can tolerate mediocre businesses or bad public policy; but during a recession they come under heavier scrutiny. This appears to be the case for medical care. The Washington Post reports that
For years a booming economy camouflaged the burden of medical debt. Patients borrowed against their homes or whipped out credit cards, including some specially designed to pay medical or dental bills. But falling house prices and tightening credit have eliminated those options for many.

It’s long been recognized that medical care in the US needs improvement, it’s just that when the economy was good we could afford its extra costs. Michael Moore’s documentary Sicko – a polemic rant about our lack of universal healthcare – was released in the summer of 2007, which was one of the decades’ most prosperous economic times. Only now, with money tight, are we forced to do something about it. An estimated 78 million baby boomer retirees are thought to further weigh down the future of medical care. However, I’ve always been baffled about the inability of our medical care system to take advantage of economies of scale.

What are economies of scale?

An economy of scale refers to the advantages a business gains from an enlarging consumer base. It’s a piece of economic jargon, but don’t let that throw you: Knowledge in modern times is heavily fragmented, so fields of study are constantly adopting new idiosyncratic jargon-terms, with the unfortunate result of often alienating outsiders and novices. Economy of scale however is one of the most valuable concepts in modern times – even outside of economics – because, by any scale of measurement, the world’s stage is getting larger. The future of truth and knowledge itself – epistemology – is likely to be interwoven with this principle of economy of scale.

The principle is pretty simple. At its heart is an exchange of capital for economic security. For instance, a full-time job that pays $10 an hour is often more valuable than a temp-job with erratic hours that pays $20 an hour. In accepting the full-time position, you’re trading the potential extra earnings of the temp-job for the economic security of knowing your salary for certain. Likewise, when you buy large quantities of goods, you’re guaranteeing a supplier economic security; suppliers often offer discounts in return. That’s why products at stores like Best Buy or Costco are inexpensive.

Ford’s Model T car is the classic example: By marketing the car towards the general population, Ford Motors drew in large quantities of capital, which made it cheaper for them to buy supplies and hire permanent workers. If Ford only bought enough supplies for 1 car and hired a temp to construct it, then the Model T would have been unaffordable for most people; on the other hand, if Ford mass produced the Model T and it turned out to be a flop, they’d have gone bankrupt.

The Model T was of course a hit and the investment payed off over many times. Inventors were playing around with cars long before Ford, but Ford’s ability to tap economies of scale made cars accessible to the population at large. The automobile went on to revolutionize our economy more than any other single invention. Likewise, Microsoft popularized the computer by marketing an operating system accessible to non-geeks.

Economies of scale have fueled such transformations, which would’ve been impossible without enough capital and without enough people. People – in both quantity and quality – are an economy’s best asset.



That’s why international trade sanitations against foreign nations are so harmful: When a nation is left to fend for itself it can’t take advantage of economies of scale. The harms of trade sanctions are escalated as the world population grows: If there are only half a billion people in the world, and a nation is cut off from four-fifths of them, then they’re not missing much; but if a nation is cut off from 5 billion people, then they’re missing much more.

A similar effect occurs when groups of people cut themselves off from the rest of the world in order to become “self-sufficient”. Self-sufficiency will always be difficult regardless of the world’s population, but as the world population expands, the drawbacks of self-sufficiency become more obvious. The Amish for instance weren’t so different from the original American settlers; but today their differences from mainstream America are magnified tremendously.

Self-sufficient groups such as hippie communes lack any economy of scale. In fact, you might even say that their isolation makes them anything but sufficient. It’s not just that they miss out on this or that technology, they also miss out on all the opportunity created by technology: The time saved through efficient transportation, or a PC’s computing power.

Likewise, protectionist international trade policies, or the push to make the US "independent" from foreign oil, isolate us from economies of scale. The costs of such policies often outweigh the benefits. And these costs extend beyond the extra money we're forced to pay; they retard progress as a whole.

Healthcare's "impending crisis"

…all of which is why a predication such as the the following would be a blessing to almost any industry except for medical care:
We face an impending crisis as the growing number of older patients, who are living longer with more complex health needs, increasingly outpaces the number of health care providers with the knowledge and skills to care for them capably. (CBS News, 04/2008, quoting John Rowe)

Say, for instance, we find out that, without a doubt, in 10 years, a quarter of all 18 year-olds will purchase a new MP3 player. As early as possible, Apple would plan to mass-produce more iPods at more competitive prices. As the leader of the industry, Apple’s stock would soar immediately. And as a direct result of the expected economy of scale, the price of iPods and other MP3 players would fall significantly.

But in healthcare an influx of customers is a crisis not a blessing. This maybe because health care is different: It’s a service industry, and it relies on insurance and risk. But at the same time, other service industries – such as IT support - have adapted to increasing demand. Now is in fact the best time in history for your computer to break down, since so many other people own computers. If there were only 500 other computers in the whole world, and yours broke down, you’d be SOL. Likewise for your car. Yet the point remains that health care lacks such a safety in numbers; on the contrary, it has a danger in numbers.

The problem is that advances in healthcare haven’t been applied to economies of scale. It’s like in the early 20th century, after the car was invented, but before it was mass-produced. I suspect that the difficulties in boosting health care through economies of scale are due structural inefficiencies rather than a lack of technological advancement.

Consider for instance the costs involved in becoming a doctor or in producing drugs, which include huge sums of both money and time. These costs are inevitably passed onto society at large. Additionally, anti-competitive practices such as social security and medical care leave no incentives for cost-cutting or increased efficiency. Some liberals might shiver at the prospect of business profiting from elders' health problems. But the costs of our present system are too great. Indeed, the current system benefits much more from high-cost solutions to medical problems than from low-cost solutions. Similar to trade sanctions or hippie communes, the flaws of poor healthcare policy only become more apparent as the world gets bigger.

And herein lies economies of scale’s epistemological import: As populations continue to grow, advancements in cost-effectiveness will become more important than other types of scientific or technological advancements. This is somewhat counterintuitive because we tend to think in categorical terms. Medical science seeks cures, not ways to save money. But with more people in the world, the benefits of less expensive treatments are more pronounced. It’s not just that they save lots of people lots of money, it’s that they free up lots of money for society to pursue other problems.

The debate on healthcare in America is backwards because it’s from the perspective of who should pay the bill, not how we can lower it. From the perspective of society at large, at any given moment, it doesn’t matter who pays off patients' debts – it still costs society the foregone alternatives of applying that capital elsewhere. In other words, the expensive cost of medical care will wreck havoc on society regardless of who foots the bill.

Thomas Sowell points out that modern times are unique because for the first time in history the poor and middle classes combined have more capital than the wealthy class. This is why economies of scale are important. And it’s why – if you measure time by the quantity and impact of significant events each year – time is exponentially speeding up. Unfortunately, sometimes we’re forced to advance by learning from bad policy, which can take years to start reaping rotten fruit. But properly harnessed, economies of scale will propel us into the future. We have the requisite capital, know-how, and gumption. Most importantly we have the people.

-KJ

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Media (in order of appearance)

Photo: (1) Crowds in Hong Kong, 12/22/2008, by LipJin Lee; (2) Costco, 12/16/2004, by Ryan Ozawa; (3) Old but not forgotten, 05/19/2008, chisdonia; (4) Life in Orange County, Indiana, 02/28/2007, by Cindy Seigle; (5) Ginza 銀座, 09/16/2006, by Nathan Duckworth; (6) Medical insignia; (7) faster than the speed of light, 12/28/2007, by Via Bulatao.

Music: Music video, 09/22/2008, from KERAKO's channel, of the song "TNT" by Tortoise from the 1998 album
TNT. Sphere: Related Content

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