Health and Economics

Krugman and Wells' Analysis of the Health Care Crisis

From obesity to ADD, health care issues often seem to be of serious concern to Americans. However, it seems like barely a day goes by without the media reporting on the declining quality and increasing cost of health care in the US. This crisis has been developing for some time; between 1960 and 2006 the US saw a 33-fold increase in the amount of money spent per capita on health care (Sarafino).

According to Krugman and Wells' article "The Health Care Crisis and What to Do About It," a series of factors have prevented health care from becoming one of politicians' primary concerns; these factors include the unwillingness of politicians to confront insurance agencies, a temporary slow in the growth of health care spending by HMOs in particular, and other nation-wide distractions including terrorism.

Krugman and Wells further identify the three problematic outcomes of rising medical costs as "the increasingly rapid unraveling of employer-based health insurance," "the plight of Medicaid," and "the long-term problem of the federal government's solvency." Moreover, the authors say that the failure to implement universal health care has led to the development of more players in the health care system including private insurers and for-profit hospitals who contribute to rising costs but not to overall quality. They suggest that a universal "single-payer" system, like in Canada where the government provides insurance to all citizens, would be both cheaper and more effective than the current system in the US today. Thus, the article begins by analyzing the underlying economic concepts that pertain to health care. Then it describes how these concepts relate to the problems faced by US health care consumers. Finally, it makes predictions and suggestions for future improvements.

Krugman and Wells

Paul Krugman and his wife Robin Wells are both professors at Princeton University, where they have collaborated on a number of scholarly articles, such as the one we will discuss here, as well as our lovely textbook. Additionally, Krugman's research focuses on international trade and currency crises; he is one of the founders of the "new trade theory." Wells' research is devoted to theories of organizations and incentives.

Is Health care spending a problem?

Since 1960 US spending on health care has risen from 5.2 percent of GDP to 16 percent. The authors note that "health care spending is rising rapidly 'regardless of the source of its funding.'" In other words, government and private health care spending are growing faster the economy is. To back these assertions up with some numbers, from 2000 to 2004 in the US, private health care spending increased from approximately $756 billion to $1,030 billion, while public spending (national, state and local government) increased from approximately $602 billion to $874 billion (National Center for Health Statistics). Furthermore, the US has the highest percentage of per capita spending on health care and the highest percentage of GPD spent on health care when compared to other countries (National Center for Health Statistics). Krugman and Wells point to the development and increasing importance of new, expensive medical technology as a contributor to these high costs. The article states, "so far, this sounds like a happy story. We've found new ways to help people, and are spending more to take advantage of the opportunity."

However, there are two major reasons why rising medical spending is not simply a response to expanded choice. In the first place, Krugman and Wells note that the US health care system is extremely inefficient. And, as health care spending increases as a proportion of GDP, so does the amount of wasted money. This contributes to the problem of irrational choices in the health care system. The best example of this is how the health care system divides people into "insiders," those who have access to good insurance and medical help, and "outsiders," those with poor or no insurance or medical care. Krugman and Wells note that as the health care system spends more money on the technology to help "insiders," they have to compensate for the additional spending by forcing more and more people into "outsider" status.

The unraveling of employer-based insurance

The main methods of payment for medical bills consists of public or private insurance. In 2003, only 16 percent of health care spending was paid out-of-pocket. Since insurance companies are responsible for the costs of medical treatment, patients and doctors make decisions based on what is or is not covered by insurance. Generally people only have small medical bills every year, but there is a small percentage of the population that has very large bills. An example of this is the "80-20" rule which means that 20 percent of the popuulation accounts for 80 percent of medical expenses. Insurance is a necessary part of health care since most people would be unable to afford majority of medical procedures by paying out-of-pocket. However, an economic problem known as adverse selection has a negative effect on medical insurance.

An example of adverse selection would be an insurance company who charges one set price on their policies to everyone. The portion of the population with large medical expenses would find this a great offer, while the people with very few medical expenses would not. The insurance company would then be aquiring clients with very high medical costs, and the average medical costs would actually be higher than an average person in the population. In order to account for this, the insurance company would have to raise the costs of their policy, and in doing so the insurance company would be driving away their healthier clients. The insurance companies are able to avoid adverse selection by carefully picking who they choose to accept as clients. Clients with high medical costs will generally not be accepted or need to pay higher premiums. Screening is also an expensive process as well and generally tends to turn away those who need medical care most. For those who cannot afford health insurance, the government has provided Medicaid and for seniors the government has provided Medicare.

Employer-based insurance has worked to decrease adverse selection throughout the years. Employer-based insurance began in World War II because of the labor shortage. The employers could not attract employees by offering higher wages due to the controls on wages. The health benefits were then used as a way for employers to compete for workers. In 2004, 63.1 percent of the American population under the age of 65 received health insurance through their employers of family members employers. In previous years, employers used insurance as a way to reward their employees. However, the annual cost of coverage for a family of four is estimated at more than $10,000. Now that health care costs are incredibly expensive, some companies are paying their employees more than their competitors pay similiar workers. This inflicts a pressure to completely remove health benefits. However, adverse selection cannot be completely removed through employer-based insurance. Some people actively seek out jobs that have generous benefits, and the employers now are doing a version of their own screening by making hiring decisions based on a candidates likely health costs. Unfortunately, due to an increase in technology, medical procedures are becoming increasingly expensive and employers want to stop providing health benefits.

Medicaid and Medicare

In the United States, nearly half of all health care spending comes from the government through Medicare and Medicaid. In 2004, Medicaid covered 37.5 million people and Medicare covered 39.7 million people. Medicaid has become increasingly important in providing medical care now that the employer-based insurance is unraveling. The number of Americans covered by Medicaid rose by 8 million between 2000 and 2004. Over this same time frame, the number of people uninsured rose by 6 million. Unfortunately, Medicaid is under political scrutiny. As Richard Titmuss, a British welfare scholar, said, "Programs for the poor are poor programs." The recipients of Medicaid generally don't vote, are poor, and poorly educated. Medicaid is a fedieral-state matching program, and the state provides approximately forty percent of the funds. So when state budgets are facing trouble, pressure is put on the Medicaid programs. Because of rising health costs, Medicaid is also as risk for unraveling like the employer-based insurance. To prevent this unraveling, South Caroline is attempting to re-work their Medicaid system by distributing a voucher that can be used to purchase health insurance. Unfortunately, many people would find this voucher would not cover the costs of their health insurance and would be denied care.

Medicare is a vastly different institution from Medicaid. There is very little threat of Medicare unraveling like employer-based insurance and Medicaid. A problem in rising costs is known as excess cost growth, which is "the persistent tendency of health care spending per beneficiary to grow faster than per capita income." So basically, health care costs are exceeding income of the average person over age 65.

The "Consumer-Directed" Diversion

One of the two big reasons to be concerned about the rising spending on health care is that as the health care sector grows, its inefficiency becomes increasingly important. It is widely agreed that the US health care system is extremely inefficient, yet there are disagreements about the nature of the inefficiency. The analysts who have the ear of the Bush administration are committed to a view that is clearly wrong. The underlying view behind the Bush administration’s health care proposals is the view that insurance leads people to consume too much health care.

The view that American consume too much health care because insurers pay the bills leads to what is currently being called the “consumer-directed” approach to health care reform. The main idea of this approach is that people should pay more of their medical expenses out of pocket. Right wing reformers believe that the way to reduce public reliance on insurance is to remove tax advantages that currently favor health insurance over out-of-pocket spending. Last year Bush’s tax reform commission proposed taxing some employment-based health benefits, however the administration recognized how politically explosive this move would be and rejected the proposal. Instead, the administration decided to cut taxes on out-of-pocket spending.

In their book Healthy, Wealthy, and Wise, John Cogan, Glenn Hubbard, and Daniel Kessler call for making all out-of-pocket medical spending tax-deductible, although tax experts from both parties say that this would present an enforcement nightmare. So far the administrations proposals are more limited, focusing on an expanded system of tax-advantaged health and savings accounts. This allows for individuals to shelter part of their income from taxes by dipositing it in such accounts, then withdraw money from these accounts to pay medical bills.

Problems with consumer-directed health care: -One immediate disadvantage is that health savings accounts provide yet another tax break for the wealthy. -A deeper disadvantage is the such accounts tend to undermine employment-based health care, because they encourage adverse selection: these health savings accounts are attractive to healthier individual, who will be tempted to opt out of company plans, leaving less healthy individual behind. - Another problem with consumer-directed care is that evidence says that people don't, in fact, make wise decisions when paying for medical care out of pocket. People tend to cut back on their consumption of health care when they pay the medical expenses themselves.

Perhaps the biggest objection to consumer-directed health reform is that its advocates have misdiagnosed the problem. They believe that American have too much health insurance. The implication is that health costs are too high because people with insurance consume too much routine dental care and are too ready to visit the doctor about a sore throat. That argument is all wrong. Excessive consumption of routine care, or small-expensive items, are not a major source of health care inefficiency, because such iteams don't account for a major share of medical costs. The great bulk of medical expenses are accounted for by a small number of people requiring very expensive treatment. The problem of health care costs is not due to visits to the family doctor but by expensive procedures including coronary bypass operations, dialysis, and chemotherapy. Nobody is proposing a consumer-directed health care plan that would force individuals to pay a large shore of extreme medical expenses, such as the costs of chemotherapy, out of pocket. This means that consumer-directed health care can't promote savings on treatments that account for most of what we spend on health care. The administration's plans for consumer-directed health care, then, are a diversion from meaningful health care reform, and will actually worsen our health care system.

Single-payer and beyond

According to Krugman and Wells the United States spends double the amount on health insurance than other advanced countries like France and Britain. While at the same time the U.S. fares worse in certain criterion including life expectancy and infant mortality. Many argue that the U.S. health care system is actually better than other countries but it is negated by high rates of obesity. But evidence shows that the U.S. not stand out in quantity of care; but it does stand out in health spending per capita (Table 1). According to a study published by Health Affairs the U.S. has no advantage in the quality of care as well. They assess that, “the United States often stands out for inefficient care and errors and is an outlier on access/cost barriers.”

The main reason as to why U.S. health care is so expensive is the use of private insurance as opposed to public insurance. Research by Krugman and Wells has shown that the public insurance of other countries are cheaper and achieve equal or better results. This result can be derived from two factors in public insurance: low administrative costs and the ability to bargain with suppliers. Private insurance companies take the time to select their customers based on risk evaluation. Public systems such as Medicare are the Canadian single-payer system do not need to worry about these costs because they cover an entire population (Medicare covers every American that is sixty-five or over). The ability to bargain with suppliers such as drug companies creates loads of savings. Privately insured Americans play ridiculously large bills for prescription drugs while Americans under public insurance pay as much as several times less. The advantages of a public health system are blatant. The percentage of American’s covered by insurance would skyrocket and prices would stay the same. In 1995, Taiwan switched to a single-payer system and the percentage of the population covered by health insurance went from 57% to 97%. At the same time health care cost grew a very surprisingly slow rate.

There are already decent public health systems in the United States. The Veteran’s Administration runs its own hospitals and clinics and offers some of the best health care in the country while at the same time maintaining some of the lowest costs. This is done by the advantage of knowing that they will be supporting individuals for the duration of their lives. This allows them to keep better records and the ability to invest in preventive care.

Unfortunately, the US government is not ready to implement a complete public health system. In 2003, new legislation added drug coverage to Medicare. However it introduced a new concept to Medicare because the government was not actually paying for the drugs. It was a program that had private insurance companies offer insurance and they would receive subsidies in return. They also barred seniors from dealing with Medicare directly to support the private insurers. This new program came with many problems. There was a lot of confusion because of its complexity since there were so many drug plans. The addition of private insurance also led to higher administrative costs and the loss of the ability to bargain with health product suppliers. The legislation actually included a provision that restricted Medicare from trying to get lower prices. Essentially. the foreseeable success of a potential public health system has been effectively dismantled by the Bush Administration.

Beyond reform: How much health care should we have?

When analyzing how much health care we should have, many factors go into determining the outcome. For example, if a future US administration were to push through a fundamental reform of health care that covered all the uninsured, replaced private insurance with a single-payer system, and took into account the advantages of integrated health care, our health care problem would still not be solved. The problem is that while reform would bring great improvements to our situation, the concept of advancements in technology would bring about the question of "How much of what can we do, should we do?"

While advancements in technology would allow the country to spend large sums of money on medically useful health care, the question still remains of how will we make choices about what no to do if there are few restrictions on our budget. Economists Henry Aaron and William Schwartz studied this dilemma, and in doing so, compared the United States healthcare to that of the British system. The British system has operared under tight budget limits that force it to make hard choices in a way that the United States does not (nybooks.com/articles/18802). In other words, the British system is more strict about how much money to spend on certain procedures and surgeries for specific people; for example, in this country our system allows an expensive surgical prodcedure to be perfomed on an elderly person who may not have many years left to live; but in England, the strict limits on health care would not allow this specific procedure to go through. This study forces the U.S. to think about problems that it will potentially face regarding money and health care, and how much money the U.S. should ration in its health care policy.

When analyzing how much health care we should ration, Aaron and Shwartz argue that the reason the United States needs universal health care is because a universal system can ration care in a way that private insurance can't (nybooks.com/articles/18802). Universal health care would cover those who are uninsured and it is cheaper than the system we currently have. Economist Uwe Reinhardt believes that in order to eleimate the gross inefficiencies that exist in the US health care system, we need to adopt universal health care to cover the uninsured which would cost less money than we spend now.

Can we fix health care?

Liberal Economists believe that constructing complex compromise plans between universal health care and private health care would solve our inefficient health care system. These economists have proped that we should develop plans that achieve universal coverage by requiring everyone to buy health insurance, and consequently deal with those who are unable to purchase insurance through a system of subsidies (www.nybooks.com/articles/18802). Some are worried, however, that it will be impossible to cut out private insurers because they are too powerful, and the idea of a "single-payer system," which means there is only one system for the payment of doctors, hospitals, and other providers of health care" would never be successful, even though it is the least expensive way to provide universal health care coverage.

While compromise plans by cautious reformers would run America into the same political problems, Henry Aaron and William Schwartz believe, that in time, America will end up with national health insurance, and with a lot of direct government provision of health care, becaue nothing else has proved to work.

[[Image:

This graph illustrates the difficulties in measuring the value for money in healthcare in the countries of Enland, UK, Scotland, and Northern Ireland as compared to the United States. This puts the above comparison of Britian's philosophy on healthcare comparde to the United States' philosophy into some perspective when analyzing other countries.

Image is credited to: www.bma.org/uk/.../$FILE/graph-fig4.jpg

References

Sarafino, Edward P. Health Psychology: Biopsychosocial Interactions. 5th edition. John Wiley and Sons. 2006