Is Healthcare Expensive?

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The Incidental Economist has an excellent series by Aaron Carroll and Austin Frakt on what makes the US Health system so expensive. Here’s the killer graph:

What’s doing a lot of work here is “adjusting for relative wealth.” This phrase pops up a lot on their series, which finds that America spends more on healthcare in all sorts of categories, even when “adjusted” for wealth.

Yet it’s interesting that wealthier countries seem to spend more on healthcare in general, even correcting for purchasing price parity. This adjustment is designed to correct for differences in relative prices between countries, and is based on the principle that trade should equalize the price of transportable goods across countries.

This clearly does not apply in the case of healthcare, which gets progressively more expensive with relative wealth. That’s because healthcare, unlike a typical tradable good, is a service highly intensive in local skilled services. You need highly trained doctors and technicians to deliver healthcare, and the general level of prices of those inputs grows with relative income. For instance, barbers earn more in richer countries than poor ones; not because they are more productive, but because they can implicitly draw upon the greater productive resources in the richer society.

As countries get richer, they face Baumol’s cost disease. Tradable goods like manufactured goods experience large gains in productivity that steadily lower consumer costs and required labor inputs. These sectors of the economy steadily shrink as countries get richer, like how agriculture went from employing 70-80% of the US population in 1870 to 2-3% today. On the other hand, service and labor-intensive industries tend to see rising costs and grow to dominate the economy over time.

Yet while this would predict rising health costs over income, it doesn’t say whether that trend should be linear or quadratic or what have you. The regression line drawn in the table assumes something like a linear trend of health spending with respect to per capita GDP. While this may be reasonable for the cluster of European countries in the middle of the graph; it’s not at all clear that extrapolates to America, an outliner in terms of income.

In the absence of a model for health spending, which doesn’t seem to be provided, there’s no reason to assume a roughly linear relationship from the other OECD countries. Here’s another situation that has some similar characteristics to healthcare: higher education among OECD countries:

Like healthcare, tertiary education is a sector intensive in the use of highly skilled labor, expensive buildings, and land in prime locations. The relationship between expenditure per student and PPP-adjusted GDP appears to be non-linear, suggesting that societies spend proportionately more on these education expenses as they grow richer.

To be sure, there are also differences. American higher education spending is driven upwards by large resources spent on research, as opposed to pure student expenses, though this may be the case to an extent for healthcare as well. But America spends far more on education that would be “accounted for” by this simple regression model. Yet we don’t see a great deal of worry on where this excess spending is coming from, or where all the waste is in College education.

With the exception of the people at Cato, few analysts assume that the variance in costs of providing education can be attributed largely, or even partially, due to wastage. Economists typically assume that differences in relative prices ultimately reflect differences in productivity or product type valued at prices determined by supply and demand. Yet in the case of healthcare, economists tend to attribute cost variation as a problem to be addressed by various solutions, either left or right-wing in nature.

There’s a similar situation within the US. The Dartmouth study examines variation in Medicare reimbursements around the country. Their implicit assumption in their raw figures is that all the variation in costs around the country can be attributed to “wastage.” As Richard Cooper explains:

Regional variation is a product of regional differences in wealth, overlaid with differences in poverty. It’s not generally appreciated that health care expenditures for people in the lowest 15% of income are 50% to 100% greater than for people of average income. There’s also a difference at the high end. The wealthiest 15% also consume more, but only about 20% more. So there’s greater utilization at both ends of the income spectrum, but for different reasons and with different outcomes.

More spending at the high end improves outcomes, not simply for a specific condition but across the board, because the care consists of a broader spectrum of beneficial services. More yields more. But among the low-income patients, outcomes are poor despite the added spending. In fact, the added spending is because of poor outcomes – more readmissions, more care for disease that’s out of control.

And these differences are exaggerated in dense urban environments, like Detroit, Chicago and Philadelphia. Now, when you blend all of this into “regional” studies, which average rich and poor, urban density and ex-urban comfort, racial and ethnic groups, you get just what you’d expect. High costs with average outcomes in urban areas (the average of excellent and poor outcomes at different ends of the income spectrum)…

And you would expect that things would be very different in these vastly different “regions.” But everything was the same. Quality, access, satisfaction, even mortality. When things were average in each of these heterogeneous groups, it was all the same. Differences were not discerned because differences were not discernable. But, then, if they had, what could be made of it. Why would anyone want to know how Newark compares with Nebraska?

Most people I went to school with would have said, “Oh gee, there are no differences, I must have done something wrong.” But not the Dartmouth crowd. They said that because differences were not found despite all of that extra spending, the extra money must have been wasted. And if health care could be the same in both regions, the US could spend 30% less.

As the recent closure of St. Vincent’s shows, hospital in urban environments face unique cost challenges. These reflect different prices for urban land, higher costs of living in urban areas, and unique demographic characteristics of local populations. These factors explain, for instance, why education spending varies so dramatically around the country. Yet only in healthcare do we interpret these cost differences through the lens of “why are we spending so much?” as opposed to “what factors of regional variation would cause price differences?”

Aside from inherent differences in costs of inputs, price indices, and population differences; there are several other reasons to expect that healthcare will consume an increasing share of national output:

1) Healthcare is consumption. Suppose that one found that America spent more on automobiles than France. This difference may be due to underlying inefficiencies in American car production. Alternatively; it may be that Americans simply prefer to buy more expensive cars — more BMWs than Kias. Perhaps even the same amount of “driving” may be going on. Yet purchasing luxury cars still counts as a form of consumption.

In draw the analogy to healthcare: it seems that at least a part of higher healthcare spending comes from spending that does not improve health outcomes, but does affect patient experiences. Single-patient rooms and flat-screen TVs are more common now, for instance (even if hospital food remains poor). In higher education, too, it looks like much of higher spending is going to capital improvements that result in more gyms, better dorms, and better facilities. These forms of spending do not improve health or education outcomes, narrowly defined. Yet they should still count as improved consumption. Medicine is not about healthcare; education is not about learning, etc.

After all, what should increasingly prosperous Americans spend their money on? We’re headed for a society that produces all of its goods and food using under a tenth of the workforce. Everyone else is a service worker. What’s wrong with spending more and more resources on health services? Why is that any worse than spending money on flat screen TVs or concert musicians?

2) Health Spending Provides Value.  I’m hoping to read Aaron and Austin’s future posts on outcomes. But certainly there is evidence to suggest that higher health spending results in better health outcomes.

The Dartmouth Atlas found otherwise: that Medicare spending had no correlation to health outcomes. Ignoring the connection between health spending and outcomes (you might expect areas of high health needs to require higher spending); this appears to be a result isolated to Medicare spending. Richard Cooper suggests that there is an aspect of cost-shifting going on as states tend to bill Medicare in order to recover losses from other health provisions. He finds instead that overall health spending is positively correlated with health outcomes.

Of course, America overall has relatively poor life expectancy statistics relative to other countries that spend less on healthcare. Yet as Samuel Preston and Jessica Ho find, differences in life expectancy reflect both differences in health systems, as well as differences in public health and individual choices. For instance, they cite a study finding that:

[I]f deaths attributable to smoking were eliminated, the ranking of US men in life expectancy at age 50 among 20 OECD countries would improve from 14th to 9th, while US women would move from 18th to 7th.

Of course, as Aaran and Austin point out, America has relatively low smoking rates today. Yet America’s per capita cigarette consumption was once among the world’s highest, leaving a durable mortality burden.

To be sure, the authors find that America has a higher prevalence of various diseases. But these could reflect differences in medical treatment, or differences in detection, or longer survival durations from diseases.

To address these issues, Preston and Ho focus on diseases, like cancer, that are likely to be similarly diagnosed across various countries. They find that America has developed relatively effective methods of treating and curing such chronic diseases compared to other lower-spending countries. Patients with cardiovascular diseases, too, appear to fare better in America than Europe.

Another rigorous study tackling these issues comes from Joseph Doyle at MIT. In order to address the endogeneity issue (that health costs may be high exactly because health needs are high), he examines the medical treatment of tourists in Florida. Tourists don’t tend to choose to have heart attacks based on the spending rates of local hospitals, so they can be assumed to be randomly assigned to high and low cost hospitals.

The key result is that high-cost hospital delivered better results for out-of-town tourists, but not so for locals. The interpretation here is that higher medical spending is associated with better health outcomes. However, this is not a result you would find simply by examining how hospital treat local patients. High cost hospitals spend a lot exactly in order to deal with sicker patients, so simple correlations between health spending and health outcomes seem to suggest that health spending is “wasted.”

Of course, this research does not show that better health outcomes coming at a higher price is worth the money. Yet research by Richard Topel and Kevin Murphy at the University of Chicago suggests that the value of health improvements is large. They find that benefits of longer longetivity due to health improvements has yielded roughly $2.8 trillion a year from 1970 to 1990. Gary Becker, for one, suggests that even modest gains in longevity as a result of higher medical spending may prove to be worthwhile given conventional estimates of the value of life.

Still, I would probably support many of Aaron and Austin’s proposed suggestions. I agree with them that the RAND Insurance study represents an important landmark study. I would be happy to voucher-ize both health and education spending, and I would expect those measures to cut costs. There may even be enough room to cut medicine in half.

Where I disagree is in our ability to actually deliver these reforms and make them work through government action. The fact that Aaron and Austin don’t isolate higher health spending into any one category suggests to me that America’s higher health spending ultimately comes down to our higher consumption of healthcare in general as valued at prevailing prices. The fact that Medicare spends about as much just on the elderly as many other countries do on their entire health systems suggests that pure government control is not the problem. Can we sustainably cut down these costs over time? I’m skeptical. I don’t think our higher education costs are coming down anytime soon either. I think we’re headed for durable increases in health spending, and that’s not the worst thing in the world.

However, the fact that medical costs are disproportionately borne by the public sector suggests that dealing with permanently high medical spending will mean either a) shifting these costs to consumers, b) coping with permanently larger government, or c) else fiscal collapse). Like Aaron and Austin, I would prefer to see a) happen. But I think b) and c) are more likely.


  1. Thanks. Most informative.

    How much do doctors get paid in the U.S. versus in European countries? How about nurses?

  2. What is the ratio between general practitioners and specialists in the US vs Europe? In the US, economic incentives tend to push more doctors into more expensive specialist practices. But the upside is that we get higher quality specialist care – see the horror stories about long waits for specialist treatments in Europe. On the other hand, the cheaper preventative care that’s often provided by GPs is more accessible in Europe probably because of the relative lack of economic incentive to specialize in Europe. Does this result in better long term health outcomes for a better price? Or at least as long as you don’t need highly specialized care…

  3. What about adjusting, say, for average body weight? The US seems to be ahead of the curve of global fattening, though many other countries do their best to catch up.

  4. Like meat consumption, quality of life in USA is the best as indicated by health care spending.

    Life expectancy is also function of genetics. Asian Americans have lower health care spending yet highest life expectancy.

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