A rather interesting shockwave came across the newsfeeds this week. US gross domestic product (GDP) shrank an annualized 2.9 percent in the first quarter. A quick perusal of the data on a government website revealed the culprits: exports and healthcare spending. Last year I was one of the very few who suggested that the implementation of Obamacare could cause a recession. Such a suggestion was universally dismissed by all right-thinking economists. But sometimes the real world neglects to adhere to our models and theories, and that was my concern.
The healthcare system in the United States is massively dysfunctional. The Affordable Care Act (ACA or Obamacare) was one way to try to address the problem. The majority of the country now feels this might not have been the best way, but that really doesn’t make any difference. It is going to be the basic law for another three to four years. My job, at least in this letter, is not to discuss policy but rather the economic effects of the policies we have chosen to implement, and what those effects may mean for our investment portfolios.
First, let’s look just at the facts. Last week’s revised data show healthcare spending number has dropped from the previous quarter, against a projected doubling. In fact, it dropped an enormous 6.4 percent.
During the 19 quarters since the current expansion began in June 2009, the economy has grown at an annual rate of 2.1 percent, compared to the 4.1 percent average in every other expansion since 1960. With last quarter’s negative revision included, we’ve only grown 1.6 percent for the last 12 months. Dude, who stole my productivity?
On October 6, 2013, I penned a rather lengthy discussion of the economic impact of the Affordable Care Act. Essentially, we are moving to a three-tiered system. Somewhere between 3 to 5 percent of people will have what is coming to be known as concierge care, another 20 percent or so will have what we think of as traditional insurance, and the remaining 75 percent will get by with some form of government-mandated and -controlled healthcare.
Let’s run through a quick summary of my analysis then – which is the same as how I see things today. We are going to reduce the amount of money we spend on healthcare by around 1 percent of GDP a year for the next four years, or about 5 percent per year in actual reductions. While right-thinking economists will point out that money will be spent elsewhere, and they are correct, my concern was – and it is evidently turning out to be pretty correct – that the transition will be messy.
I simply do not believe that you can change the “plumbing” of how healthcare dollars are spent, totally change the incentive structure, and demand more service for 20 percent fewer dollars while reducing the number of workers at hospitals, without serious short-term dislocations. Like we saw last quarter.
Will all this wash out over the next few years? Absolutely. We are not on some permanent healthcare spending death march where quarter by quarter healthcare spending will keep dropping. It is just, to borrow a phrase from my friend Mohamed El-Erian, that we are entering into a New Normal of Healthcare Spending. And eventually that money that we are not spending on healthcare will get spent on something else, and those people that are not employed in the healthcare industry will find other jobs or end up taking less pay for doing the same job. But it is the turmoil created in the midst of that process that is going to create some ups and downs in the economy.
So what happened in the first quarter? Evidently, several things. Number one, if you haven’t noticed, the deductibles for most of the ACA programs were quite high, often running as much as US$5,000.
The high deductibles were a shock to many people who were used to more-traditional health insurance. They postponed some services and started looking for transparency of pricing for the more expensive services. It is no longer uncommon for a patient to ask for a prescription for an MRI that they can take to another provider across the street who will charge them half of what the hospital provider will. If you’re paying it out of pocket, you begin to pay attention to what you’re paying. I think we should applaud that increase in transparency.
To those points, Dr. Toby Cosgrove, CEO of Cleveland Clinic, recently noted: “The entire healthcare system will have less money coming into it – we are taking costs out, so will all hospitals…. Obamacare is accelerating the process…. but this is due to transparency of costs and consumer[s] with high-deductible plans. This is a huge social experiment involving almost 18% of GDP and 100% of people… this will take four to five years to shake out.”
Further, there were a lot of people who didn’t get Obamacare insurance in the first few months and had to wait until March or April for their insurance to kick in. Other people have lost their insurance inexplicably because insurers are losing control of their internal management systems amid all the turmoil. People are postponing what they can until their insurance kicks in or gets reinstated.
Apparently, some of this has gotten sorted out in the second quarter, and healthcare spending is on a trajectory to the “new normal”, which may eventually be about 20 percent less than what we spend today.
I still think the next shoe to drop may be in the third and fourth quarter when hospitals begin to realize that they have significant cash-flow problems. Estimates are that we have about 10 percent too many hospitals, and the creative destruction of the new healthcare system is going to relieve us of that excess. Only the strong and well-managed will survive. This is of course going to create turmoil in the whole healthcare employment world, etc., etc.
Further, Obamacare is the largest middle-class tax increase in history. Yes, enrollees are getting healthcare for their additional expenditures, but you get extra government services for an increase in regular taxes. Call it a premium or call it a tax, it still amounts to a reduction in disposable income for individuals and families. Tax increases have a negative effect on the economy equal to roughly three times their actual amount. We have gone over that research numerous times.
And that negative effect doesn’t come all at once but is actually spread out over about three years, so the Obamacare taxes will still be creating a headwind to growth this year and next.
Further, although the president has postponed some of the “features” of the ACA, such as the business mandates, they are going to kick in eventually. We’ve already seen a rather large rise in temporary employment as employers shed full-time employees so they don’t have to cover their insurance. We’re going to see more such unintentional consequences, because that’s just where the incentives are. This will of course create even more headwinds for growth and productivity.
While I don’t think the US will fall into an “official recession” next quarter, we are extremely vulnerable to “exogenous shocks”. If either China or Europe has a serious problem, or the price of oil increases dramatically for this or that geopolitical reason, then, with the economy flying barely above stall speed, it wouldn’t take much to push us into a recession. We need to have our antennae up in a world where the biggest bull market seems to be in complacency.
The writer is an author, commentator and publisher of Thoughts from the Frontline newsletter.
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