Evolution has no foresight. It often stumbles down an irreversible path that produces a design inferior to what might be ideal. Vertebrates, by chance, evolved a system of focusing the eye whereby tiny muscles alter the shape of the lens. Unfortunately, as our lenses age, they become less flexible. By middle age, it becomes impossible to focus on things that are close. So if you have passed your mid-40s, you’re probably reading this with glasses, no matter how good your eyes were when you were 20.The higher mollusks such as squids and octopuses evolved a focusing system that moves the lens backward and forward, just like a telescope. This is a much better system, but we vertebrates are stuck with what evolution gave us.

Humans are endowed with foresight, at least in theory. But our programs and policies often evolve by chance more than foresight, for two reasons.

Tim Foley for Barron’s

There are the unintended consequences—those that were not foreseen and those that were seen but were ignored for reasons of political expediency. In the first category, Prohibition was supposed to get rid of demon rum. It didn’t; it gave us Al Capone instead.

The other category exists because once policies and programs start, they foster constituents who are benefited by them. These beneficiaries then resist even the most obviously logical reforms because they would change the pattern of benefits. There is no better example of this second phenomenon than U.S. “health insurance.”

HOSPITALS HAD BEEN rare before the germ theory of disease began to revolutionize medicine in the mid-19th century. There were only 149 hospitals in the entire U.S. in 1873. By 1923, there were 6,830. But hospitals are capital intensive and labor intensive. Such expenses run on regardless of the patient load.

In 1929, Baylor University Hospital in Dallas had a bright idea to smooth out its cash flow. For $6 a year in premiums, it offered a local teachers’ association with 1,500 members up to three weeks of paid hospital care per year, a very long hospital stay even then.

Designed by hospital administrators, not insurance men, this was the first step down the wrong road. It paid the first dollar of unexpected expenses, not the last, the opposite of real insurance. It also incentivized patients to demand to be treated as a hospital inpatient—the most expensive form of medical care—rather than as an outpatient or simply by the doctor at home.

Most foolishly, it didn’t indemnify the patient against loss; it paid for services regardless of cost. That was an open invitation for hospitals to raise prices, which they have been doing ever since, with a vengeance. It also made patients indifferent to costs, allowing medical-service providers to raise prices more easily.

But because it improved the big problem with hospital finances, the idea quickly spread to other hospitals and was elaborated into Blue Cross, which first operated in Sacramento, Calif., in 1932. The Blue Cross model (along with Blue Shield, which covered doctors’ fees) quickly spread across the country.

State insurance regulators moved to force these plans to act like insurance companies, maintaining sizable reserves to meet unexpected claims. Had they been regulated as insurance, Blue Cross and Blue Shield might have evolved into real insurance companies.

But the American Medical Association and the American Hospital Association lobbied to have Blue Cross-Blue Shield exempted. The Blues offered instead to accept anyone who applied for coverage, and they said they would operate as nonprofits. State insurance departments and the Internal Revenue Service accepted this bargain.

Hospitals thus came to be paid almost entirely on a cost-plus basis, eliminating any incentive to watch costs. Doctors were paid on the basis of “reasonable and customary charges,” which turned out to be a powerful incentive to add to the charges and a powerful disincentive against offering lower fees

By 1940, Blue Cross and Blue Shield had half of the health-insurance market, and private insurance companies were forced to model their plans on the Blues. In the 1960s, Medicare and Medicaid would also be modeled on Blue Cross-Blue Shield.

WORLD WAR II PRODUCED another step down the wrong road: wage and price controls. Because of wage and price controls, companies could not compete for workers by offering higher pay; they competed by offering perks, including company-paid health insurance. The IRS ruled that companies could deduct the cost of their health-insurance plans while employees did not have to consider the insurance as taxable income. By the 1950s, most people got their health insurance at work, making them care still less about the cost of their medical care.

This topsy-turvy medical insurance system might not have mattered much, if medicine had remained as limited in its ability to ameliorate human illness as it was in 1929. But a revolution in medical effectiveness began at about the same time as medical insurance. Science and industry hugely extended human life and health, which increased the cost of medical care because so much more could be done to help people live longer and use more medical services.

Indifference to costs by both patients and the medical industry, multiplied by the increase in possible treatments, has produced a medical-care system that is an economic disaster. It cries out for thorough reform along lines that would make it in the interests of patients, hospitals, and doctors to find ways to lower costs.

Unfortunately, a large part of the American political spectrum prefers to use rising health-care costs to justify government’s takeover of one-sixth of the American economy.

JOHN STEELE GORDON is the author, most recently, of An Empire of Wealth: The Epic History of American Economic Power.

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