How Medicare Promotes Wasteful Innovation

How Medicare Promotes Wasteful Innovation

Imagine what would happen if car mechanics got to decide the extent of car insurance coverage. They would immediately expand customers’ coverage since more coverage would be a boon to business. If, for example, your car insurance fully covered something as simple as seasonal tire rotations, would you interrupt your busy life to shop around for the lowest bid? Most of us would simply head to the closest mechanic. The hassle would be gone and we’d wait for our cars in well-equipped waiting rooms, enjoying cable TV, Wi-Fi, and coffee without wondering for a second if we’d gotten the best deal. 

As appealing as this might seem, few would want to pay the premium for such extensive car insurance. But what if we didn’t have to pay those premiums? 

This is essentially how the current taxpayer-funded Medicare system works. As a provider of health insurance for senior citizens and people with disabilities, Medicare pays for all “medically necessary” care and services, regardless of their cost effectiveness.

In fact, cost considerations are explicitly forbidden by the Medicare statute. Effectively, physicians — like the hypothetical mechanic — control which new services and treatments are reimbursed since a medical license is required to certify medical necessity. And since a medical treatment’s profitability often hinges on whether Medicare reimburses for it, innovators and entrepreneurs have a strong incentive to invest in the development of products and technologies that enhance, rather than challenge, physicians’ set way of doing things.

The dynamic leads to ballooning health-care costs and a distorted pattern in health-care innovation. As I argue in a new study published by the Mercatus Center at George Mason University, Medicare encourages the development of expensive technologies, often of dubious value, while discouraging disruptive, cost-effective innovations. 

Medicare has led to an expansion of traditional hospital infrastructure, medical device patenting, and the diffusion of imaging technologies. At the same time, its rigid structure discourages entrepreneurial experimentation and slows down the adoption of telehealth services, remote monitoring, and other new models of health-care delivery.

Proponents of “Medicare for All” often suggest that the road to cost reduction is through the adoption of a single-payer system. But there is a fundamental difference between Medicare and the single-payer systems in other countries: While Medicare decisions are cost blind, other countries’ coverage determinations are based on cost effectiveness. This means that new treatments are only covered if they significantly contribute to a patient’s lifespan, adjusted for quality of life. In contrast, the “medically necessary” care covered by Medicare often includes expensive care of dubious value. At one point, for example, Medicare was spending an unnecessary $1 billion annually on an expensive eye drug when an equally effective substitute was available for one-fortieth the price. 

Certainly health insurance and car insurance differ in many respects and serve very different purposes, but the dynamic is the same. While these conclusions sound rather gloomy, the good news is there is plenty of room for improvement.

Fixing Medicare’s perverse incentives means allowing beneficiaries to share in the savings that come from smart, cost-conscious decision-making. Instead of paying hospitals, physicians, and pharmaceutical companies, Medicare should give money directly to seniors, allowing them to purchase health insurance and health services directly from providers. This would increase competition, decrease prices, and better incentivize the development of cost-effective technologies. 

Marta Podemska-Mikluch is an economics and entrepreneurship professor at Gustavus Adolphus College and author of the new study “Understanding Medicare’s Impact on Innovation,” published by the Mercatus Center at George Mason University.

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