In one of Steve Verdon’s recent posts on healthcare, physician “Our Paul” conceals his steel fist in a velvet glove in his response to my comment on the post:
Part of the rise in cost of Medicare may have been lack of “Congressional oversightâ€, but certainly the major part of the cost inflation was the introduction of novel and effective diagnostic approaches and treatment modalities.
That said, of the various bloggers on OTB, Dave Schuler seems to have the best grasp on this subject. A bit nihilistic at times, but hey, nobody has ever claimed that perfection is easy…
I’d prefer “coldly rational” to “nihilistic” but as “Our Paul” notes, perfection isn’t easy.
Unfortunately, his view of the reason for the rapid growth of healthcare costs, particularly in the period 1966-1981 does not stand up to scrutiny.
From 1965 to 1981 national expenditures on health care more than doubled from $201 billion to $507 billion in real 2009 dollars. Most of the increase in costs in healthcare can be explained by three factors: increased utilization, particularly immediately after the enactment of Medicare and Medicaid during the period 1965-1972, higher prices, particularly during the period 1972-1981, and inflation. Most of the increases after 1981 can be explained by inflation alone.
In the period 1965-1972 use increases accounted for 45.8% of the increase in healthcare spending and price increases accounted for 45%. In the period 1965-1972 57.5% of the increase in spending for physician services can be accounted for by price increases and 32.2% accounted for by increased utilization.
Hospital expenses and physician services account for the majority of healthcare costs and both of those are other words for people’s incomes. Rent, insurance, equipment, and so on are a pittance by comparison with wages as components of both of those.
Here’s my alternative explanation for what has happened to healthcare costs. In the immediate aftermath of the enactment of Medicare and Medicaid in 1966 there was an increased utilization of healthcare. That is what was supposed to happen: old people and poor people were supposed to get more healthcare. In a fee for services environment, the model that prevailed at the time and still has considerable force, that means that physicians and hospitals made significantly more money. Their incomes increased. When utilization levelled off (as should also have been expected) they continued to increase their incomes by raising prices. They had become accustomed to increasing incomes.
In the late 1970’s and early 1980’s the increasing healthcare expenditures capturing of such a quickly rising proportion of the federal budget finally caught the attention of the Congress and a number of steps were taken to slow the increase. But the harm had mostly been done. A high cost basis had been built into healthcare, healthcare was a major component of total GDP, and inflation alone (of which rising healthcare costs are one of the largest components) was enough for healthcare costs to grow unsustainably.
I am not blaming healthcare providers for acting this way. I believe it was a natural human response and they responded as anyone else would have under the circumstances.
However, it means that simple cost control won’t achieve what we need to accomplish. The primary components of healthcare costs are hospital costs and physician services which comprise the majority of costs, insurance administrative costs which comprise something like 30% of costs, pharmaceutical costs which comprise something like 10% of costs, and other factors which comprise very small proportions of the whole. All of these costs are other words for wages, somebody’s income. Healthcare costs are high because wages in the sector are high.
Most of the information in this post was derived from the paper, Inflation and Healthcare Prices, written by John R. Virts and George W. Wilson. In turn most of the statistics in the paper were derived from the Bureau of Labor Statistics. Statistics on GDP were derived from the St. Louis Federal Reserve.
I’ll go read the paper, but in the interest of time, is there a quick breakout of the components of “increased utilization” (eg nursing home care as I surmised, or expensive procedures/treatments as Our Paul posited)?
As for prices, well, as they say, people on expense accounts eat steak, not burgers……..
It is of course very dangerous to take anecdotal evidence and extrapolate, but for someone like me who grew up in a medical family you have sort of a “who you gonna believe, me or your lyin’ eyes issue.” Especially when you consider how politically charged the health care subject is, and the papers written about it.
I used to accompany my father as he made his hospital rounds etc and over the years watched the staggering rise of expensive medical technology and the practice of defensive medicine, plus the transfer of procedures from primary care physicians to specialists and the rise of nursing home care as a primary residence for the elderly. It makes it hard to imagine these aren’t significant components in cost increases.
By “utilization” the authors mean a variety of measurables, e.g. physician visits, prescriptions, lab tests, and so on. I know too much about what the actual cost components of various tests and items of medical equipment are to believe that technology is the main driver. When a test is sent to a lab the actual cost of the test is pennies. What costs is the pathologist who (sometimes nominally) looks at the test results.
I suspect that the authors of the article have divided the issue you’ve raise, i.e. more being done by specialists, between utilization and price increases. It’s reasonable to ask if that’s appropriate but, since that process is one that has been created and driven by physicians themselves, I don’t think it makes a great deal of difference.
My own opinion is that the future of healthcare looks a lot like what has happened in dentistry with much of what was formerly done by dentists now being done by hygienists and one dentist overseeing the work of many hygienists.
Dave –
So I read the paper, and I found another study……
I find the Virts and Wilson paper odd, quite frankly. I do not know who “Denison,” is or the robustness of the methodology. But the former engineer in me asks questions like: how do you account for a new procedure like a heart bypass, and differentiate escalation in doctors or hospital prices – because heart plumbers make more than pediatricians – from their “U.” In any event, more striking was this: their central thesis was that general inflation (“imposed,” in theri vernacular) dominates “specific” inflation, or other factors, like N. Well, given the time frame of their study, in the post 70’s/80’s hyper-inflationary environment we shouldn’t be talking about health care expenditures, right? But we are.
Here is another study:
http://hadm.sph.sc.edu/COURSES/Econ/Classes/nhe00/
I can’t vouch for its veracity, my earlier point, but here are some conclusions I drew from its presentation:
1. They would absolutely substantiate your assertion that there was an “adoption” factor (eg consumers responding to medicare) in the 60’s when government entered the game in a big way. This was a major factor in setting the subsequent cost path. The other periods of large increases in real per capita consumption are the post recession 90’s and post recession 2000’s. Hmmm. Dare we say it??? Health care a luxury good?!!?!
2. The move to nursing home care was a significant cost issue, although a factor largely in place by the end of the 70’s.
3. Per my point about Virst and Wilson, there is no evidence that their general inflationary explanation for the period of 1965 – 1983 explains our subsequent experience.
4. What V&W would refer to as “specific” inflation was most prevalant in 1975 – 1983.
5. There can be no doubt about the entrance of an 800 lb gorilla in the room as health care costs took off. None. The Federal share of spending on HCE went from 11% in 1960, and starting with the 1965/1966 jump, to 30% today. State and local has been steady, private is then obvious. Anyone surprised costs took off when Johnny Fed showed up? Of course we could be like the man made global warmists and ignore obvious connections in favor of exotic but tenuous models.
6. The second smoking gun, in my opinion. When they looked at out of pocket expenditures to total HCE we see a declining path from 48% in 1960 to appx 10% currently. As I have noted so many times: no one eats hamburger on an expense account. We have taken the price mechanism away from the consumer in the arena of health care. We have gotten what any economist would expect when people think health care is “free.”.
6a. As a corrolary. The same graph shows the increasing percentage of insurance premiums over this period. Hence the bitching and moaning about insurance companies, and natural employer reactions. But, see “6” there is no free lunch.
None of this deals with advances in medical technology, defensive medicine etc. But I’m a root cause guy. We can build Rube Goldberg explanations for the behavior of people and markets in health care all we want. But for me, it goes back to first principles; think operationally. When the consumer thinks its “free” because the Feds and employers subsidized it………you get price escalation, you get price acceptance for all manner of things……..and you get no push back to malformations in the market.
I remember listening in a class long ago (the topic was wage behavior) when a student asked Kevin Murphy why some economists didn’t acknowledge the role of price in the demand for labor. Without missing a beat came classic Murphy: “because they aren’t really economists.”
Same as it ever was.