Yesterday, Harvard economist Greg Mankiw pointed out that increasing demand for health care driven by expanded insurance coverage will increase prices. Today, the New York Times reported that pharmaceutical manufacturers are increasing prices in anticipation of health care reform. The magnitude of price increases for physician's services depends on how quickly supply increases to match demand and unilateral price increases should reduce demand for pharmaceuticals. So what's going on?
The Pharmaceutical industry says the price rise is due to the need for more R&D but the Congressional Budget Office disagrees. When you exclude spending on human clinical trials and the money spend on manufacturing process (neither of which are research) as the National Science Foundation did (above), pharmaceutical R&D expenditure has been flat.
We also expect large price changes for physician's services (the right panel in the first graphic). Because the supply of physicians services is fixed both in the short- and long-term (it takes a long time to train a physician, not every unemployed manufacturing worker can be retrained as a physician and US medical schools have graduated the same number of physicians every year for many years), large price increases can be expected from increased demand.
Markets for pharmaceuticals and physician's services are classical examples of market failure. A public option that could directly bargain with pharmaceutical manufacturers (as exists in every other major industrial company except the US) would help hold down drug costs and have very little impact on R&D. Increasing supply of physicians services would require restructuring how health care is delivered. Physician's assistants could easily give screening physicals, for example, in response to increased demand. The public option might also be able to exert some leverage here. Reducing payments to physicians could induce some innovation and reorganization.
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