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May 21, 1993
"Whiz-bang Costs Must be Controlled"
San Jose Mercury News
By Timothy Taylor
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THE RISE in U.S. health care costs over the last five years is eye-popping, jaw-dropping and heart-stopping. In 1988, the United States spent $546 billion on health care. This year, the nation is on track to spend about $940 billion. This increase in health care spending since 1988 -- not the total, just the increase -- is about 40 percent bigger than current federal spending on Social Security or the defense budget.

Of course, everyone has a favorite scapegoat for the rise in health costs:

  • Malpractice.
  • High profits for insurance and drug companies.
  • High doctor salaries.
  • Coddled patients.
  • Broader insurance coverage.
  • Wasteful paperwork.
  • Fraudulent claims.

While each of these have their place, the experts agree that there's one driving reason behind the rise in costs: new medical technology.

Henry J. Aaron of the Brookings Institution, in his recent book "Serious and Unstable Condition," says, "More than any other factor, the proliferation of medical technology explains the growth of health care spending."

Joseph Newhouse of Harvard University, in an article last summer in the Journal of Economic Perspectives, lists factors that might drive up health costs, including an aging population, increased health insurance coverage, increased income, and others. He then writes, "My own view is that they account for well under half -- perhaps under a quarter -- of the 50-year increase in medical care expenditure....I believe the bulk of the residual increase is attributable to technological change, or what might loosely be called the march of science and the increased capabilities of medicine."

Or Burton Weisbrod of Northwestern University, writing in the June 1991 issue of the Journal of Economic Literature: "Yet it is clear that much of the growth in health care expenditures during the post-World War II period has resulted not from increased prices for existing technologies, but from the price for new technologies. Newly developed technologies have driven up both costs of care and the demand for insurance, while also expanding the range of services for which consumers demand insurance."

In short, if health reform plan is going to come to grips with rising costs, it must tackle the incentives for producing and using new medical technology. The challenge is to do so in a way that encourages new technologies that will save money and have a substantial effect on the health of many, while providing less support for extraordinarily expensive technologies with limited health benefit.

Talking about greater efficiency in providing the existing level of health care won't evade this issue. Imagine, just for the sake of argument, that with an unexpected outbreak of highly competent management, the federal government reforms health care in a way that cuts wasteful paperwork costs by $100 billion. Surely this estimate bumps against the upper limits of optimism.

But if health care costs keep rising by more than 10 percent per year, even savings of that magnitude will be wiped out in a little more than a year. We'll be right back where we started, with medical technology still driving up costs. Of course, saving $100 billion remains a worthy goal; my point is that savings from greater efficiency are one time only. The rising costs of new technology happen every year, over and over, without limit.

As a Clinton health reform plan takes shape, a variety of methods for controlling costs are being considered: price controls, expenditure limits, and managed competition. Each approach would offer different incentives for encouraging the most cost-effective medical technology.

Price controls are the economic equivalent of trying to do a tonsillectomy with kitchen silverware: matters may sometimes work out, but the side effects are usually worse than the problem. A politically appointed group of government price regulators is not likely to be capable of making subtle distinctions between more and less worthwhile technologies.

A limit on health care expenditures has a better chance of limiting medical technology in a sensible way. After all, doctors and health care personnel are in the best position to decide which technologies are worth the money. Expenditure limits force them to make some choices, which encourages seeking out the cost-effective technologies, rather than having a fling with every whiz-bang treatment that comes along.

The heart of "managed competition" is the idea of health purchasing networks competing to provide a package of health benefits as cheaply as possible. Its effect on new technology depends on what services the health purchasing networks are required or pressured to cover for everyone.

Under these various approaches, choices will be made by some combination of price regulators, doctors facing fixed budgets, health purchasing networks, and government defining the "basic" package of care. But in every case, someone has to employ the R-word, and say how medical technology will be rationed.

Since new medical technology holds out a promise of life and health to sick and despairing people, any explicit limitations could be political dynamite. But unless health care reform tackles the cycle where health insurance encourages the development of new medical technology, which in turn makes insurance more expensive and necessary, it will fail in controlling costs.

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