What am I missing? – a price specialist discusses healthcare inflation

This recent-ish interview with Mark Bils, a macroeconomist at the University of Rochester who specializes in price measurement (via Mark Thoma), has really got me scratching my head. In it, he goes on at some length about the potential pitfalls of measuring growth in an economy and how some price signals and other factors can give you bad readings on such things. For instance, if you overestimate inflation, you would be underestimating growth (i.e. deciding that inflation is 3% instead of 2% would result in underestimating the growth of an economy by they same amount of error, etc.). All good stuff, particularly in regards to general price inflation, which is a tricky figure to come up with, laden as it is with political baggage. However, he goes on to have this exchange on healthcare spending with the interviewer, Brent Meyer:

Meyer: What type of prices do you think might have been overestimated?

Bils: Services and healthcare. When you look at healthcare expenditures, you see that inflation is extremely rapid, much more rapid than other inflation rates. But we have no idea what the inflation rates for health expenditures really are. We don’t know! You can’t measure quality of healthcare very well.
If I compare healthcare costs today versus in the year 1800, well, I could go out and buy a bunch of leeches today for almost nothing. And I could have the healthcare I had in 1800. If you had a certain condition and you had $10,000 to get treated at today’s health prices, or $10,000 to get treated at 1960s prices with 1960s technology, I don’t think it’s so obvious that people would want to go back in time to get their important health conditions dealt with. In that sense, you say, I don’t know if there’s inflation. It’s pretty hard to say that there’s been a lot of inflation over the long haul in healthcare.
The thing that struck us was that you would see much faster inflation for healthcare expenditures, but also much faster real increases in people buying more and more [healthcare services]. We still haven’t been able to explain this.

Now, I am not a PHD. I’m not even a BA yet. However, none of this seems that hard to explain. I would love to know what I’m missing here, but I would venture that this data alone presents strong evidence that there is VERY significant inflation in US healthcare spending and it’s at least pretty measurable (this is per capita by the way, bad graph title on my part):


Especially noteworthy is our neighbor Canada, a geographically contiguous nation with heavy trade, technological and cultural ties to the US. In 1971 we spent about 120% of what Canada spent per capita on healthcare (measured in  “purchasing power parity” US dollars, the cost of buying a large mixed basket of goods in both countries as a measurement of equalized spending values). In 2007, we spent more than 180% of what Canada spends per person (again PPP dollars). This means that while Canada’s healthcare spending increased more than 11 times in 36 years, spending in the US increased more than 18 times. You can see from the above graph that in the period from 1993 to 2000, which corresponds with the explosive growth of HMOs, that the increase in the growth of spending was substantially slowed (presumably at least in part due to the monopsony-like characteristics of HMOs), but even in that period we outstrip the spending growth of the other 5 countries compared here in the same period by a significant margin.

Bils goes on to say that you can’t measure quality of healthcare very well, but it seems like there are quite a few people taking a stab (and many might say succeeding) at doing just that. Here are a bundle of them from the Commonwealth Fund.

If you thumb through a few of these, one striking thing is that many of the respondents, both in a survey of primary care physicians and patients, rank the US and Canada quite similarly in many areas both good and bad, making the fact that they have had a seven-fold pricing divergence over less than 40 years all the more striking (though they are NOT rated similarly in critical areas such as delays in seeking care due to cost).

To paraphrase Professor Bils, they aren’t using leeches in Canada so that doesn’t explain it, they are pretty much doing all the same things we are doing here in terms of treatment. If you want to begin to think about places where costs diverge, the hypothesis below is perhaps a good place to start. From The Economist 2 weeks back:

…Here’s one example among a million. The other day I went to the IPO announcement of a company that does some fairly state-of-the-art medical stuff. The company was spun off from a public institute a few years back to exploit this technology, but it’s been unable to establish significant revenue or market share, or to get within shouting distance of breaking even. Meanwhile, competitors with similar technologies have gobbled up most of the market share, and one is already quite profitable. The company said it planned to raise some tens of millions of dollars with the share issue, many times its current annual expenditures and about a third of its overall market cap. And what would it do with this money? It was going to use half of it to finance a marketing drive, targeting key decision makers at American health-care providers and health insurers, and doctors.
…Just think about this for a minute. A medical technology company is going public to generate the money it needs to advertise its products to hospital directors and insurance-company reimbursement officers. This entails significant extra expenditures for marketing, the new stocks issued to fund the marketing will ultimately have to pay dividends, banks will have to be paid to supervise the IPO that was needed to generate the funds to finance the marketing campaign (presumably charging the industry-cartel standard 7%)…and all this will have to be paid for by driving up the price the company charges to deliver its technologies. But beyond the added expense, why would anyone think that a system in which marketing plays such a large role is likely to be more effective, to lead to better treatment, than the kind of process of expert review that governs grant awards at NIH or publishing decisions at peer-reviewed journals? Why do we think that a system in which ads for Claritin are all over the subways will generate better overall health results than one where a national review board determines whether Claritin delivers treatment outcomes for some populations sufficiently superior to justify its added expense over similar generics? What do we expect from a system in which, as ProPublica reports today, body imaging companies hire telemarketers to sell random people CT scans over the phone?

What do we expect indeed? I would guess that one might expect prices to be higher in a country where healthcare is treated as a commodity produced by a massively profitable growth industry than would prevail in countries where healthcare is treated as a public good. Healthcare is like water, everyone needs it (at least sooner or later). When a nation provides life sustaining/lifesaving commodities from the framework of a rigged market system exercising cartel pricing power, one would be quite reasonable to expect that what you would get is what we have. Namely a massively inflated “market” of both critically important and quite frivolous healthcare procedures which is subject to the whole gamut of market failures: asymmetrical information, agency problems, regulatory capture, sticky prices, and on and on. These factors seem like more than enough to explain unwarranted divergence from both other industry pricing/cost structures as well as divergence from healthcare systems in other developed market economies where the only difference is that government serves as either the sole (monopsony) or the majority buyer in the market and is able to exert a countervailing pressure to the gross market failures that are entirely predictable in such a scenario.

Here’s another telling graph. This one from the St Louis Fed. It shows:

1) The normal Consumer Price Index (a large sample of goods less food and energy)

2) New car prices (something Bils mentions in the article “Yes, the inflation rate for healthcare prices has been overestimated. It relates to the work I did later on durable goods, like cars. When we get a new model car, the 2011 Camry versus the earlier model, the prices jump. Now, is that inflation, or is it a better model?”)

3) Healthcare spending

4) and finally, gas prices.

Only one of these alternative indicators exhibits price increases that wind up at all similar to healthcare spending increases and that is gasoline, a totally non-renewable, cartel-controlled resource. New cars aren’t really much to make a fuss over by comparison (there is actually vigorous competition in that market). What is the healthcare industry’s excuse? Factors such as economies of scale, low-wage production, and mechanization and increasing expertise in producing fancy machines, improvements in record keeping, passing tasks on to nurse-practitioners and the like are all boilerplate econ101 stuff that should be at least alleviating price increases, but hospitals all over this country are still charging for 2 aspirin by the $13 bottle or for 1 titanium bolt by the $800 6-pack, etc. etc.

Bils’ final comment on finding it confusing “that you would see much faster inflation for healthcare expenditures, but also much faster real increases in people buying more and more [healthcare services]. We still haven’t been able to explain this.” seems amply explained by the aforementioned problems of asymmetrical information and agency problems in healthcare. If your doctor says you need an MRI (and who can blame them for covering their asses right? We don’t generally NOT sue doctors because it seemed like an MRI was probably a little unwarranted, oops it turned out to be cancer but I can see why you wouldn’t have been worried) you are pretty much going to get an MRI. It doesn’t really matter (especially to the insured) if the price has gone up, and even if it did, most normal people will just do what their doctors suggest. If the practice just happens to have their own machine, well all the better. How is this even mystifiying? I am fully open to the possibility that I’m missing a lot of nuances, but they must be pretty subtle, because very basic principles of economics seem to confirm and explain the incredible outlier that is healthcare spending as a full-fledged market failure.

I can only attribute it to a missing-the-forest-for-the-trees problem. Here’s the University of Chicago’s Raghuram Rajan discussing why he thinks almost all economists missed the signs of the recent financial meltdown and implosion of the housing bubble. His choice of analogy is telling:

Like medicine, economics has become highly compartmentalized – macroeconomists typically do not pay attention to what financial economists or real-estate economists study, and vice versa. Yet, to see the crisis coming would have required someone who knew about each of these areas – just as it takes a good general practitioner to recognize an exotic disease. Because the profession rewards only careful, well-supported, but necessarily narrow analysis, few economists try to span sub-fields.

There’s an apocryphal (as far as I can tell) quote attributed to Ronald Reagan that an economist observes something in reality and asks “yes, but does it work in theory?” I think we may have such a case here. I doesn’t take a PHD to see the problems that are baked into the US healthcare system, maybe in this case it requires, specifically, the lack of one.

If you want a LOT more really good reporting on the muddy and complicated world of conflicting interests and interwoven problems, listen to these two great This American Life episodes on healthcare.


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About theunlikelyeconomist

theunlikelyeconomist is in the midst of the long slog to attain a PhD in economics.
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