Why Healthcare Spending Must Fall

by Dave Schuler on April 16, 2014

The graph above accompanies the very interesting post by Tom Liu at The Incidental Economist on how we can be confident that the PPACA hasn’t caused healthcare costs to fall which I recommend you read in full:

While reducing unnecessary utilization is one goal of ACA delivery system reforms, those reforms didn’t predate the signing of the law. For example, the Medicare Shared Savings Program and Pioneer ACO programs weren’t launched until 2012. And they are still finding their footing—of the 32 Pioneer ACOs (arguably best poised to achieve utilization reduction), only eight of them significantly slowed cost growth relative to their local markets in their first year. More dramatic value-based models such as Iora Health or Qliance, which can claim inpatient reductions of up to 41%, are only just beginning to achieve scale.

Something else must be causing the slowdown in utilization growth over the last decade.

What caught my eye in the graph above was how neatly it illustrates the point I’ve been making, the importance of not merely reducing the rate of increase of healthcare spending but actually reducing the spending. Note the labeling of the graph at left. Spending is divided into two components, a price component and a utilization component. The topline green line is the total increase in the rate of spending. That line has been above zero every single year for the last twenty years, i.e. real healthcare spending is rising monotonically. Actually, that’s been the case for the last forty years.

I would be remiss in not mentioning that to at least some degree the distinction between prices as a driver of spending an utilization as a driver of spending is specious. Physicians create utilization. An alternative interpretation to the last few years of that graph are that as the rate of increase in prices decline the rate of increase in utilization rose to maintain a more-or-less constant rate of increase.

Let’s do a thought experiment. Imagine a country in which healthcare spending, education, and defense spending account for a third of the economy and all of that spending is government spending. If spending in those three categories alone rise just 3% and general rate at which prices are increasing is 1%, those three categories account for 100% of the growth in the economy.

Now imagine that every dollar in those three sectors results in fewer people being employed than in any other sector of the economy. That’s a country in which fewer people will be able to find jobs every single year.

Now, there are two distinct strategies for addressing the obvious problem that presents. One is for those three sectors to start employing more people at lower wages than they’re accustomed to. The other is for the growth in those three sectors to be less than the average growth in the economy outside of those three sectors. In some years it might be a little more, in some a considerably less, but on average the growth would be less than the growth outside of those three sectors. That would be an economy in which more people would be employed each year, allowing for what’s quaintly known as “the natural increase”.

My thought experiment is over-simplified but IMO it’s a reasonable simulacrum of the actual economy. My assessment has been that it will be easier to contain spending in those three sectors than to change how they operate in more drastic ways, e.g. having much, much more of the actual work now being performed by physicians being performed by twice as many technicians and other practitioners who are being paid a third what today’s physicians are (for example). That’s why I think that healthcare spending must fall.

{ 3 comments… read them below or add one }

steve April 16, 2014 at 2:29 pm

1) I dont know what the ideal level of spending on health care should be. I guess that in an ideal world, markets would sort this out, but no one knows how to make markets work in health care. I guess we will stumble through on this.

2) As I have said before, if you want to control costs, you cannot ignore the utilization side. You cannot look only at the fees. Provider induced demand is a real entity.

3) The approach taken in the ACA is controlling costs. What they are not doing is telling docs and hospitals how to cut costs. They are simply giving us less money and letting us figure it out. My Level one, tertiary care facility will receive $20 million less from Medicare next year. We have to figure out how to make it work.


Dave Schuler April 16, 2014 at 3:09 pm

I dont know what the ideal level of spending on health care should be.

I don’t either. However, I think that under conditions of extremely slow growth in the non-healthcare (and non-education) parts of the economy and when millions are unemployed healthcare spending somehow needs to be constrained by the growth in the rest of the economy.

In many countries that’s done by establishing a budget for healthcare and sticking to it. Heretofore we haven’t been willing to do that.

Ben Wolf April 17, 2014 at 6:02 am


A health care market cannot even exist. It’s always been a fantasy.

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