Feedback, knowledge and the division of labor

by Russ Roberts on January 31, 2008

in Health, Prices, The Profit Motive

Arnold Kling over at EconLog tells the poignant story of worrying about his father’s health care. Anyone who has had a loved one in the hospital can relate. There are a lot of smart and caring people involved in the treatment, yet no one is overseeing the process and noting the interactions between this specialist and that one. No one is watching the heart rate zealously. The overworked nurse under pressure from another patient fails to note something crucial on the chart. Lots of cooks but no one’s in charge. Usually a family member has to play that role, a family member who more often than not doesn’t have the time for the full-time assignment and more than often not doesn’t have the expertise other than to ask a lot of questions.

Economists talk about the power of specialization and the division of labor. Economists talk about how well things can work when no one’s in charge. In the hospital though, it appears not to work as well as it might. Lauren in the comments to Arnold’s post asks the right questions:

For which kinds of economic entities does division of labor break down?
Why is it that sometimes having no one individual in charge is the
economic ideal that is coordinated by the invisible hand, and other
times not?

One answer is that maybe it works better in the hospital than it looks. Would we really want our parents in the hospital to be treated by a generalist? There are enormous amounts of knowledge and technology being brought to bear in curing people in a modern hospital.

But it clearly could be so much better than it is. We want the benefits of specialization without the costs, the same way we get them in other areas of our lives. What we want is someone to coordinate the process, someone other than ourselves to look out for the hammer-nail problem. All the specialists I’ve known are people with a hammer. Everything looks like a nail. The surgeon wants to cut. The oncologist want to give chemo. Beside the interaction problem, you want to make sure you don’t have a specialist blinded by too much specific knowledge who fails to see the bigger picture

So why do we need someone in charge in the hospital but not in the graphite industry? In the graphite industry, there are plenty of pencils, tennis rackets and fishing rods and the dozens (thousands?) of products that use graphite. We don’t need a graphite czar to make sure there’s enough graphite to go around. All the specialists that contribute to those products don’t get out of control. Their interactions don’t get ignored. As Hayek pointed out, the knowledge gets coordinated without a coordinator. Why does it work there but not in the hospital?

The simple answer is that the price system and profit motive interact in the graphite industry causing the whole thing to work smoothly without it being anyone’s intention. The prices and the profit motive lead to feedback and accountability. There are a whole bunch of people with the incentive and the information to make the system work well.

The simple answer is right. But it cannot explain why other organizations work well without prices and profits. Within a firm and within a family, resources and decisions get made without prices and often without profits. The answer (as Coase understood and as Lauren notes in her comment) is that in these organizations, the savings in transaction costs overcomes the loss of feedback and information benefits from using prices. But there are still incentives. There still is a residual claimant who bears the costs of failure and the benefits of success—the boss or the parent. Love motivates the parent. Bonuses and keeping your job motivate the boss.

So why doesn’t a hospital work better? The answer I think, is that the level of specialization in medicine has emerged from a process that has very few incentives to make sure that the level of specialization is as productive as it should be. There are very few informational feedback loops. Very little accountability. Sure, if a surgeon leaves a scalpel in your chest cavity and sews you back up, the surgeon bears a cost. And as a result, it doesn’t happen very often. But the kind of errors that Arnold worries about, the kind of errors that I’ve worried about with my Dad in the hospital (and the kind I’ve seen made) are the ones that have little or no consequence to anyone other than the patient.

These errors are built into the system. When a drug leads to unexpected side effects because the right questions weren’t asked, when an opportunity for a safer treatment is missed, when an aggressive treatment for one illness weakens the immune system and leads to other problems, who can you blame? Who bears a cost other than the patient?

You can blame the hospital of course, whatever that means, but the costs to the human beings who work in the hospital are small. There are no feedback loops within the hospital to reward generalists who look for the costs of specializations. And the reason there are not is because the patient is not the customer. The patient is not paying the bill. The financial incentives that do exist are coming from Medicare and Medicaid and the insurance companies. The normal feedback loops that protect the customer from error and greed and simple stupidity are missing. In a way, it’s amazing it works as well as it does. It works as well as it does presumably because most doctors and nurses do care about the lives in their hands. But it’s imperfect and could be much better.

And because there isn’t a residual claimant within the hospital, it is left to the wife or the husband or the parent or the child of the patient to represent the patient’s interests in the face of the decentralized incentives presented by the hospital and its specialists. Ironically, the monitoring and feedback comes from the family, another organization that is usually not using monetary incentives to improve performance. But the love works pretty well.

But the patient who is unrepresented for whatever reason, who must rely on the system itself to keep an eye on the treatment regimen is at a greater risk than the patient whose wife is a doctor or better yet, a loving doctor or better yet, a loving doctor who is at her husband’s side 24/7 until he comes home safely.

It’s a flawed system that will stay that way until the incentives change. In the meanwhile, my heart and prayers go out to Arnold and his Dad and to anyone with a loved one at a distance going through a medical challenge.

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{ 29 comments }

Matt C. January 31, 2008 at 3:37 pm

In the December 2007 issue of the Freeman, John Stossel writes about how competition in the medical profession helps patients. He's not an economist, but he has been able to master the ideas of the endless possibilities within the free market framework. The article can be found here-
http://www.fee.org/publications/the-freeman/article.asp?aid=8211

Stossel writes:
"Dr. Brian Bonanni has an unusual medical practice. His office is open Saturdays. He e-mails his patients and gives them his cell-phone number.

'I need to be available 24 hours a day,' he says. 'I want to be there when a patient has questions, and I want to be reachable.'

I’ll bet your doctor doesn’t say that. Bonanni knows he has to please his patients, not some insurance company or the government, because he’s paid by his patients. He’s a laser eye surgeon. Insurance rarely covers what he does: reshaping eyes so people can see without glasses.

His patients shop around before coming to him. They ask a question that people relying on insurance don’t ask: 'How much will that cost?'

'I can’t get away with not telling the patient how much exactly it’s going to cost,' Bonanni says. 'No one would put up with it. And the difference of a hundred dollars sometimes makes their decision for them.'"

Of another Doctor, a generalist, he writes:
"'It’s coming out of their pockets. And they’re afraid. They don’t know how much it’s going to cost. So I can tell them, ‘OK, you have heartburn. Let’s start out with generic Zantac, which costs around five dollars a month.’ ' When his patients ask about expensive prescription medicines they see advertised on television, he tells them, 'They’re great medicines, but why don’t you try this one first and see if it works?'"

You don't have that in a Hospital. A hospital is a different situation, they take the patients. If they don't have insurance then they work with them to pay, but the doctors don't ever ask. They tell. And people don't ask "How much?" All that often and there becomes a complacency and anticipated acceptance of the Doctor Knows-Best.

Grant January 31, 2008 at 4:50 pm

Very well said Russ, I am in complete agreement.

I'm often amazed at how nice and polite many people working in government agencies are, just as nurses and doctors are often pleasant towards patients who aren't their customers. The courthouse near my house, for example, is staffed with people who are as helpful as any I'd find in a competitive industry, yet its not like I can take my business to a competing courthouse if they insult me. That got me thinking about more corrupt governments in other countries.

Is the reduction of government corruption in largely capitalist countries due to capitalism itself? Does the market economy breed an honest work ethic which sometimes spills over into the non-competitive government sector?

FreedomLover January 31, 2008 at 5:01 pm

Grant:

Nothing friendly about workers at the DMV in California. Maybe it's regional.

spencer January 31, 2008 at 5:11 pm

Isn't the CEO managing the pencil factory exactly the coordinator that is not present in the hospital?

The pencil factory itself is a command economy with all the employees doing what the management(CEO) tells them to do. The firm that makes the pencils interacts largely with other command economies –firms — through the market. But the actual production of the pencil is the product of a command economy.

If you include the value of everything that is produced within the large corporations
the US economy is actually more a command economy then you believe.

Biomed Tim January 31, 2008 at 6:06 pm

"It's a flawed system that will stay that way until the incentives change."

We may be able to change incentives but I doubt we'll be able to change information asymmetry.

Grant January 31, 2008 at 6:49 pm

"We may be able to change incentives but I doubt we'll be able to change information asymmetry."

No, but the information asymmetry isn't as great as many other industries which function better than health care. And besides, people's use of the Internet to get medical knowledge is increasing every day. I'm always amazed how easy it is to be more informed on your specific illness than your doctor (who's knowledge is often limited to his preferred treatment) is.

GuyF January 31, 2008 at 8:04 pm

The patient is not paying the bill. The financial incentives that do exist are coming from Medicare and Medicaid and the insurance companies. The normal feedback loops that protect the customer from error and greed and simple stupidity are missing.

Shouldn't the insurance companies have an incentive to discriminate among hospitals based on how well they coordinate among specialists, since the insurance companies are in competition to provide the most effective insurance for their customers?

Keith January 31, 2008 at 8:06 pm

My father recently had quadruple bypass surgery with a valve replacement. When he left the operating table, the surgeon handed him off to his nurse. She stood by my father's bed for the next 8 hours, watching every indicator, adjusting the pacemaker, the IV contents and fluid flow levels. She owned the patient. It was amazing and impressive. The reason it works this way is that this surgeon wants his nurse to do this on patients he operates on. They have worked together for decades. There is no way a similar quality of care could have been achieved by roving specialists.

The surgeon and nurse get paid whether my father lives or dies. It is not a purely economic incentive that drives them. I sincerely doubt there is any set of economic incentives that would have led to the same behavior. They believe they're there to save lives.

Biomed Tim February 1, 2008 at 12:26 am

"And the reason there are not is because the patient is not the customer. The patient is not paying the bill."

Sometimes I fear that we may be putting too much faith in price-transparency. When I buy a pencil, I can rationally decide how much it's worth to me because I've used multiple pencils before; the experience I gained from using pencils allows me to judge how much I'd pay for it. Most importantly, when I make my economic decisions about my pencil purchase, I'm not physically, mentally, nor emotionally compromised.

The same can not be said of many health care services.

How many quadruple bypasses am I going to get in a year? Just exactly how much is a stent worth to me? How much time am I given to research on the web about my specific illness? (written in medical vocabulary that I'm not familiar with) Am I mobile? Do I really have time to talk to different doctors or do I need to decide within a few days?

Most people are not–and never will be–experienced consumers of medical services. When we consume services like surgery, we're often in very vulnerable states which differ dramatically from pencil-shopping.

To make matters worse, if I'm dealing with a $50,000 surgery, do I really care about a few extra diagnostic tests that costs several hundred dollars? When I'm 70 years old, do I really care how much it costs?

Many proposals I come across advocate for insurance only for catastrophic care. But isn't catastrophic care the most expensive care? How does this change the moral hazard problem?

I don't have the answers. I'd be interested in hearing what you guys think.

Jacob Oost February 1, 2008 at 1:22 am

The problem is that the division of labor in the health industry is very highly regulated, thanks to the lobbying of trade unions like the AMA.

Milton Friedman's assertion that we don't need compulsory licensure of doctors and other health practitioners is seeming more relevant every day. There is a lot of featherbedding involved to give doctors things to do that could be ably handled by less expensive labor. There is less room for experimentation in division of labor under these regulations.

Possibly apart from the government paying negotiated low rates for health care instead of market rates (crowing out non-subsidized health consumers and raising their prices), I think the division of labor regulations are the most efficiency-retarding thing in the medicine business right now.

Daniel Earwicker February 1, 2008 at 3:08 am

The "invisible hand" was never a good metaphor to label this stuff with. I doubt Smith intended it as such. It's not at all explanatory, more an expression of astonishment. It's even open to deliberate misinterpretation (the "selfish gene" suffers from the same problem; both are bad labels for great ideas).

The point isn't that "no one is in charge", it's that no one should be in charge of things about which they lack the necessary information to guide their decisions. The truth is that in a smooth running system, lots of people are in charge, each directing their actions, and in some cases the actions of a few others nearby, because those are the things that they are best qualified to direct, both because they can see what is practical, and they know best what they want.

If in a hospital patients are consistently getting poor treatment, you can bet they aren't in charge of this very important thing, not even to the extent that I'm in charge of such trivial things as which shop I get my ice cream from.

It may be partly a bundling problem: as patients, we rightly don't feel qualified to direct our specific medical treatment because we aren't trained in medicine. But along with that treatment, there are lots of aspects of "general care", which in Kling's post he refers to as "dignity", and which we are all pretty well qualified to judge the quality of. Unfortunately these aspects are bundled together along with the actual medical treatment, meaning that we must "shut up and take our medicine" in all sorts of ways. In the UK even basic hygiene, something anyone can understand the importance of, is apparently no longer taken seriously in state-run hospitals. People dread falling ill (or injured, or pregnant) in case they catch some fatal bug during their stay in hospital. By bundling this general care together with provision of specific medical treatment, patients submit themselves to the decisions of others in areas that they themselves could reach good decisions on, where they could match their resources to their needs and "get the system to share my goals" as Kling put it.

Grant February 1, 2008 at 3:41 am

Tim,
Most people are not–and never will be–experienced consumers of medical services. When we consume services like surgery, we're often in very vulnerable states which differ dramatically from pencil-shopping.

This is true for many consumers in many industries. Many people buy cars based almost entirely upon how they look. Yet the actions of informed consumers and civil tort still punish the lemons and make the automobile market improve every single year.

Its not hard to research one's particular disease and learn what options are available. The fact that some people won't or can't do this wouldn't prevent the rest of the (hypothetical) free market from punishing quacks.

I won't deny that information asymmetry is a problem, and that knowledge, as a public good, is generally under-funded. But those problems are being solved more and more each day. Internet medical websites are a huge business. If they were allowed in medicine, brand names and other voluntary licensing schemes could be used to convey trust just as they are in other industries.

For example, most health care consumers in the USA know they could get cheaper care in Mexico. But how often do they travel to Mexico for care, expecting it to be the same quality as in the USA? Not often; they aren't that stupid. Medical licensing conveys the same information as a voluntary license or brand name. I don't see any reason to suspect patients would purchase health care from irreputable sources when the market would (if it were allowed) undoubtedly provide reputable options.

Jody February 1, 2008 at 7:30 am

I think it's important to point out that it's not the division of labor that failed, the feedback system failed.

Specifically, there's no one allocated to the role of "decision maker" or "manager". An assembly line )the most commonly cited example of a division of labor) still has a line manager. And there's a manager of the line managers for factory-wide decisions.

In a hospital, there's the factory manager (hospital admin), but there seems to be no one filling the role of line manager.

Per Kurowski February 1, 2008 at 7:45 am

Yes it is an unbelievable faulty system.

Taking my uninsured visiting nephew to see if he had appendicitis which he did not have, lucky me, I was hit a couple of weeks later with six invoices from different subcontractors. Though each one of them, except for one that I never understood and just seemed to be out on a fishing tour, seemed reasonable, together they amounted to something crazy.

You need to be able to get back into the hands of trustworthy contractors (oxymoron?) but letting an uncoordinated runaway happening do the sub-contracting for you does not work. If I hade been a European I guess I would be asking something as… do you not need an ombudsman at each hospital?

John Dewey February 1, 2008 at 10:13 am

Keith: "It is not a purely economic incentive that drives them. I sincerely doubt there is any set of economic incentives that would have led to the same behavior. They believe they're there to save lives."

Thanks for making this point. Although hospitals and their employees are conscious of markets and costs, the overriding goal for almost all of them is to save lives and reduce sufferring.

John Dewey February 1, 2008 at 10:25 am

Russell: "The overworked nurse under pressure from another patient fails to note something crucial on the chart."

I appreciate your post and agree with your points. I think, though, that "overworked nurses" – and overworked physicians – miss far fewer crucial events than is perhaps implied by this sentence. Lawyers are good at finding "evidence" of malpractice in the tiniest variations of patient care. IMO, though, the checks in today's hospitals work remarkably well.

Consider one example of the success rate in modern hospitals. My R.N. wife has assisted in approximately 22,000 surgeries of varying complexity over the past 30 years. Exactly one patient – an 85 year old woman in poor health – has died in her operating room over that period.

FreedomLover February 1, 2008 at 12:45 pm

Disastrous job news today. Great depression around the corner as new trade wars brew. Judging by the callers into Rush Limbaugh, people are absolutely convinced it's the fault of multinational corporations moving jobs overseas. Smoot-Hawley II here we come.

seldon February 1, 2008 at 1:08 pm

If you go back to the original post you will see that he is complaining that the cardiologist wants to keep up the treatment even if it means the patient has to stay in bed all day, that every specialist tells him what they can do for the patient along with the sideffects. Then the author complains that no one looks at the big picture of maximizing life expectancy while also maximizing quality of life. He is asking them to make all his tough decisions!

Would you get an operation with a 10% mortality rate that has been shown to extend lifespan by 5 years? No doctor can answer that question, only the patient. Still, patients like Arnold King's dad want someone else to make the decision for them. They want someone to tell "here, this is what you want".

In other words, they don't want a doctor, they want a salesman!

Ken February 1, 2008 at 2:10 pm

"So why do we need someone in charge in the hospital but not in the graphite industry? "

Russell, this question doesn't even make sense. A hospital is not an entire industry! I'm sure graphite plants have someone in charge.

In every job I've had, someone has been "in charge", but this does not make him in charge of the whole industry. Just his little part of it. In hospitals, someone needs to be in charge of patients. Which does not mean being in charge of the health care industry.

-Ken

John Dewey February 1, 2008 at 4:29 pm

A very close relative is right now struggling to survive liver disease and multiple strokes. He's spent 30 of the past 45 days in ICU at two different hospital, having been flown 400 miles from one to another via private jet.

Two weeks ago, the insurance company hired a consultant physician to investigate the care being provided and make recommendations to the family. As I see it, this consultant is doing what Arnold seems to want done for his father. But make no mistake about it, the consultant physician is acting in the interests of the insurance company. That's why he urged the family to allow a "Do Not Rescue" order for my relative who can still recognize and occasionally communicate with his wife, his mother, and his sister.

This consultant physician, IMO, is a master salesman. Phrases such as "end his life with dignity" rolled off his lips with practiced ease. I'm sure he would confidently assume management of my relative's medical care if the family allowed it.

Someone has to decide how much medical care to provide a dying patient. I don't want that to be a government bureaucrat, but I don't trust an insurance company representative, either.

Russ Roberts February 1, 2008 at 4:49 pm

Seldon,

I think you misunderstand Arnold's post.

He doesn't want someone to make the decisions for him. He wants someone to coordinate the information so that SOMEONE can make an informed decision, ideally, the patient or the patient's family. Without an advocate, either the patient or the patient's family member, tradeoffs don't get taken into account and sometimes mistakes get made.

John Dewey,

My mom's a nurse and I think a fabulous one. I was careful to talk about the importance of care and devotion in creating quality care and I think that goes a long way, especially with dedicated people. But it this issue of coordination is a real issue from my experience.

Ken,

Of course you're right. They're not really analogous. But all of these issues in the firm, in the family and in the industry are about coordinating information. These are issues about what do you buy and sell vs. get via other means. Families and firms generally don't use prices to make allocation decisions. Usually that works out well because families use love and firms use the profit motive to motivate good decisionmaking and the flow of information.

But without enough love and without enough profit incentive, families and firms don't work very well. That's my point.

John Dewey February 1, 2008 at 5:06 pm

"I was careful to talk about the importance of care and devotion in creating quality care and I think that goes a long way, especially with dedicated people."

Sorry if I misunderstood. You have been close to the medical care system, and certainly realize how few real mistakes are made.

vidyohs February 2, 2008 at 10:50 am

In related news but not directly pertaining to the thread.

UK: Don't treat the old and unhealthy say doctors.

http://www.telegraph.co.uk/news/main.jhtml?xml=/news/2008/01/27/nhs127.xml&CMP=ILC-mostviewedbox

save_the_rustbelt February 2, 2008 at 2:03 pm

Research has indicated that the greatest danger to patients is a nurse shortage.

Despite near unanimous agreement that there is a nurses shortage, almost nothing is being done about it.

There is a dire shortage of nursing faculty because the labor market is not working, educational bureaucrats will not pay nursing faculty enough to attract them to be professors (in the hierarchy of higher education nursing professors do not have the prestige and political clout of professors in other departments – most nursing professors have actually done real work in the real world, which makes them second class citizens of academia.)

On another note, in his best year as a malpractice lawyer John Edwards made about the same income as four RNs, that is, the LIFETIME income of 4 RNs.

FreedomLover February 2, 2008 at 7:45 pm

Actually the greatest danger to hospital patients is being so sick that you need to be in the hospital. Eat right, exercise, smoke a cigar a day and you'll live to 90 easy.

Sam Grove February 3, 2008 at 6:43 pm

The pencil factory itself is a command economy with all the employees doing what the management(CEO) tells them to do. The firm that makes the pencils interacts largely with other command economies –firms — through the market. But the actual production of the pencil is the product of a command economy.

If you include the value of everything that is produced within the large corporations
the US economy is actually more a command economy then you believe.

But the CEO can't afford to be arbitrary. He has to understand and respond to the market. In effect, he is commanded by customers.

Sean Murphy February 7, 2008 at 4:00 pm

Good Article!

A couple of the issues that do not seem to be raised very often when considering where the medical system appears to break down in consideration to the Free Market, or Smith's invisible hand are the control of government and the third party payer system. Having been in the medical insurance industry for about 10 years, during which the Clintons changed the face of the industry, I have followed the further destruction of this industry first hand with the passing of laws and the regulation of government and the third party payer system.

Basic economic theory (101) teaches us that a third party payer system does damage to the free market system, and health insurance is no exemption. Behind this is HCFA (The Health Care Financing Administration) who has created a coding system that places a time element on codes. For instance, a code that represents a 15 minute visit vs. a code that represents an hour long visit (comprehensive). Each of these codes is assessed a dollar amount limitation according to the financial demographics of the area of the country that is services by each insurance carrier. The agreements they have with the physicians states that a physician cannot charge above this dollar amount for the given service or they will need to hold the patient harmless for the additional charges, or write them off in other words. This not only restricts the amount of time the physician is able to spend with each patient, but removes much of the financial incentive to being a dr. (this is just a small example of a larger problem).

In addition I have watched as politicians who know nothing about health care pass laws that are ludicrous. For instance, it is required by law for every policy to have a maternity benefit, even if you are a man, or past the age of bearing children, and so everybody who has a policy pays for this "right." Under the old cafeteria plans a person could pay for what they wanted and leave the rest out.

I guess the moral of the story is that our healthcare system is being held somewhat hostage under the current way of doing business because it is over regulated and crippled by a third party payer system that dictates what can and can't be done, as well as removing much of the incentive for being in healthcare. Over the last few years I have had more than one Dr friend leave the profession for these reasons. If we continue down this road free market theory tells us that smart people who would have gone into medicine will go elsewhere because the incentives are greater. If we want to make the healthcare system better we need to remove the burden of regulations, restore the incentives, eliminate the third party payer system (as it now exists) and allow the market to work to set prices. I can say this because I am not currently seeking any votes or running for any offices.

Now, can anybody say Hillary-care?

Ron Withrow April 16, 2008 at 10:18 am

I find the articles and comments here very informative. I think we all should promote alternative products a lot more since the MEDICAL Profession is such a RIPOFF

wulansari July 31, 2008 at 2:44 am

Many travel nurses claim that working as a travel nurse gives them a renewed sense of patient focused nursing.

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