Category Archives: Economics of Health Care

McKinsey Hubris

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Tom Latkovic writes,

Because episodes have, by definition, a finite duration, it is now relatively easy to mine data sets to identify which providers can solve specific medical problems more effectively and at a lower cost than other providers. Whether the category being considered is surgeons who perform hip replacements, oncologists who treat prostate cancer, or hospitals that take care of stroke patients, the goal of this approach is to reward providers for delivering a patient’s desired outcome (say, walking, remission, or hospital discharge without readmission) with as few complications as possible and for providing the best experience at the lowest possible cost. Focusing on episodes of care makes it easier to compare performance across providers and encourages productive competition among them. We believe that more than $2 trillion of US annual spending on health care, which currently totals about $2.7 trillion, could be paid through an episode-focused approach.

McKinsey folks think very highly of themselves. I have always resented that.

In this case, Latkovic appears to be comparing the existing compensation system with a system that would not be gamed. That is unrealistic. Instead, ask yourself how doctors would game an outcomes-based compensation system.

1. Over-diagnose. That is, report that the patient has a condition that is worse than it is.

2. Under-treat. Suppose that 10 percent of the variation in outcomes is due to doctor actions, and 90 percent is due to other random variables. Then the profit-maximizing strategy is to pocket the payment for the “episode,” do nothing, and hope for the best. In fact, you should avoid patients where the routine action produces cure with certainty, because the profit margin is likely to be low.

3. Select only patients with high conscientiousness, because they will have much better outcomes than patients with similar ailments and low conscientiousness.

etc.

Howard Dean on IPAB

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He writes,

If Medicare is to have a secure future, we have to move away from fee-for-service medicine, which is all about incentives to spend more, and has no incentives in the system to keep patients healthy. The IPAB has no possibility of helping to solve this major problem and will almost certainly make the system more bureaucratic and therefore drive up administrative costs.

He does not say what we need to move to. Of course, I would say we should move to a system where consumers pay for their health care, and insurance covers catastrophic expense.

Keep in mind that there is no perfect system for compensating doctors. For example, if you pay them a fixed amount of money per patient, then their incentive is to see a lot of healthy patients and avoid the sick ones. If you pay them a fixed salary, their incentive is to work short hours. If you pay them for “quality care,” that means that a central bureaucracy, comparable to IPAB, has to define the meaning of quality.

Health Care Budget Implosion

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Not just in the U.S. Frances Woolley writes,

Right now all of the provinces and territories except for Newfoundland, Saskatchewan and Yukon are running deficits

In Canada, provinces run the health care system(s).

Canada has a very pronounced baby boom – a big bulge of people born between 1947 and 1962 (when the birth control pill was introduced). That oldest members of that cohort are now 66. As people get age, their health care needs increase. Pick your metaphor. Health care as Pac Man, that gobbles up the provincial budget.

Central Planning, in Practice

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The Washington Post reports,

Unknown to most, a single committee of the AMA, the chief lobbying group for physicians, meets confidentially every year to come up with values for most of the services a doctor performs.

Pointer from a reader, who requested that I comment. Actually, I had seen the article, but I thought it was too depressing/frustrating to even begin to comment.

The truly fundamental error is the belief that there is any objective way to measure cost. See my essay on subjective value. If you really want to see the fundamental nature of the error, see James Buchanan’s Cost and Choice. And, speaking of Buchanan, would he have been the least bit surprised that when the government is deciding how doctors get paid, a trade group representing doctors takes over?

McMedicine, Coming?

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Lifted from the comments:

Well, it’s not scientifically valid, but I did have dinner last weekend with a friend who is a CEO of a 2000 person HC provider, and he would tell you that margins are being squeezed mercilessly. Overhead is enormous – 80% of his employees are NEITHER doctors NOR nurse-practitioners. Consolidation is going to come very fast, and a decade from now, there will be less than 100 healthcare providers in the United States.

Some remarks:

1. This prediction may be quite independent of whether Obamacare remains intact.

2. Higher education, too, has bloated overhead. Of course, that industry is not being squeezed mercilessly. Yet.

3. There was once an essay that began, “The traditional model of medical delivery, in which the doctor is trained, respected, and compensated as an independent craftsman, is anachronistic.”

Nominal GDP and Employment

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The chart comes from Dan Diamond. Pointer from Tyler Cowen.

Let’s pretend that health care is the whole economy. The top line is the growth rate of nominal GDP. The lower line is the growth rate of employment. Growth in nominal GDP is growth in real GDP plus inflation. Growth in real GDP is growth in number of workers plus growth in output per worker. Inflation is growth in compensation per worker plus growth in the price markup over compensation. Putting this all together, we have

growth of nominal GDP = (growth of number of workers + growth of output per worker) + (growth of compensation per worker + growth of the price markup over compensation)

Scott Sumner would say that the two most reliable numbers here are the ones shown in the chart–growth in nominal GDP and growth in the number of workers. The division between nominal GDP and real GDP depends on making the correct quality adjustment for prices, which Sumner would argue is much less reliable than the other two measures. (I think everyone would agree that quality-adjustment is less reliable, but some of us prefer to believe that it is not much less reliable.)

The difference between the two lines on the chart consists of productivity growth, wage growth, and growth in the price markup. Diamond says that wage growth does not account for the slowdown in nominal GDP (although wage growth did decline–I think by about a percentage point, based on the data in Diamond’s link). He alludes to a mix shift. If people shift away from prescription drugs and toward other services, those other services could have lower productivity and/or a lower price markup.

In any case, it looks as if either productivity growth has declined or the growth in the price markup has declined. This should show up as a decline in corporate profits in the health care industry. Can anyone find data? I have trouble navigating the Commerce Department’s web site.

I did stumble across this paper, which tries to decompose the rise in health care spending from 2003 to 2007.

Our decomposition also sheds light on productivity in the treatment of cancer. Over the four-year sample period, expenditure per capita rose twice as fast for malignant neoplasms (48 percent growth in expenditure per capita) than non-malignant neoplasms (24 percent growth in expenditure per capita). A large reason for the discrepancy is the difference between growth in the cost of treatment (that is, expenditure per episode of care). Service prices for malignant neoplasms grew over twice as fast as service prices for non-malignant neoplasms. This may indicate that more expensive and innovative services are playing a role in cancer spending growth.

This is interesting, but for present purposes it is of little use. The chart above shows a slowdown in the rate of growth in overall health spending between 2003 and 2007.

But my main point is that we expect nominal GDP growth and employment growth to line up. If they do not, something must be going on with either productivity, compensation, or price markups. This is a matter of accounting.

The Theory of the Firm: Hospital-Provided Health Insurance

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Sarah Kliff writes,

Insurance plans and hospitals are typically at loggerheads. They squabble over claims that the hospitals submit and insurers sometimes deny…

Now, a growing number of large hospital systems are betting that, with a little help, they can do that just as well — or even better…Seeing health insurance companies as the middlemen, these hospitals are only too eager to squeeze them out.

Often, there is a lot of back-and-forth between hospitals and insurance companies over paying a claim. The hospitals think that by vertically integrating they can get rid of the unnecessary paperwork.

I think that Ronald Coase and Oliver Williamson might be a bit more skeptical. Or at least I would. The hospital half of the insurance-hospital hybrid still has an incentive to do find ways to raise charges. And the insurance half still has an incentive to find ways to reduce charges. They no longer have the cost of dealing with each other at arms length. Instead, they face the cost of creating internal alignment. Do not assume that this cost will be trivial.

Taking Care of Elderly Parents

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Timothy Taylor writes,

Some other high-income countries have government programs to pay for long-term care. Not surprisingly, they spend a substantially greater share of GDP on long-term than does the U.S. In any event, the long-term U.S. budget picture is grim enough that adding another entitlement for the elderly isn’t likely.

As usual, he has useful links, primarily a CBO study.

I have a vision of the year 2025 in which the difference between the rich and everyone else is that the rich can afford to send their children to private schools, pay full fare for the children’s college education, and pay for their own parents’ long-term care. Everyone else will depend on public schools, community colleges and scholarships, and government-provided nursing homes. Otherwise, the lifestyles of the rich and the non-rich will look pretty similar.

A Surprising Finding

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from Janet Currie, Mark Stabile, and Lauren E. Jones:

We examine the effects of a policy change in the province of Quebec, Canada which greatly expanded insurance coverage for prescription medications. We show that the change was associated with a sharp increase in the use of Ritalin, a medication commonly prescribed for ADHD, relative to the rest of Canada. We ask whether this increase in medication use was associated with improvements in emotional functioning and short- and long-run academic outcomes among children with ADHD. We find evidence of increases in emotional problems among girls, and reductions in educational attainment among boys. Our results are silent on the effects on optimal use of medication for ADHD, but suggest that expanding medication use can have negative consequences given the average way these drugs are used in the community.

The Future of American Health Care Policy

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Tyler Cowen prefers,

The Singapore system, involving single payer for catastrophic expenses and health savings accounts for smaller expenditures. To varying degrees you can combine this with forced savings for the HSAs and price controls on service provision, both of which you will find in Singapore. Where “catastrophic” starts can vary as well. This is my first choice, although if you wish to dismiss it as “utopian” for the United States you have a point.

My view is that we are headed toward a two-tier system regardless of the political configuration. We will have a government system under which doctors are unhappy with how they are paid and how they are regulated, and in which consumers are denied some treatments that they otherwise would want. We will have a private system in which doctors and patients have more choice, but patients bear much more of the cost directly. People who rely almost entirely on the government system will tend to have lower wealth than people who use the private system.

I do not think that Americans are egalitarian enough or tolerant enough of a price-control regime to be willing to destroy the private tier. On the other hand, I do not think that they have enough confidence in markets to do without a large government tier.

I do not think that Americans would vote for the Singapore system. Maybe Singaporeans would not vote for it, either, but that country runs differently. Consider three choices:

1. Uninsured

2. Comprehensive insurance

3. Catastrophic insurance

Economists strongly prefer (3). But I think that most people around the world would prefer (1) or (2) to (3).

That does not mean that I want to give up on reforms that make catastrophic insurance competitive. On the contrary, I am willing to make the case for it any time I get the opportunity. Obamacare is designed to make it harder, not easier, for people to choose catastrophic insurance. That means either that Obama’s economic advisers failed, or perhaps didn’t try, to make a case that I believe they should have been making. As a result, I am pessimistic about the prospects for Obamacare. My book still needs to be read.