Robert J. Stonebraker, Winthrop University
The Joy of
Economics: Making Sense out of Life
Robert J. Stonebraker, Winthrop
University
Health Care
Why? Your insurance will cover it.
...dentist
upon hearing that your author would seek a second opinion regarding
the need for recommended oral surgery
Health care accounts for a large and growing proportion of all spending and production in the United States. We currently spend close to 15 cents of every dollar on health-related items, up from only 5 percent in 1960. Why such an increase? Two factors stand out.
First, we keep getting older. Life expectancy is up and the percent of Americans who are 75 years or older is increasing rapidly. That’s good news for those who need more birthday candles than a typical cake can accommodate, but it comes at a cost. The older we get, the poorer our health becomes. That means more aches and pains, more disease, more trips to the doctor, more medications, and more days in the hospital. As the population ages, medical expenses rise.
But the primary cause of higher medical costs is technological change. In the not too distant past we spent almost nothing on cancer or heart disease or kidney disease or even infections. We spent nothing because we had no treatments to offer. Physicians could do little more than verify illness and wait for patients to die. CAT scans, MRIs, kidney transplants, chemotherapy, hip replacements, heart bypasses – common procedures in modern hospitals – were unknown even fifty years ago. In a world in which we could neither diagnose nor treat most medical ailments, health care was cheap.
Mounting medical costs now have forced countries to confront a critical question: who should pay? Should we treat medical care like potato chips and allow individual consumers and producers make free choices about what and how much to buy and sell? Should we allow market supply and demand to allocate medical resources?
Health care systems differ significantly across countries, but all can loosely be categorized as either government-run or privately-run. Most countries view basic health care as a “right” of all citizens and provide universal access to all citizens through a taxpayer-financed government-run system. For example, Canadians visit government clinics or government hospitals that are staffed by government-paid physicians, nurses, technicians and pharmacists. The services provided are “free” to the patient. All costs are covered by government (tax-payer) funds.
The U.S. has chosen a very different route. We rely more on free-market supply and demand. Private health-care professionals and organizations offer services and compete for patient business. Individual consumers visit the health-care providers of their choice and pay for whatever services are provided. Some consumers pay out of their own pockets, but most of us have medical insurance that covers major expenses. Medical insurance often is part of the package paid by our employers.
Even though government does not provide medical care directly in the U.S. (with the exceptions of medical care to military personnel and some veterans), it impacts the system nonetheless. All health care professionals, hospitals and medical schools must meet government licensing standards. All drugs must pass Federal Food and Drug Administration (FDA) testing for safety and efficacy. The federal government provides heavily subsidized health insurance for elderly citizens through Medicare and covers medical costs for eligible low-income families through Medicaid.
Although countries vary widely in the way medical care is provided, they share one important characteristic: discontent. Citizens throughout the world are increasingly frustrated with their respective health care systems. U.S. health economists share that frustration. The U.S. system falls far short of attaining the economic goals of efficiency and fairness. We lead the world in medical spending, but we lag behind many other countries in life expectancy and health outcomes.
Demand-side inefficiencies
Many Americans demand inefficiently high levels of health care. Remember, most of us have medical insurance that covers a large chunk of the costs. The net cost to consumers is well below the true marginal cost of providing the care.
Check the graph below. For allocative efficiency, we should produce care as long as the marginal benefit covers the marginal cost (Q0). However, suppose that our health insurance covers 80 percent of the expense. Because this lowers the net MC to the patient, the rational consumer will want to purchase Q1 units of care – considerably more than the efficient level.
Stop and listen. Is your memory calling out moral hazard, moral hazard? It should be. It’s exactly the issue we discussed with saving lives. The more we insure against the effects of something, the more likely it is to occur.
Supply-side inefficiencies
Similar problems arise on the supply side of the market. Health-care providers have traditionally supplied more than is efficient.
Imagine walking into a boutique and explaining to the sales clerk (working on commission) that you have been a bit blue and are thinking about some new clothes. If you ask the clerk whether or not new clothes will boost your spirits, what response should you expect? Is the sales person likely to say “no” and send you on your way? Of course not. Next imagine explaining that you will buy whatever clothes the clerk recommends. Should you expect the clerk to point you toward the clearance rack? Of course not. The clerk has a financial incentive to sell you as large and as expensive a wardrobe as possible. The more you spend; the more commission the clerk earns.
Historically, the patient-doctor relationship was quite similar. Patients seldom decided what and how much care to buy; their doctors made those decisions. Patients would ask their doctors what they needed and would usually purchase whatever the doctor recommended. With the traditional fee-for-service arrangements, just as with the sales clerk on commission, the more tests and visits and procedures the doctor would recommend, the more income the doctor would earn. The incentive was to recommend or supply as much as possible without scant attention to relative costs and benefits.
Could health care providers be so crass? Would they actually prescribe medical care that cost more than it was worth just to pad their own wallets? Some would not, but many would. Such oversupply provided another benefit to physicians as well – protection against malpractice suits. As long as they were provided with everything possible, unhappy patients had few legal grounds on which to sue for malpractice. Besides, many doctors would reason, the extra expenses are being paid by insurance companies, not by the patients themselves. So, why worry?
Controlling costs
As expenses mounted over time, pressure to control costs mounted as well. Trying to moderate cost increases in its Medicare and Medicaid programs, the federal government acted first. It threw out the traditional reimburse-for-services-provided system and began paying hospitals and physicians set amounts for treating a specific ailment. For example, if the government decided that $18,000 should be enough to cover the costs of an appendectomy, it would agree to pay $18,000 for the procedure, regardless of what actual costs were incurred. This radically altered incentives for health-care providers. If the hospital was to receive a flat $18,000, it had no incentive to hold on to patients any longer than absolutely necessary. If the $18,000 was enough to cover three days in the hospital, administrators had no incentive to let a patient stay a fourth day. Longer hospital stays now meant fewer profits rather than more profits for the institution. In fact, pushing such patients out after two days would be even better. Hospitals would still get the same $18,000 revenue, and would save the expense of caring for the patient the third day.
Private insurers soon followed suit and then went further by pushing patients into managed care programs such as health maintenance organizations (HMOs). Members of HMOs pay a set annual fee in return for free health care from HMO physicians. Because the HMO receives the same fee regardless of how many services you require, it has the incentive to keep you well and to supply as few services as necessary. While physicians under the pay-for-services-rendered system have an incentive to supply as much as possible, HMOs have an incentive to provide as little as possible.
To some extent the reforms have been successful. The rate of cost increases did slow appreciably and billions of dollars have been saved. But the savings have been partially offset by a drop in quality. Patients who belong to HMOs or other managed care groups often assert that necessary care and access to specialists is withheld “to save money.” Numerous patients have complained that they have been released from hospitals prematurely and have been forced to hire private-duty nurses and other professionals to care for them at home. Since these home-care professionals often are not covered by insurance, cost savings for the insurers have often meant higher costs for the patients.
Is this drop in quality a bad thing? Not necessarily. Like other products, higher quality is efficient only when its marginal benefit exceeds its marginal cost. In daily life we willingly choose lower quality options when the dollar savings are large enough. We choose cheap generic foods over higher quality brands to save money. We choose cheap used cars over new luxury models to save money. We choose cheap coach seats over first-class seats on airlines to save money. If the cost savings are large enough, people rationally will choose lower quality medical care as well. Nonetheless, cost containment measures in health care have not been free. Some health care quality has been lost.
New concerns about fairness also have come to the fore. In the past, uninsured patients who were unable to pay for care often were treated as charity cases. Hospitals covered the costs of this care by charging those with insurance a bit more. In essence, patients with good insurance were indirectly subsidizing care for those who could not afford it. However, as government programs and private insurance firms clamp down, hospitals increasingly are unable to raise the extra dollars to cover the costs of charity care. It is not unusual for sick, uninsured patients to find themselves being pushed from hospital to hospital -- like the proverbial hot potato – seeking needed care.
More importantly, the cost savings seem to have been short-lived. The reforms did wring some fat out of the system, but medical costs are being driven primarily by technological change, not by fat. As technology continues to enable us to diagnose what we previously could not diagnose and to treat what we previously could not treat, cost increases have reverted to their long run rise. As one medical researcher put it, the “capacity of medicine to provide ever-advanced technology is endless. No matter how much you spend, you can always spend more.”
As things currently stand, we cannot afford to provide all of the medical care insured patients demand. Privately-run and government-run systems face the same pressures. In the long run we have only two choices. Either we spend more, or else we deliberately withhold care from those who might potentially benefit from it. Neither option sounds like much fun.
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Testing Yourself
To test your understanding of the major concepts in this reading, try answering the following:
1. Explain why Americans are spending an increasingly large percent of income on health care.
2. Describe the major ways in which the government impacts the U.S. health care system.
3. Explain why most Americans demand inefficiently large quantities of health care and illustrate with an appropriate graph.
4. Explain why American health-care providers historically supplied inefficiently large quantities of care.
5. Describe what government and private insurers have done to control medical costs and explain how they have changed incentives.
6. Explain the impacts these cost containment measures have had on the quality of care, on the system of charity care for low-income uninsured patients, and on the long-run trend of medical costs.