Wrong Incentives


Have you ever wondered why so many countries remain poor for so long? It is easy to infer that the people are lazy, or blame another country for the poverty. On the other hand, how can you explain that some countries suddenly turn around and make good progress?

On a country level, success depends on how the people view themselves collectively. There is a vast difference in collective outlook between a rich country and a poor one. Besides, there exists something much more important. It’s the system of incentives that a country has developed.

A communist country is destined to be poor. Why? It’s due to the lack of incentives, and the misplacement of priorities. People are not created equal although we all agree that they should be given equal opportunities. Let them run, and some people will run faster than others. Let them operate their own businesses, and some will succeed and some fail.

A communist country is so obsessed with equality that everybody is paid more or less the same amount whatever they do. Thus nobody has any incentive to do better due to lack of rewards. Why should they?

In a communist country, nobody is allowed to own much. Therefore the state winds up owning everything. The state is in turn owned and tightly controlled by the all-powerful communist party. The top members of the party in fact control all the resources of the state. They are free to enjoy all the material benefits because of their status, but are too embarrassed to admit it. A communist country always winds up having the top party members being too rich and powerful while the people are all equal and poor.

On the other extreme, a capitalist country can also develop a wrong system of incentives. The health care industry in the US is a good example. Health care in the US has degenerated into a system of high cost, low quality, and extreme complexity that have the potential of bankrupting the entire middle class and the whole country. The wrong incentives have developed as follows:

Because the system is not government run (except Medicare for seniors and Medicaid for the poor), the private insurance companies practically take over the health care industry. They collect premiums from individuals and pay doctors and hospitals. In order to make maximum profits, the insurers have to collect as much as they can and pay as little as possible. Most of us have had bad experiences with insurance companies without my having to elaborate.

The doctors and hospitals are not paid by how much they help the patients, but by how many procedures they perform, and how much drugs they prescribe. The consequence is over-testing, over-surgery, and over-prescription. This leads to over-payment by the insurance companies, which in turn demand higher premiums from individuals. A dangerous vicious circle is thus created.

The lawyers are attracted to the health care business because of some unavoidable mistakes made by doctors, hospitals and drug companies. The lawyers help the patients sue for malpractice while getting a large share of the millions worth of damages being awarded by the courts. This causes the health care providers to practice defensive medicine, which involves over-testing and over-prescribing to cover any possible mistake that may wind up in court. This adds to the vicious circle mentioned earlier.

Drug companies are out there to maximize profits, grab market shares and reward their shareholders rather than helping to combat diseases. Drugs that will fetch high prices and sales will be given higher priority, rather than those providing most benefits for the common people.

The traditional relationship between doctor and patient has been disconnected by the insurance companies, which insert themselves as middlemen to collect premiums and dispense payments. When you see a doctor, the first question he asks is whether you have insurance rather than what is wrong. The doctor wants to earn as much as possible from the patient’s illness. Since the patient is paying a monthly flat premium, he wants to receive as much service as possible. He does not mind that for a normal cough, the doctor sends him to a lung expert, gives him an X-ray, prescribes various drugs, and performs further tests. Why should the patient care? The insurance company pays anyway. But the patient does not understand that the insurer will come back later to demand higher premiums.

In many respects, the US health care industry is plagued by a grave system of wrong incentives resulting in high cost and low quality, with the prospect of bankrupting the country.

(July 2010)

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