“It’s the Prices, Stupid”: Why US Healthcare Spending is So Damn High
US healthcare spending is abnormally high in comparison to other wealthy countries. In this post, I examine why that is and what we can do about it. Hint: think single-payer.
Last week, I made a post about the US’s exceptionalism in terms of both its high level of healthcare spending and its low average life expectancy in comparison to other wealthy countries. If you missed it, you can check it out here.
For this week’s post, I want to hone in on one half of that story, namely the extraordinarily high level of healthcare spending in the US.
US per capita healthcare spending rose from $1,036 in 1980 to $12,318 in 2021. The comparable country average (an average of eleven other OECD countries) over that same period was an increase from $708 to $6,003.1 US healthcare spending as a percentage of GDP has likewise outpaced other comparable countries since 1980:
To get a sense of why the US has seen such abnormally high spending growth, let’s look at the components of that growth.
At a basic level, healthcare spending essentially reflects two factors: utilization (use of healthcare) and prices (prices for that care).2 Increases in each have contributed to growth in US healthcare spending over the last several decades:
But the fact that both utilization and prices have increased over the past forty years doesn’t necessarily mean that each has contributed equally to the US’s deviation from the comparable country average in its healthcare spending. One could well be the primary contributor.
And the choice of which to blame has serious implications for healthcare policy. If high utilization is to blame, that implies stereotypical American excess on the part of healthcare users and suggests restraint as a solution. But if high prices are to blame, that implies stereotypical American greed on the part of the sellers of healthcare and suggests cracking down on that greed as a solution.
What then to blame? Greed or excess?
“It’s the Prices, Stupid”
As Zack Cooper observes,
Historically, there has been more attention paid to the role of quantity differences and quantity changes over time than to the role of prices in explaining health spending variation and growth over time.
However, in 2003, the late legend of the healthcare economics game Uwe Reinhardt proposed a different approach. In a famous paper titled “It’s The Prices, Stupid: Why The United States Is So Different From Other Countries,” he and several co-authors made the case for prices as the main driver of higher healthcare spending in the US relative to other countries.
The authors pointed out that, on key measures of utilization, the US ranked below the OECD median:
Utilization, they concluded, must not be the main driver of cross-country spending differences. In other words, “It’s the prices, stupid.”
Subsequent studies have come to similar conclusions.
One JAMA study published in 2018 found similar healthcare utilization in the US to that of other countries on key measures and concluded that even the areas of higher utilization, specifically certain surgical procedures, “did not appear to explain a large part of the higher spending in the United States.” The study instead pointed to prices as the likely primary culprit.
A 2019 follow-up to Reinhardt’s 2003 study, which his co-authors assembled as a tribute to him, likewise confirmed the original study’s findings that higher prices were the main cause of higher healthcare spending in the US.
And a 2012 study by researchers from the Center for American Progress showed that prices for the same medical services and procedures were higher in the US than in other wealthy countries:
It further noted that high prices can incentivize increased utilization. As the authors wrote,
High prices coupled with high profit margins may help explain the high utilization of magnetic resonance imaging, computed tomography, cardiac procedures, knee replacements, and caesarian sections in the United States.
(Though about half of American hospitals are “nonprofits,” this is a misleading label.)
A reduction in prices for these services would disincentivize use and could thus lead to lower utilization. So even when utilization may seem to be driving high spending, the root cause may actually be prices.
But Why Are Prices So High?
Reinhardt and his co-authors cited three possible reasons for relatively high American prices in their 2003 paper: (1) higher input prices (i.e. prices for pharmaceuticals and medical equipment, salaries for healthcare workers); (2) more intensive care; and (3) higher administrative costs.
As the follow-up study noted, the second explanation is hard to assess since “there is little literature comparing the service intensity between the US and other OECD countries.”
In the case of explanations (1) and (3), however, there is significant supporting evidence.
In the case of (1), data on healthcare worker salaries show the US leading other wealthy countries:
Similarly, when it comes to pharmaceutical prices, the US leads the pack:
And in the case of (3), studies have repeatedly estimated annual administrative waste in the US to be in the hundreds of billions of dollars.
The Importance of Economic Rents
In the 2003 paper, Reinhardt and his co-authors drew attention to the central role of economic rents in exceptionally high American healthcare spending. Rents are generally considered a form of unearned income and occur when, for instance, the seller of a good/service gets paid more for that good/service than they would have in a perfectly competitive market.
In the healthcare marketplace, a significant source of rents is the disproportionate market power of sellers (e.g. hospitals and pharmaceutical companies). This power allows them to negotiate favorable deals with buyers and set higher prices than they would be able to if there were more serious competition among sellers. The result is what’s called monopoly rent.
There’s good reason to believe that rents explain a large amount of the difference in healthcare spending between the US and other countries. Buyers of healthcare are uniquely fragmented in the US due to the prevalence of private insurance companies and the lack of government intervention. Monopoly rent can thus accrue to sellers in the healthcare market at much higher rates in the US than other countries.
A paper published in the Review of Social Economy in 2020 titled “The big cost of big medicine – calculating the rent in private healthcare” examined in detail the contribution of rents to American healthcare prices. The authors drew a link between changes in antitrust and patent laws, and the ensuing concentration in the healthcare sector, and higher prices. They found,
The annual rent from the increase in market power of hospitals, physician groups, prescription drugs, and net medical insurance reaches between 2.47 and 4.30 percent of GDP in 2016 – truly a big cost for big medicine.
To illustrate the dramatic impact that rents have had on the growth of US healthcare spending over the last several decades, the authors modeled counterfactuals meant to depict the trajectory of spending had such consolidation not occurred in the healthcare sector and had the government stepped in to curb healthcare price inflation instead:
The authors cautioned that even the upper bound estimate for rents is probably an underestimate of total rents in the American healthcare marketplace, meaning rents could well explain the entire difference between the US and the next highest spender on healthcare.
What to Do
One way of dealing with monopoly power is to build up monopsony power on the buy side. Reinhardt and his co-authors explained that increased monopsony power can reduce prices for healthcare goods and services and redistribute rents from the sellers of healthcare to the rest of society.
But it matters how you do this. The 2020 paper on rents in the American healthcare sector observed that increased monopsony power among private insurers generally did not lead to lower prices for consumers. Insurers simply used their monopoly power vis a vis consumers to take the rents for themselves. The 2019 follow-up to Reinhardt’s 2003 paper made a similar conclusion.
A more foolproof option would be to turn the government into the sole buyer in the healthcare marketplace. In other words, implement a single-payer system (i.e. Medicare for All). This would create a pure monopsony. Another option would be an all-payer system, which creates similar monopsony power among buyers.
Other countries have seen great success in controlling costs with this sort of approach. For instance, Japan, while achieving the highest life expectancy in the world, has kept a tight lid on healthcare spending with its all-payer system. A 2012 Commonwealth Fund study looking at thirteen wealthy countries found that Japan had the lowest healthcare spending of the bunch, which the report attributed to aggressive government intervention to control prices.
Reinhardt, for his part, was a longtime advocate of policies that would target rents in the healthcare marketplace. In 1989, he recommended Taiwan adopt a single payer system while serving as a high-level adviser to their government. Taiwan subsequently implemented this system in 1995. Since then, despite high healthcare utilization and short wait times, Taiwan has managed to keep healthcare spending remarkably low (at 6.1 percent of GDP in 2017 versus the US’s 17.2 percent). Here’s how prices there compare to here:
It’s hard to imagine a starker contrast.
The US has the ability to take the route that other wealthy countries have taken. It can control healthcare costs, and do so without sacrificing quality. According to one study, Medicare for All would not only save the US $450 billion each year in healthcare costs, it would also save 68,000 lives annually. At the end of the day, the reason healthcare spending is so high is simple: It’s the politicians, stupid.
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This is a minor simplification, describing what’s referred to as personal health care expenditures, which make up roughly 85% of total national health expenditures. The CDC defines personal health care expenditures as follows: “Outlays for goods and services relating directly to patient care, plus expenses for administering health insurance programs, the net cost of health insurance, and public health activities. This category is equivalent to total national health expenditures minus expenditures for investment in noncommercial research as well as expenditures by health care establishments on structures and equipment.” So another part of healthcare spending is investment, but we’re leaving that to the side.