Code Red: Two Economists Examine the U.S. Healthcare System

August 3, 2012

You Have to Break Some Eggs if You Want to Make an Omelet

Filed under: Uncategorized — David Dranove and Craig Garthwaite (from Oct 11, 2013) @ 9:35 am

In my last blog I explained how at one time our nation’s healthcare budget was relatively small and our economy was robust, so that economic growth could accommodate rising health spending and still allow us to spend more on other goods and services. Today our healthcare budget is huge and growing, while our economy stagnates. Economic growth is barely enough to pay for rising healthcare spending, with little left over to buy more of anything else. In the next few blogs I will explore our options for cutting health spending. To the extent that economic theory and empirical evidence allows, I will also discuss the likely consequences. It should come as no surprise to say that all of these options entail some risks. But if we are to avoid putting all our eggs in the healthcare basket, then we must decide which risks are worth taking.

A simple fact of accounting guides my analysis: If we want to spend less money on medical services, then we either (a) pay lower prices for the services we buy, (b) substitute away from high price services in favor of lower priced alternatives, or (c) purchase fewer services. There are no other options. Moreover, we can do these things either by government fiat or through markets and incentives. In this blog I explore options (a) and (b), mainly focusing on Medicare.

The Affordable Care Act calls for substantial reductions in Medicare fees, providing the largest anticipated cost savings in the ACA. (Private insurers relied on market forces to reduce provider fees in the 1990s, only to see providers gain the upper hand and sharply increase fees in the 2000s.) It is clear that the federal government has the power to reduce Medicare fees, but should it? What are the consequences?

One of the strongest arguments against the proposed Medicare fee reductions is that physicians and other providers will balk at accepting Medicare patients. The main idea underlying this argument is that no business will sell to a customer at a low price when it can sell to other customers at a higher price. Indeed, many providers have balked at treating Medicaid patients, choosing to instead focus on Medicare and privately insured patients. But I don’t think that cuts in Medicare fees will trigger a similar access crisis.

Ask any provider with a thriving practice and they will tell you that they are seriously considering curtailing their Medicare caseloads in favor of treating more privately insured patients. This is cheap talk. The strategy cannot work in the aggregate, as there are not enough privately insured patients to go around! If there is an access crisis and many providers stop accepting Medicare patients, these providers will have a lot less income and a lot more leisure time. I suspect that few providers will wish to remain underemployed for long, and the access crisis will quickly pass.

(Note: You may be wondering why the same argument doesn’t apply to Medicaid, where fee cuts have led to access problems. For most providers, Medicaid represents a small portion of their caseload. If they stop seeing Medicaid patients, they experience only a small increase in leisure time. Medicaid’s very low fees may be insufficient to draw them back into the office.)

Suppose that Medicare slashes provider fees and private insurers hold the line or cut fees. This could go a long way towards reducing total healthcare spending. But fee reductions may have unintended consequences. Providers may be reluctant or unable to invest in quality improvements. Physicians might cut staff, hold off on equipment purchases, or try to squeeze more patients in a given amount of time. (The latter seems unlikely as there are only so many patients to go around. Perhaps they will simply see the same number of patients in less time, and enjoy more leisure.) Hospitals and home care providers might lay off nurses. Indeed, research shows that there is a positive correlation between hospital quality and Medicare and Medicaid hospital payments.

These are just the short run responses to fee reductions. Provider incomes will almost surely fall, and in the long run, this may reduce entry. We might see fewer (and less gaudy) hospitals; fewer college students will apply to medical school. The latter might be particularly alarming, as it is comforting to think that our physicians are among the best and brightest. While I am unaware of any research tying the quality of care to the number of medical school applicants, this is a concern that gives me pause.

Thus far, I have discussed saving money by lower fees. As an alternative, we could hold the line on fees but substitute towards less expensive types of providers. Go to “doc in the box” drug store clinics. Travel abroad for surgery. Visit nurse practitioners instead of doctors. Use nurse anesthetists. While we see all of these substitutions and more, regulations stand in the way of a full-blown revolution. The nurse who treats you at the corner drug store must practice “under the supervision” of a physician, and only some types of nurses can prescribe drugs. Nurse anesthetists must practice under physician supervision, with strict limits on the number of nurses per physician. Yet research evidence suggests that nurses can effectively substitute for more costly physicians under the right circumstances. Should we take down regulations that sustain the dominance of physicians, or will the unintended consequences give us cause for regret?

So those are our basic options for reducing prices. After reading this blog, you may feel that the risks are too great. If you still want to cut healthcare spending, then your only other option is to purchase fewer services. In the next blog I describe some of our options for doing this. These will include producing health services more efficiently as well as preventing the need to purchase health services in the first place. In the third installment, I discuss some ways to harness market forces to facilitate price and quantity reductions. You can be certain that these strategies also come with their own set of risks. But cutting health spending is not for the weak of heart, which may be why politicians (and, dare I mention it, executives at our largest health insurance plans) have not been up to the task.


  1. […] David Dranove, PhD, is the Walter McNerney Distinguished Professor of Health Industry Management at Northwestern University’s Kellogg Graduate School of Management, where he is also Professor of Management and Strategy and Director of the Health Enterprise Management Program. He has published over 80 research articles and book chapters and written five books, including “The Economic Evolution of American Healthcare and Code Red.” This post first appeared at Code Red. […]

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