On Hospital Organization

One of the important drivers of ever rising healthcare costs is hospital system consolidation. Since the Great Recession, doctor’s pay has not kept pace with Consumer Price Index (CPI) inflation, yet the annual mean compensation for major “nonprofit” medical center CEOs increased 93% between 2005 and 2015 from $1.6 million to $3.1 million according to the Medical Economics magazine. One study showed that between 2007 and 2014 Cesarean section physician costs rose 5.9% while hospital costs (facility service fees) rose 41.9%. A family practice doctor now makes about $200,000 a year and takes his orders from an overpaid CEO with much less education and training, and usually with much less intelligence. What accounts for this situation? Hospital consolidation is largely to blame.

As discussed in last month’s blog, free market capitalism only works where there is atomistic competition, and that requires active governmental interference in the markets through the enforcement of antitrust laws. Over the past two decades hospital consolidation has resulted in healthcare monopoly or oligopoly in most regions of the country. It is said that whenever two capitalists enter a room the result is a conspiracy to fix prices. That is why you have to have many players competing for market share as the more you have, the less likely it is that all will follow the leader and settle for their current share; someone will undercut the accepted pricing structure and that will benefit consumers. Large consolidated hospital systems eat up smaller hospitals and use their monopoly or oligopoly power to negotiate higher facility fees with the insurance companies, driving up costs and insurance premiums.

There are two possible solutions to this problem. One is to break up these hospital systems and encourage the building of lots of small hospitals. The second is to recognize that this is a natural monopoly and to treat hospitals as governmental utilities. Most states (35) recognize the problem but approach it through half-measures that have failed to contain costs; they outlaw the building of new hospitals yet refrain from taking control of the hospitals that exist pretending that they are “nonprofit” organizations working for the public good. One of the first things I learned in tax law at Georgetown Law School is there is no such thing as a “nonprofit” company, only a difference in where the profit goes. In your typical business entity the profit goes to the officers, directors, and shareholders, but in the “nonprofit” there are no shareholders so the money is pocketed by the officers and directors, hence the enormous rise in the pay of CEOs.There is nobody here doing the public good. That is the role of government.

As a practical matter, for the free market to work, you would have to have around 10 hospitals within about a half hour drive of most patients. This would provide real consumer choice and real competition. But there are very few areas in the country where there is sufficient concentration of population that this would be feasible. Better to realize that the free market can provide most medical services through direct primary care, but in the case of hospitals, government must centrally plan the distribution of limited resources and avoid the unnecessary redundancy of expensive equipment and specialized services.

– Gary Gallo, MD