Ed Lotterman: Health care system mixes market, regulation

August 30, 2013 

Regardless of how we structure the financing of health care — mandatory private insurance in the Affordable Care Act, government-run single-payer, vouchers, or our current muddle — we are going to face the challenge that the cost of health care itself will rise faster than national output, the general price level and median household incomes. This means that spending on health will take up a larger portion of resources, both at the national and household levels.

Having dealt with a neck cancer over the past 16 months, I am both a witness and an example of some of the factors driving these expenditure increases.

First, I am a baby boomer, one of the 81 million people born from 1946 through 1964. Many health problems become far more prevalent with age, including many cancers, diabetes and cardiovascular problems. So a growing fraction of the population is entering a period in which their medical needs will grow. This will push up overall and per capita health spending even if there are no other changes in health care.

But there are such changes, one of which is the ongoing introduction of technology. I had surgery and chemotherapy, but 35 radiation sessions were my primary treatment. Radiation therapy goes back more than 50 years, but the linear accelerators and other radiation delivery systems have become much more sophisticated and much more expensive. I understand that the machine used on me cost at least $5 million.

Amortizing that amount means there is a big fixed cost for every treatment, even though the variable or marginal costs of giving one more session are low. And there are institutional factors that keep the number of treatments per machine per day well below what would be economically optimal for society as a whole. More on that later.

There also are many more diagnostic devices than there were only a couple decades ago, including increasingly sophisticated CT, PET and MRI scanners.

All of these improve outcomes for patients and prolong lives. But they are expensive.

We have a muddled system of health care delivery that is part free market and part regulated. One of the market aspects is that health care providers operate in a structure that economists call “monopolistic competition,” like that of gas stations and grocery stores.

In this market structure, there is much competition, but it is not the “pure” or “perfect” competition, like that of farming, that inherently has necessary incentives that automatically deliver economic efficiency. One of the characteristics of monopolistic competition is “apparent excess capacity.” In other words, there are incentives for competing businesses to purchase more cash registers, gas pumps or CT scanners than is economically efficient and than they would in a fully competitive situation. This equipment ends up standing idle much of the time. But any single provider maximizes profits by having this excess capacity.

Fitness centers and study-abroad programs at private colleges are other examples of this same excess-capacity phenomenon, but that is a different column.

The fixed costs of one more check-out station is small compared with the total costs of a big-box retailer. But the fixed costs of one more PET scanner or linear accelerator are the biggest single items for many clinics. At 8 percent interest and a life of 10 years, a $5 million machine has a principal and interest cost of some $2,000 per day. Keeping the machine occupied 12 hours per day rather than six, would halve the per-treatment cost. But a lot of expensive machines do stand idle for much of a 24-hour day and on weekends.

I had my radiation treatments at 7:45 every morning. At that hour, the clinic clicked patients through one after another. But one day there was a glitch, and I was asked to come back later. At 3:30 in the afternoon, the clinic was nearly deserted. “People like to have their radiation or their chemotherapy in the morning,” the technician explained. “So we usually have plenty of openings in our schedule.”

The economist in me immediately thought that if the clinic would offer $100 cash payments to people to come in at less convenient hours, they would probably have a lot of takers, get by with fewer machines, and have lower per-treatment costs. But institutionally that seems very hard.

Moreover, once a clinic has some new diagnostic or treatment device that is not fully scheduled, there is a monetary incentive to prescribe it for more patients. I never perceived any time when this was true in my treatment, but experience shows that people often respond to economic incentives.

Since most patients with insurance or other third-party payer like Medicaid face little, if any, of the billable cost of one more use of some expensive machine, there is no one to weigh the marginal cost of the treatment versus the marginal benefit. And even when they do pay, our medical research system puts few resources into calculating the marginal benefits of one procedure relative to another. So neither the patient nor the physician really has the needed information.

In my treatment, there have been several occasions in which my doctors walked me through the medical tradeoffs of some decision. I recently decided not to have another PET scan to resolve inconclusive ones months ago. The extra radiation from the scan seems a greater risk than the slight chance my cancer has returned undetected by simpler clinical diagnostics. But during the entire 16 months, no one has ever raised the question of monetary cost versus benefit. Our generous insurance coverage has no incentives for us to do so, and there are no “death panels” making such evaluations for alternative procedures in general. So overuse and cost growth continue apace.

Economist Edward Lotterman teaches and writes in St. Paul, Minn. Write him at ed@edlotterman.com.

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