Research I conducted shows that Medicare had a substantial effect on the health-care sector. By 1970, the program caused a 37% increase in hospital spending. This is an enormous number. If I extrapolate from the Medicare experience to compute the effect of the overall spread of insurance — both public and private — between 1950 and 1990, it suggests that it is responsible for about half of the sixfold growth in real per capita health-care spending during this period.
Why does increased health insurance lead to increased health spending? One factor is that when individuals have insurance, they tend to consume more health care. This makes sense: If you only have to pay some fraction of the cost, you are more likely to go for an extra doctor’s visit or get an additional diagnostic test than when you have to pay the full cost out of pocket.
Another reason is that hospitals and doctors respond to the increased demand for health care by changing some of the ways in which they practice medicine. For example, hospitals were more likely to adopt new medical technologies after Medicare was introduced because now, with greater insurance coverage, there were more people who could afford these new technologies.
I disagree with Finkelstein on one important point, to be explained below.Finkelstein’s research came up when I was at CBO the other day, feeling like an amateur in a room full of pros. One of the pros said that Finkelstein may have under-stated the extent to which Medicare increased insurance coverage. If so, he pointed out, she may have overstated the response rate of medical spending to insurance coverage. However, his criticism would only cut her estimated elasticity in half.
Another pro asked why insurance has not emerged that has the characteristic that it does not pay for newly-invented medical services. Such insurance would be less expensive than standard health insurance.
My only response is was that there are lots of forms of insurance that economists have dreamed up that would be more affordable and provide good protection to consumers. However, we do not observe these in the market place. Instead, the main cultural imperative that seems to be driving health insurance and many other of our health care institutions is the imperative that doctors must earn high incomes.
Finkelstein says,
Recent state efforts to create universal health-insurance coverage would reduce the fraction of the population in a state without insurance…We are likely to witness an improvement in the financial security of the currently uninsured. There are also likely to be increases in health-care spending — quite possibly substantial ones.
She fails to distinguish between insulation and insurance. Insulation–health insurance with broad coverage and low deductibles–helps ensure that doctors have high incomes.
Real health insurance would protects consumers who have illnesses requiring really expensive treatment. It would provide financial security with less incentive for increased spending.
My point is that expanding the number of consumers with real health insurance does not have to increase health spending by the levels that Finkelstein’s research would project. The key is to switch from insulation to real insurance, which in turn means changing the cultural imperative from one of supporting the income of doctors to one of giving consumers the ability to mitigate their financial risks.
READER COMMENTS
Mike
Feb 28 2007 at 9:36am
I think that people raise moral objections to this. However, there are not a few people who choose to take their modest retirement wealth and live well in places like Belize and Costa Rica – with the explicit understanding that if they get a serious illness, they would be receiving 1975 medical care and not the 2007 medical care in the US.
Would people want to make the decision to migrate to places like CR and Belize illegal? That’s the effect of the moral case against companies offering such policies.
Buzzcut
Feb 28 2007 at 12:07pm
Health insurance companies aren’t competing on price. The decline in HMOs tells you that.
jp
Feb 28 2007 at 1:19pm
I agree with the point about insulation vs. real insurance, but I don’t follow the rest of the sentence. Do doctors really have that much power? My own (admittedly impressionistic) sense is that insurers currently have the upper hand, with doctors scrambling to regain control.
Matt
Feb 28 2007 at 1:37pm
Flat collective fee, variable service with government rationing.
Conservatives and progressives do it, the result is unlimited expansion.
Arnold speaks like an unbiased liberal when he talks about real health insurance.
Gore and Kling understood this same problem, and one of Gore’s aims when VP was to fix the problem.
Commenter
Feb 28 2007 at 5:10pm
A few thoughts.
First, why is it necessarily bad that people consume more healthcare than what they exactly need? I understand the case for people rationing their healthcare appropriately, but there is a real human cost to people underutilizing the healthcare system too. Indeed, we do see this among those with more limited resources, where people do not get the medical attention they need and as a result suffer in the end run.
It would be nice if everyone were wise and all-knowing enough to perfectly calibrate their healthcare consumption to the appropriate point for their individual needs, but that’s not going to be the case. All people will either overutilize or underutilize the healthcare system…no one will get it perfect…all things considered, I’d rather err on the side of caution and have people somewhat overconsume in this area.
Secondly, it’s nice to decry the high income of doctors, but let’s face reality: without those high incomes how many people would become doctors? It’s the simple rule of supply: decrease the price (in this case the income of doctors) and you get less supply.
I mean, why in the world should someone labor through all of the years of education, training, etc, and absorb all of the cost and stress of that, if they are not going to get paid well? Plus, it’s not only doctors, but nurses, pharmacists, techs, etc, who are relatively well paid in the medical profession and whose wages drive up the cost of healthcare. Should we seek to slash those wages as well? Do you really want a WalMart style healthcare system, with its practitioners paid bargain basement wages?
Sure there are problems with the current system. But let’s not pretend that any proposed solution won’t also have its own set of problems. The question is which set of problems is more tolerable.
Ajay
Feb 28 2007 at 7:18pm
There is a simple answer to both of the previous commenter’s objections: there is far more waste and corruption in the system than you know. It’s not a matter of consumers slightly overconsuming, they are consuming much more than they should or even than is good for them, not because they want to, but because they’re forced to by the doctors. The doctors abuse the system and order more tests than necessary because it means more revenue for them. Read Arnold’s previous post on this and my comments there.
As for your argument about supply and demand, there is no working system of supply and demand in place currently! The medical profession artificially restricts supply by only allowing a small amount of people to become doctors. Further, the current broken medical compensation system allows them to steal and waste far more money than necessary. You claim that all those years of training are necessary, I claim that they’re not. Not only that, I claim that one can come up with a system that requires far less training AND will be much better for patients, as the current medical training is fairly bad. The only reason current medical training stays so horrible year after year is because the medical schools just maintain the same low status quo year after year. And the reason they’re allowed to do is that they exist in a socialist system, where 50% of payment is made by the government (with no quality of care appraisals done), and ~40% of payment is made by an over-regulated and apathetic insurance industry. The way to solve all this is to bring competition to bear by allowing the consumer to decide where he wants to spend his money (and insuring him against true catastrophes by using high-deductible catastrophic insurance). If you can’t see this, I feel sorry for you when you actually have to, as a patient, use the currently horrible medical system.
Dr. T
Feb 28 2007 at 7:57pm
I, too, disagree with comment “…the main cultural imperative that seems to be driving health insurance and many other of our health care institutions is the imperative that doctors must earn high incomes.”
The current health insurance system did not evolve to give physicians high income, it evolved because workers mistakenly thought they were getting something (low- or no-deductible health care) for nothing. One effect of the current health insurance situation was increased physician revenues. Rapidly rising medical costs, over-utilization, and unnecessary technologies are the more financially significant effects.
I object to what appears to be a strong anti-physician bias by Arnold Kling. Physicians are among the most intelligent persons in the world, and they go through more training than any other profession. Is a $200,000 annual income unreasonable for such persons?
And before anyone jumps on me: I am a salaried pathologist at a VA medical center. I don’t benefit financially from the current health insurance system. Also, I chose a high-deductible health insurance plan for my family, because insuring against predictable, low-cost events (such as routine health care) is silly.
Mark Seecof
Feb 28 2007 at 9:03pm
Like Commenter I question why we should think high remuneration for doctors would be a flaw in any scheme to pay for health care. By and large smarter doctors are more effective, so we should wish to entice smart people to become doctors. That requires high pay since doctors have to go through a lot of training, etc. and smart people have other career options. (Note that I think we would wish a strong link between doctors’ productivity (positive patient outcomes, that is) and their income.)
I think a much bigger problem than doctors with sports cars is the tendency of popular healthcare-payment schemes to minimize variation in doctors’ incomes, or to tie such variation only to quantity of patients “seen,” rather than quality of work. A government bureaucrat or an insurance-company executive may see “cost control” advantages to fixing payments to doctors (whether by diagnosis or procedure–say, $100 for every sniffly child checked for AOM or strep throat or $500 for every broken arm set–or by capitation fees, like $100/month for every patient assigned to a “primary care physician” gatekeeper). However, these schemes discourage doctors from improving their skills and encourage them to “see” (but not necessarily pay attention to) too many patients.
Sometimes these schemes are like the way the public schools pay teachers. By paying them all about the same (with increases tied to seniority), the system discourages all of them from working hard. Other times they’re like the way the Soviet Union paid factory workers. By rewarding measures of production divorced from consumer satisfaction (say, kilograms of carpenters’ nails produced) the USSR obtained perverse outputs (for example, truckloads of nails too thick to be useful).
Various payment schemes may beat down doctors’ pay but they also make it hard for patients to seek the optimum level of care. For example, I might think a low-cost family practicioner good enough to take sniffly children to, but want a top diagnostician when the sniffles persist too long. If the third-party-payer (or worse, single-payer) insists on paying all doctors the same amount “per consultation” then I’ll have trouble finding that top doctor–not just trouble paying, but trouble finding him at all, because the system “disincentivizes” him out of existence.
Mr. Econotarian
Mar 1 2007 at 5:00pm
The market for health insurance is undifferentiated because of the large number of federal and state mandates on coverage.
These include things like mammography screening, diabetic supplies, hair prostheses, blood lead screening, etc.
Federal requirements prohibit premium variation among individuals on the basis of health-status related characteristics.
Richard O. Hammer
Mar 2 2007 at 9:31am
Government regulates the insurance industry to a high degree. We who want liberty should blame this regulation for the mess that now exists.
For instance, somewhere I heard that medical insurance companies were forbidden by government edict to ask applicants whether they had AIDS. Whereas these companies routinely ask applicants if they smoke and may even be required to ask this. So politics determines the price and extent of medical insurance coverage which can one can purchase. Whereas I believe the price and extent of medical insurance coverage should be determined by unregulated entrepreneurial calculation.
Government also regulates the insurance industry by running the system of courts. In this way government determines which claims get paid. But an honest system of courts, courts regulated by market forces, would award different payments.
I suppose it would be easier for me to convince readers, that wrongs in the present medical insurance industry derive from government regulation, if I gathered data in a scholarly way. Unfortunately it is often difficult to perceive the effects of regulation on a given industry unless you are an insider in that industry. It takes a lot of special knowledge of time and place. Such scholarly effort rarely pays for iteslf.
Mike N
Mar 2 2007 at 3:47pm
An example of larger providers attempting to erect statutory barriers to entry in the health care market here in Idaho: http://www.idahobusiness.net/archive.htm/2007/02/19/Idaho-House-Senate-wont-touch-Certificate-of-Need-Competition-in-health-care-is-between-hospitals-ph
Ajay
Mar 2 2007 at 6:45pm
Wow, Mike N, the gall of the hospital association to ask that they be the ones to decide when new hospitals are built. Yes, why don’t we just give the car salesmen association the power to decide when new car lots can be built. Although, I’m not sure that there’s a need for certificate of need regulation at all. Presumably it’s in place because hospitals need to be a certain size before they make fiscal sense and the state doesn’t want too many big hospitals being built and wasting too much money (how thoughtful of them). But I don’t see the scale argument at all. It seems to me that there are small and big hospitals anyway and there’s not much sharing of expensive resources, like medical equipment, that goes on so I would think all sizes would be okay. In that case, there’s no reason to restrict the market at all (there probably isn’t a case for restrictions even if size does matter, but since it doesn’t seem to, that’s moot).
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