How So-called Experts Mislead Us about

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GDP Govt.exp. Gov.exp. in 1997

(nominal) (nominal) as % dollars

Year per capita per capita of GDP per capita
1980 $12,226 $4,232 34.6% $8,233

1990 22,979 8,921 38.8% 10,959

1995 27,605 11,630 42.1% 12,242
Involuntary servitude

Not only have some jurisdictions turned over the operation of prisons to private companies, which in itself can make human rights advocates uneasy, but prisoner labor is being used to create profits for private companies. More than 100 companies in 29 states contract out the use of inmates as part of a Department of Justice program. Prison operating companies, such as Corrections Corp. of America, advertise inmates as an ideal labor force.

Wackenhut operates Lockhart Correctional Facility in Texas, where prisoners work for three different corporations assembling circuit boards, manufacturing eyeglasses, and making valves and fittings. Under the name of Lockhart Technologies, U. S. Technologies began using prison labor 45 days after selling its Austin electronics plant and laying off 150 workers. In Ohio, prison inmates assembled Honda parts for 35 cents an hour until the United Auto Workers got the practice stopped.135
Government has no monopoly on bureaucracy

Politicians enjoy cheap shots at government workers, who generally have meager resources to fight back. While some government underlings are bravely fighting a hopeless battle

against backlogs of work, other persons, usually higher in government agencies, can always be found wasting time and money for little or no benefit to the taxpayers. Agency heads sometimes enjoy about as many junkets as Senators and Representatives to the world’s resorts and tourist meccas.

Without for a moment questioning the wisdom of correcting government waste and abuse, we can see a fallacy in claiming that these inefficiencies prove the need to turn government functions over to private industry. Proponents of privatization make no mention of similar inefficiencies that are widespread in large private corporations. The success of the “Dilbert” cartoons depends on readers recognizing idiotic management policies as familiar in their own experience.

To take one example from the wild world of Wall Street wheeling and dealing, consider the $25 billion leveraged-buyout (LBO) of RJR Nabisco by Kohlberg, Kravis, & Roberts (KKR) in 1989. KKR reportedly collected nearly $500 million in transaction, advisory, and other fees.136

Like other corporate bosses spending the stockholders’ money lavishly, RJR Nabisco’s CEO, F. Ross Johnson, a principal in the record-breaking LBO, maintained a fleet of 10 planes and 26 corporate pilots, known informally as “Air Nabisco,” and built a palatial hangar in Atlanta to house them.137 Johnson and other top executives received “golden parachutes” in the end, and millions of dollars were passed out like dollar-bill tips to numerous law firms and brokerage houses as “fees.” The company ended up enormously in debt.

(In March 1999 RJR Nabisco revealed plans to sell its international tobacco operations to Japan Tobacco Inc., helping to pay off some of its $9 billion of debt, and to split RJR’s domestic tobacco operations and Nabisco’s food business into separate companies.)

Such profligacy is typical of huge corporations and the people who buy, sell, and run them. These pillars of private enterprise not only resemble privileged politicians in their conduct, but also provide most of the financial support to politicians and to propaganda mills called “think tanks.” Those

politicians and think tanks proclaim the efficiency of private enterprise while denouncing waste in government.

The private sector is unfortunately not a free market. Private enterprise as conducted by giant multinational conglomerates restricts trade in ways that have nothing to do with the competitive supply-and-demand economy of Adam Smith.

Government spin-offs

It may be useful to contrast the administrative record of Medicare with Social Security, although not directly comparable. Social Security is administered by the federal government at a cost of less than 1%, and most seniors have found the staff of Social Security offices very helpful. Extremely few abuses have been discovered, mostly concerning claims for disability benefits.

Medicare, on the other hand, is administered by private insurance companies which are responsible for one or more regions and are paid by the government under contract. Seniors and their physicians are frustrated by a bewildering maze of forms and procedures. Year after year fraud and abuse have remained a scandal, although estimates have varied as to its extent.

Medicare fraud was totalling between $20 billion and $40 billion annually, according to Gross.138 The agency that investigates Medicare and Medicaid fraud recovered merely $70 million in 1992, and the agency was closing offices and curtailing its operations because of budget cuts, according to AARP Bulletin, May 1993. Besides outright fraud, which may be hard to prove, improper billing is rampant.

The latest government attempt to deal with this problem is Operation Restore Trust launched by President Clinton in May 1993, which collected $187 million in two years ($10 for each dollar spent, but less than 1% of the losses), according to Secure Retirement, which also cited the HHS Inspector General’s audit showing an estimated $23 billion, or about 14% of all fee-for-service benefits were paid for services not medically necessary, billed incorrectly, or not even covered by Medicare.

That did not even include intentional fraud such as phony records or kickbacks. For example, Medicare was billed over $3

million by a California nursing home for nonexistent supplies, nearly $71 million in excessive charges by a Florida supplier to nursing homes, and hundreds of millions of dollars by equipment suppliers who charged for expensive pumps while delivering cheap ones. A California psychiatrist collected from Medicare several times for the same nursing home visit.

The public is told that it should hold down medical costs by quizzing doctors about their fees, avoiding unnecessary and expensive treatments, and questioning any doubtful charges on Medicare or private insurance. Isn’t it a little hard to imagine patients, especially elderly ones on Medicare, disputing a procedure the doctor has said is necessary or even desirable?

Despite the enormous amount of fraud in Medicare billing, the system has made it difficult for the patient to blow the whistle. A typical notice sent to the patient reports on a hospital stay, “Medicare paid all covered services except: $716.00 for inpatient deductible.” Please note that the patient is not even told how much the hospital billed or how much Medicare money the hospital collected. Studies have revealed that the insurance companies under contract to handle Medicare paperwork for the government have been very lax in allowing fraudulent billing to be paid.

Unfortunately, the contracts that private companies have for processing claims apparently include no responsibility for preventing or detecting fraud. The vice president for audit of a major Medicare contractor commented, when asked about investigating fraud: “There is no reward for finding fraud....We have to think about our shareholders.” He pointed out that the company suffered no out-of-pocket losses. Another official of the same company explained that fraud losses “are not operating expenses. It’s just someone else’s money that’s passing through.”139

Even with the weaknesses just discussed, Medicare contradicts in another way the conventional assumption that private enterprise is more efficient than government. Insurance companies calculate a “loss ratio,” the ratio of benefits paid to premiums charged. The higher the ratio the more efficient and

more favorable to the consumer, although often less profitable to the company.

The Medicare system, run by the government using private contractors for regional administration has a loss ratio in the 90% range; that of Prudential private medigap policies endorsed by the American Association of Retired Persons (AARP) is 78%; that of the companies which sell their medigap policies on television is usually a little above or below 50%.140
Altruism beats market incentives

Advocates of privatization have great faith in financial incentives, and they predicted that if payment were made to blood donors in England the blood supplies would increase. The comparison of British and American blood banks in Richard Titmuss’s classic, The Gift Relationship (1970), showed the British system, which prohibited the sale of blood, to be far superior to the American system, where nearly a third of blood products came from professional donors (the rest from voluntary, nonprofit institutions coordinated under the Red Cross).

From its establishment in 1948 to 1967, the British system increased annual donations from 9 to 19 per thousand of population, and the blood supply increased by 77% in England and Wales between 1956 and 1967, but only 8% in the United States. Professor Titmuss concluded that privatization of blood is riskier to recipients and donors, and in the long run produces greater shortages of blood. Paradoxically, he noted, “the more commercialized a blood distribution system becomes (and hence more wasteful, inefficient, and dangerous) the more will the gross national product be inflated.” This is yet another example of the errors in measuring national product discussed in an early chapter of this book.141
Public school privatization

It is hard to dispute the contention that the nation’s public schools in general are falling short of any reasonable standards, even including their own stated objectives. There is less

agreement as to the best solution. Advocates of privatization offer two possible solutions: furnish parents government vouchers to pay for enrolling children in private schools, or contract out the operation of public schools to private enterprise.

The voucher proposal runs into the problem that private schools may only accept well motivated and well behaved students, leaving the public schools with a higher percentage of difficult pupils than they already have. A further problem is that religious groups may try to use the voucher system to get public subsidies for teaching their sectarian doctrines.

The other proposal raises the question whether private contractors can operate the public schools more efficiently than public agencies when they face the same obstacles and are trying to extract a private profit from the available funds.
The Baltimore and Hartford experiments

Early in the 1990s a Minnesota-based company, Educational Alternatives, Inc. (EAI), told Baltimore it could run the city’s public schools better and got a contract from Baltimore to run nine of them at a cost of $18 million more than the city was planning to spend on them. Although the schools got cleaner, educational results in the first two years of this privatization experiment were disappointing.

Test scores dropped at the EAI schools while rising in other Baltimore city schools. Special education programs were slashed as EIA fired half of the qualified teachers. While attendance improvements were made in the rest of the city’s schools, EAI schools lagged. An independent study by the University of Maryland concluded that EAI was spending more money per pupil than other Baltimore public schools, but their pupils weren’t achieving more.142 Three and a half years into the five-year contract, the school board in Baltimore voted unanimously to dump EAI.

In 1994 the city of Hartford, Connecticut, contracted with the same company, EAI, to run all its 32 schools and $200 million budget. The company was to keep half of any money it could save. In spite of overcrowded classrooms, EAI submitted a budget

that called for firing almost 300 teachers while planning to have the city pay $1.2 million for expenses of its top executives. For these and other reasons Hartford decided to take back control of 26 of their 32 schools.143
Removing the “non-profit” from hospitals

Hospitals began in some cities as municipal services. In other areas health care facilities grew up as cooperative community enterprises. Civic minded members of the public, including physicians and nurses as well as business leaders and ordinary citizens, contributed their time and money to organize and develop non-profit community hospitals.

Government’s contribution to community hospitals was in the form of tax exemption. No federal, state, or local taxes were imposed. Hospitals were exempt from income tax because they were non-profit, and they generally were exempt from sales taxes and real estate taxes as charitable non-profit organizations. Their financing was assisted by tax-free bonds, and government also assured hospitals of a considerable cash flow from Medicare and Medicaid payments.

Private hospitals had been rare until about 1970, when promoters saw the potential for profits from Medicare and Medicaid payments. New issues appeared on the stock exchanges and over the counter for companies building chains of hospitals and nursing homes for profit. This resulted in excess bed capacity and duplication of specialized equipment, which led to under-utilization and higher unit costs. The costs were used as justification for charging more to the government.

By 1995 non-profit hospitals had become an endangered institution. Many were being taken over by the two largest hospital chains, both of which have been charged with health-care fraud on a large scale.

Commercializing Blue Cross

Another non-profit area raided by commercial opportunists consists of the various state Blue Cross/Blue Shield

organizations. They were founded in the Great Depression by doctors and hospital administrators so that people (and their employers) could pay premiums before they got sick and the money would be there to pay the hospitals and doctors in time of need. In the process, the Blue Cross organizations accumulated considerable assets that are coveted by private individuals and corporations.

It is possible for Blue Cross executives and outside investors working with them to become overnight millionaires by capturing those assets. Blue Cross of California converted from its non-profit status, taking the name Well Point, and then merged with for-profit Health Systems. As part of the deal, however, the State of California required two new grant-making foundations with a total endowment of $3.3 billion transferred from the nonprofit Blue Cross of California.

Georgia’s legislature, on the other hand, passed a law in 1995 that made it much easier for the state’s Blue Cross and Blue Shield plan to avoid using its assets for any public benefit and to provide its executives and investors with a windfall amounting to hundreds of millions of dollars.

In March 1996 the hospital chain Columbia/HCA announced plans for a joint-venture agreement tantamount to purchase of Blue Cross of Ohio. The top three executives of the non-profit Blue Cross and an outside counsel are to receive $19 million for a non-competition pact and agreements for future consulting. Blue Cross assets include $230 million in reserves. For 85% of all the assets and an option to purchase for one dollar the remaining 15%, Columbia is to pay $300 million (out of which it is to be insured against losses up to $30 million annually).144

In other states, such as Colorado, Maine, New Jersey, and North Carolina, Blue Cross plans have attempted to change state laws to make conversion easier and to keep contributed assets in the new private companies. Virginia’s Blue Cross plan got a law allowing it to convert by giving the state $175 million for the state’s education budget. The amount was not independently assessed and was probably much less than fair market value. The executives of Blue Cross plans and hospitals in these conversions and their lobbyists are typically well paid and well connected.

None of this was possible until, in June 1994, the national Blue Cross and Blue Shield Association voted to allow members to become for-profit companies.

Trying to defuse opposition to state legislation in behalf of Blue Cross and Blue Shield of North Carolina, its chief executive officer, Kenneth C. Otis, wrote a signed article published February 1, 1998, in the Greensboro News & Record.

He disputed a column in the paper that stated the bill would have allowed Blue Cross to convert to a profit-making investor-owned company. “The state gave BCBSNC the authority to convert 45 years ago,” he claimed. “Last year’s bill...simply provided a road map so taxpayers’ and customers’ interests would be protected if we convert later.” Blue Cross had hired a telemarketing giant to make calls urging subscribers to favor the bill, an action that drew criticism but was not illegal according to the N.C. Secretary of State’s office.145

Privatization not necessarily more efficient

The claimed efficiency of commercial operation is belied by studies of the California Medical Association reporting that in 1995 the newly converted for-profit California Blue Cross plan spent only 73% on health care versus 27% for administration and profit. In the same year, the state’s largest non-profit, the Kaiser Foundation Health Plan, devoted 96.8% of its revenue to health care and retained only 3.2% for administration and income. Likewise among those health maintenance organizations (HMOs) where medical care got the highest proportion of revenue, seven out of the top ten were nonprofit in 1994; nine out of ten in 1995.146

Making the point that for-profit does not necessarily equal more efficient, Robert Kuttner, co-editor of The American Prospect, wrote in the May-June 1996 issue: “It was not old-fashioned savings and loans, which were nonprofit mutuals owned by their depositors, that turned speculative and cost the taxpayers hundreds of billions of dollars. That debacle occurred after most S&L’s converted to profit-making institutions....

“In New York State, where the business of home care has become a lucrative profit center for private businesses, the hourly

cost billed to Medicaid has climbed to nearly a hundred dollars an hour, of which the nurse’s aide gets less than $10. Nonprofits do the job more ethically and efficiently....”147
Health Maintenance Organizations (HMOs)

The Clinton plan for universal health care proposed to put a brake on skyrocketing costs by encouraging health maintenance organizations. The plan was soundly defeated in Congress by the propaganda and lobbying campaigns of the health care industry, but HMOs have since flourished as the form of medical insurance preferred by many companies for their employees.

Most HMOs, like most hospitals and the Blue Cross organizations, began as non-profit services. State statutes initially prohibited HMOs from being profit-making businesses, and the federal HMO Act of 1973 provided grants only to nonprofit HMOs. Little known to the general public, the HMOs, by the mid-1980s, had obtained laws in every state except Minnesota to allow HMOs to be run for profit and in some cases to allow non-profits to convert to for-profit businesses.

CEOs of these health organizations find conversion attractive for the same reason CEOs of industrial corporations become involved with mergers, acquisitions, and leveraged buyouts. How they gain windfall profits is illustrated by the conversion of non-profit HealthNet to profit-seeking Health Systems International (HSI) in 1992. In that conversion, Roger Greaves, former co-CEO and co-chairman, paid only $300,000 for shares that were worth $31 million in 1996, a 10,000% gain. In fact, the shares representing 20% of the company purchased by 33 executives for $1.5 million were valued at about $315 million in April 1996.

Top executives’ salaries also escalate. In 1994 HSI’s CEO was paid $8.8 million and Foundation Health’s chief $13.7 million, compared with a salary of $803,000 for the chairman of Kaiser Permanente, non-profit and one of the nation’s largest HMOs.
Typically the non-profit organization is undervalued by its executives and the regulatory agencies, the executives buy stock in the new company at low prices, and the executives become millionaires when the company’s stock trades at its actual market value. Most valuations have not used competitive bidding to determine the fair market value of the company.148

Once the HMOs became profit centers, they entered the merger and acquisition market. In 1993, there were acquisitions of five large publicly-traded HMOs for $685 million. In 1994, there were 13 major acquisitions worth $4 billion. In 1995, United Healthcare purchased MetraHealth (a joint venture of Metropolitan Life and the Travelers Insurance Company) for $1.65 billion. In May 1996 Aetna Life and Casualty said that it would pay $8.9 billion to acquire US Healthcare, one of the fastest growing HMOs.

These health care empires apparently generate great profits for their management and stockholders, but whether they are good for the public is much in doubt. There is a strong motivation to cut costs by reducing treatment below what an independent physician would prescribe. The best known example has been rushing mothers and their newborns out of hospitals within 24 hours, a scandal that has brought about government action at state and federal levels, but many other cases have been aired of doctors being pressured to give less care or lower quality care than their own judgment would dictate—and to withhold information from their patients about treatment options not favored by the insurance companies or HMOs.
Loss of professionalism

The independence cherished by professionals is endangered by mergers and corporate medicine. Doctors, for many years, resisted incorporation as undermining their independence and personal relationship with patients. They reluctantly formed professional associations (PA) and professional corporations (PC) to avail themselves of the income tax advantages given to corporations over individuals and partnerships.

Their reluctance turned out to be justified, as further steps led to corporate medicine where medical decisions are increasingly dictated by administrators of insurance companies, hospitals, and HMOs. It is similar to the top-heavy load of administrators and “coordinators” in the schools, and the paperwork they create, that make it difficult for teachers to utilize their professional judgment in the classroom.

Doctors have also come under pressure from pharmaceutical companies (who provided much of the money that killed the Clinton health plan, also opposed by the doctors’ organization). Mergers among hospitals, insurance companies, physician groups, and pharmaceutical companies create huge entities battling each other for control over patient care.

By mid-1996 big pharmaceutical companies had bought three of the five largest pharmacy benefit management companies (PBMs). These private bureaucracies that manage drug benefits for insurance plans maintain “formularies,” lists of approved prescription drugs in which price is an important factor. Insurance companies use severe financial disincentives to induce patients to use listed drugs. Senator David Prior (D.-Ark) has suggested the PBMs may be favoring drugs of their parent corporations by switching patients from one drug to another without explicit regard to health.

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