In the January 21, 2012, issue of The Economist, the main focus of both the feature articles and the special report was on the resurgence of “state capitalism.” The magazine’s reporters described a world in which major companies in major markets were either owned directly by national governments, or subject to control or heavy influence, even if they were privately owned or had issued shares to the public.

The stories reminded me that, for the last 21 years of my Pitney Bowes career, I dealt continuously with the encroachment of state capitalism in the postal sector.  In the late 1980’s and throughout the 1990’s, we successfully fought a series of battles with the U.S. Postal Service to keep it from becoming another entity with all the powers and privileges of the federal government, but with none of the regulatory constraints associated with federal government agencies.  Several senior postal officials aspired to create a power base similar to many government-owned entities, such as the Tennessee Valley Authority (which Marvin Runyon, the Postmaster General from 1992 to 1998, had led) or the New York-New Jersey Port Authority.

Fortunately, we defeated efforts by the Postal Service to regulate the mailing industry and compete unfairly with it at the same time.  The Postal Service leadership teams succeeding Runyon and members of his senior team generally tried to operate within the boundaries set by Congress. We had a very collaborative, and mutually respectful, relationship with the Postal Service during most of my tenure as CEO.

The story was very different outside the United States.  While we had similarly respectful and collaborative relationships with the postal officials in the UK, Canada, Spain, Denmark, and Norway, we had a variety of challenges with postal authorities in many other countries.

We saw three distinct challenges:

• Some postal operators, which had appeared to become privatized, acted in very anti-competitive ways in their own nations, and also secured rights and privileges from their national governments that stacked the deck against partners and competitors.  The most extreme example was Germany, during the leadership of Deutsche Post by Klaus Zumwinkel, who resigned in early 2008 for reasons unrelated to his work-related performance.  Throughout Zumwinkel’s 18-year tenure as CEO, Deutsche Post acquired companies all over the world, including a disastrous acquisition of Airborne, a major package shipper, and the worldwide operations of DHL.

In Germany, where Deutsche Post realized most of its profits, postal rates were exceptionally high (well above $.60 per piece), service was not exceptional, but competition was ruthlessly suppressed.  At the end of 2007, a few weeks before Germany had committed to open its market to full competition from within the EU, Zumwinkel successfully prevailed on German legislators to pass a law that created a minimum wage for postal sector employees only, a wage pegged at Deutsche Post’s minimum pay grade.  The immediate result was to destroy its two largest mailing competitors, since neither could secure labor cost advantages over Deutsche Post.

In Italy, Poste Italiane took advantage of complex and onerous labor laws to fend off competition, since these laws made part-time and temporary workers prohibitively expensive.

• In many countries, postal operators expanded into businesses in which the marketplace was amply served by the private sector, but in which the postal operators would immediately have a competitive advantage, because of the implicit protection from national governments.  Australia, Belgium, Ireland, China and New Zealand all started retail banks.  Japan had always had a sizable postal banking system which paid almost no interest to depositors, but which became a huge source of loans to projects favored by politicians.  Prime Minister Koizumi staked his political career on an initiative to privatize the Japan Post, not because there was ferocious opposition to privatizing the mail or package business, but because the heavy governmental control of the flow of bank loans would be jeopardized. He barely avoided receiving a vote of no confidence because his initiative upset the way government favors had been delivered for generations.

Postal operators have played heavily in the money transfer business (competing with Western Union), in retail government services, in the sale of greeting cards and stationery, and in the sale of gift items often transmitted through the mail.  Postal operators like Australia, China, Finland, and Sweden moved seamlessly into mail services businesses. In countries with a strong tradition of state capitalism, these postal operators were able to operate freely in more businesses in which they competed unfairly with the private sector.

• The postal operators often carried mandates and missions inconsistent with a business focused on cost-effective customer service.  France and Canada were prime examples of this problem, as were Japan, Spain, and Portugal. In these countries, postal operators were saddled with explicit and implicit requirements that they keep a minimum number of people employed, even if the demands of the business would not justify such employment.  For Pitney Bowes, the government employment mandates made many of our productivity enhancement tools unusable by these postal operators.  They could not improve their productivity, even if they wanted to, because they were fulfilling social mandates.  Postal ratepayers paid more, in the form of a disguised tax, to create a welfare system for workers who probably could not have secured employment at comparable wage and salary rates.

I was able to experience the ugly underside of state capitalism for over two decades.  It made me realize that the United States should think long and hard about migrating down the path these other countries have followed.  It also is a cautionary tale for large multinational corporations that aspire to compete fairly in major markets in which one or more of the competitors are state-owned or state-controlled enterprises, or in which the state considers a particular industry strategically important.

There have many articles recently in which the U.S. Postal Service has announced that a deterioration of first-class service is an inevitable result of the cost reductions it will have to undertake.  This is unfortunate, because we need a viable Postal System to perform many vital societal functions.  UPS and FedEx do a great job as for-profit institutions serving the needs of businesses and high-density residential areas, but they are far too expensive in serving lower density geographies.

Moreover, their fee structures would kill individuals and small businesses.  For example, UPS and FedEx charge over $10 for improperly addressed letters and packages.  This is a profitable source of revenue for both organizations.  They also have residential delivery surcharges, especially for more remote residential areas.  If they are to take on the responsibility for more mail delivery currently done by the Postal Service, they cannot use their current fee structure to do so.

How can the U.S. Postal Service take costs down?

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Not surprisingly, there has been a great deal of debate about raising personal income taxes on people who earn more than $250,000 per year.  The support and opposition have broken on political party lines. As a person who clearly would be subject to higher tax rates, were a tax reform law to pass, I wanted to weigh in on this subject.

I do not believe we can solve the deficit problem without raising taxes.  I also do not think that all tax increases on wealthier people are inherently bad.  I do not think the proposed tax rates are inherently bad relative to their effect on economic growth.  Furthermore, although I think we have a certain amount of “crony capitalism” in our country at all levels, money that gets redirected from the general public to a few favored corporate and union welfare systems, I think a certain amount of that will happen in any democract.

However, I have three fundamental issues with our tax system:

• Everyone should pay income taxes, except for the very poorest members of our society, and, for them, only for the period of time in which they remain below the federal poverty level.  Today, over 50% of Americans pay no income taxes.  That is wrong.  It disconnects over half of Americans from any economic stake in how income tax dollars are spent.  It has the psychological effect of deluding those not paying taxes that money will always be available from “the rich.”  Everyone should pay something.
• We need far tighter controls on how our tax dollars are spent.  I understand that, in a democracy, some uses of our tax dollars will go to causes that I would not personally support.  The majority of the voting public should help guide elected officials on the allocation of tax revenues.
• We need much more common sense in the way governments account for what they are spending, and what the long-term costs of that spending might be.  The whole issue of excessive retirement benefits has arisen because governments have hidden the long-term costs of these retirement obligations by using accounting rules that were prohibited for private businesses over two decades ago.  The Congressional Budget Office “scoring” of legislation is fundamentally flawed in two respects: first, it limits its evaluation to the ten-year period after the law is passed; and, second, it does not take into account the highly likely behavioral responses to a piece of legislation.  For example, any tax increase on businesses headquartered in the United States will cause some businesses to shut down U.S. operations and move investments and jobs abroad.  That kind of highly likely reaction to a tax increase is not factored into the CBO scoring model at all, even though any common sense evaluation of a tax law would take it into account.

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Many commentators state that the U.S. does not have a single health care system.  They are correct: there are really eight different “systems.” Regardless of what happens with the legal challenges to the Affordable Care Act, I believe the U.S. healthcare system will continue to evolve in all eight in the way I describe below.

Some large self-insured employers will move their employees to the newly created state and federal health exchanges.  They will pay taxes or penalties to do so, but it will be better economically, in the short term, for them not to have responsibility for employee health care costs.

However, many employers will invest in the health and wellbeing of their employees, and derive competitive advantage from doing so.  Why?  For employers free to design an optimal healthcare system, including onsite clinics providing comprehensive primary care and developing a selective specialist provider and hospital network, the ability to design a good healthcare system gives them much more control over their employees’ health status, sense of wellbeing, and health benefits costs.

Some employers, like American Express, are even building care delivery networks outside the United States, in countries that have single-payer systems and that have government-employed doctors and government-owned hospital networks.  The staff physicians for these employers provide far better care, which is very attractive for talent recruitment and retention.

What employers will opt out of offering direct health care coverage?  Companies that have lost control of health care costs, such as those with exceptionally generous collective bargaining agreements, will welcome the chance to offload their entire population to health exchanges.  In many companies, CEOs simply do not understand that they can manage employee health and wellbeing and deliver shareholder value.  In others, corporate benefits departments do not want to assume responsibility for health care cost reduction.

Employers who retain health care coverage will develop better provider networks, and may even create multi-employer consortia.  This is happening in Southeastern Wisconsin, with Quad Med, Briggs & Stratton, Miller Coors, and Northwestern Mutual Life.  It is also happening with a consortium of labor unions in the New York City in the UNITE Here Health Center.

What will these employer-based health plans look like?

• They will migrate toward consumer-directed plans with high deductibles and co-pays for plan participants;
• Plan participants will be given significant incentives for making the best choices for their health, health care, and health benefit plan spending;
• Plan participants will be given continuously improving tools for self-managing health, including consumer-controlled personal health management systems like Dossia, clinical decision support tools, choices among health and wellness vendors, and good information and technology tools for continuously monitoring health; and
• Employers will put more decision power into the hands of plan participants and will force health plans to market directly and successfully to consumers to secure revenues.

These employer-based “accountable care” systems will be among the world’s best health care systems.

The wealthiest Americans will leave the core systems of which they are a part and pay extra for concierge medicine. They will consult with physicians who accept no Medicare patients and who direct their patients to the world’s best care, wherever available.  These Americans may actually be consumers of medical tourism, when that care is superior outside U.S. borders.

There is precedent for this.  In the UK, the top layers of UK society initially acquired supplemental health insurance through BUPA and, more recently, seek out care wherever it can be best delivered, including India, Singapore, and the United States.  Medical tourism started to meet the demand from single-payer systems abroad, but it will get bigger here.

There will even be increased medical tourism within the United States.  Concierge doctors will refer patients anywhere in the country in which they can secure the best care.  This system will also deliver exceptional care.

Some Americans will receive world-class care because of the lucky accident of where they are living.  Those Americans in the seven states in which Kaiser-Permanente is licensed to do business, or in Utah, where Intermountain Healthcare is based, or in Washington state, where Virginia Mason is based, or in Southeastern Pennsylvania, where Geisinger is based, will get excellent healthcare.

Other systems around the country will attempt to copy them, and some will succeed, but most will have difficulty, because, for the most part, world-class accountable care organizations will have been created in business models in which the primary care physicians are staff doctors paid a salary and in which there are tightly controlled specialist networks.  These systems work because they effectively limit patient choice by steering patients into a single managed care network.  They will stop seeming like a satisfactory alternative when the limitation on patient choice produces bad outcomes in a handful of high visibility cases.

There is precedent for this.  Back in the 1990’s, payers were effectively controlling healthcare costs and utilization through tightly managed care networks.  These systems also delivered a reasonable level of care quality.  However, they were dismantled because there were a variety of high-profile cases in which it appeared that the healthcare delivered was of inferior quality because the patient could not select the provider of choice.

Most government-run systems outside the United States use some form of provider choice control or give patients no choice as to providers.  Some have “gatekeeper” systems in which the patient cannot directly consult a specialist.  In the United States, such systems can survive only if they can avoid getting legislated or regulated out of existence because of the appearance of delivering inferior care.  They survive, but are highly vulnerable to being dismantled.

Many people have used the Veterans Administration and Military Healthcare systems as models for great healthcare at an affordable cost.  They have electronic health record systems.  They take advantage of broad clinical learning.  They deliver convenient and low-cost care through staff physicians and nurses paid on salary, and they develop long-term relationships with their patients.

However, because premiums paid by users are so low, and raising the prices paid by veterans and military families is politically suicidal, the federal government will reduce the financial burden of this system by quietly reducing the supply of care, rather than working to reduce demand.  They will shrink the size of facilities, the size of their staffs, or the hours of service, rather than increase the cost of accessing them.  Although shrinking a hospital or outpatient center is politically challenging, demanding that users increase their premium payments by several thousand dollars a year would be politically suicidal.  For example, the military health care system charges a 60-year-old military retiree $426 per year in premiums, a ridiculously low payment, considering that this type of retiree costs the system in excess of $10,000 per year on average.  However, raising premiums to even $1,000 per year is the metaphorical “third rail” issue; politicians will not touch it.

The best place for low income Americans dependent on Medicaid or other safety net health care programs is at community health centers.  These centers are generally better equipped to handle the complex problems low-income Americans face, particularly those with language and cultural barriers.

The top community health centers have expert resources to assist patients in applying for government benefit programs, in managing transportation and childcare issues, in addressing related social service issues, such as domestic violence, and overcoming language and cultural barriers.  They also tend to manage appointments for patients with more unpredictable schedules far better than a traditional private health practice.  Finally, they develop expertise in managing the different kinds of health problems very poor people have, compared with their non-indigent counterparts.

The Medicaid legislation passed in 1965 contemplated that Medicaid and Medicare patients would be part of mainstream health care systems and that Medicaid and other safety net programs were simply ways of paying for health care for poor people. We now know, from nearly five decades’ experience, that low income people have other overwhelming life challenges.  Their health care, economic and family needs are different, and are interrelated.  They need expert care a community health center is better equipped to deliver.

Medicaid and other safety net programs could have paid more for health care, and enabled private practice physicians to handle Medicaid patients, but the reimbursement rates for Medicaid providers are so low that private practice physicians have increasingly stopped seeing Medicaid patients.

Therefore, the community health centers will end up handling them, and will actually do a reasonably good job delivering care.

In trying to address budget deficit issues, the Obama administration and its successors will try to reduce what Medicare pays for health care.  This will cause even more medical practices to drop Medicare patients, because these patients have more complex health challenges for which the doctors will be paid less.

We continue to see a hemorrhaging of primary care physician populations, which leaves the Medicare populations even more poorly served by private practice physicians.

Medicare patients will seek out more care at retail clinics for minor illnesses or injuries, at urgent care centers for serious conditions, at emergency rooms for acute conditions.

We will see shrinkage of the physician population with the skill and will to take on older patients with more complex health care challenges.

Most Americans who work in small businesses, who freelance or are self-employed, who are unemployed, or who work for large companies that have abandoned health care coverage will end up in health exchanges.  They will get a progressively poorer quality of care from private practice physicians. They will wait longer for care, have long waiting times in doctor’s offices and hospitals, have short visits with healthcare providers, get too many diagnostic tests in place of more careful physical examinations because the fee-for-service system will survive and drive dysfunctional behavior by physicians and hospitals.

They will also visit urgent care centers and emergency departments more than they should, because these parts of the healthcare system will be accessible to them.

While the quality of care delivered through this government-regulated system will decline, the cost for patients will increase significantly.  There will be high deductibles and co-pays, and the risk pool in this population will get worse over time.  The state-run exchanges and any other system created and managed under the Affordable Care Act or any regulations emerging from it will receive those members not wanted in other systems.  For example, employers with already healthy populations will retain their health plans; employers with unhealthy populations will happily dismantle their health care coverage and drive employees to the exchanges.  There will be an “adverse selection” problem.

The titanic battle between proponents and opponents of the individual mandate, that is, the requirement that individuals either purchase health insurance or pay a penalty for not doing so is constitutionally and politically critical, but arguably irrelevant to whether our country will end with everyone insured.

The individual mandate design created by the Affordable Care Act, as well as the Massachusetts design, both are flawed in driving individuals to secure health insurance because the penalties an individual has to pay if he or she does not elect to secure insurance are inadequate.  I have commented on this more than once: if an individual driving into New York City were to have a choice between paying $40 to park legally in a garage or paying a $20 parking ticket for parking illegally on the street, the vast majority of individuals would elect to park illegally.  It’s nice to have a symbolic penalty, but such a penalty works only if the cost of noncompliance is close to, or better yet, greater than, the cost of following the law.

Because our elected officials did not have the courage of their convictions to create meaningful incentives or penalties for getting every individual covered by health insurance, a significant part of the population, many of whom will be young, healthy people who usually subsidize older, less healthy people, will remain outside the health insurance system.

They will actually have more attractive health care options available to them.  They will access retail clinics for treatment of minor illnesses and injuries. They will have more retail choices for both immunizations and periodic screenings.  They may even be able to access medical tourism options for surgical procedures that would otherwise be prohibitively expensive, even in an insured health care system. They will continue to access acute care at emergency departments.

They really do not need to secure health insurance until they have a condition that is both expensive and chronic, one in which emergency department care is inadequate.  In the past, they would not have risked waiting to get health insurance until getting a chronic condition, but the Affordable Care Act eliminates any barriers to them securing insurance whenever they can no longer operate in the uninsured system.

Oddly enough, absent a much more punitive individual mandate, the Affordable Care Act may actually drive more individuals into the uninsured system for longer stretches of their lives.

Final Comments

It is very difficult to reform the multiple health care systems that, in aggregate, employ over 15 million people, most of them in middle-class jobs, that contribute almost $3 trillion per year to our economy, and that are perceived to deliver two public goods, healthcare and insurance protection against catastrophically high healthcare expenses. Change will come from a combination of evolutionary development of better care for those who can acquire it outside the systems heavily regulated by the government and increasingly complex and dysfunctional government interventions.

The goal of universal healthcare equitably available to all Americans will not happen.  Those smart, rich, or resourceful enough to demand great care will get it; the remaining Americans, overwhelmed in trying to manage their daily lives or not sufficiently “street-smart” or rich will be lucky to get adequate, affordable care.  The more government tries to intervene to achieve fairness or to correct fraud, waste, and abuse, the more the system will create new opportunities for fraud, waste, and abuse. Moreover, as noted above, the government’s misguided attempt to eliminate denials of coverage for preexisting conditions will provide a perverse incentive for more individuals to drop out of the health insurance system until it becomes economically untenable for them to stay out. Every government intervention will result in a new set of “gaming” opportunities.

Some people would say that we have a crisis in health, healthcare, and health insurance, and that the crisis should be a call to action.  Unfortunately, the history of our representative form of government would suggest that crises are noticed and acted upon when they are triggered by highly visible events, coupled with strong leadership and large movements to take advantage of them.

Moreover, even when there is a crisis, there has to be an agreed-upon paradigm for how to think about the issue.  We do not have that:

• We do not have a consensus on how to resolve the healthcare crisis.
• We want everyone to have health insurance, but are not prepared to take the hard steps to penalize those who refuse to buy it.
• We support the goals of unlimited patient provider choice, unlimited access, very limited penalties for irresponsible and destructive patient behavior, and the belief that more access to care always yields better care and better health.
• We know that unlimited access and unlimited choice yield bad economics, but do not fully understand that most of the cost of healthcare comes from preventable and controllable decisions that should be penalized more; and
• We have exceptionally little understanding of the degree to which more care often means worse care and poorer health.

Our system will simultaneously improve in certain respects and deteriorate in many others for the next decade, but I am confident that it will settle into a complex, multi-segmented system like what I have described.

On the morning of September 11, 2001, I was in Pitney Bowes Stamford Main Plant building, having a difficult meeting with a group of factory employees, explaining why we needed to outsource much of the low-end product then manufactured in that facility.

I received a call a little bit after 9 am from Karen Garrison, then President of Pitney Bowes Management Services, who had seen the video footage of an airplane crashing into the first of the World Trade Center buildings.  I immediately began to return to the World Headquarters, a few blocks away. During my brief trip back to the Headquarters, an airplane crashed into the second World Trade Center building, One World Trade Center.

As I tried to absorb what had happened, I reflected on the fact that my wife Joyce had worked at One World Trade Center when we first lived in New York City in 1981 and 1982, and that I had been in the building many times over the years to visit customers.  By 10 am that morning, we had set up a command center in our boardroom, from which I ran the company for two weeks after that.  I left the boardroom many times, to address groups of employees both in the Headquarters and in other buildings, and to visit our New York offices.

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Our family was fortunate this past weekend in not experiencing any property damage or loss of power from Hurricane Irene.  700,000 other residents of Connecticut were not so lucky.  However, as I have thought about this disaster and others through which I lived during my lifetime, I have increasingly realized that much of the devastation of natural disasters is not “natural.”

Sometimes, the influence of bad human decision making on the scope of a disaster is obvious: Hurricane Katrina would not have been anything more than just another bad Gulf Coast hurricane, had the levees protecting big portions of New Orleans not failed to protect the city against water damage.  The levees were not built to protect against Category 4 or 5 hurricanes, so a disaster of the type that happened was inevitable and experts were not surprised when it happened.  Experts warned of this kind of problem, but were ignored year after year. Nevertheless, most of the time, we forget the degree to which we can anticipate disasters and minimize their impact.

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Devin Leonard, a reporter for Bloomberg Business Week wrote a great article diagnosing the issues facing the U.S. Postal Service, entitled  “The U.S. Postal Service Nears Collapse.” He delivers a number of great insights, among them:

• The near-term insolvency of the Postal Service was created by a Congressional action in the 2006 Postal Reform legislation which required the Postal Service to prefund all its retiree benefit obligations over the first 10 years after the legislation passed.  Why?  Since the Postal Service is off-budget, and it was getting its overpayments into the federal pension system returned to it, the artificially fast prepayment was a budget-balancing gimmick.  The Congress should have made the Postal Service prefund the retiree benefit obligations the way any private sector company would do so: over the expected 30-40 year life of the obligations.
• The longer-term problems of the Postal Service are driven by rapid and deep declines in mail volumes.  The Postal Service needs to reduce its cost structure much faster.  There are many good ideas that have been proposed for years, but that have not been adopted, such as the relocation of retail postal functions into convenience stores and supermarkets.  However, the Congress and the White House have to step aside and let the Postal Service take some of these steps.
• The Postal Service wants to reduce mail deliveries from 6 to 5 days.  I am not convinced that this step can be taken without damaging the growth potential of certain categories of mail.  What the Postal Service needs to consider is whether it needs to do 6-day-a-week to every address.  Sweden has variable frequency delivery, with 5 days in urban areas, three days in remote mainland rural areas, and two days to remote islands.  The Postal Services needs to begin delineating differences between profitable urban delivery routes and unprofitable rural delivery routes.
• On the flip side, the Congress and the Postal Service need to consider whether pricing for mail originating or being delivered to remote areas should be priced the same as mail traveling a few city blocks.  Uniform pricing has always been seen as a core feature of a communication system on which Americans have depended for political discourse, educational content management, charitable purposes, and other important social causes.  The broad penetration of the Internet makes many of the needs for uniform pricing less compelling.  However, to the degree that we continue uniform pricing, it can be for certain categories of mail, with others starting to move toward distance and cost based pricing.

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I have occasionally written blogs on the degree to which the jobs crisis has been made worse by government laws and regulations.  However, even I was shocked by what guest columnists Chip Mellor and Dick Carpenter wrote in an op-ed piece in the July 28, 2011, issue of The Wall Street Journal entitled “Want Jobs? Cut Local Regulations.”

I had previously understood the excessive licensing requirements states impose on professions that can be available to people without 4-year college degrees. For example, I learned this past year that, in Connecticut, a person aspiring to cut hair at a beauty salon must take a course costing $20,000 for one year and pass a licensing exam.  While requiring barbers and beauticians to be licensed is a reasonable exercise of state regulation, because of the degree to which a beautician is handling and applying dangerous chemicals to their customers’ hair, scalp and face, I believe that there has to be a lower-cost way of preparing and qualifying individuals for this profession.

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In the July 6, 2011, issue of The Wall Street Journal, Roger Bate has written a column entitled “Beware the Risks of Generic Drugs.” He specifically zeroes in on drugs produced from ingredients sourced in China.  Although this story is about the issues associated with generic drugs, the bigger question it raises is why pharmaceuticals would cut corners on such critical processes as the sources of ingredients for their drugs. At least one of the root causes is the relentless pressure governments, insurance companies, and employers feel to reduce costs by reducing the acquisition prices of drugs.

When governments, private insurers, and self-insured health plans try to drive drug prices down and, specifically, to convert patients from using generic drugs instead of branded drugs, there is a limit in terms of cost-saving opportunities available, without putting patients at risk.  To push cost savings beyond that point inevitably raises a huge risk of acquiring generic drugs priced at a level that does not optimize patient safety.

We cannot solve our health care cost crisis entirely primarily by driving prices down for drugs, supplies, devices, and medical services.  We have to reduce unnecessary usage of the health care system, and to drive the healthier behaviors that are the most sustainable way of reducing health care system usage.

Publicly held businesses and governments under stress for excessive costs often have the tendency to flex their muscles in procurement processes to demonstrate their ability to save money.  The unit cost savings are visible, the savings opportunities are often immediate, and the purchasers can present themselves as fiscally responsible.  Moreover, it is far more comfortable for payers to beat up on suppliers through the procurement process than to deal with the messy questions associated with inappropriate usage of the health care system, or driving people to engage in healthier behaviors.

There are two things wrong with relying on procurement strategies as the primary cost reduction tool:

• Unless there are tight controls on what is purchased, cost reductions are often covered by sellers cutting corners in what they are providing, or reserving the right to charge for what had been given away.  Government contractors have mastered the process of low-balling initial contract price offers, and then making huge profits from “extras” which are inevitably required by the government at a later time.  The so-called savings are phony; they are merely costs that are deferred to a later time and are often higher than a more comprehensive competitive bid.
• The sellers who agree to accept lower prices and try to honor them according to their terms often find themselves unable to perform profitably.  Over time, the pool of sellers willing to bid on business that is consistently likely to be unprofitable shrinks.  Eventually, the purchaser has no competitive options.

In the pharmaceuticals context, the corner cutting can be fatal to patients, as was the case with heparin.  Although I obviously cannot know what happened in every health plan procurement negotiation, I would not be surprised that purchasers which drove a hard bargain on pricing for generic drugs created an environment in which the supply chain functions of pharmaceutical manufacturers attempted to acquire ingredients for the drug at a price that could not be supported with the extra cost of a tightly controlled supply system.

There are no “magic bullet” ways to take drug prices down beyond a certain point.  Major drug manufacturers are administratively inefficient; they spend excessively on marketing and sales; and they may still have less efficient research and development processes.  However, beyond a certain point, cost cutting will cause people in their organization to take actions that put processes at risk.

Employees of pharmaceutical companies are not excessively evil or reckless compared to other businesses or governments; this is true of every large organization.  Employees under severe pressure anywhere to cut costs make stupid and reckless decisions to keep their jobs.  They particularly cut costs in areas in which the consequences are less visible or more likely to appear at a later time, especially if they can transfer the risk to someone else.  They are unlikely to go after the most sustainable cost reductions, which involve messy structural reform of their organizations.

In the health care marketplace, this was illustrated particularly with the Johnson & Johnson manufacturing safety problem in the last few years.  Much of the publicity about that case demonstrated that the root cause was a culture that, over time, became excessively focused on cost cutting at the risk of patient safety.

Relative to other areas of health care, the same principle applies: there is no free lunch when costs are cut excessively in the procurement space.  One major firm was very happy with the fact that its insurance plan administrator significantly reduced the payments due to physicians, hospitals, and other healthcare providers. The plan administrator secured a very good long-term contract because it presented itself as having a better ability than other administrators to negotiate prices with providers.

Unfortunately for the Company, the consequence of this hardball negotiation process was that many providers left the network and stopped treating patients with whom they had long-term relationships.  As a result, the Company lost in two ways:

• Some patients stayed with these providers, who were now out of the network and were charging much higher prices.  Even with lower reimbursement percentages for out-of-network care, the Company still paid more.  Out-of-network costs shot up.
• Some patients changed providers, received disruptive and suboptimal care, and were very unhappy with the Company for causing this to happen.

As a CEO, I was never comfortable with strategies based predominantly on procurement-based price reductions.  They tended to work for 2-3 years, and then fell apart.  The better strategy was to work with vendor-partners to get better products and services through sustainable cost reductions.  For example, I always liked solutions in which parts were re-engineered or packaging was reduced, or a less expensive, but equally reliable, way to ship the product was found.  These kinds of cost reductions were more challenging, but they worked.  Cost reductions based solely on price concessions struck me as a very lazy way to reduce costs.  I supported them, but, to a limited degree and for a limited period of time.

Ultimately, the challenges of reducing health care costs will require us to make deep and broad structural changes on how we live our lives, and allocate societal resources.  The move from branded to generic drugs is a small step in health care cost reduction, but, like every other, it has limited value and has to be managed with great care.

Why don’t more Americans go into public service?  This is a most important question, because the public sector is being crippled by mediocre, sometimes poor, and, infrequently, but too often, corrupt leadership.  When I was young, my parents strongly encouraged me to consider either a career in public service or taking on periodic assignments in public service. I do not want to romanticize government officials in the past, because many of the pathologies we see today have been around for centuries and even millennia.

Nevertheless, I grew up reading about historical figures like the Roman leader Cincinnatus who left his farm to serve in a leadership position, fulfilled his public responsibilities, and then returned as quickly as possible to his farm and his family.  George Washington was admired because he completed his two presidential terms, and then went back to his Virginia home.  Both of these leaders represented a set of values which placed public service above personal ambition.

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