Home > Uncategorized > Baumol’s disease? George Will’s misdiagnosis of U.S. health care costs

Baumol’s disease? George Will’s misdiagnosis of U.S. health care costs

from Dean Baker

In his Washington Post column today George Will told readers that the problem of rising costs in the U.S. health care system is simply a case of Baumol’s disease. This refers to the problem identified by economist William Baumol (who recently died), that productivity in the service sector tends to rise less rapidly than productivity in the manufacturing sector. The implication is that if workers get paid the same in both sectors, then the cost of services will always rise relative to the cost of manufactured goods. Will tells us that this is the story of rapidly rising health care costs.

There are a couple of big problems with this story. First, it is not always the case that productivity in services rises less rapidly than productivity in manufacturing. ATMs have hugely increased the ability of banks to serve customers without tellers. Film developing became hugely more productive with digital cameras.

It is quite likely in the decades ahead that we will see innovations in technology that will lead to large increases in productivity in health care. For example, improvements in diagnostic technology will likely allow a skilled technician to diagnose illnesses with better accuracy than the best doctor. Similarly, robots will almost certainly be able to perform delicate surgeries with more precision than the best surgeon. In these and other areas of health care there is enormous potential for productivity gains, assuming that doctors and others who stand to lose don’t use their political power to block the technology.

This brings up the second point. While health care costs have risen everywhere, no other country pays anything close to what we do in the United States, even though they have comparable outcomes. The figure below shows per capita health care spending in the United States and five other wealthy countries since 1971. (The numbers shown are from the OECD and expressed in purchasing power parity. I converted them to 2016 dollars using the PCE deflator.) 

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As can be seen, health care costs have been rising everywhere, but nowhere have they risen anywhere near as rapidly as in the United States. At the start of this period in 1971 the United States didn’t even lead the pack in per capita spending, coming in slightly below Denmark. In 2015, health care costs in the U.S. were more than twice as high as in Denmark and France and almost 2.4 times as high as in the United Kingdom. Even if we compare costs with Germany, the second most expensive country in this group, the savings would still be almost $4,200 a year per person, or more than $1.3 trillion for the country as a whole.

The reason our health care costs have risen so much more rapidly than anywhere else is not Baumol’s disease. Health care is a service everywhere, not just in the United States. The difference stems from the fact that doctors, insurers, drug companies, and medical equipment makers are far more capable of controlling the political process in the United States than in these other countries. They use their political power to restrict competition and get government subsidies. As a result, these actors are able to secure massive rents that come out of the pockets of the rest of us.

It is understandable that columnists and newspapers that would like to protect these rents would try to tell the public that high-cost health care is just a fact of nature, but it is not true.

  1. Bill Turnier
    May 23, 2017 at 2:25 am

    George Will completely ignored productivity advances in medicine that occur entirely because of new developments in medicine due to improved modalities for treatment. For example, the halo device has resulted in people who suffer an unstable neck break no longer spending 6-8 weeks in traction in a hospital. Instead once the break is detected, the halo device is employed and the patient sent home to spend the 6-8 weeks with family. Much surgery, such as hernia repair. that used to require a stay of a few days in hospital now are done quickly with the patient returning home in a few hours.

  2. May 23, 2017 at 4:16 am

    There is another reason for the increase. Privately owned, for profit health care insurance companies, like all other for profit companies, wish to increase sales, increase profits and increase executive salaries. To accomplish this they need to increase premiums which can be justified by increased cost for medical treatments. Hence, whenever they have an option they will naturally seek to bolster the cost of health care because it will benefit their bottom line.

  3. patrick newman
    May 23, 2017 at 9:35 am

    There should be no significant difference in productivity between developed countries because medical knowledge – both treatment and procedures – is shared globally and investment readily funded. The difference is complex and unnescessary ‘bureaucracy’ required to sustain and develop the commercialisation and monetisation of patient engagement. It explains why in the UK there is universal national health insurance that eliminates any third party that modulates and processes patient access to health providers. May Bernie Sanders lives till he is 100!

  4. Paul Davidson
    May 23, 2017 at 4:01 pm

    A basic principle of my Post Keynesian theory is : “A cost is always somebody’s income”. . If we are to control costs of health care we must control the incomes of doctors, hospitals drug companies, etc
    Most countries that have kept heath care costs from rising as rapidly as cost have risen in the USA have “socialized” medicine where doctors, hospitals, etc income are directly controlled.

  5. Risk Analyst
    May 23, 2017 at 9:31 pm

    I am guessing that I am the only one on this site who has actually worked in hospital pricing, at a children’s hospital in a big city. In contrast to some of the above, our hospital had no political power as far as I know. I will say there was one case where I was in a meeting and management was considering contacting a competitor to see if they would discuss pricing, although I believe that is actually not OK from a legal standpoint. I do not think they did or that information would have been added to my project. I will tell you what I do know from this part time job I had during college.

    I did database programming and analytics for the purpose of identifying the relationship between our prices for various surgical procedures and what our reimbursements were from the various insurance companies. If our reimbursement as a percent of the bill was really high, it was a flag that we were not charging enough and the group (eg. like cardiology) was counceled to increase their prices. Never once was I asked to look at costs, and no other person would have been working on this except me so I don’t think costs were a consideration. I have no idea about any other contractual relationships if any existed specifying pricing with the insurers and I cannot now go back and ask. So my view from the trenches was that the prices were increased in response to how well insurance companies were reimbursing. Now as I said, this job was a couple of decades ago but I assume the same kind of approach is still used.

  6. May 24, 2017 at 9:52 am

    I wonder if G Will knew this concept or had one of his multiple interns dig it up —i think he has many more people doing research help for him on his weekly or newspaper column than people writing a technical paper in biology, physics etc. —one reason its often smarter to go into journalism or politics than sciences.

    I think oomments got it mostly right. There is an incentive for hospitals to charge people for as many treatments as they can–run up the bill (almost like people who would take their car in for a tuneup and then get told they need a whole lot of costly work). Another issue is ‘allergic reactions’–i had one a few years ago when i had pneumonia—i should have ben out in 3 days which ran into 6 weeks—220,000$ (which i didnt pay except 8. %–tax payers picked that bill up since i didnt have it. Sometimkes its better to avoid hospitals and ride it out). They do have some very good doctors in hospitals–i was on life support so i had alot of doctors.)

    One thing is the lower level staff from nurses to janitors dont really make the big money. Prevention is better but in this society getting ill is a business—one has junk food, opiate and other drugs on the street, often little encouragement to have a healthy lifestyle–often one is encouraged to watch a TV show and eat junk food rather than take a hike outside.

  7. May 24, 2017 at 10:33 am

    Many parts of the US had socialized medicine at some points in the past. But we lost it. I grew up in TX but had family all over the southern US. From Louisiana to Kentucky, from Florida to Virginia. When I visited as a kid in the 50s most hospitals were religious or owned by government (e.g., state, city, county). And many doctors received scholarships from local community organizations for medical school on the understanding they would return to practice locally. This is an interesting mix of a private business and a government service. This changed greatly over the next 50 years. Many of these religious and government hospitals have sold off and turned into private, for-profit businesses. The Boston Catholic hospital made famous as TV’s “St. Elsewhere” is now privately owned.” Between MDs wanting to maximize earnings, hospitals wanting to maximize profits, and the greed of drug companies is it any wonder that per-capita health care costs that were near $500 in 1950 are now nearly $,9000 (2016 dollars). Half that amount it can be argued is the result of general inflation. But what about the other half? This is not a problem in economics but rather a problem in social organization. Most other developed nations choose a different organization of health care from the US. An organization that does not artificially increase prices/billing to increase the wealth of MDs, hospitals, and insurance companies. The US made some poor choices in health care between 1950 and today. Particularly between 1980 and 2016.

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