As an economist, I’m bothered by gross oversimplifications underlying the glib statement that costs of health care are rising. Mistaken notions of cost, in combination with shallow political discourse, help explain why health reforms consistently fail to solve deep-seated economic problems of American medicine.
Cost is only one factor in the equation of total spending. If we really want to limit the number of dollars flowing through the medical economy, we must develop coordinated policies that impact all variables. A quick review of the fundamentals of Economics 101—production theory and supply & demand—reveals the range of variables that policy-makers should be addressing to reform health care.
Cost means cost of production. It is represented by U-shaped curves showing how much a producer pays for various combinations of inputs that produce a particular good or service. Costs can be lowered with a less expensive combination of inputs (e.g., substituting advanced practice nurses for physicians) or economies of scale (e.g., consolidating underutilized clinical services into a single unit) that yield the same product.
Price is the producer’s charge for selling its goods and services. Obviously, producers cannot stay in business if production cost exceeds market price, so they must constantly lower costs and/or convince consumers to pay a higher price by differentiating their product through advertising and other promotional activities.
Total expenditure on a good or service is determined by the price that consumers pay, multiplied by the quantity they purchase. Expenditures can be reduced through economic policies to lower costs of production and/or to curtail demand (e.g., disease management programs).
The health “reforms” of 2010 were not directly focused on reducing production costs, prices, and demand in ways that would stop the relentless increase in total spending on health care. Instead, the new laws’ focus on insurance overhaul will almost certainly have the opposite effect, first by increasing demand and then by increasing production costs by creating chaos in the marketplace. Ideally, the spending outlook could have been more promising if sound economic analysis had not been derailed by hard-ball politics.
However, the outcome would be bleak even if lawmakers had acted in accord with the lessons of Econ 101. Effective (i.e., paying) demand for health care is going to be severely constrained for years to come because consumers are being expected to pay a growing share of their total bills while consumer income is stagnant. Patients simply won’t have money to cover the additional expenditures that reform is shifting to them. Congress may ignore the basic laws of economics, but providers and payers cannot. I think that their survival requires cutting costs of production, providing acceptable medical services at affordable prices, and helping patients reduce demand—in spite of the new reform laws. What do you think?
2 comments:
Jeff, your Economics 101 analogy is an important reminder to all of us about applying fundamental principles to solve problems. I don't believe "chaos" was a key element to consider in ECON 101, but it sure is what we have with health reform! Thanks for reminding us to stick to the basics.
Completely agree. Legislating access and growing the giant pool of (insurance) money to pay for increased demand will do nothing to cut medical costs - at least not at the GDP level. But increased financial burden on individuals will. Doctors will no longer be able to say "don't worry, it's covered," when asked how much something will cost. Smart practitioners will find ways to deliver care much more efficiently than they have been allowed to over the past 30 years. Similarly, people might just decide that a $150 X-ray is sufficient and, not demand a $1,000 MRI "because it's covered."
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