The Problem of Healthcare Costs

Many argue that the Affordable Care Act (often referred to as Obamacare), is better for patients.  Those who do not have healthcare will be forced to purchase health insurance.  This mandate provision in the law that requires the uninsured to purchase health coverage gives those under certain income levels a subsidy to buy their insurance, and all others will pay for their insurance out-of-pocket.

The Congressional Budget Office (CBO) recently reported that the number of Americans who will face tax penalty unless they purchase insurance is 50 percent higher than originally estimated when the bill was passed.  One of the unintended consequences of this new law is that many who must purchase health insurance (or face a penalty) are increasingly those in the middle class that President Obama promised to protect.

One question that arises is what criteria determine the best system for patients?  In any country, there will not be enough healthcare to provide all citizens unlimited care.  Healthcare is a scarce resource and must be allocated as such.  Yet, one of the most prominent problems with healthcare allocation is that costs have climbed at a much faster rate than inflation and the rapidly changing technological improvements in healthcare don’t lower costs as in most industries.  Thus, the myriad challenges with government spending and huge deficits for entitlement programs such as Medicaid and Medicare.  Costs continue to rise, and the Affordable Care Act does little to deal with this cost problem and patients suffer because they cannot afford care.

New York University economist William Baumol, recently published the book Cost Disease where he addresses this issue.  The subtitle of the book “Why Computers Get Cheaper and Health Care Doesn’t” gets right to the heart of the issue.  In it, Baumol explains this disease where in the service sector (and particularly in government) productivity tends to stagnate while costs rise over time.  In healthcare for example, it takes the same amount of time for a nurse to perform a basic task, such as bandaging a wound, today as it did 20 years ago.  So, healthcare workers’ wages rise overtime yet productivity tends to remain flat (or flatter).  Presumably then we should experience lower costs in healthcare on the capital intensive/technological side of the industry.

Why does technological advancement in healthcare fail to reduce costs?  The answer here is not that a MRI scan and a personal computer are fundamentally different in terms of their technological development, but the pricing system for these products and services is profoundly different.  It is estimated by the CBO that half of all healthcare costs are driven by advances in technology, and while patients are the primary beneficiaries of this technology third parties pay for them.  Insurance companies and government programs approve a specific payment for a particular medical procedure and this procedure becomes available at the mandated price.  The supplier now has no incentive to lower its price because there is no competitive pressure to do so, and there is little prospect of increasing sales and market position by reducing prices.

Consequently, in healthcare both the cost disease problem explained by Baumol and the third party payment system create an industry where prices rise unchecked and there is no market-based means of cost reduction.  The Affordable Care Act fails to address the most basic problem with the U.S. healthcare system, which is uncontrollable costs

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