A medical doctor examines a patient with a stethoscope. (Photographer: Andrew Harrer/Bloomberg)

Health-Care Costs Are Still Eating the U.S. Economy

(Bloomberg Opinion) -- Health-care costs are not as much in the news nowadays as they used to be. A big reason might be that cost growth has slowed in recent years. Between 1967 and 2007, per-capita health care costs rose at an average of 2.36 percent a year. Since then, it's only been about 1.31 percent.

That's actually not such great news. Health-care costs as a percentage of the economy have continued to rise:

Health-Care Costs Are Still Eating the U.S. Economy

What's more, health-care prices have still been rising faster than overall prices:

Health-Care Costs Are Still Eating the U.S. Economy

Together, these facts tell a simple story. As economic growth has slowed, growth in demand for health care has slowed, leading to slower cost growth. But at the same time, prices have risen, allowing health-care providers and insurers to extract a rising share of economic output.

Where is the money coming from? Until about 2007, a lot of it was coming out of wages:

Health-Care Costs Are Still Eating the U.S. Economy

Higher health-care prices drive a wedge between the amount that companies have to spend on employees and the amount that workers actually take home.

In recent years, however, most of the additional spending has come from the government -- probably as a result of Obamacare. This will cause either large persistent fiscal deficits, or much higher taxes.

In sum, health care is still eating the economy, and that's still cause for alarm.

Why is this happening? Some argue that the U.S. is just very rich, and that prosperous countries choose to spend more on health care, which drives up prices. They note, for example, that although U.S. health-care spending is unusually high as a percent of gross domestic product, it's not that high as a percent of individual consumption. But this isn't very convincing, because consumption is a result of high health-care prices as well as an effect -- high health care prices force Americans to use more of their income than people in other rich countries.

A new report by Josh Bivens of the Economic Policy Institute, a think tank, suggests that U.S. customers are indeed paying too much. Looking at how often Americans use specific medical services such as knee replacements and C-sections, he finds that they generally tend to use fewer of these procedures than people in a number of other developed countries. This strongly cuts against the narrative that Americans are simply choosing to consume more health care. They're using less, but getting charged a lot more. Bivens also demonstrates just how much higher U.S. health prices are than prices in any other rich country.

As for why prices in the U.S. are so high, there are several potential explanations. The simplest is sheer inertia and cultural complacency -- as in construction and higher education, Americans pay more simply because they're used to paying more. Lack of transparency in health-care pricing probably exacerbates the problem.

A second possible reason is health-care providers' monopoly power. Often, patients don't have the option of driving a long distance to find a different provider. Research by economists Zack Cooper, Stuart V. Craig, Martin Gaynor and John Van Reenen has found that hospital mergers tend to raise prices more when the combining hospitals are close to each other -- clear evidence of monopoly power in the industry. Consolidation of suppliers and middleman purchasers may also be a factor.

Economic theory suggests that the market power of sellers can be counteracted by the market power of buyers. In most other rich countries, which have government-run health insurance systems of one sort or another, the government is the main purchaser of health care. This allows it to negotiate lower prices with providers, passing the cost savings on to patients. And Bivens finds that in the U.S., Medicare gets better prices than private plans do:

Health-Care Costs Are Still Eating the U.S. Economy

So this would suggest that a government health insurance system -- a single-payer system like Bernie Sanders' Medicare For All, or a public option like the Medicare X plan -- would be able to reduce prices and bring American health care costs more in line with those enjoyed by other countries. Health care spending would still probably rise, as the population ages and per capita income increases, but at least some of the premium Americans now pay relative to people in France, Japan or Canada would vanish.

There's another good precedent for this approach -- military spending. A recent paper by economists Rodrigo Carril and Mark Duggan found that although U.S. defense contractors have been consolidating, and have adopted a form of contracting that's generally favorable to contractors, defense procurement prices haven't risen as a result. The likeliest reason is that the government's market power cancels out that of even the biggest contractors.

There is, however, a potential problem with the government approach. As Bivens documents, employer contributions to health-care spending have been essentially constant since 2009, with almost all of the spending increase coming from the government. This suggests that the government could be doing a lot more than it is now to negotiate lower health care prices. Why this is happening isn't clear; perhaps it's because government insurance is fragmented between Medicare and a variety of other systems, or maybe it's because Medicare and other government insurers are prevented by law or culture from wielding their negotiating power to full effect.

Any government system must therefore have price negotiation as its primary focus. If the U.S. continues to complacently accept ever-higher health care prices, ever more of workers' wages and national output will be sucked away with nothing more to show for it.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Noah Smith is a Bloomberg Opinion columnist. He was an assistant professor of finance at Stony Brook University, and he blogs at Noahpinion.

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