Spending other people’s money drives up prices

by Grace

Dr. Jeffrey A. Singer writes about “Health Care’s Third-Party Spending Trap”.

Contrary to “conventional wisdom,” health insurance—private or otherwise—does not make health care more affordable. The third party payment system is the principal force behind health care price inflation. This should come as no surprise.

Nobel-winning economist Milton Friedman, in his masterpiece “Free to Choose,” wrote of four ways to spend money:

Category I—You spend your money on something for yourself. Here you are very careful, because it is your money, and the good or service you are buying is for you.

Category II—You spend your money on something for someone else. Here you have the same incentive as in Category I to economize, but since you are buying something for someone else, you are not quite as meticulous when it comes to the purchase meeting the needs or values of the recipient.

Category III—You spend someone else’s money on something for yourself. Here you are not concerned about how much you spend, because it is not your money. But because you are spending on yourself, you make sure you are getting what you want.

Category IV—You spend someone else’s money on something for yet another person or persons. (This is what we ask our legislative representatives to do every day.) Here you are the least incentivized to economize, or to buy something that meets the needs or values of the recipient.

Healthcare prices are affected by Categories III and IV spending. 

Medicare, Medicaid, and private insurance are examples of Category IV.  Politicians and bureaucrats buy goods and services with other people’s money.

Meanwhile, when the third party payer is perceived as picking up most of the tab, then health care consumers and health care providers engage in Category III spending. Neither have an incentive to take cost into consideration.

Health insurance should not cover “routine, predictable events”.

This isn’t to say we don’t need health insurance. Health insurance that covers truly unforeseen, costly catastrophic occurrences makes sense for most people. As does life insurance, property and casualty insurance, and auto insurance. But health insurance that covers routine, predictable events isn’t really insurance. It’s prepaid health care. And it is driving up prices for everyone with everyone else’s money.

Policymakers need to understand that the key to “affordable health care” is not to increase the role of health insurance in peoples’ lives, but to diminish it. We need much less Category IV spending on health care, and much more of Category I.

Third-party payments are also a factor in higher education.

Higher education, which along with healthcare has experienced a recent history of soaring costs outpacing inflation”, also suffers from the inefficiencies of third-party payments.  The latest number I saw was that the average student at a private, nonprofit college only pays about 57% of the sticker price of her education.

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Related:  Can young college graduates burdened by student loans be convinced to buy health insurance? (Cost of College)

4 Comments to “Spending other people’s money drives up prices”

  1. How does this theory explain the fact that healthcare costs in countries with single payer, or with universally required comprehensive insurance, are much lower?

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  2. I didn’t know that was universally true, but I suspect there are many factors at play besides the third-party effect.

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  3. We pay a lot more than any other developed country. Here is data for 2012

    http://www.washingtonpost.com/blogs/wonkblog/wp/2013/03/26/21-graphs-that-show-americas-health-care-prices-are-ludicrous/

    The countries in this survey have varying means of paying for healthcare, but all have universal comprehensive coverage except us. In all, insurers and providers are highly regulated, except us. faced with this data, I think it is clear that comprehensive health coverage is not the culprit

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  4. I don’t know what the main reasons are for the differences, but the third-party payment factor could very well play a bigger role boosting costs here in the U.S. This could be tied into the greater diversity (less cohesive culture) and different attitudes towards government that exist here.

    I noticed that in almost all those countries from that link healthcare costs have been rising faster than in the U.S,

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