Why Washington Can't Reform Healthcare

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It's not for lack of will. It's not for lack of power. It's not even for lack of money. Washington can never effectively "reform" healthcare for one simple reason. The healthcare industry runs on fake prices.

On any given day each of us makes a diverse array of price decisions. On rare occasions, like buying a car or a house, we haggle. Most often we simply decide to buy this or maybe that or instead save for a rainy day.

We make these choices based on knowledge unique to our own situation. Should I replace that moth eaten sweater my girlfriend hates? If I splurge on steak tonight does that mean Ramen noodles tomorrow? You cannot answer questions like this for somebody else.

Every purchase decision is a vote. Add them up and hundreds of millions of votes are cast every day. Each is based on a balancing of desires, means, and personal knowledge possessed by no one but each buyer.

Our votes not only tell sellers what to make but when to ship how many where, what color they should be, and how much to charge. Sellers that get it right win our votes and thrive. Sellers that don't disappear. Every day is Election Day. There's no need to wait four years to throw bums out.

Business works the same way, only with more haggling. Prices and the information they communicate are the nervous system of any market. Complex supply chains sprout, evolve, and die as every player in the chain responds to the price signals he can see. These signals tell businesses how much to pay for inputs, what to charge for outputs, when to take risks, where to best innovate, and when it's time to take a hike. If any link in a supply chain consistently loses money the chain breaks and a new one forms. Or not, in the case of buggy whips.

When it comes to running an economy, votes in Congress mean nothing compared to the votes of consumers and producers. Replace the votes of hundreds of millions of buyers and sellers with the votes of a few hundred Congressmen and what do you get? You get our healthcare system - a market whose nervous system has been paralyzed.

Imagine the world's smartest food expert with access to the best culinary research trying to decide what the right price is for a ham sandwich. Once the price is set, that's it - selling a ham sandwich for more or less is against the law. Oh, and homeless people get free ham sandwiches. Refuse to serve them and you lose your deli license.

Laughable, isn't it? Just imagine the mess freezing prices would create up and down the supply chain that makes it possible for us to walk into a deli and order lunch.

Regulations would have to specify what qualifies as a proper ham sandwich. Inspectors, accountants and lawyers would have to be roped into service to monitor compliance. Activists would picket if paying customers got fresh sandwiches and the homeless got stale leftovers. Ham sandwiches would mysteriously disappear from menus whenever pork belly prices spike.

Are you still laughing? So why don't you laugh when some expert claims he can set the right price for a colonoscopy?

Healthcare prices are fake, inflexible, and inflated because they are set not by the repeated interactions of buyers and sellers but by opaque acts of collusion between government bureaucrats and special interests. Even if this system were run by a benevolent genius who happened to set prices exactly "right" - whatever that means - these prices would be obsolete the moment they were published.

This state of affairs has turned the healthcare industry into a staggering zombie. It took several decades for Medicare price setting to swamp the price signals required to keep the market in balance, but we have clearly passed the tipping point. Lacking these signals and the constant corrections they engender, 16% of our economy is flying blind.

Add insurance to the equation, particularly insurance that the public has been encouraged to think of as free stuff paid for by someone else, and the problem only gets worse.

Can't we fix these problems by fixing insurance regulations? Contrary to popular belief, insurance companies love regulation. Regulation eliminates both business risk and pesky competitors. "Reforming" the insurance industry is not going to eliminate pricing dysfunctions, although it may eliminate insurance companies.

Who cares, you say? Wouldn't we be better off using all those insurance industry profits to pay for healthcare? One small problem. If you took all the profits that all the health insurance companies made in 2009 and used them to pay for medical care in 2010 you would cover the country's medical bills for ... two days. Then what?

Even if there were complete bipartisan comity, it is not possible for Congress to "reform" a system whose fundamental price signaling mechanisms are thoroughly broken. Howling politicians can only run up the tab as they lurch from one crisis to the next.

Bill Frezza is a fellow at the Competitive Enterprise Institute, and a Boston-based venture capitalist. You can find all of his columns, TV, and radio interviews here.  If you would like to have his weekly columns delivered to you by e-mail, click here or follow him on Twitter @BillFrezza.

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