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

August 17, 2012

The Way Out of the Wilderness

Filed under: Uncategorized — David Dranove and Craig Garthwaite (from Oct 11, 2013) @ 9:37 am

In 1932, the Committee on the Cost of Medical Care identified rising medical costs as a threat to the financial security of millions of Americans. In a series of studies that created the field of health services research, the Committee recommended several strategies for cost containment that reads like a blueprint for today’s cost containment efforts: prevention, price controls, capitation, elimination of unnecessary care, and integration. If it sounds like a précis of my previous two blogs – cut prices and cut quantities – it should. We have known for a long time that those are the only ways to cut spending. And yet here we are, 80 years later, facing a spending crisis that threatens to take down the entire economy.

In my lifetime, we have been subjected to a steady drumbeat of rising medical costs. There have been respites – for a couple of years after Medicare introduced DRGs and for about five years in the 1990s during the heyday of HMOs. While DRGs and HMOs shifted costs down, they did not seem to reverse underlying growth trends, although HMOs did not thrive for long enough to be certain.
Not for lack of trying have medical costs continued to increase. We promote prevention, regulate prices, capitate providers, and review utilization to eliminate wasteful spending. We have seen horizontal integration that led to market power and higher costs, and vertical integration that more often than not created unmanageable bureaucracies. Most of today’s proposals for cost containment can be encapsulated by two words: “Try harder.” The Affordable Care Act gives us free preventive care, stricter price controls, ACOs, and the Comparative Effectiveness Institute. We need radical change but all we get is creeping incrementalism. I will take creeping incrementalism over the do-nothing approach of the previous decade, if only because we could use another respite. But the ACA is no permanent fix.

The problem is that no one in the system has an incentive to embrace radical change. Obama and Romney are arguing about who will do less to change Medicare. Dominant health insurers have been among the least innovative companies imaginable. (Is it a coincidence that exceptions can be found in states like California and Minnesota, where the health insurance market remains reasonably competitive?) Physicians and hospitals have been in positions of power for a century or longer, an extraordinary length of time when compared with dominant firms in other industries. (I admit that universities have enjoyed similar longevity, but look at our rising tuitions.) Patients still put their physicians on pedestals, ignorant of the data on medical errors, practice variations, demand inducement, and all of the other ways that our providers fritter away our healthcare dollars. And why should patients care, with someone else paying the bills and tax subsidies helping to pay for expensive insurance plans?

We won’t fix this system until people with power have much more skin the game. The astonishing response to the announcement of Romney’s selection of Paul Ryan tells me that we still have some way to go before we see a game changing redesign of Medicare. Providers will not propose any radical change from a system that has served them so well for so long. This leaves things up to us – the consumer. We must be open to new forms of medical care delivery. Rethinking our hostility to HMos would be a start. While we are at it, we could embrace narrow network health plans. DaVita wants to create a health plan just for diabetics. Why not? And what about plan that only pays for treatmetns that pass rigorous cost-benefit criteria? Some consumers may welcome such an opportunity to save money without sacrificing quality.

This is just a short list of health plan innovation. Who knows what breakthrough innovations in healthcare delivery are waiting to be discovered? I don’t, but that hardly matters. I didn’t imagine the iPhone, the Prius, Amazon, Netflix, or Sam’s Club, but that didn’t stop someone else from inventing them. We will continue to see breakthrough innovations throughout the economy, because the market will reward them. That is not a leap of faith. That is reality. In the same way, we will see breakthrough innovations in healthcare delivery if the market will reward them. That too is a reality. And that is where we must steer our healthcare economy.

We can get there in one of two ways. We can let the government be the “market,” through its ongoing control of Medicare (or even within a single payer system.) But the notion of breakthrough innovation emerging from Washington may strike some as oxymoronic. Besides, if Washington controls everything, we will at best get one set of innovations. The main thing about innovation is that one rarely knows in advance which will work best.

Truly breakthrough innovation comes from the cauldron of market competition. This is why health economists have time and again offered the same simple prescriptions:

– Eliminate the tax exemption for health insurance, or at least limit the exemption to the cost of some base plan. If some consumers want more generous coverage, let them pay for it with their own dollars. (Paul Ryan has a similar idea for Medicare. But this by itself is not nearly enough.)
– Relax laws that restrict entry of providers and insurers. Certificate of Need is number one on this list, but there are many others.
– Vigorously enforce antitrust laws against payers and providers. The appointment of Leemore Dafny as Deputy Director in the FTC Bureau of Economics is an exciting step in this direction
– Find a way to reduce the power of dominant insurers. This is easier said than done and I cannot say more about this for reasons that many of you might guess.
– Relax rules on insurers that require them to cover virtually all medical services regardless of cost-effectiveness.

As important as these steps are, I think we need to do more one thing. Patients have delegated power to their doctors and hospitals for a reason – they need someone they can trust who will not place cost above quality. As we know, this system went too far, virtually ignoring costs without necessarily assuring quality. A system that emphasizes cost competition without proper quality controls will go too far the other way and could be just as disastrous. We must strike some balance in the marketplace, and for this we must have reliable measures of quality of care that can be used to hold our providers and our payers accountable. More importantly, patients cannot continue to ignore these measures.

In my next blog, I return to the theme of healthcare quality – how to measure it, how to report it, and how to reward I, and how to hit patients over the head with it.


  1. Regarding your “simple prescriptions”, ACA does start limiting the tax exemption for health insurance (re: “Cadillac plans”). This can indeed go further, but it’s a start, and already law. I don’t know about relaxing rules for insurers, but IPAB – staffed by doctors/researchers who follow the latest research – can be a good start for cost-effectiveness, if not also quality and innovation.

    Comment by R Subramanian (@randomsubu) — August 24, 2012 @ 9:25 am

    • You are correct about the Cadillac plans. But the threshold premium is so high as to be meaningless. IPAB is limited to comparative effectiveness for now. Are these two feet in the door? Perhaps.

      Comment by dranove — August 24, 2012 @ 9:27 am

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