July 11, 2017

Runaway Train: The Price of Healthcare in the United States

By In Essays

From doctors and nurses to big businesses and from the general population to the politicians who represent them, everyone seems to agree that the American healthcare system is broken. Numerous presidents have tried fixing it. Barack Obama was the only one to have some form of comprehensive scheme passed by Congress, but the battle over its implementation and whether it is a better system for the country than the previous status quo continues to be hotly debated. While President Obama’s Affordable Care Act directly tackled one of the twin healthcare challenges of the United States, access, it did not do nearly enough for the second challenge: skyrocketing costs.

Spending more of a country’s income on health care is not always a bad thing. Internationally, there is a strong correlation between affluence and spending on health care. In the poorest countries there is simply no access and therefore no cost for a large segment of the population. As a country’s wealth rises, health care spending tends to adjust upward as a percentage of income rather rapidly until hitting a kind of speed limit and leveling off. Adjusted for income levels, in the United States it would be expected that healthcare spending would be about 9% of GDP and to be in line with other developed economies, the United States would spend slightly more than that, perhaps 10% – 12% of GDP. To call the United States an outlier at 17% of GDP would be an understatement. The gap between 12% and 17% GDP implies $1 trillion is wasted every year in the American health care system.

Healthcare spending to GDP and GDP per capita (at PPP) for selected countries, 2014.

What are the principle causes of the dramatically higher health care expenses in the United States and why does there seem to be such paralysis to tackle the issue?

Most economists agree that there are three principle reasons why health care in the United States has become so astronomically expensive. They are overtreatment, administration costs, and pricing.

Of the three large contributors, overtreatment is probably the largest, but it is important to precisely define what is meant by that. For the most part, Americans see the doctor less than their counterparts in other nations, but when they do they are more likely to receive tests and unneeded treatments. There are multiple reasons why this is the case. American patients seem to enjoy the psychological benefit of believing that something is being done and their trip to a professional was not a waste of time. The professional is incentivized to perform unnecessary tests and procedures because of how they bill the patient or their insurance company and doing more is likely to somewhat reduce the risk they will be sued for malpractice. Americans also have a particularly hard time accepting poor outcomes and transitioning from treatment to palliative care in the final stages of their lives. Studies on overtreatment in the United States place the cost to the healthcare system at anywhere from $300 billion to $1 trillion, with the difference largely driven by how broadly the category is defined. Using a middle of the road estimate of $500 billion would mean that 2.6% of GDP is lost to overtreatment each year, accounting for half of the gap between an expected 12% to GDP rate of health care spending and its current 17%.

It is also undeniable that the health care system is administered inefficiently in comparison to other countries. About a quarter of expenditures are for administration in the United States, compared to about 15% for the least efficient developed countries in Western Europe. That amounts to about $300 billion in waste and would be equal to a third of the 5-percentage point excess in health care spending to GDP in the United States. The reason for the gap is pretty straightforward: other developed countries are likely to employ government run systems that are single-payer, drastically simplifying the billing and payment process for healthcare professionals. In the United States, a healthcare provider must negotiate with several insurance organizations and apply Medicare and Medicaid regulations according to the law in order to be paid. They then often also have to collect from the patient.

The final reason is that drugs, devices, and specialists tend to cost more in the United States than other countries. Government health care schemes vary from country to country, but they often involve the government negotiating the cost of drug prices or regulating what health care providers can charge if a government agency is not directly providing the service. Private insurers have far less bargaining power than many foreign governments do in negotiating prices and most government agencies in the United States are barred by law from negotiating themselves. The United States spends about $1,000 per person on just prescription drugs versus about $700 in other countries. That gap alone is $240 billion. It becomes much higher when medical devices and hospital stays are included in the total. One day in the hospital in the United States now costs about $5,200, which is about five times the European average.

Prescription drug spending per capita in selected countries (2011).

Obviously, these three categories overlap each other and so if each of the problems would be corrected so that the United States’ healthcare system operated at more or less in the middle of the developed world, health care costs would decline less than the cumulative total. Still, these causes of health care expenses are not very controversial and steps could be taken to address them even short of a single-payer health care system.

Medicare, for example, could start negotiating drug and other medical costs and publishing those prices. Outcomes could be incented more than simply the inputs selected by the provider and while the direct savings of tort reform may not be an impressively large number, capping payments in lawsuits could lower malpractice premiums and begin to reverse some of the overtreatment as well.

Why is it that straightforward approaches to the health care system have been near impossible to take? Because if someone is spending too much money, someone else might be making it, and they are. Health care companies form a powerful and well-organized lobby.

Market fundamentalism is also a key reason why reform has been difficult. Markets are often the best way of arranging society because the price mechanism is the most efficient means of allocating resources. It is true to say that markets often work best, but it is demonstratively false to say that markets always work best, as market fundamentalists often assert. It is not debatable that market failures routinely happen.

To illustrate this, consider electric utilities. This is a business that requires an enormous amount of fixed investment and in which marginal costs are extremely low. The market solution, then, is for natural monopolies to form as the most efficient means of delivering electricity to customers. Rather than allow for inefficient competition, the constituent states of the United States decided long ago that the best solution was to allow the monopoly, but heavily regulate prices and performance to protect consumers from the market power of the monopolies. It is not a wholly market system, but it is a sensible means of coming to terms with a situation where unregulated markets do not produce the best outcome.

Other industries are in metaphorically similar situations. Healthcare is one of them. A market-oriented approach to health care requires price discovery, which is non-existent. Few consumers price shop their health care. They could not do so if they wanted to because their providers would be unable to quote them prices for most procedures. It is also a system in which most consumers are unable to understand on their own exactly what they should be consuming. They are forced to trust health care providers and have little incentive to weigh their options. An efficient system for health care would be one in which an eighty-year-old man consider bypass surgery contemplates his life expectancy with and without the surgery and makes trade-offs based upon relative values. Doctors are not, nor are they equipped, to guide patients through these kinds of comparisons. Health care is also, like utilities, one where a natural monopoly can be beneficial, which is why a single payer system often outperforms ones with private insurers.

It is unlikely that in the short-term, single payer health insurance will be seen. Perhaps not even in the long term. But, that does not mean that some reforms cannot take place that focus on the specific drivers of higher health care costs. Combined with the previous reforms of the Affordable Care Act, the United States could powerfully overhaul its health care system to be one more competitive on costs and with wider access to the population. Doing so by no means impedes the “free market” or takes the country down the path to socialism. In fact, should costs come down for the country, the effect would be a substantial tax cut for businesses and individuals.

We have clung to ideology for too long. We should start looking at success and making that the benchmark of our progress in health care and across the board in setting public policy.

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