Will Obama’s Approach to Containing Medicare Costs Lead to Shortages?

The Weekly Standard quotes Paul Ryan’s claim that it will:

Medicare’s non-partisan chief actuary, Richard Foster, has been clear on this point: Going from 6 percent growth down to the President’s targets, using only the blunt tools that his law gives to IPAB, would simply drive Medicare providers out of business, resulting in harsh disruptions and denied care for seniors … You cannot control costs by using price controls, which impose painful cuts within a fundamentally broken framework.

Ezra Klein provided a link to this Weekly Standard post towards the end of an important discussion:

You’re not allowed to demand a “serious conversation” over Medicare unless you can answer these three questions: 1) Mitt Romney says that “unlike the current president who has cut Medicare funding by $700 billion. We will preserve and protect Medicare.” What happens to those cuts in the Ryan budget? 2) What is the growth rate of Medicare under the Ryan budget? 3) What is the growth rate of Medicare under the Obama budget? The answers to these questions are, in order, “it keeps them,” “GDP+0.5%,” and “GDP+0.5%.” Let’s be very clear on what that means: Ryan’s budget — which Romney has endorsed — keeps Obama’s cuts to Medicare, and both Ryan and Obama envision the same long-term spending path for Medicare. The difference between the two campaigns is not in how much they cut Medicare, but in how they cut Medicare.

If we do nothing, the CBO predicts that Medicare spending , which is now running at 3.25% of GDP will grow to 6.5% of GDP by 2050. Both the Obama and Ryan plans propose to limit this growth so that Medicare spending will be only 4.75% of GDP by 2050. As Ezra notes:

Romney would give Medicare beneficiaries a voucher permitting them to choose between traditional Medicare and private plans. Romney’s people tell me his plan will use competitive bidding, in which the value of the voucher is tied to the lowest-cost (or, in some versions, second-lowest cost) plan. If beneficiaries want a more expensive plan, they’ll have to pay the difference out of pocket. On his Web site, however, it just says that Romney “is exploring different options for ensuring that future seniors receive the premium support they need while also ensuring that competitive pressures encourage providers to improve quality and control cost.” ... Republicans believe the best way to reform Medicare is to fracture the system between private plans and traditional Medicare and let competition do its work.

If we had perfect competition in the provision of health care, the traditional model predicts that price controls will lead to shortages. But the evidence is clear that we don’t live in this ideal world of perfect competition in terms of the supply of doctors, the supply of pharmaceuticals and medical devices, or in the provision of insurance. On the first issue, Romney and Ryan should talk to Greg Mankiw on how much doctors make in the U.S. versus abroad. Dean Baker once criticized Greg for hiding the role that government plays in this upward distribution of income towards doctors:

We could have designed trade policy to make it as easy as possible for smart kids from China, India and elsewhere to study to U.S. standards and then practice medicine, law, and economics in the United States. This would put the same downward pressure on the wages of these professions as we have seen for manufacturing workers and non-college educated workers in general.

To be fair, Greg has made the same recommendation. But let’s also note this from Dean:

the fact that drugs are expensive is entirely due to government-granted patent monopolies. We spend about $300 billion a year on drugs that would cost less than $30 billion a year in a free market.

Is it generally true that the cost of production is only 10 percent of revenues? Johnson & Johnson – a company that produces both pharmaceuticals and medical devices – might quibble that their cost of production is 30% of revenues but that still represents an enormous amount of market power. Finally, insurance companies tend to pay out around 80% of their premium revenues in terms of benefits keeping the other 20% to cover their bloated administrative costs and provide for rather generous returns to investment. In a world of imperfect competition, price controls can reduce costs without reducing the benefits to consumers. Maybe there are market means for reducing this market power but we have not seen any such proposals from Romney-Ryan. As far as I can tell, their approach will allow the providers of health care to continue to enjoy high incomes even as those that rely on Medicare will end up paying more for their health care.