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

August 10, 2012

Burt’s Question, or Why Are There 13 Eggs in a Baker’s Dozen?

Filed under: Uncategorized — David Dranove and Craig Garthwaite (from Oct 11, 2013) @ 8:47 am

In the previous two blogs I explained why we must take seriously the effort to reduce health spending and explored ways to do so by cutting prices. In this blog I look at the alternative to price reductions: quantity reductions. I should state upfront that many proposals to reduce quantities involve some sort of rationing – limiting the level of utilization from what it would be if patients could ignore prices altogether. But let’s not draw a line in the sand and refuse to accept solutions that involve rationing. We already ration medical care. Copayments temper medical spending by insured patients, while the uninsured face even bigger financial barriers to care. If we are going to cut costs, we should at least consider alternative approaches to rationing.

In theory, one way to ration is to slash utilization of all services, sort of the quantity counterpart to proposed across-the-board reduction in Medicare fees. No one is serious proposing such a draconian measure nor has anyone proposed how such rationing could be implemented. I will say no more about it.

Perhaps we can selectively ration by reducing “unnecessary” medical goods and services. Few Americans protest when the FDA prevents physicians from prescribing “snake oil” medications, proof that we are willing to accept some forms of selective rationing. (Source: Utilization review and the new Comparative Effectiveness Institute (part of the PPACA) can be thought of as efforts to ration “snake oil” services. But most Americans object when insurers (be they Medicare or private insurers) disapprove their physicians’ choices of diagnostic tests or surgical procedures, even if there is abundant evidence that those tests and procedures have no value. (And before doctors have a chance to chime in, I will admit that some of these unnecessary tests and procedures may be defensive, even though the empirical research suggests that concerns about defensive medicine are somewhat overblown

Most government health insurance programs outside of the United States explicitly control “unnecessary” utilization through cost-effectiveness analysis. (I wrote a decent, if not widely read, book about this with the unfortunate title What’s Your Life Worth?) Cost-effectiveness analysis has its flaws as a policy tool, but no more than any other approach to cost containment. If we are going to ration medical care, doesn’t it make sense to employ rational rationing, allocating our scarce health care dollars where they provide the most bang for their buck? (And before free market supporters have a chance to chime in, I support allowing individuals to opt into more generous health insurance plans that might adopt more generous cost-effectiveness thresholds.) I think it is unfortunate that the PPACA forbids the Comparative Effectiveness Institute from considering costs. But I understand the reasons for this prohibition. Republicans labeled the Institute a “death panel” because it would have the audacity to refuse Medicare coverage for ineffective treatments regardless of cost. I cannot imagine what words they would have chosen if the Institute refused coverage of effective treatments that cost far too much. Even so, I wonder if the Institute isn’t the camel’s nose in the tent of formalized cost-effectiveness analysis.

There are less controversial ways to cut quantity, though I do not know if they are equally as effective at containing costs. We can substitute some products and services for others. This came up in the last blog when I discussed substituting away from high priced providers like doctors towards lower priced providers like nurse practitioners. We substitute in all sorts of other ways, taking drugs instead of undergoing surgery, receiving outpatient surgery or home health care instead of staying in a hospital or nursing home. The design of health insurance goes a long way towards determining which choices we make, and Value Based Insurance Design is a new idea for steering us towards the most cost-effective choices while still giving us the option of using our own money if we prefer something more expensive. I like this approach but I question whether it will have a first order effect on costs. When I think about the power of disruptive innovations to reduce costs in other markets, from computers and telecommunication to publishing and steel manufacturing, I wonder why healthcare seems to have been largely left out. I will say more about this in a moment.

Prevention is an obvious way to substitute away from high cost services. Policy makers have been preaching prevention for at least 80 years, so let’s not pin all our hopes on this seemingly simple solution; it is not likely to be the magic bullet that its supporters would hope. Heck, even if we did the impossible and completely eliminated obesity, medical spending would fall by less than 10 percent. That is a big chunk of change for sure, but that would only forestall, not prevent, our spending crisis.

There is one final way to reduce quantity. Rather than reducing the quantity of services that we receive, we reduce the quantity of inputs used to produce them. Cut length of stay. Reduce testing and drugs. Employer fewer staff. In other words, produce the same services but do so more efficiently. In business this is known as process innovation and it has been a central element of the total quality management movement in healthcare for the past two decades, with seemingly little to show for it. Considering the dramatic effects of process innovations in so many other sectors, such as manufacturing and retail sales, I again wonder why healthcare is different.

My colleague Burt Weisbrod has often asked me why I think innovation in healthcare always seems to drive up spending, in stark contrast to disruptive and process innovations in most other markets. Should we blame it on the sanctified physician/patient relationship, or is this just the nature of medical science? Perhaps we still have the incentives wrong or maybe there are too many regulations stifling creative new approaches to delivering medical care. Or do we need a “benevolent dictator” to step in and regulate the system from the top down? I suspect that if we can answer Burt’s question, we may unlock the key to saving our healthcare system.

Whatever the answer to Burt’s question, it should be clear that there is no easy way out of our spending crisis. Any viable approach will be systemic, based on a range of regulations and/or market design principles that target spending while respecting access and quality concerns. Some of this is evident in the rules governing Accountable Care Organizations in the PPACA. But there are many other approaches to consider.

To be continued…

P.S. If you want to be notified about future blog posts, or just want to read my random musing about healthcare, you can follow me on Twitter at @daviddranove

Blog at

%d bloggers like this: