Structural Spending Reform, Part 4

Health care is one of America’s most contentious policy issues. While Democrats keep pushing for more government involvement, Republicans have presented a good reform to move in the opposite direction. It remains to be seen which way Congress ultimately goes on this issue; with the budget deficit essentially out of control and the two political parties deadlocked in a mad fight over ideology and a highly contested election, it is unlikely we will see sound reform efforts any time soon.

That said, if the Democrats recognize the voter message in their loss of seats in the House of Representatives and that they probably will not gain control over the Senate; if they replace Nancy Pelosi with an ideologically more moderate Speaker, there is a chance for reform efforts across the aisle. That, in turn, could become a moderating force in the event a radical Biden administration were to take office in January.

America is in dire need of bipartisanship on major, structural entitlement reform. If we continue in the opposite direction; if we see more monetization of deficits; we are destined for uncontrollable deficits, hyperinflation and eventually economic implosion.

Too many people still shake their heads at this prospect, thinking it cannot happen in America. They are foolishly ignorant.

Fortunately, there are reforms out there that could appeal to a bipartisan coalition of common sense in Congress. I will discuss three of those reforms, starting today with health insurance.

To work, structural spending reforms must meet three criteria:

  1. Part with the algorithm that grows government spending. The modern American welfare state is built around the principle that entitlement spending should grow annually as the economy becomes more prosperous. We must redesign the welfare state in line with socially conservative principles, where it provides a basic safety net and an institutional framework.
  2. Protect the weakest among us. It is essential that a structural reform does not make life worse for those who are unable to provide for themselves and who live on the very edge of destitution. If they end up worse as a result of a market-based structural reform, then the reform has morally failed. This demographic depends critically on the welfare state because government has essentially marginalized the private sector in providing for the poor and the vulnerable; when we roll back the welfare state, we therefore have to prioritize the weakest demographic and secure their path to a better life before anyone else benefits from the reform.
  3. Stimulate economic growth based on free-market principles. No economic system is better at combining efficiency with quality than free-market capitalism. It rewards him who finds a way to do more with less and thereby drives resources to where they can steadily improve quality and affordability.

We will discuss these three criteria in the context of Social Security and welfare reform. First, though, we will take a look at how we can reform our health-insurance market with these criteria in mind.

The Republican Study Committee reform plan is important in this context, but there is an even more interesting example, namely the Dutch health insurance reform. It gives us a context from a political environment that generally favors government involvement in the economy, yet the reform took a few important steps in the opposite direction.

In 2006 the Netherlands reformed its health-insurance system, from one that primarily relied on taxpayers to one where private insurance became the norm. The shift was dramatic, literally flipping the proportions of tax-paid and private insurance funding:

Figure 1

Sources of raw data: Eurostat, OECD

The reform did not happen abruptly, but followed logically after the country moved in the direction of “managed competition” in 2000. That reform, in turn, came on the heels of a long struggle to contain costs in what was essentially a system with Medicaid for the masses and private insurance for the privileged few. From Health Affairs, 2008:

By the end of the 1960s the Dutch government became worried about the seemingly uncontrollable growth of health care spending. The reason for this was twofold. First, rising health care spending could jeopardize the goal of universal access to basic care. Second, the government feared that rising health care costs would result in higher labor costs, which would raise unemployment and harm the Dutch open economy, which relies heavily on exports. The growing pressure to contain medical spending led to increasing supply and price regulation beginning in the mid-1970s.

When they realized that more government involvement did not solve the underlying problems of runaway costs for an inefficient health-care system, they tried a different approach:

From the early 1980s top-down rationing policies were subjected to growing criticism, focused particularly on the lack of incentives for efficiency and innovation within the prevailing system of health care finance and delivery. This led to broad support for incentive-based reforms and a reconsideration of the role of competition. In 1987 the government-appointed Dekker Committee advised a market-oriented health care reform and a national health insurance system. The Health Insurance Act (2006) and the current regulatory regime are based on these proposals.

The reform was centered around a market for private insurance. It was not a complete market-based reform: there are price controls that give price signals a moderate scope for transmitting supply and demand signals through the market. There is also a coverage mandate, which is controversial from an American viewpoint but understandable if you transition from a Medicaid-for-the-Masses model into a predominantly private system.

One of the best accounts of the Dutch health-insurance reform is from 2008 and was actually written at Lehigh University by an undergraduate student, Rachel Stewart (confirming that a wide assortment of PhD’s fall victim to the sea squirt theorem). Titled “Dutch Health Insurance Reform: An Evolving Effort to Transform Healthcare”, the report highlights the introduction of competitive elements in what was previously an over-regulated system. For example:

Although the basic policy’s coverage is prescribed, insurers can establish their own contracts with healthcare providers. This was not the case in the old system, where insurers were required to contract with all healthcare providers in their respective region.

Government mandates a basic package of benefits to be covered by every insurance plan, but the system is open-ended in terms of supplementary insurance plans.

Institutionally, the funding model is designed to allow for more room for market-based premiums, but there is also a “risk equalization fund” that essentially fills the function of U.S. high-risk pools. Stewart reports:

The new system’s elimination of risk selection by requiring insurers to accept all applicants is an important feature; it provides everyone with the opportunity to purchase health insurance, but it poses a financial problem for insurers. Because there is a strong incentive to select against higher health risks, and because forbidding the practice creates a potential for an unequal distribution of risks between insurers, the Risk Equalization Fund (REF) compensates insurers for bearing uneven cost burdens.

This is, again, an institutional feature characteristic of a reform that goes from Medicaid for the Masses to a generally private model. While better solutions are available, it fits within the framework of a reform that seeks broad political support for the introduction of market-based mechanisms to combine efficiency with quality.

In this respect, the reform appears to have worked. It was designed to create incentives for both patients and providers to be efficient with resources and mindful of quality. In this regard, the reform appears to have worked, as visible in Eurostat and OECD health-care data.

  • Cost containment has worked: in the seven years prior to the reform, total national health-care costs in the Netherlands increased by 7.4 percent per year; in the seven years immediately after the reform, the annual cost increase was less than 4.7 percent.
  • In the same pre-reform period, the number of hospital employees decreased at -0.35 percent per year; after the reform staffing increased by almost two percent per year.
  • In 1999-2005, medical doctors accounted for 18.7 percent of hospital employees; in 2006-2012 that share increased to 21.2 percent, on average. This increase was visible in annual growth rates: pre reform, hospitals added 1.7 percent medical doctors per year; post reform the annual growth rate was 4.1 percent.

Overall, the Dutch health insurance reform brought key features of the free market into a system that for decades had been dominated by government. While not directly informative for an American reform model, it shows how a reform effort in an ideologically charged political environment can be honed in on the three criteria listed above:

  1. The spending-growth algorithm. While the Dutch model does not confine government strictly to a last-resort provider role, it does reduce government funding to a secondary function. Its focus is on subsidies that indirectly benefit low-income earners more than others. Unlike the Obamacare model, which seeks to simply redistribute insurance coverage, the Dutch reform designed subsidies to guarantee access to basic care. This is a more socially conservative approach than a traditional socialist model.
  2. By scaling back government participation to a secondary function, the reform can better guarantee protection for the poorest citizens. This role is not perfected in the Dutch reform, but it is highlighted. When government parts with the socialist ambition to provide a benefit to everyone – when the Medicaid-for-All idea is tossed out – it can limit its burden on taxpayers while moving closer to fiscal sustainability.
  3. Putting market mechanisms in the front seat means that both health-insurance plans, health-care providers and patients have incentives to do more with less. Competition and consumer choice are prioritized. To be clear, the Dutch reform is by no means perfect in this regard, but available quality data suggests that the reform has worked in this respect. Cost increases have tapered off while patients have better access to doctors than before the reform.

The Dutch reform is relevant from an American viewpoint more for its design features than for its actual performance. What matters is the thinking behind the reform; to move our system in the right direction, and away from increasingly costly government involvement, we need a somewhat different focus. Again, the Republican Study Committee has given us a very good idea of what that means.

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