By Edward W. Fuller*
Opposed to advocates of the profit-and-loss system, many healthcare reformers believe socialized medicine can progressively improve the price, quantity, and quality of healthcare. But can socialized medicine achieve this goal? Accounting theory answers no.
All advocates of socialized medicine commit one fundamental intellectual error: they ignore the overwhelming social importance of financial accounting. Financial accounting is the language of business, the language of production. To fully grasp the main problem with socialized medicine, it is necessary to start with the social function of financial accounting.
The Social Function of Accounting
The consumers are supreme in the profit-and-loss system. The consumers ultimately determine what will be produced, how, and in what quantity and quality. Consumption is the ultimate purpose of all production, and it is impossible to earn profits by producing goods consumers do not want to consume. The consumers’ decisions to buy or not buy ultimately determine every producer’s profits and losses. To understand the social function of the accounting language, it is vitally important to realize that consumers regulate production in the profit-and-loss system.
The profit-and-loss mechanism forces producers to obey the consumers. Profit is a sign that the consumers are satisfied. By contrast, losses indicate that business activities have not satisfied the most urgent needs of consumers. Moreover, losses cannot continue forever. Any producer that consistently fails to satisfy consumers will suffer consistent losses until it is finally driven out of business. The profit-and-loss mechanism forces any business that suffers losses to adjust its production activities to the best possible satisfaction of consumers. Profits and losses are the forces that make consumers supreme in the market economy.
Financial accounting is the information system that reports the profits and losses of production activities. In other words, financial accounting is the language that communicates whether business activities are doing a good or bad job of satisfying consumers. A profit on the income statement informs the producer that it is doing a good job satisfying consumers. On the other hand, a loss on the income statement tells the producer it is failing to satisfy consumers.
Beyond the overall state of the business, accounting hints at how to improve operations. Profit and loss can be calculated for each segment of the business. Losses in one segment of the business mean resources should shifted between different segments. Accounting tells businesses whether they are doing well or poorly, and it suggests how to adjust operations to better satisfy consumers. In summary, financial accounting is the language of production, and its purpose is to foster the best possible satisfaction of consumers.
Financial Accounting Is Impossible Under Socialized Medicine
Just like any language, financial accounting is not perfect. One limit of accounting must be stressed repeatedly in the debate over socialized medicine: financial accounting cannot exist without money prices. Financial accounting is impossible if buyers do not pay money prices for goods and services. In a socialized healthcare system, consumers (or patients) do not exchange money for their medical services. Therefore, there are no money prices for medical treatment in a socialized healthcare system. This means financial accounting is impossible under socialized medicine.
To demonstrate, consider the first line of the income statement: revenue. Revenue equals price times quantity. A socialized healthcare system can certainly record the quantity of health services provided. However, the patients do not pay money prices for their medical care. And if there are no prices, it is impossible to calculate revenue. This means the first item on the income statement, revenue, cannot be calculated in a socialized healthcare system. But if there is no calculated revenue, then there is no calculated gross profit and net income. Simply put, there is no income statement in a system of socialized medicine.
With no income statement, a socialized healthcare system will never really know whether it is doing a good or bad job of satisfying consumers. Moreover, it will be impossible to calculate profit-and-loss for each segment of the system. This means it will be uncertain which segments are doing well or poorly. Without profit-and-loss, a socialized healthcare system will never really know how to shift precious resources to improve consumer satisfaction.
The absence of the income statement in a socialized healthcare system affects all the other financial statements. The income statement flows into the balance sheet, the cash flow statement, and the shareholder-equity statement. Hence, under socialized medicine, the problem of no measured revenue reverberates throughout the entire system of financial accounting.
The balance sheet loses all economic significance in a socialized system. The healthcare system’s most important assets are long-term assets, or assets that provide healthcare services over many years. The value of an asset equals the present value of its future cash flows. But if there are no money prices paid, then the assets do not produce cash flows. And if there are no cash flows, then it is impossible to compute the present value of the assets. The balance sheet is not economically meaningful in a system of socialized medicine, because there is no way to ascertain the value of long-term assets.
Under socialized medicine, there are no profits or losses from existing medical services, and it is impossible to calculate the present value of the assets that already exist in the system. But allocating the assets that already exist in the system is only part of the problem. The goal of healthcare reform is to establish a system that continually improves the price, quantity, and quality of medical care. This requires making new investments in the future of healthcare.
At any time, there will be a whole range of investment options available to the medical industry. However, resources are scarce. It is impossible to invest in every investment project, and it is essential to ensure scarce resources are not invested in wasteful projects. In any healthcare system, there must be some way to rank the potential projects so investment only occurs in the most important projects.
The net present value is the most fundamental concept in investment theory. The net present value is used to rank competing investment projects. The projects with the highest net present values are the most important projects, so investment must first occur in those projects with the highest net present values. On the other hand, a negative net present value indicates that scarce resources will be wasted if they are invested in the project. The net present value is mankind’s indispensable investment tool, as it is required to make sure scarce resources are invested in the most important projects rather than wasteful projects.
However, under socialized medicine, it is impossible to calculate the net present value of investment in medicine. These projects will never generate cash flows, because no money prices are paid for their services. And since there are no money prices, it is impossible to forecast and discount the future cash flows. Under socialized medicine, the directors of the system lose mankind’s indispensable tool for making investment decisions. As a result, socialized medicine must lead to irrational investment decisions concerning the future of healthcare.
Sadly, humanity lives in a world of scarcity. This means mankind must produce to survive. Since human beings must produce, there must be some system to determine whether production is successful—that is, whether production is satisfying human wants. Financial accounting is the information system, or language, developed by mankind to indicate whether production is successful (profit) or unsuccessful (loss). Financial accounting is absolutely essential to mankind because it is the language of production.
Like any other good or service, healthcare is scarce and must be produced. In medicine, as in other industries, humankind requires some system to determine whether producers are satisfying the most urgent needs of consumers. But in the case of medicine, the consumer is the patient, and failure to satisfy the consumer can be fatal. For this reason, financial accounting, the system of assessing consumer satisfaction, is more important in healthcare than perhaps any other industry.
However, socializing medicine makes financial accounting impossible in the healthcare system. This means socialized medicine has no language, no system to verify whether the most urgent needs of the patients are being satisfied in the best possible way. It impossible for the directors of the system to determine whether scarce medical resources are satisfying the most urgent needs of the patients, or whether those precious resources are being wasted. Without financial accounting, production decisions in socialized healthcare systems are always irrational. Consequently, a socialized healthcare system will be arbitrary, chaotic, and inefficient.
In the contentious debate over healthcare reform, it is important to remember that nearly everyone agrees on the ultimate goal of reform. Everyone wants a healthcare system that continuously improves the price, quantity, and quality of healthcare. Socialized medicine cannot achieve this goal because it rules out the language of production: financial accounting. The profit-and-loss system is not perfect, but there is no such thing as perfection in human affairs. Despite its imperfections, a healthcare system based on profit-and-loss is the only way to progressively improve the price, quantity, and quality of healthcare.
About the author:
*Edward Fuller, MBA, is a graduate of the Leavey School of Business.
This article was published by the MISES Institute