Is the High Cost of U.S. Medical Care Due to an Oversupply of Services?

The notion that excessive supply can result in overly high costs no doubt contradicts most reader’s understanding of how markets work, but the market for medical services in the US bears no resemblance to an efficient market, in which buyers and sellers possess an equally good understanding of the merits of the goods and services being offered. Patients rarely reject a doctor’s recommendation for a course of action; the vast majority accept whatever tests or procedures he recommends. At most, patients might get a second opinion for a high risk or high cost procedure. Thus medical services is not a well functioning market; most customers are price insensitive, even accepting charges that will put them into bankruptcy, and their inability to evaluate service quality makes them the perfect stuffees (seriously: are you in any position to evaluate your doctor’s competence? Unless you are a medical professional yourself, you rely only on crude proxies, namely his bedside manner and how he describes his decision process in recommending a course of investigation and treatment).

Arnold Relman, in a New York Review of Books essay on John Wennberg’s Tracking Medicine: A Researcher’s Quest to Understand Health Care (hat tip reader Roger Bigod), explains the seeming conundrum of how oversupply is a central, if not the central factor in the US medical services mess. I recommend reading the article in full.

He describes the pathology of the US health care system: that the core problem is cost, yet the mislabled health care reforms not only sidestepped this issue, but if made matters worse by assuring health insurers a monopoly position. Relman estimates that the peculiar private health care insurance regime alone adds at least $150 billion to $200 billion to the total expense of US health care without providing benefits even remotely in line with the price tag.

However, he does not regard that as the central problem but instead focuses on the role of physicians:

[O]nly in the US are there such strong business incentives to supply ever-increasing amounts of expensive technical care, even when it is not medically needed….these incentives cause US physicians and hospitals—both for-profit and not-for-profit—to act like businesses and to maximize their income, thus increasing health expenditures….

Of all the providers of medical care, physicians are most important in determining how much will be spent. In the US they account for only about 20 percent of medical expenditures, of which about half they use for expenses. But in treating patients, physicians call on the facilities and services of all the other providers of care—hospitals, imaging centers, diagnostic laboratories, manufacturers of drugs and equipment, etc.—and thus they control most medical expenditures.

What most people do not understand, but is actually well documented, is that medicine in the US is a retrograde form of Say’s law in action, where supply creates its own demand:

[Wennberg’s research] provides convincing evidence that oversupply of services throughout the US adds greatly to the cost of care. This evidence rests on an ingenious analytical approach devised by Wennberg and his colleagues, which compares health care expenditures in many different regions of the country…..

Wennberg founded the Dartmouth Institute for Health Policy and Clinical Practice and has spent his career studying the distribution of health care. Nearly forty years ago he made the seminal discovery that there were large differences between neighboring Vermont towns in the frequency (i.e., incidence per population) with which tonsillectomy was performed. These differences could not be explained by medical need or by the sociodemographic characteristics of the populations involved, and were not accompanied by any discernible differences in the health of the children in these towns.

These initial observations were followed by the discovery of similar regional disparity in the provision of other medical services elsewhere in New England….

Such large variations in medical services occur widely, as Wennberg and his colleagues later found when they began to analyze the masses of data collected by the federal government on payments for the care of Medicare patients. They devised new methods for studying the frequency of selected common medical services for the treatment of chronic diseases among the elderly as they neared the end of life (this helped correct for any regional differences in the average severity of illnesses). Their results were published in many articles in peer-reviewed medical journals and in a series of richly documented volumes from the Dartmouth Institute (The Dartmouth Atlas of Health Care)….

The data revealed as much as two- or threefold variations in the use of services when the country is divided into 306 hospital referral areas. The variations in Medicare services resembled those Wennberg first found in New England. They closely coincided with the availability of hospital beds and physicians in those areas, but not with the sociodemographic characteristics of the populations served or their need for medical services. Furthermore, he found no evidence that these variations in medical services resulted in different overall outcomes in the health of patients.

The general implications of the research by Wennberg and his Dartmouth colleagues are now widely accepted. Other researchers repeating some of the Dartmouth studies have come up with slightly smaller estimates of the extent of the area variations, and there have been a few technical criticisms of the Dartmouth methodology, but there is general agreement with Wennberg’s central conclusions.

Yves here. It is hard to believe that the people in the Obama Administration tasked to develop a health care reform plan were not aware of this research. The failure to take on the core issues leading to health care costs run amok shows a lack of imagination and will. Admittedly, any solution to the problem would need to be far-reaching (for instance, the huge cost of often-student-loan-financed medical education would need to be addressed in parallel with efforts to restrict physician excesses). But a realistic problem is that most patients are unwilling to think that their doctor might be racking up unnecessary costs on their behalf, even when the evidence is compelling that that sort of behavior is widespread.

Originally published at naked capitalism and reproduced here with the author’s permission.

2 Responses to "Is the High Cost of U.S. Medical Care Due to an Oversupply of Services?"

  1. gregtooke   September 15, 2010 at 7:45 am

    I lived with enlarged cryptic tonsil most of my life because of a movement like this in the U.S. in the 1970’s. I had strep throat, tonsillitis almost monthly, and as an adult, obstructive sleep disorder. I finally had a tonsillectomy at age 44, (a rough experience read about it: ), I haven’t had so much as a cold since, and sleep through the night.How much bettter would life have been, had some “directive,” hadn’t been instituted?