The United States spends about $3 trillion on health care annually, nearly $10,000 per capita — accounting for about 18 percent of gross domestic product. Medical technology is costly, but it is not the only reason medicine is expensive. A variety of factors are to blame for what makes health care expensive in this country and abroad.
Role of Technology in health care spending. Technology is a significant driver of high health care expenditures, accounting for more than half of spending. Not only is providing medical care expensive, new treatments are developed every year. Many treatments common today were not available 40 years ago.
Moreover, every breakthrough therapy extends life — but at a cost well beyond the cost of the episode of care. Someone who does not die of a heart attack in their 50s because they have heart surgery may require periodic checkups and costly medications for the rest of their lives. Indeed, the patient who survives a heart attack in his or her 50s may need cardiac medications throughout their lives, a hip replacement in their 70s and later be diagnosed with cancer in the 80s. The societal (and individual) benefit of living longer is obvious, albeit costly.
Some new technology do replace more costly older technologies. For instance, drugs often substitute for more costly hospital care. Joint replacements may allow individuals to live independently longer, requiring less nursing home care. Once a drug’s patent expires, a low-cost generic is usually available within a couple years. By contrast, information technology has boosted productivity in many industries making them more efficient, it doesn’t have quite the same spillover effects in health care. Although health care systems use information technology, it has hardly changed the way patients are treated. Patients often encounter the health care system the same way their grandparents did 50 years ago. Telemedicine — speaking to a doctor by phone or remotely using information technology — is often a last resort rather than the first resort.
The Cost of Many Therapies Never Fall. Therapies that have been in use for decades are often still quite expensive. Of course generic drugs are cheaper than brand. But hip replacement implant designs that have been around for decades are not comparatively cheaper than when first introduced.
In typical consumer markets, the quality of technology gets progressively better while the (real) inflation-adjusted prices often fall as older technology is supplanted by newer technology. This is especially true of consumer electronics but also of true of automobiles, appliances and other types of consumer goods.
The reason consumer goods prices have held steady in the face of increasing quality is because consumers are price-sensitive. In consumer markets, consumers reward the firms who successfully compete for their business. Health care is different, however. It does not exhibit the hallmarks of typical consumer markets.
The role of Third-Party Payment. Health economists believe third party payment plays a role in keeping health care expensive. It also plays a role in keeping it inconvenient. Third party payment is common in the United States, where 88% of health expenditures are paid by someone other than the patient.
- As recently as 1960, patients themselves paid about 96 percent of their drugs and dental care.
- In 1960 they paid 60 percent of their physician care but only 21 percent of their hospital care.
- Today Americans pay about 40 percent of dental care; 17 percent of prescription drugs; 9 percent of physician services and 3 percent of inpatient care.
Characteristics of Third-Party Payment. Third-party payers establish which treatments they will pay for and negotiate how much they will pay. When patients are not their primary customers, it is not in health care providers’ self-interest to compete on the basis of price. As a result, instead of price competition, competition among providers takes the form of providers seeking to maximize revenue against third parties’ reimbursement formulas. Over-use of third party payment also results in administrative overhead that is burdensome and rather expensive.
Another characteristic of third party payment is that hospitals negotiate reimbursement terms with insurers and employer health plans. This generally takes the form of negotiated discounts off list prices. It is seemingly in both payers’ and providers’ self-interest to ensure the spread between “list prices” and the percentage discounts are as high as possible. Hospitals then disaggregate services into as many billing codes as possible to boost billed charges. Health plans then reimburse the discounted amounts and hospitals write off the difference (what’s known as a contractual allowance).
Unfortunately, this is not in consumers’ best interest to have artificially high list prices with large discounts given only to health plans — especially uninsured consumers who get stuck paying list prices that are artificially high. Artificial list prices few payers actually owe also makes it hard for patients who want to compare prices — since providers are not competing on price. When providers are not competing on price, they have little reason to disclose price.
In addition, under a third-party payment scenario, hospitals and doctors are not competing to lower patients’ costs; providers are only trying to lower their own. This is why hospitals do not bundle and repackage service in patient-pleasing ways as is common in consumer industries.
The Role of Competition in Innovation. This lack of price competition has a profound effect on the cost of technology. Doctors, hospitals, drug makers and medical device makers are not competing in beneficial ways that rewards cost-saving technology. As a result, older technology does not sell at a discount. Consumers might buy a used car, but they mostly cannot make similar cost-saving in health care. What often occurs is patients decline services they cannot afford rather than seek out a lower price.
The Role of Regulations in Health Care. Regulations also play a role in keeping medical care and medical technology expensive. Medical technology firms and drug makers cannot innovate as easily as their counterparts in consumer markets. New drugs and medical technology must be approved by the U.S. Food and Drug Administration or other regulatory bodies.
Many estimates put the cost of bringing a new drug to market at more than $1 billion or more. The cost to bring a new medical device to market is also high.
Furthermore, doctors and other health care works are licensed, which also creates barriers to entry. Health insurers (both governmental and private) add their own layer of bureaucracy that stands in the way of competition.
The Role Consumer Sovereignty in Health Care. There is little in the way of consumer sovereignty in health care. Whereas consumers are always on the lookout for a good deal and novel goods and services they may be willing to pay for, insurers and third-party payers are not on the lookout for new ways to spend their money. Patients may like being able to merely call their doctor and consult over the phone, yet insurers are not going to reimburse new services until those services have been assessed to not increase spending.
Health Care in Other Countries. Patients are insulated from the cost of care in many countries. If price rationing is not to be used, another type of rationing has to take its place.
Faced with these constraints, different countries use a variety of methods to hold down the cost of medical care. These include:
- Patients Cost-Sharing;
- Third-party payers negotiating prices;
- Monopsonistic (single-payer) price controls;
- Rationing of equipment and services.
Cost-Sharing. The Rand Health Experiments conducted in the 1970s through the early 1980s discovered that patients exposed to cost-sharing consumed about 30 percent less medical care without impacting their health status. Insurers and employers use some variation of cost-sharing to align patients’ incentives more closely to insurers’ own. This included deductibles before benefits are paid and copayments. Third party payers also negotiate prices.
Monopsonistic Price Controls. Single payer is the ultimate government control of the health care system. By definition, a single-payer is a monopsony — the only purchaser of a good or service. When there is only purchaser in the country, it has significant market power to dictate the prices it is willing to pay — and limit with services it is willing to pay for.
Economic theory suggests a monopsony should set fees low enough so a sufficient number of providers exit the market, creating a slight shortage of services. This results in what is known as rationing by waiting.
To significantly reduce medical expenditures under a single-payer system, hospital fees would have to be lower than what American Medicare pays today — which is between 70 percent of what private payers reimburse. Doctors, medical device makers and drug companies would face a similar squeeze on fees and prices under a single-payer system.
Price controls are typically used to limit the cost of drugs and supplies in single payer programs like in Canada, Britain, New Zealand, etc. A single-payer could also use government data to arrive at a fixed global budget for each hospital.
Absent any of these preconditions a single payer would cost more than the current system.
The United States has a version of single-payer for seniors. Medicare pays slightly lower fees to hospitals and doctors, although it has shown very little political will to use what little monopsony power it has. Politicians who get campaign contributions are reluctant to enact price controls. Neither has Medicare shown a willingness to deprive seniors of costly treatments of little value.
Singapore Health Care System. The system that does the best to reduce perverse incentives can be found in Singapore. Singapore requires individuals save for their own future medical needs throughout their working lives. Singapore cannot be characterized as a truly free market for health care. However, it is an alternative to the socialized health care systems commonly found in Europe and in North America. Whereas other countries rely on government and / or employers to fund health care, Singapore relies on private saving and private insurance. The system in Singapore does its best to reduce cross subsidies across society and generations. Singapore believes:
- Each individual should mostly pay his own way;
- Each family should pay its own way;
- Each generation should be self-sufficient and pay its own way.
How Singapore Works. The government has a safety net for those who fall through the crack in these three levels. In Singapore, people are required to save for health care needs. For individuals up to age 50, the required saving rate is 7 percentage points is for health care and is deposited in a separate Medisave account. Individuals are also automatically enrolled in catastrophic health insurance with a deductible of about US $1,200, although they can opt out.
When a Medisave account balance reaches about US $35,000 excess funds are rolled over into another account and may be used for non-health care purposes.
Medisave accounts are a form of self-insurance that relies on personal saving. This results in beneficial incentives that benefit the entire marketplace. These incentives effect not only the demand side of the market, but also on the supply side. Individual patients have heightened incentives to be prudent consumers of health care, while providers have the incentive to compete for patients’ business. When consumers control more of their dollars, suppliers are more likely to compete for those dollars in patient pleasing ways.
After several decades of experience, Singapore has proven that individual self-insurance works and it works well. The Singapore model has shifted an enormous amount of money and power from the public to the private sector. Since 1984, the Singaporean government’s share of the nation’s total health care expenditure dropped from about 50 percent to 20 percent. The U.S. government share of health expenditures is approaching 60 percent when subsidies.
When Consumers Manage Their Health Care Dollars? Cosmetic surgery is one of the few types of medical care for which consumers pay almost exclusively out of pocket. In health markets without third-party payers, doctors and clinics use price competition, package prices, convenience, and other amenities in order to attract patients willing to purchase their services.
When patients pay their own medical bills, they become prudent consumers. Thus, the real (inflation-adjusted) price of cosmetic surgery fell over the past two decades — despite a huge increase in demand and considerable innovation.
- The price of medical care has increased an average of 129 percent.
- The price of physician services rose by 101 percent.
- All goods, as measured by the inflation rate, increased by 69 percent.
- Cosmetic surgery prices only rose only about 25 percent.
Cosmetic services have become competitive for a variety of reasons: As more people demanded the procedures, more physicians began to provide them. Licensed medical doctors are free to perform any cosmetic procedure they have been trained to perform, so there are fewer barriers to competing doctors. Physicians hire and train aestheticians and nurses to perform some minimally-invasive cosmetic treatments — boosting capacity.
Many providers increase efficiency by locating operating rooms in their clinics to reduce the cost of outpatient hospital surgery. Surgeons generally adjust their fees to stay competitive and quote package prices. New products and procedures have also become available.
- The cost of having a physician administer botulism toxin averaged $371 in 2014, little more than the average price of $366 in 2000.
- Yet deals on Groupon and Living Social occasionally offer Botox for as little as $99, with $149 quite common.
- The cost of laser skin resurfacing was $1,062 in 2014. Yet, couponing websites routinely offer numerous laser resurfacing deals for only $299.
Furthermore, wherever there is price competition, quality competition tends to follow. Consider corrective eye surgery. From 1999 through 2011, the price of conventional Lasik fell about one-fourth due to intense competition ($2,100 per eye to $1,600). Eye surgeons who wanted to charge more had to provide more advanced Lasik technology, such as Custom Wavefront and IntraLase (a laser-created flap).
By 2014, the average price per eye for doctors performing Wavefront Lasik averaged just over $2,100 per eye — about what conventional Lasik had been more than a decade ago. However, the quality of custom Wavefront is far better. In inflation-adjusted terms, this represents a huge price decline.
Moreover, it’s often the same doctors who work in curative medicine who also dabble in cosmetic medicine. In one area of their practice they are encumbered by bureaucracy. In the other they compete for patients by on price, quality and other amenities
The following was based on my presentation at the May 4th conference, Healthcare in Hungary: Are There Any Lessons From Abroad? sponsored by the Budapest Institute, Budapest Hungary.