Arnold Kling  

Why is Health Care Inefficient?

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Tyler Cowen raises a good question.


Have you ever heard the claim that U.S. medical care is in trouble because we subsidize third-party insurance through the tax system?

...If the argument is that tax deductibility leads to too much health care, I can see the logic. But then the problem is in the pretzels and beer markets; health care should be doing fine, albeit in bloated form.


Another way to pose Cowen's question is to say that the tax subsidies and third-party payments reduce the consumer's incentive to be cost conscious. However, they do not affect the supplier's incentive to produce as efficiently as possible.

I think that the inefficiency of the health care system comes from the fact that compensation is for procedures rather than for outcomes. For example, the cheapest way to treat an illness is often for the doctor to prescribe an antibiotic over the phone. However, because office visits are what drive physician compensation, you have to come into the office and be seen in order to get your prescription.

For Discussion. The economic theory of compensation schemes is that employers will pay for what is least costly to monitor. When a worker's output is hard to measure, the employer will pay for hours worked. When output is easier to measure, the employer is more likely to pay for results. Does this theory explain the way compensation takes place in medicine?


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The author at d-42.com: Josh Cohen online in a related article titled Carnival of the Capitalists writes:
    The Carnival of the Capitalists for the week of 5/17/04-5/23/04 Greetings and salutations to you. I'm Josh Cohen, author, traffic reporter, radio producer, and blogger. I'll be hosting this week's Carnival of the Capitalists, which you're reading right... [Tracked on May 16, 2004 5:41 PM]
COMMENTS (9 to date)
Chris C writes:

I think that Arnold's theory of compensation schemes probably has some applicability to health care. Although you can measure outcomes in health care, it isn't always tied to the doctor's effort. Sometimes it's just luck.

To see how the perverse compensation scheme works in health care, consider the way in which surgeons are compensated compared to doctors who practice internal medicine. Since the compensation scheme is determined by procedures, surgeons make two or three times what internists make. This takes no account of the outcome or the amount of work for the physician. It is just as difficult for an internist to stay up all night trying to save a patient's life by getting them out of septic shock, but he only gets about $100 for it. On the other hand, Ob/Gyn docs get $1000 for performing routine gynecologic procedures.

Speaking of Ob/Gyn, consider the incentives created when the physician must make a choice between normal delivery and ceserean section. The cesarean procedure is quicker and pays more. So it shouldn't surprise us to see that many in the medical profession feel that Ob/Gyns opt for the Cesarean more often than they probably should.

Note that I have nothing against Ob/Gyn docs, it's just that they're a good example.

Trent McBride writes:

I agree with the point above regarding obstetricians and C-sections, but part of this is due to malpractice risk. Of course you could argue that such is a form of paying more for C-sections.

Lawrance George Lux writes:

The real problems is the AMA. It is not wrong for Doctors to organize, but the health care industry suffers like all unionized industries suffer. It is easier to pass extraneous costs on to the Consumers--if done on an industry-wide basis--than to fight a funded, organized set of unrestricted Payscales. lgl

Mcwop writes:

Moral Hazard.

Some resources below

Resource 1


From resource 2:
Conventional theory holds that people buy health insurance because they prefer a certain loss to an uncertain loss of the same expected magnitude. That is, consumers would rather pay Rs 10,000 for an insurance premium than pay a Rs 100,000 medical bill that occurs with a 1 in 10 chance. Recent studies, however, have shown that consumers do not behave that way. When consumers are actually given a choice between losing 10,000 rupees and a 1 in 10 chance of losing Rs 100,000 rupees, they tend to choose the uncertain option! Thus, according to conventional theory, people should not purchase health insurance, but of course, we know that many people do.
Resource 2

Resource 3

Resource 4

Vince Daliessio writes:

In order to formulate a solution, you must first define the problem. By "in trouble", what exactly does the author mean? Too expensive? Too many uninsured? Too scarce? Quality too low? There are multiple ways that government involvement causes distortions in the healthcare system, To tease all the threads out takes a tremendous amount of time and effort.

Giri Fox writes:

A parallel concept to the question of how measurement drives behaviour, is how litigation/personal risk drives behaviour.

For example, a Doctor is not likely to admit to his mistakes and errors publicly under a program of knowledge management so that other Drs can learn from them, for obvious reasons of litigation. This is even the case in Australia (my home) where we have lower medico-legal litigation than the US.

I have seen many example of measurement driving behaviour in medical field, and would agree it's a core problem with most medical systems.

Boonton writes:

I see Arnold's point about paying for output rather than results but that is nothing new. If Wendy's pays their cashier $6/hr it doesn't matter if that hour is busy (high output) or not (low output).

There's no easy way to seperate output caused by good medical service from output that is the result of luck or factors beyond the doctors control. In other words, giving a cancer patient an extra year of life is often more of an accomplishment than not killing a patient during a nose job. How could a 'pay for results' compensation scheme avoid paying the doctor who does low risk, easy nose jobs more for 'good results' than the doctor who finds innovative ways to help the worst off patients?

Thomas writes:

Regardless of the absolute effect on health care costs, the tax write-off for employee health insurance links jobs and health insurance at a time when jobs are becoming less permanent. I don't get car insurance from my job, why should I get health insurance from there?

This is just another in a long line of tax complexities that makes life more difficult.

Vik writes:

I posted this at another blog discussion a while back which is why it may seem disjointed but I think most of it is topical:

Ok this is my take as a medical student on why the system is so absurd in america when it comes to costs and the service (and yes, much as i will defend the fact that we have the best research and technology here, it is absurd). Essentially it comes down to the fact that there are huge fixed costs in the system that you do not see elsewhere and too many ppl committed to defending those costs.

First, the cost of suing doctors far outweighs the benefits. Hospitals and doctors get charged exorbitant amounts which are passed on to the consumer but more importantly, the standard of care goes down enormously as a result. Most of my teachers order unnecessary tests all the time (most CT's for example) just because the fear of getting sued pervades the sytstem. In addition, in many cases, operations will not be performed for cancer patients or others for whom the risks of surgery are deemed too high i.e. the risk that the patient's family will sue later despite knowing that the operation is risky even if, as in most cases, it is the best option for the patient (full disclosure: my best friend's grandfather had this happen to him as he found that although there were a few surgeons willing to do his particular procedure, none of their insurance companies would allow it). You might ask why if this system is so bad for the doctors, the hospitals, and the patients (for most patients who actually have malpractice happen to them do not get compensation and of the group who do get settlements, a large percentage do not deserve it but merely had the best lawyers like the cerebral palsy 'victims'), who benefits? Well, both insurance companies and litigators make large profits from the system and are powerful enough to prevent substantive change, which I have to say is a natural reaction on their part.

Next, the large number of uninsured people and the indigent who most hospitals are forced by law to take care of (they are typically the most unhealthy as well) institutes a large financial burden that has to be carried by someone and thus most health care insitutions charge exorbitant costs to those who do have coverage. Your 100 dollar bottle of water or 2000 dollar hospital bed is not just going to pad profits. In addition, these patients also have the most motivation to sue and so feed into the problem detailed above of too many procedures.

Finally, the whole disassociation of customer from payment is the final major structural problem. Have you noticed the costs of Lasik surgery for example plummeting the last few years? When people pay directly for their care, they ration themselves and don't demand the most expensive procedures unless absolutely necessary while also demanding the best deal on it. Under the present system, no one has any idea who is paying the bill according to the Economist magazine and so there are no barriers to health inflation nor realistic limits on health services. While it sucks to wait for surgeries and mammograms, resources are finite and if you want top class and immediate health care (waiting times for serious procedures in the US are far less than in universal health care systems in general) for most people, then it will cost enormous amounts.

As for drug prices, I don't want to get into this in detail but the truth is that the other coutries in the world are not getting drugs at anywhere near cost. The US government subsidizes the research and the drug companies fork over large amounts of capital in a gamble that it will get approved by an often byzantine and irrational FDA (read about the recent fuss about antidepressants for example) and so essentially, the US market both inspires and pays for the massive amounts of drugs produced. At that point, the other medical systems' in the world can cut much better deals with the pharmaceutical industry since the industry's marginal costs are pretty much zero when selling it elsewhere, having recouped their capital in America. In addition, not even Medicare buys in sufficient bulk in America to force discounting and this aggravates the differential in prices.

After this long litany of problems, I'm actually surprised the system isn't even more dysfunctional though there are some explanations for this (higher salaries for doctors and researchers draw much better talent than in the past despite the lack of 'bedside manner' often seen, the incredible technological leaps seen in the past half century, etc.). In the end, though, I wouldn't despair since the truth is that what would one rather spend too much money on? Which other aspect of the economy would one rather see waste and overallocation of resources in, if one assumes that reform will be slow if at all possible? After all, just in the last few decades, the lives of most American patients have gotten far better. If you don't believe me, think of the knee or hip replacements that cost 30 grand versus most post-70 year olds not walking at all, the use of new expensive pharmaceuticals that have made clinical depression, schizophrenia, Parkinson's, hypertension, and even heart disease very treatable, or finally, the fact that even the chance that your baby would die or be born with a birth defect now is so rare that it is a tragedy rather than a 'fact of life' as my grandparents thought of such things. For some reason, the vast majority of these advances do not really seem to spring from the Singaporean health care system or any other wonderfully efficient one. Thus, be careful what one wishes for though of course, your points are still strong ones...

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