Top 10 Reasons for Soaring Health-Care Costs, according to yahoo's featured economist

The Naked Economist
by Charles Wheelan, Ph.D.
http://finance.yahoo.com/columnist/article/economist/2760?p=1

The Top 10 Reasons for Soaring Health-Care Costs
by Charles Wheelan

What's the most intractable public policy problem the U.S. faces? Health care. I don't think any other issue even comes close. Health care has all the ideological fireworks of social issues like abortion or gay marriage (e.g. is health care a right or a privilege?). Yet the system itself -- the process of providing care and allocating those costs -- is also stunningly complex.

Health care is increasingly expensive because of powerful, perhaps inexorable economic forces that make medical care different than all other goods and services in a modern economy. Here are my top 10 reasons for why health care is so expensive -- and likely to get even more expensive in the future, regardless of what patches we put on the system.

1. Nobody shops for value.

When was the last time you heard someone say something like this: "You're having chest pains, Al? Sorry to hear that. You should see Dr. Smith. He's not as fancy as those cardiologists at the Cleveland Clinic, but you can't beat his prices! In fact, I think he's having a Presidents' Day special on angioplasty right now." There's no medical equivalent of Wal-Mart. Everyone wants Neiman Marcus.

2. Medical innovations are usually more expensive, not less.

Economic progress tends to come in two forms: Learning to do old things better and cheaper, or learning to do new things. Medical progress tends to involve the latter. A bone-marrow transplant may provide new hope for many cancer patients, but it's not necessarily cheaper than the old alternative.

In the case of pharmaceuticals, we've explicitly designed the system so that new drugs will be expensive. We grant patent protection -- a legal monopoly -- to pharmaceutical companies for breakthrough medication. The more impressive the drug, the more the company can charge, regardless of the actual cost of producing the pill. Yes, those prices are high, and the profits can be huge -- which is exactly what creates the incentive to discover such drugs in the first place.

3. Health care is a "luxury good".

Wait. Before you start sending me angry e-mails, please let me clarify. I'm not saying that health care is a luxury. I'm saying that health care is a "luxury good," which is a technical term in economics. It refers to any good that wealthy people demand in disproportionately greater amounts than less wealthy people.

The opposite is an "inferior good", which is something that people actually consume less of as they get richer. Ramen noodles, for example, are likely to be an inferior good. I'm certain that my graduate students eat far more of them than Donald Trump does, his capacity to afford huge quantities notwithstanding.

Richer societies, and richer people within a society, have higher expectations for health care than less wealthy people. We increasingly demand medical fixes -- and have the technological capacity to provide them -- for problems that our grandparents would have just tolerated. Think hip replacement, stomach stapling, Lasik eye surgery, and so on. Our spending a rising share of our GDP on health care as we grow richer as a nation is not inherently a bad thing.

4. We don't pay for what we consume.

Health care is unique in that neither the service provider nor the patient gets the bill. For most people, the tab gets sent somewhere else. So nobody directly involved in the transaction has any incentive to control costs.

Imagine if you could buy a television that way. You would walk into a retailer and discuss your needs with the salesperson (working on commission), knowing that the bill for your eventual purchase would get sent to Aetna. Would anyone walk out of the store with less than a 60-inch flat screen with surround sound?

The insurance company will try to contain costs, albeit without the benefit of being in the office with the doctor and patient. So that may mean somewhat arbitrary limits on care or time-consuming hurdles for more expensive procedures -- which is why everyone hates their HMO and doctors complain, rightfully I'm sure, about the staggering paperwork and bureaucracy associated with nearly all insurance plans.

Even then, it's easy to game the system. Imagine the expert salesperson at the shop writing a letter to your insurance company explaining that you need a giant, high-definition screen because of your poor eyesight.

5. Baumol's disease.

This is not something you should fear testing positive for at your next check up. Rather, it's an important insight made by economist William Baumol: As societies become richer, labor-intensive endeavors, such as health care, become increasingly expensive relative to goods and services that can be produced using less labor.

Why? Because there are none of the cost savings that usually come from rising productivity. Compare farming to brain surgery, for example. A typical farmer today may grow 20 times as much corn as a farmer could 100 years ago. Thus, it's possible for a farmer to be 20 times as wealthy without any increase in the price of corn. A brain surgeon, on the other hand, cannot see 20 times as many patients. (I don't know if there were brain surgeons 100 years ago, but you get the point). Baumol's famous example was that a string quartet will always require four musicians.

So, for brain surgeons' income to rise at the same pace as the rest of society (a necessity if smart people are to be induced to enter the field), then the price of brain surgery must go up relative to less labor-intensive goods and services (like corn). In short, as long as the doctor-patient relationship remains relatively unchanged, health-care costs will rise faster than prices in general. (Baumol's observation was described as a "disease" because it afflicts certain sectors of the economy, such as health care and higher education.)

6. The old.

I've written before about the "baby boomers", the huge demographic "pig in a python" born just after World War II (see "Tackling the Social Security Mess" http://finance.yahoo.com/columnist/article/economist/2415). This huge cohort of Americans is getting older, and older people have greater health-care needs. So even if nothing else on this list were true, an aging population would drive up the nation's health-care spending.

7. The uninsured.

Quick quiz: Your child has a high fever and a scary cough. Do you (1) call your pediatrician or (2) take your child to the nearest emergency room? If you've got a pediatrician, you do (1). If you don't, you do (2) -- which is a very expensive use of a trauma center's highly trained staff. Or maybe you never do anything at all, in which case five years later society is paying to deal with diabetes or asthma or some other chronic condition that could have been managed far more cheaply with better primary care.

8. The fat and lazy.

Most of us, in other words. We smoke too much, eat too much, and exercise too little. Why? I have no idea. A woman from Canada once asked me if fining Americans for unhealthy lifestyles might help. My off-the-cuff answer still rings true: "If someone is behaving in a way that's going to prematurely end their life, do you think a $200 fine is going to make much difference?"

9. Because death is sometimes the low-cost option.

What happens to people who are miraculously treated for heart disease or cancer? They die of something else. Or of the same thing later. Any medical success merely begets some later medical expense, particularly if we continue to spend so much on end-of-life care.

10. Malpractice.

I almost didn't add this to the list, as it's more of a legal problem than an economic one. But then I began to anticipate all the angry e-mails from folks who are convinced (wrongly) that malpractice suits are the only reason that our health-care costs are skyrocketing. So I stuck it in.

And, in a sense, my behavior proves that it belongs on the list: By attempting to preempt angry e-mails, I'm acting like doctors who practice "defensive medicine." Doctors seeking to avoid lawsuits have an incentive to overtreat all kinds of maladies -- a rational, albeit expensive response to a highly litigious climate.

That's my top 10. A group of brainstorming economists could probably come up with 16 or 18 structural causes for rising health-care costs, but I think I've hit the big ones, including some that are not intuitive or widely discussed.

What's my solution? Thankfully I've only got space here for the diagnosis. But that should make clear that there's no single cure -- because there's no single problem. Any serious and pragmatic fix for the system will require six or eight pills, not one. And even that will be treatment, not a cure.