The US Center for Medicare Services recently published a database of physician Medicare billing histories. One interesting bit of information from data release is the fact that a leading source of expenditures for big billers is drugs. As it turns out, Medicare incentivizes physicians to choose the most expensive drugs by reimbursing them for the cost plus six percent. Just another illustration of the way healthcare runs on the same cost-plus markup accounting culture as the rest of the American (and world) economy.
Our whole economy is governed by a set of metrics equating the consumption of inputs to the creation of value. The greater the cost of inputs consumed to produce a given good or service, and the higher its resulting final price, the more value is perceived. This is the opposite of the commonsense approach we take in our daily lives: When we find a way to meet our needs at lower cost and with less effort, we consider ourselves better off.
Not so with the GDP, in which increased efficiency — meeting our needs more cheaply and with fewer material inputs — results in a reduction in national income. The less efficient things are, the more damage resulting from our daily activities to meet our needs, and the more resulting expenditure of inputs, the higher the GDP. A massive auto pileup results — via the costs of repairing and replacing cars, treating victims in Emergency Rooms, etc. — in the addition of untold thousands to the national income. On the other hand, the widespread substitution of the free and open-source Wikipedia for the expensive Britannica, the destruction of newspaper advertising revenues by Craigslist, the replacement of travel agents by online booking services, etc., count as radical reductions in economic output, and hence prosperity on paper — despite the fact that actual individuals and families can now meet needs for free that would once have required them to work hundreds of hours to pay for.
The same is true of the standard corporate accounting system, in which capital expenditures, management salaries and administrative costs, are counted as general overhead, and — through “overhead absorption” — incorporated into the arbitrarily set internal transfer prices assigned to goods “sold” to inventory. The more such inputs wasted in making a finished product, the higher its price, and the higher the resulting book value of the inventory sitting in the warehouse — despite the fact that there’s more inventory than customers are willing to buy at that bloated price. The large corporations that follow this accounting method are generally in oligopoly markets with price leader systems, in which three or four firms in an industry control a majority of sales in a given market and can pass their costs directly on to the consumer via administered pricing.
It works this way in regulated utilities, where rates are set politically so as to guarantee a defined rate of return on expenditure, and in military contracts (the reason it’s in contractors’ interest to come up with those $600 toilet seats). It’s also the way the old Soviet-model planned economies assigned prices to unfinished and finished goods within their systems: So many refrigerators or microwaves produced were so much value, regardless of whether they worked or were destroyed by careless handling during shipping.
In every case, the incentive is to maximize production costs and do things in the most inefficient manner possible, because the measure of value (and standard of reimbursement!) is the cost of the inputs consumed. This is what Paul Goodman called “the great domain of cost-plus.”
This is the reason for most of the cost inflation in higher education. A major part of the industry’s revenues are guaranteed by third parties (for example government aid to higher education and banks that get guaranteed returns on student loans). Since tuition is set through the same administered pricing to the third parties that govern the corporate economy, there’s every incentive in the world to maximize overhead costs through utterly stupid and wasteful construction projects, ever-rising administrator salaries and the like. As a result, inflation in college tuition is even higher than that in healthcare, with a dwindling share of the price going to cover actual delivery of services.
The state, the giant corporation, and large institutions of all other kinds are part of an interlocking culture designed to extract as much money from us as possible while delivering as little as possible in return. That’s why political agendas centered on guaranteeing our ability to pay for services, without touching the institutional culture that makes them so expensive, are a dead end.