A Range of Approaches to Procurement for COVID-19

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Shortages of medical products, including but not limited to ventilators, personal protective equipment, and nasal swabs, continue to be a danger. If the number of COVID-19 cases continues to increase exponentially for weeks before peaking, many lives may be lost as a result. In a series of posts, I have applied an approach described in a paper in progress to the specific problem of ramping up ventilator production. But for this post, let me place the specifics of that proposal aside to canvas the range of options for increasing medical production.

The Pure Market Approach. Alex Tabarrok argues that we should let the markets work. As he points out, ventilators and other scarce medical equipment are extremely valuable right now, and that value drives up prices, and the price signal creates incentives for production. In response to concerns about price gouging, he states,"It's very important that manufacturer prices be allowed to rise to reflect true scarcities and to get resources flowing in the right direction." I agree, but Tabarrok concludes, "So far, we are doing that and the system is working well." Are we? I believe that if manufacturers created needed medical products and charged five times the usual rate, they would be vilified as price gougers and maybe even prosecuted. But that multiplier or maybe even a higher one might be necessary to provide incentives for creation of new production lines that produce machines that might be useful for only a limited time, if caseloads continue to increase and no alternative treatment emerges. The market will work in the sense that production will go up somewhat, but under the constraint that prices can't rise much. Production thus will not ramp up nearly as much as it would in a genuinely free market. The fact that we haven't seen alleged price gouging on new ventilator contracts suggests to me that the market is not working. The pure market approach seems likely to work only if the government were to pass new laws clearly indicating that producers can charge whatever the market will bear, without vilification. That seems unlikely the day after a new executive order preventing price gouging and hoarding of medical supplies.

State Procurement. President Trump has argued that the federal government isn't a "shipping clerk," and thus that states should procure what they need. State procurement is not without virtues in this context. States can be "laboratories of experimentation" in taking different approaches, both with respect to what they wish to buy and with respect to how they go about approaching the purchasing. Moreover, states competing with one another might bid up the prices of needed resources. If one's goal is to stimulate production, this is good; perhaps there will be fewer complaints about price-gouging if states (rather than individuals) are making high offers, and, as noted above, high prices may be necessary to stimulate extraordinary production. But there are downsides. States have limited expertise and resources to think comprehensively about how to design a procurement system. Different states may demand different standards, preventing production at scale. States may learn from one another only very slowly, and speed is of the essence. Some have criticized state procurement because it will not lead to production going to where it is most needed (although rigorous application of that criterion suggests that perhaps we should ramp up production and ship off everything we produce to other countries). Some states may end up with excess capacity and other states with insufficient capacity, and states may be hesitant to sell their excess capacity to others, both because of the chance that they may lead it later and because criticism will prevent them from selling at market prices.

The Defense Production Act. The government can simply order private manufacture of particular goods, although "there is a genuine question as to whether the law can be used to compel a company to accept a new contract for a product or service it does not ordinarily provide." Even assuming legality, however, the government may not know which companies are best positioned to produce which goods. Moreover, forcing a company to produce may not lead to the company having incentives to produce as efficiently as possible. When the company faces a bottleneck, for example because of a shortage of an input, it may just do nothing, rather than what it would do in a market system, namely seek out alternative suppliers, bid up the price of the input, or produce the input itself. The government can respond by forcing some other supplier to produce the input. This requires the government to perform well in its central planning, and even with the best planning, reluctant producers may not perform well. Carrots are generally better than sticks.

Moral Suasion. President Trump has encouraged automobile manufacturers to produce. This has the same problems as the Defense Production Act. Do we think the government can choose the right producers, identify what is needed, and motivate them properly? But when the only stick is the possibility of bad publicity, the approach may be even less effective. Elon Musk initially promised to convert factories "if needed" (by which time it might be too late), but then bought himself some good publicity by importing some ventilators from China. That is certainly a useful contribution from the United States's perspective, but the key is to increase manufacturing capacity, either domestically or internationally if other countries will permit such goods to be exported.

Federal Procurement. My colleague Chris Yukins offers a powerful argument for federal procurement generally, while calling the Defense Production Act a "risky prospect." The federal government, Yukins argues, has "nearly unlimited resources–its commitment to pay, and the world's largest procurement apparatus–to drive procurement of equipment that will save lives." Central to his argument is that federal contracting always includes a clause allowing the government to "terminate for convenience." It might seem that this would be exactly what we would not want, because producers may be concerned that they will be left with nothing if the pandemic abates. But Yukins points out that when a contract is terminated for convenience, companies' sunk costs will be covered by the United States. Thus, one might think, contractors have nothing to lose—at worst, their costs will repaid, and at best, they will receive the contracted-for price. Unfortunately, however, these sunk costs are not likely to include lost opportunity costs. Conversion of a GM plant from cars to ventilators not only costs money, but also means that GM will manufacture fewer cars. There are also additional reasons to worry. First, will the government be able to conduct a procurement sufficiently quickly? Second, does the government have enough information to choose wisely and then make adjustments as necessary? There are many plausible designs for ventilators, including for example designs in which multiple patients share a single ventilator. The optimal design may depend on the number of cases, with simpler and cheaper designs to be preferred, the worse things get.

Cost-Plus Pricing. Ezekiel Emanuel also suggests federal procurement, specifically endorsing the use of cost-plus pricing. He cites an article by Utpal Dholakia, who argues that one virtue of this approach is that it is simple to implement and to explain. But Dholakia also acknowledges that cost-plus pricing "discourages efficiency and cost containment," especially for stand-alone projects. Suppose that the government simply promised to pay costs plus 10% for all new ventilator production in the next six months. A producer then has no incentive to be restrained on input price; indeed, the more that is paid for inputs, the better, at least up until the point where the government decides that the price was inflated, a difficult assessment to make in a time when many inputs face shortages. Meanwhile, there is little incentive to make sensible decisions about just what ventilator models to produce, and opportunity costs are not covered, so many of the objections above still apply.

Cost-Plus-Performance Pricing. In a recent article, I discussed various recent proposals to use cost-plus measures for calculating damages in patent cases. Some of the problems that I identified apply here as well, such as the danger that incentives will be too low if incentives are set too low and the danger that too much will be spent. But I offered a simple model that suggested that it might make sense for patent damages to be based in part on a cost-plus calculation and in part based on traditional considerations. The intuition is that if only half of what one receives is based on a cost-plus calculation, then the incentive to overspend is eliminated or at least greatly diminished. At the same time, if patent damages sometimes are either windfalls or insufficiently compensatory, having damages partly determined by cost-plus considerations should diminish this concern.  Much the same could be true for production of ventilators and other supplies. If we promise to compensate producers for some of their costs but make their overall payment depend on performance (for example, measured in QALYs saved), then we can improve predictability while still giving incentives for performance.

There are many ways something like this could work, but let me suggest just one. Like my previous proposal, this involves ex post assessment of performance, but I will place aside the element of random selection. Suppose that the government commits $100 billion to production of needed medical equipment, and it wants ten companies to be competing to produce equipment. Those companies could be selected at auction, with the auction proceeds added to the fund to be distributed to the companies. Companies can be required to release information about their spending commitments as those commitments accrue, so that all of the competitors can have a good sense of what is happening in the market and how much it makes sense to invest in different approaches. When all is said and done, the government will measure the performance of each of the ten companies in terms of QALYs saved, and it will calculate cost figures for each company. It will then distribute $50 billion based on the performance measure and $50 billion based on the cost figures.

A system like this requires minimal government oversight ex ante and thus could be created quickly. The auction mechanism helps ensure that the companies best situated to perform will be chosen and that those chosen have a genuine commitment to an aggressive effort. The compensation for performance gives companies incentives to save lives and to identify the types of goods and approaches that are most needed. Finally, the compensation for costs reduces the risk to each company. My own view is that this last component is not essential and that the entire contracting process could be based on performance, because capital markets can effectively absorb risk, but this is a concession to those who believe that the contracting process demands greater predictability. Of course, one could adjust the portion of the fund to be allocated to cost and the portion to be allocated to performance.

The bottom line is that we need production. Any of the approaches discussed here is better than nothing. And approaches that can generate production quickly and that can harness incentives for private sector creativity should be preferred. I fear that it is too late to make a meaningful impact on cases over the crucial next few months. But it is not too early to identify better approaches for the next emergency.

NEXT: Law Professors quietly agree with my post on pass/fail grading

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  1. Maybe you were being more nuanced than it deserves. I too believe free markets would do the trick — prices would rise sharply and fall back as production ramped up, with the proper response being that only the desperate would buy at first, which is the proper rationing response. But we don’t have free markets in that sense. There *are* price control laws precisely because politicians are pandering to voters and ignoring reality.

    Remember, the first rule of economics is that things are scarce, and the first rule of politics is to ignore the first rule of economics.

  2. “I fear that it is too late to make a meaningful impact on cases over the crucial next few months.”

    That is likely as close as the Conspiracy will come to criticizing Pres. Trump’s personal performance with respect to this problem, which is not close at all . . . but still probably closer than the Conspiracy would like, an oversight I attribute to this Conspirator’s relatively recent enlistment.

    1. It’s a good thing we have you here as a regular commenter criticizing President Trump’s personal performance.

      1. You prefer your right-wing reading to be unleavened by non-conservative content?

        1. As long it’s not delivered by slack-jawed, slope-foreheaded hicklibs.

  3. The states really can’t set individual specs because national specs have already been established by H&HS and the accreditators (e.g. Joint Commission) — the hospitals want to receive Medicare/Medicare money and this is a condition of that.

    Now there are things outside of spec — hospital grade N-95 masks are designed to protect against AIDS-infected blood while industrial ones are designed to protect against asbestos fibers and lead paint dust. CAN a hospital use the industrial ones in the absence of the hospital ones — and if they do, what happens when they are sued? Sued for malpractice by a patient alleging that the infection resulted from a mask not meeting H&HS specs — that’ll happen…

    Multiple-patient respirators scare me (cross contamination) but they could be made a LOT cheaper if they were not failsafe — but then one fails and a patient dies — there will be the inevitable malpractice liability to both the hospital and the manufacturer.

    1. Let me rephrase that — the States COULD all set their own specifications, but the state’s hospitals wouldn’t be able to (legally) use the stuff unless it met the established Federal standards. And one nice thing is that Federal agencies tend to recognize good standards of other agencies (easier than writing your own) — N-95 is hence nationally established as “95% of 0.3 micron particles” — and that may even be international.

      States also adopt other state’s standards. Portable gasoline containers are approved by either the Massachusetts State Fire Marshal and/or the California Department of Fire Safety — the other states accept a MA or CA approval as meeting theirs. PA has strict bakery laws, the rest of the states accept PA’s approval of a bakery. The same is true of MA boiler rules and NY fire safety rules, with other states accepting that MA/NY rules are stricter than theirs and hence accepting the approval for a product.

      And then there are private outfits such as Underwriter’s Laboratories (UL) which is in some cases legally required by states, although the Canadian Standards Association (CSA) is also accepted. There is some common sense.

      But yes, the states COULD be stupid enough to write their own specs.

  4. Why have it depend on QALY’s saved? That seems random. Some manufacturers might, for one reason or another, see their machines go to an older population. so even though they work just as well as others they save fewer QALY’s.

    Indeed, this might prove counterproductive. Suppose some, more expensive, machines work better with more severely ill patients, and are assigned that way at the hospital. Even so, you might see a lower than average survival rate for that group.

    If there are standard specs, as other suggest, then why not simply ask companies to submit offers to the government – price, quantity, delivery date, and go from there.

  5. MY ALTERNATIVE APPROACH

    New York State Governor Andrew Cuomo has been asked to take advantage of a very new FDA ruling suggesting and authorizing the use of CPAP breathing machines to cover a major part of the state’s huge shortfall in hospital ventilators when the number of COVID-19 patients in respiratory distress begins to peak shortly; a major shortage he continues to claim only the federal government can possibly deal with.

    He said Tuesday that New York has procured some 7,000 ventilators, but that the state will need, “at a minimum,” some 30,000 which he cannot find or even buy. Although the federal government has an estimated 20,000 ventilators in its stockpile, it plans to give New York only 400. As Cuomo angrily put it, “FEMA is sending us 400 ventilators …400 ventilators? I need 30,000 ventilators!”

    And after noting that new ventilators cannot suddenly be built, even in ten days, by Ford and other companies volunteering to help, “if we don’t have the ventilators in 14 days, it does us no good,” and patients will die.

    Indeed, hospitals in Northern Italy, currently facing a major shortage of ventilators, is reportedly already refusing to provide any to COVID-19 patients over the age of 60.

    The shortfall, which Cuomo says will cause many deaths, is so serious that he is even planning to have hospitals, on an experimental basis, use the untried and completely experimental tactic of putting two or more COVID-19 patients in respiratory distress on the same ventilator – even though they may need different pressures and other different settings, despite the clear risk of cross contamination and infection, and many other unforeseen problems.

    That’s why he is being urged to follow the advice of the FDA which has said that CPAPs and similar small breathing devices – sometime called “poor man’s ventilators” – can be used by many COVID-19 patients who will die without some breathing assistance, but who do not necessarily need the full power and sophistication of a hospital ventilator. A weaker and less sophisticated ventilation machine such as a CPAP is better than none at all when you are dying.

    On Sunday, in a little noticed decision, the FDA issued a press lease entitled Coronavirus (COVID-19) Update: FDA Continues to Facilitate Access to Critical Medical Products, Including Ventilators – “The FDA also provides recommendations for other alternatives that should be considered such as devices for treating sleep apnea, continuous positive airway pressure (CPAP), devices.”

    The agency said that “Continuous Positive Airway Pressure (CPAP), auto-CPAP, and bilevel positive airway pressure (BiPAP or BPAP) machines typically used for treatment of sleep apnea (either in the home or facility setting) may be used to support patients with respiratory insufficiency provided appropriate monitoring (as available) and patient condition.” This is important for many reasons.

    First, millions of these machines are already in use, largely in homes, so that users who can spare them without serious health risks could be paid to make them available for a few weeks. Indeed, when I first proposed this idea on the Internet, many users said they would even volunteer their units, especially if they only used them to limit snoring, had an older one no longer being used, didn’t use an existing one because it was too inconvenient, etc.

    In addition, there are many more of these devices in storage waiting to be sold or rented to new sleep apnea sufferers, so they could be made available in days, rather than weeks or months, to New York hospitals which are running out of ventilators.

    Since they are smaller and less sophisticated than hospital ventilators, even more CPAPs could be made quickly and more easily by new companies such as Ford than such companies could ramp up to produce new ventilators. As Cuomo noted, it would take at least ten days to produce additional ventilators.

    Moreover, as the Washington Post reported in an article entitled “More Lifesaving Ventilators Are Available. Hospitals Can’t Afford Them *** Health industry experts cite cost and uncertainty as disincentives to stocking up, leaving a potential life-and-death gap in treatment options,” many hospitals, and perhaps even some cities and states, will likely be reluctant to spend the $25,000-$50,000/each (plus necessary staff to operate and maintain) to buy dozens of ventilators which probably would never be needed again once the crisis abates.

    On the other hand, CPAP machines cost only about $850/each, and even less in bulk. So hospitals, cities, and states would be far more willing to purchase a significant number of these devices, especially since they could later sell or rent them to patients newly diagnosed with sleep apnea.

    Cuomo says it is “inexplicable” why the federal government will not provide the many more ventilators which will be needed very shortly in New York to prevent certain deaths, and that he is even willing to experiment with lives by trying to put two or more COVID-19 patients in respiratory distress on only one ventilator.

    But it would be equally inexplicable if Cuomo does not agree to even try to follow the advice of the FDA, and experiment by using CPAP machines for patients who may not necessarily need the full power, sophistication, and specially trained operating personnel of hospital ventilators to survive.

    1. “The shortfall, which Cuomo says will cause many deaths, is so serious that he is even planning to have hospitals, on an experimental basis, use the untried and completely experimental tactic of putting two or more COVID-19 patients in respiratory distress on the same ventilator – even though they may need different pressures and other different settings, despite the clear risk of cross contamination and infection, and many other unforeseen problems.”

      Your medical knowledge is not showing up here. The least of which, is that two patients sharing a ventilator for COVID-19 don’t have a cross-contamination or infection risk, as they’re both already sick from the same disease.

      1. Not necessarily. Some researchers have suggested that the so-called coronavirus itself may be mutating into slight variations, so that a patient with one variant could possible infect another patient with a different variant. Also, there are always risks of contamination or infection from other diseases – e.g. the common flue, or many others – which could be particularly serious because patients hooked to ventilators are probably especially susceptible.

        1. Are you unaware that ventilators don’t intake air from any patients?

          Similar-sized patients can split the same machine because settings will be similar. There is no risk of cross-contamination from a device that only sends air to patients, and does not receive any of their exhalations.

          Patients requiring the use of a ventilator will be kept in the ICU, which already has robust procedures regarding infectious diseases.

          At the end of the day, the underlying argument about sharing a ventilator is quite simple. Even if you ignore the facts above, if the choice is to share a ventilator with someone also infected with COVID-19 or to die, the right choice is pretty obvious.

  6. American ingenuity and the flexibility of a free market beats politics hands down every time.
    Hanes is making face masks. Ford, Tesla and GM are making face shields and respirators, etc

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