Why Are Health Care Costs So High?

Preface: What follows is a blog by John Goodman, PhD, a conservative economist who founded and heads up the National Center for Policy Analysis. His analysis runs counter to what occurs in our health system, namely, that it requires third party intervention to control costs. You may not agree with what he has to say, but his point of view is worth pondering, namely that good intentions to protect the public sometimes run amuck, lead to artificially high costs due to perverse incentives to consume more care, and create expensive third party bureaucracies. Goodman is considered the father of Medical Savings Accounts, now generally known as Health Savings Accounts, which are owned by more than 10 million Americans.

"Why are health costs so hard to control? Actually, it’s not all that hard. Name a routine test or procedure and I can show you somewhere in the world where you can obtain it for a very reasonable price, provided by doctors who are U.S. board-certified, or have received training in the U.S. or Europe, and are meeting the highest quality standards.

Here’s the hitch. In order to find low-cost, high-quality medicine, you have to go where (a) the third-party payers are absent and (b) normal market forces have not been systematically suppressed.

The conventional view is that markets don’t work in health care and the only way to keep costs down and quality up is for third-party payers to tell doctors how to practice medicine.

The reality is that low-cost, high quality medicine requires the presence of markets and the absence of conventional third-party payment.

If this is so,

(1) Why have so many people been so completely wrong for so long a time?

(2) What is it about the nature of markets and third-party payment that makes my observation true?

Perverse Incentives

In health care, people with insurance obtain tests and procedures and even undergo hospital surgeries they would not have opted for had they been spending their own money.

On the average, every time a patient in the United States spends a dollar on health care, only 12 cents comes out of his own pocket. On paper, therefore, we have an incentive to consume health care until its value to us is worth only 12 cents on the dollar. But the reality is even worse than that. All too often, where patients have the most discretion they often face no copayment at all; and where they have the least discretion, their copayments are irrelevant.

Bad as these incentives are, the perverse incentives are even worse on the supply side of the market. Almost nowhere in the health care system are providers competing for patients based on price. And since they are not competing on price, they have no interest in reducing the cost of care.

To make matters worse, the structure of health insurance almost guarantees wasteful spending. In particular:

1. There is almost no similarity between conventional health insurance and the type of insurance a rational person has. Rational insurance assigns responsibility for decision-making to the person in the best position to make those decisions and wherever possible decision makers bear the cost and reap the benefits of the choices they make.

2. Historically, the model for conventional insurance was not designed for the purpose of controlling costs; it was designed to ensure that providers got their bills paid. For most of the post-World War II period, commercial insurers paid claims the same way Blue Cross did. Even Medicare paid bills the way Blue Cross did. But the traditional Blue Cross approach was not the product of competition in a free market. Blue Cross was created by hospitals and Blue Shield was created by doctors.

3. The conventional insurance market is not the result of competition in the free market; it is instead the result of suppressing normal market forces. Special interest legislation allowed the Blues to so dominate the market, that providers could refuse to accept insurance that paid in any other way. Today, we are still living with that legacy.

Bottom line: Successful cost control does not require more laws, more regulations, more bureaucracy, and more non-doctors telling doctors how to practice medicine. To the contrary, it requires liberating the marketplace. Not only does the market work in medicine, where it’s allowed to emerge, it’s proving to work quite well.