• The US Health Care Rip-Off

    This post originally appeared on The Finance Buff.

    A question posed to me by a reader turns out to be relevant to the current debate over the inclusion of a public plan option in a remade US health system. After I address the question posed, I’ll make the policy connection in the final paragraph.

    Question: “I hear that the US spends a lot more per person on health care than other countries. How much of that difference is due to the price of care and how much is due to quantity of care consumed?”

    The premise is correct: the US does spend more on health care than all other Organization for Economic Cooperation and Development (OECD) countries. The OECD median was 9.1% of GDP in 2005, at which time the US rate was 15.3% and the country with the second highest proportion was Switzerland at 11.6% (source). In 2009 the US will spend an estimated 17.6% of GDP on health care (source).

    The relatively high US spending on health care must be due to relatively higher prices or greater health care consumption or both. The consensus in the academic literature is that price, not quantity, is the driver of costs in the US. In a thorough review of the literature, a 2007 Congressional Research Service report concludes

    “[T]he United States has far fewer doctor visits per person compared with the OECD average; for hospitalizations, the United States ranks well below the OECD and is roughly comparable in terms of length of hospital stays…U.S. prices for medical care commodities and services are significantly higher than in other countries…”

    Uwe Reinhardt and colleagues simply conclude “it’s the prices, stupid.” In another paper the same authors attribute higher prices to higher provider wages, lower consumer purchasing power (single payer systems in other nations can negotiate lower prices), greater supply constraints, higher administrative costs, and consumer demand for care at any cost. These ideas are echoed elsewhere. Adoption of new and costly medical technology is also blamed for increased costs.

    When we spend money on health care what are we purchasing? Are we buying a specific service (like a vision exam) or are we buying a degree of health (like better vision)? Since the ultimate goal is better health there is good reason to think of the product in terms of the outcomes it produces: longevity, quality-adjusted life years (QALYs), etc.

    Taking this perspective, the academic literature suggests that the US spends more on health care for poorer outcomes. Findings of this type are summarized in Tom Daschle’s Paying More but Getting Less. For instance, Americans have a lower life expectancy than other OECD countries, a point made forcefully by Anderson and Frogner. They show that the US is an outlier among OECD countries with both far greater health care spending and far lower life expectancy. They report that the US has mixed performance on other quality indicators: it is about as likely to be in the top half as in the bottom half of countries ranked.

    There is no good excuse for the higher costs and poorer outcomes in the US. The US population is younger than the average OECD country, with lower rates of smoking and drinking (source). Growth of US health spending is much higher than that of other OECD countries even after controlling for population aging (source).

    What do you call a transaction in which you pay more than others for the same or lower quantity and mediocre or low quality? I call it a rip-off.

    The foregoing discussion suggests that in reforming the health system for the non-elderly we should not place emphasis on reducing aggregate quantity since it is not particularly high. Reducing costs via quantity reduction would require an aggregate level of health services substantially below other OECD nations. Therefore, the emphasis should be placed on driving down price, which is high, while increasing quality. These are precisely the things that could be achieved with a greater concentration of purchasing power. A popular public plan is one way, though there are others (see also Ezra Klein’s post, and that of Uwe Reinhardt). One thing seems clear based on the record; lowering price is something the current marketplace of private plans is unlikely to achieve on its own.

    7 May 2009 update: A December 2009 report (and executive summary) by the McKinsey Global Institute addresses the issues discussed in this post.

    • You might find Section 1 in the following article useful. It speaks to the OECD figures and their comparison with the US.

      Top Ten Reasons For ObamaCare Are Based On False Information

    • realistTheorist,

      Thanks. I took a look at Secton 1 of the article you linked. I was most interested to see their objection to PPP for adjusting prices across nations. I’m not an expert in PPP but it does seem like a more thought-out and complete approach to the accounting of the value of a good in different countries. There are problems with using straight exchange rates that the PPP attempts to overcome. I would like to see a much more thoughtful development of why PPP is not appropriate in this context then is provided by the authors.

      In any debate that relates to potential government involvement in the distribution of resources it is easy to find arguments from various points of view. Alas, one cannot even find agreement on what the facts are.

    • Do you know of any attempt to account for differences in cost of living across countries? I would assume that higher costs would drive salaries higher and increase the cost to the consumer.

    • Helixso,

      The articles I referenced in my post takes this into account. That’s what PPP (purchasing power parity) is all about.

    • I do not believe that it is correct to say that the academic literature concludes that the excess spending in the U.S. is mostly from higher prices. In my book, I examine this issue at length. There is in fact a lot of evidence that the mix of services in the U.S. uses more physical and human capital.

      The health sector in the national income accounts provides very important evidence. The government statisticians are doing the best they can to break down price increases from changes in quality and quantity. As I show in my book, those accounts show that much of the increase in health care spending in the past 25 years remains after adjustment for inflation.

      Other very important evidence comes from the Dartmouth group’s research into spending differences across regions in the United States. This research shows that these differences are driven by the quantity and mix of services for a given type of patient, not by price differences.

      The Dartmouth studies are very influential. In addition to affecting the thinking in my book, they affected Peter Orszag (now head of OMB and considered a leading expert on health care) and Shannon Brownlee, author of Overtreated. I would recommend her book as well as mine, Crisis of Abundance.

    • Arnold Kling,

      Thank you for your reply. In preparing my post I searched the academic literature for peer reviewed articles relating health costs to prices and quantities. My search tools were Google Scholar and EconLit. I am certain I didn’t find everything and your post suggests I missed some important work. But it wasn’t for lack of trying, nor did I intend to exclude anything of import. If/when I find/stumble upon peer reviewed articles that support the arguments you make (and to which I can link) I will update my post to include them. (Were you to explicitly cite and link some in a follow-up reply or on your blog, that would be helpful.)

      Having not read your book I am going out on a limb a bit to reply to your comment. Two of your points (in your second and third paragraphs) pertain to temporal trends and regional variation in the US, not cross-nationally. It is an out-of-sample generalization to draw a conclusion about differences between the US and other nations based on US-only analysis.

      There is, however, another perspective that you didn’t address in your comment. If one views what is purchased as a quantity of health not a quantity of physical/human capital then is it not quite clear that we pay more for less in the US than other OECD nations? If so, there are two extreme solutions to the cost problem (assuming one views it as a problem): (1) lower prices while maintaining the delivery system or (2) increase value/dollar via changes to the delivery system. A middle-way does some of each. I infer that you would put more emphasis on (2) than would be implied by my post (which was focused on (1)). If the evidence supports the notion that it is the delivery system that is the source of the cost problem, then that is entirely reasonable.

      By the way, I have heard your excellent interviews on EconTalk, of which I am a big fan.

    • I would guess that the reason aggregate US outcomes are so bad has more to do with distribution than with cost-effectiveness. A marginal increase in quality-adjusted life expectancy costs a lot more for someone who is already receiving adequate health care than for someone who is not. Therefore the distribution of individual outcomes is skewed downward, and universal coverage improves aggregate outcomes by truncating the distribution. I would guess that, for the subsample of those who receive at least the “standard” quantity and quality of health care, outcomes in the US are considerably better than those abroad. Assuming I’m right about that, the issue with respect to prices becomes a subjective one of whether these improvements are worth the cost.

      Also, to the extent that we are being “ripped off,” there are important policy implications to the question of who is doing the off-ripping. Certainly foreigners themselves are doing some of it. The US finances a disproportionate share of health care R&D, and some of that share is paid for by producers in the health care industry, who pass those costs on to domestic purchasers. (The obvious example is drug development.) If other countries use either legal mandates or the greater bargaining power of larger purchasing groups to push prices down closer to the marginal cost of production, then they are effectively receiving the benefits of US R&D with out paying for it. In that case it’s not so obvious that policies which push down prices in the US will provide a net benefit.

    • I’m not an expert in the area, so bear with me. I’m just flummoxed at how the concentration of purchasing power will ever do any good. It seems the hard choices are the politically-incorrect ones: reduce quantity and quality, and streamline the bureaucracy (whether that be insurance companies, the government, or a combination of both). FWIW, the French appear to be facing some hard choices:

      Everybody’s got an experience to share. No point in wasting bandwidth with our family’s experience (feel free to e-mail me).

      I think the bottom line is that any true solution is going to have to be offensive to many large constituencies (not just “any”). And that’s why we’ll keep nibbling around the edges. I’m just not convinced that concentrating purchasing power will do anything other than capping reimbursement levels. Services and products will still be rationed, one way or another.

      I have some off-the-wall ideas, but I’m sure to be hooted down.

      Nice chatting with you,


    • How, exactly, does increased “purchasing power” (concentration of resources in a single-payer, for example) drive down medical costs? Will physicians be required to charge only what the payer mandates? Hospitals? Testing labs? Drug companies? Will providers of services (and medical products) be required (as a condition of licensing or product approval) to supply their services and/or products to all comers?

      Example: surgeon “X” is a widely acclaimed as the “best” in the area for (pick a specialty). He/she does not accept insurance. Period. He/she still has more work than he/she can handle.

      Example: hospital “Y” is nationally-recognized as being “state of the art” for the treatment of (pick an illness). It’s very, very costly, however. Its ambulatory care surgery waiting room is routinely filled with very sick, but very rich (and scared) patients and their families. Insurance pays but a portion of their costs. They could care less.

      I suppose I could go on, but you get the drift. It seems as if “quality” and “quantity” are hot buttons, since nobody wants to reduce either, and it’s apparently politically-incorrect to suggest that the only real way to reduce medical costs is to reduce both.

      In the case of the surgeon above, the only way to drive down his or her fee is to mandate it. But if you drive down the fee, you will increase the demand beyond the ability of the surgeon to provide (I seem to recall supply and demand curves way back somewhere). In the case of the hospital, mandating cost caps will require the hospital to stop buying all that fancy equipment, lay off nurses, etc. in which case it will no longer be “state of the art” and its (former) patients will go elsewhere (Thailand?).

      I’m certainly no economist, but what am I missing here?


    • Bozo,

      Prices for care are negotiated between providers and insurers all the time. That is how it is done. That’s the market. Large insurers who can drive more utilization have more power and can negotiate steeper discounts. It doesn’t matter if that insurer is public or private. This is purchasing power. A mandate isn’t necessary.

      Nobody has to accept the terms of a contract. Providers can walk away. They will if they can earn more without contracting with the large insurer. Theoretically, some high-end, boutique providers may in fact do that if insured prices are too low.

      But it is at least a three-way political fight: insurers, providers, and patients. Their demands are all mediated through the constraints of regulation and Congress. If enough patients can’t get what they want they will rebel (e.g., enough providers walk). Same goes for providers and insurers. It is a constant fight. One sees it in Medicare all the time. It shows up in the non-elderly market too (remember the HMO backlash in the 90s? the patient bill of rights?).

      I’m not exactly sure what your question is or if I’ve answered it. I think the basic point is that it is a dynamic system and one should not expect it to settle into an equilibrium that is very offensive to any large constituency.

    • Bozo,

      Sticking to one issue at a time, let’s talk purchasing power. Say you’re a doc and I’m an insurer covering 1,000 lives. The only other insurer in the market covers 100 lives. There’s only one other doc in the world too. Your competitor is willing to accept $100 a visit from me and that will drive all 1,000 of my patients to him and none to you. Sure, you may still get those other 100 at $150/visit. Which deal do you prefer?

      The larger insurer wins the price fight. Who’s going to sign up for the insurance that pays $150/visit and therefore has to charge a 50% higher premium? This example spirals into a monopsony situation. Since the real market will have differentiated products the results won’t be so stark. But the basic idea of market power is seen in this simple model.