The Economics of Health Care

It's Going to Cost a Lot More

Everyone knows about Social Security’s financial problems. At some point in the future, payroll taxes and trust-fund surpluses will be insufficient to cover benefits, so absent other action, benefits will have to be cut (see “Just the Facts,” February 11).

What about Medicare? Is there a similar crisis looming there? Actually, it’s already happened. And the crisis is much, much bigger. Tax receipts for the major Medicare trust fund, the one that finances hospital care, or “Part A,” fell short of claims payments for the first time last year, and the Medicare Trustees project estimates that the trust fund’s savings will run out by 2019.

Unlike Part A, Medicare “Part B,” which pays for doctors’ fees, cannot technically run a deficit: it is financed by participant contributions, which cover about 25 percent of costs, with the balance coming from general tax revenues. In other words, whatever the government has to spend, it spends. Part B spending is growing very rapidly, though, and spending will grow even faster once the new prescription-drug program (“Part D”) kicks in next year. The projected cost of the prescription-drug benefit by itself-$8.1 trillion over the standard seventy-five-year forecasting period-is more than twice as big as the Social Security deficit. Total Medicare spending will eventually rise to be twice as large as Social Security payments.

Oddly, the Bush administration has chosen not to say very much about this-maybe because the Medicare funding abyss makes all the drum-beating about the much smaller “crisis” in Social Security look a bit silly. But one can also sympathize with the administration’s silence: the numbers are simply too enormous to deal with through standard policymaking processes, and the political constituencies affected by the Medicare shortfall are among the most powerful in the country. For traditional Democrats (and for many Catholic social activists, including the United States Conference of Catholic Bishops), decent health care is tantamount to a basic right. Among probusiness Republicans, it is understood that some of America’s largest companies, like hospital chains and pharmaceutical makers, have a big stake in a strong health-care market. The combination of powerful vendors, a huge population of seniors whose lives literally depend on health care, and boomers who are terrified of getting stuck with their parents’ medical bills, makes a formidable lobby indeed.

Worse, discussion of what government should or should not do is dogged by widespread confusion about what is really going on in health care. Here are six basic propositions. They are all true, but are rarely reflected in policy debates. I state them in summary form, and then develop them more fully in the body of the article.

Six Propositions

• The primary engine of health-care spending growth is not waste, fraud, or overuse, although those are all problems. The primary engine of spending growth is new technology-new technology that cures people of terrible diseases and saves lives. Even at the most conservative managed-care programs, the standard package of benefits is steadily expanding. HMOs now routinely pay for newer, but proven, treatments like brain implants to alleviate Parkinson’s disease, heart defibrillators, radioactive seeds that combat prostate cancer, stomach surgery in cases of morbid obesity, and many, many others. That process can be slowed, perhaps, by cutting back on research spending, but it won’t be stopped.

• Health care costs, in general, are not rising. The costs of common medical procedures like cataract surgery, a cardiac stent, an artificial hip, or depression therapy, in fact, are falling quite rapidly. But as new technology becomes more effective and cheaper, it becomes much more widely used, and total spending goes up rapidly.

• Complaints about “excessive health-care spending” (I’ve read some in Commonweal) sometimes sound as if the money is being siphoned into outer space. But health care is almost an ideal industry. It drives technological progress, in both electronics and biotechnology, pays better than average wages, and has a superb record in creating careers for minorities. Even better, unlike in the oil, video-game, or automobile industries, the jobs stay home. Contrary to the conventional wisdom, the fact that health care will inevitably consume a greater share of national product is not bad news.

• To be sure, controlling high-technology medicine poses big challenges in managing treatment. The mantra of “free choice,” espoused by politicians as different as President George W. Bush and Senator Edward Kennedy, is badly suited to an era when people live much longer, survive many more serious diseases, and are likely to be receiving multiple therapies. There are good current health-care management models, like the Kaiser Permanente programs, but the information systems required to improve patient care and increase efficiencies are expensive, and the habit-changing challenge, for both doctors and patients, is large.

• Because of the relatively freewheeling nature of our health-care system, medical spending in the United States may always exceed that in other industrialized countries. Still, other countries are not far behind-with about a five-to-ten-year lag-in embracing new medical technologies and in increasing health-care spending. In both Germany and Switzerland, for instance, health care now consumes 11 percent or more of national income, compared to 15 percent in the United States, while spending in most other European countries is in the 10-percent range. Great Britain, the traditional laggard, is on an explicit campaign to increase National Health Service spending. The Labor government is contracting with a number of private U.S. firms to open high-tech specialty hospitals, and Prime Minister Tony Blair recently bragged that elective hospital admissions were up by almost a million and that heart surgery and cataract surgery had increased by 59 percent and 70 percent respectively. Restricting high-tech medicine, as Canada and Great Britain do with cardiac services, unquestionably causes preventable deaths, and patients know it.

• The technical challenge facing the United States is how to finance health care, not whether we can afford to do so. The time-honored financing solution-employer-provided health insurance-is clearly breaking down. As the definition of a “basic” benefit is redefined upward, employers can’t pay for it and stay competitive globally. Turning to government is an obvious recourse-it already finances almost half the U.S. health-care tab. But conservatives are right when they complain that the Medicare “free choice” model of health-care coverage encourages overuse and misallocation of resources. The insistence on defining the problem as one of “waste and fraud” creates the illusion that we could stop the growth in health-care spending, or even make spending fall. The true political challenge is how to come to grips with a world in which health-care spending will continue to rise strongly for the foreseeable future. Unless we recognize that fact, the political and policy “debate” is just so much empty posturing.

Why Spending Is Growing So Fast

The powerful momentum behind U.S. health-care spending suggests that at some point within the next twenty years or so it will consume a quarter or more of national product. Tighter controls-like competitive bidding for Medicare drugs, or higher copayments for nonessential services-could help slow the momentum, but they would not affect its direction, or even its ultimate scale. One reason for faster growth, of course, is simply the aging of the American population. The percentage of all health-care spending consumed by people over sixty-five is a bit more than twice their relative weight in the population, so health-care spending, and especially Medicare spending, will shoot up toward the end of this decade as the bulk of the baby boomers start turning sixty-five. Older people also live much longer now, which amplifies the spending effect from aging. (The life expectancy for white males who have already reached seventy-five, for instance, went up about 15 percent from 1980 to 2000.)

But the far more important force behind rising spending is new technology. Medical interventions work much better than they used to, and are the main reason older people are living so much longer. For example, while there has been a very modest decline in the rate of heart attacks over the past few decades, the rate of heart-attack fatalities has dropped like a stone. Doctors once told heart attack victims to lie still in bed until their hearts healed; now the standard response includes rapid diagnostic tests, powerful anticlotting drugs, and aggressive “reperfusion” surgery, including stents, angioplasties, or bypass surgery, to open up arteries and get the blood flowing again. The successes in cancer have not been as spectacular, but the same combination of early diagnostics, powerful drugs, and precise surgical interventions is beginning to pay visible and substantial dividends across a broad range of cancers. In the case of AIDS, the performance of retroviral agents has been spectacular. In developed countries, AIDS is being transmuted from a sure death sentence into a chronic disease.

Paradoxically, the fact that most medical technologies are also getting cheaper helps drive spending. The cost of an artificial hip, for example-considering both the cost of the implant and the average hospital stay-has fallen by as much as half over the past ten years or so, and outcomes are much improved. As a consequence, almost every eighty-year-old golfer is likely to have one. Cataract surgery used to be a week-long inpatient procedure with very doubtful results. Now it takes about a half-hour, is performed in a doctor’s office at a fraction of the price of a hospital visit, and usually has superb results. About 1.5 million Americans undergo the procedure each year.

Minimally invasive surgical techniques have sharply reduced the cost and healing time of a wide range of procedures, from gall-bladder removal to hernia repair. When gall-bladder surgery was a fairly traumatic procedure, doctors reserved it for the severest cases. Now, and quite reasonably, the intervention threshold has been pushed down to less severe cases. Total spending therefore marches upward even as cost per case falls. Depression medications work at least as well as old-style, and very expensive, analysis-based therapies, and so are very widely used. Statins and similar drugs have well-documented track records in preventing a range of cardiac diseases, and now can be found in most family medicine chests. The arithmetic of health care, in short, is the same as for any other consumer market. As a product gets cheaper and better, total spending rises-exactly as happened with personal computers, or Henry Ford’s Model T. There’s more. Improved medical interventions almost always have ripple effects that increase spending down the road. The spectacular progress in reducing heart-attack deaths has created a millions-strong pool of heart-attack survivors. They need regular monitoring, usually require expensive medications, and are very likely to have more heart attacks. As they get older, they will contract arthritis, cancer, and other diseases of aging, and will require careful supervision to avoid nasty drug interactions. The government recently won a multibillion-dollar suit against the tobacco companies for the medical costs imposed by smokers. The macabre joke was that neither side could admit that smoking saves health-care dollars. Heavy smokers die relatively quick, early deaths; a sizeable percentage do not even make it to Medicare. From the standpoint of trust-fund solvency, they are the ideal citizen.

The Simple Answers

Like most simple answers, they are mostly just wrong. Some pundits, for instance, argue that costs can be cut by better management of terminally ill patients. It’s true that we could certainly do much to clarify the legal issues-Who can finally say: “Enough!”? But the prospect of big savings is a mirage. Seriously ill patients account for the lion’s share of health-care spending, and most people who die get seriously ill first. But most seriously ill patients don’t die, and doctors usually can’t pick out the hopeless cases in advance. In the real world, the recognition that a particular patient isn’t going to make it usually comes only after the standard interventions have failed. There has been considerable progress in expanding the provision of hospice-type services for terminal patients, including end-stage care in the home, but they have proven to be surprisingly expensive.

And yes, we have to do more to cut waste and fraud. This article is not arguing that the U.S. system works well. It does not. (Readers can hold the horror-story letters.) Surely we have to crack down on corruption and abuse, and eliminate idiocies like the direct advertising of prescription drugs to consumers. One hopes that the Vioxx lawsuits will teach pharmaceutical companies a salutary lesson in the perils of such advertising. Medicare is an extremely efficient claims-payer, but it exercises far too little oversight over the treatments people buy. And conservatives are right that upfront, out-of-pocket payments, even for lower-income people, are essential to prevent health care from becoming an overused free good-doctors will tell you that patients will try anything as long as it’s “covered.” That also implies drawing tougher lines between essential and elective treatments.

The basic truth, though, is that even if we eliminated every greedy vendor, or unnecessary drug, or fraudulent bill, we would only knock a couple of percentage points off health care’s economic bite-if indeed, the cost of the oversight systems did not exceed the savings. And the growth rate would continue unchanged: we’d still get to a 25-30 percent GDP share, although it might take a couple of years longer.

How Did This Happen?

The sudden flowering of medical technologies is no accident. To a striking degree, the last generation of American medical breakthroughs had their origin either in federal laboratories or in university laboratories with federal funding. Every congressperson fears, suffers from, or knows people with, dreaded diseases. During every budget crunch of the past few decades, federal spending for medical research has been a sacred cow. In the Bush administration’s new budget, funding for research in health, at almost $29 billion, dwarfs even the Defense Department’s research budget and is one of the few domestic programs to see continued growth. And when the federal government backed off stem-cell research, look at how fast state governments started jumping in. The boom in health care, in short, is the result of a half-century of highly focused government policy pursued with the strong support of the American public.

State regulation has also done its part. A few decades ago, health insurance generally meant insurance in the classical sense, designed to protect against the costs of infrequent, expensive calamities, like major surgery and extended hospitalization. All state legislatures, though, have steadily expanded the range of mandatory coverages-alcohol and drug treatment, inpatient and outpatient mental-health therapies, physical and chiropractic therapy, and an ever-wider range of preventive screenings, like mammograms and PSAs. For the most part, these are good things, although coverage unquestionably encourages overuse, or at least more use, however justified. The savings from the most effective interventions, moreover, like screening for breast and prostate cancer, tend to accrue outside the health-care system. All of us benefit when productive lives are saved, but the health-care budget mostly sees only the cost side.

Can We Afford It?

In a word, yes. Pundits and others advocating greater access to basic care for all often warn that our current health-care spending is squeezing out the “productive” sectors of the economy, but that isn’t really true. There are two parts to the question-is anything being “squeezed out,” and what do we mean by “productive”?

In 1950, households spent about half their income on “necessities”-food, clothing, housing, and medical care. Today, real (inflation-corrected) per capita consumption spending is about three times higher, and we still spend about half our incomes on the same necessities, although the detailed pattern has shifted-a much lower share goes to food and clothing, about the same to housing (although we have much bigger houses), and far more to medical care. That same threefold real increase in spending power, moreover, also leaves far more for the nonnecessities. What are the big nonnecessities? Recreation and motor vehicles are big items, and since 1990, their shares are both up somewhat. But the fastest growth item of all is “Furniture and Household Equipment” (think elaborate “home entertainment centers”). Medical care claimed 2.1 percent more of household income in 2004 than in 1990, but the jump in spending on furniture and household equipment, by 3.6 percent of national output, was 70 percent bigger. The “squeezing out” argument, in short, needs to do a better job of explaining how many more SUVs, jet skis, DVD players, camera phones, and video games we really need to buy.

By any test, health care is one of the most dynamic, high-employment, and high-productivity sectors of the economy. Government inflation data do not track the cost of cardiac bypasses or of artificial hips (those costs are going down); instead, they track things like the cost of in-patient days (which is going up). The divergent cost trends are not a paradox. A day in a high-tech hospital costs more than it used to, but patients are in and out much faster, and a vast array of formerly inpatient treatments have moved to outpatient centers-so inpatients are, on average, now much sicker than they used to be. Focusing on rising input costs, like inpatient days, therefore, gives an entirely misleading picture of what’s going on. To understand the dynamism of health care, just look at a company like Medtronics. Its cardiac and other electronic implants incorporate world-leading technology; it invests heavily in research and development; and it pays high wages.

The stereotyped picture of the health-care worker as the low-paid bedpan tender is long out of date. Health care is a good employer, which is why community colleges are turning out droves of X-ray technicians, dental hygienists, inhalation therapists, and other junior professionals, who generally get snapped up by the labor market. Finally, not even counting “invisible” trade-foreigners coming to America for their medical treatment-health care tends to earn a net trade surplus. If rising health-care spending means we buy fewer video games, the main losers will be workers in East Asian factories, not Americans. Health care, of course, also includes low-paid and low-skilled sectors like many nursing-home and home health-care jobs, but nursing homes and home health care together account for less than 10 percent of the health-care dollar.

So, what’s wrong with this picture?

How Do We Finance It?

The challenge of health care is not its affordability or its productivity, but discovering the right financing mechanism. Unlike spending for household electronics or SUVs, the sudden and dramatic nature of much health-care spending means that it can’t be managed within a normal family budget. In any given year, a relatively small percentage of very sick people account for the vast majority of spending; but almost all of us are in that very sick group one or more times in our lives. Employer-provided insurance worked well during the long period of modest health-care spending and stable employment relations, but it is now breaking down. As noted, when the “basic” package of health benefits is continually reset at higher and higher cost levels, lower-tier employers simply can’t afford it. At the same time, spotty health-care provision places extraordinary strain on lower- and middle-income families, and leaves both children and adults at terrible risk.

Government clearly has to be part of the solution. State and federal governments already underwrite 46 percent of all health-care spending, although actual services are overwhelmingly delivered by the private sector. Doubtless we will follow the time-honored American way of lurching toward a messy compromise, while denying that anything fundamental is going on. Programs will be introduced piecemeal, presidents will lie about their costs, and Congress will cooperate in the lie. Everyone will pretend to be shocked when the real numbers come through and politicians will make tough speeches about “waste and fraud.” Vendor fees may take a hit from time to time, at least until they scream, but almost no program will ever be eliminated (at least not for the middle classes). President Bush and congressional conservatives are following exactly that scenario with respect to the Medicare drug program.

The next most important reform step, probably more important than senior drug benefits, will be some form of government-backed insurance (through private insurers, naturally) for lower-wage businesses. It will require a substantial government subsidy, but it’s one that can be well-disguised, and conservatives can justify it in the name of maintaining the economy’s international competitiveness. The powerful array of health-care vendors-insurers, hospitals, HMOs, and others-will be there to help legislators overcome their spending scruples. John Kerry’s presidential campaign proposals were a good first draft, although Democrats accompanied them with the mandatory fib that their proposals would reduce health-care spending.

Conservatives have few counterproposals. Republican think tanks are working on a variety of plans that would theoretically help people finance their own health care, but they have a very ivory-tower air. In any case, an index of the Republican commitment to cut health-care spending is the provision in the prescription drug bill that forbids the government to negotiate lower prescription prices. Republicans fully understand that those health-care dollars mostly create jobs and purchase goods in the private sector-and they have doubtless noticed that health care is one of the top three or four stock-market sectors.

The Future Health-Care System

The health-care challenges we face have less to do with costs than with managing complexity. As Americans live longer, and survive more afflictions, health care will be making a tricky, and expensive, shift from mostly acute intervention to a chronic disease-management mode. There are disease-management models that are already working reasonably well, like the Kaiser Permanente managed-care programs. Kaiser carefully vets new technologies before authorizing their use, and maintains complete electronic patient records to track results and head off adverse interactions. It was Kaiser, significantly, that flagged the Vioxx heart-attack risk before the FDA did, and Kaiser was one of the few health systems that restricted Vioxx use to patients who actually needed it. “Well managed” is not cheaper, and Kaiser’s programs cost about the same as everyone else’s. Ensuring appropriate care means tracking undertreatment as well as overtreatment, and good monitoring is expensive.

In the medium term, rising health-care spending, and the inexorable shift toward government financing, will greatly increase federal budget pressures and underscore the unsustainability of President Bush’s multitrillion-dollar tax cuts. The rough shape of the spending curve is well understood. The only responsible fiscal policy is gradually to return the government to the surplus position it enjoyed in the second half of the 1990s.

The final shape of the health-care system won’t be reached by means of some study group’s grand plan. Instead, it will emerge over the next decade or so by a typically messy American process of groping, conniving, pushing, and pushing back, all behind a cloud of misdirection and prevarication, until the final compromise finally flops into view. And then we’ll say we planned it that way all along.

Published in the 2005-04-08 issue: 

Charles R. Morris’s most recent book is The Rabble of Dead Money, a history of the Great Depression (PublicAffairs).

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