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Why Health Care Will Always Be Unreasonably Expensive

July 5th, 2008 . by economistmom

For a few weeks now, I’ve been meaning to write about CBO’s recent work on controlling health care costs, and this morning it was an article in the New York Times by Gina Kolata and Andrew Pollack (I think to appear in the Sunday paper) that reminded me.

CBO Director Peter Orszag has recently testified on the problem of rising health costs and the best policy strategies for pushing back on that trend (or as Peter puts it, “bending the growth curve”).  On his Director’s blog he summarized that (my emphasis added): 

  • The single most important factor influencing the federal government’s long-term fiscal balance is the rate of growth in health care costs, caused largely by rising health care costs per beneficiary.
  • The significant geographic variation in per capita health care spending across the United States suggests substantial inefficiencies in health care today and an opportunity for reducing health costs without adversely affecting health outcomes.
  • These inefficiencies are perpetuated, in part, by a lack of clarity as to what insurance costs and who ultimately pays those costs– especially with regard to employer-provided health insurance.
  • Providing more information on the “comparative effectiveness” of alternative medical treatments, and changing financial incentives that encourage providers to engage in expensive treatments and procedures may help shift professional norms to improve efficiency and restrain cost growth.
  • Increased transparency with regard to specific medical services may not lead to reduced health care expenditures, however, because consumers generally don’t make independent decisions about what services to purchase from whom, particularly in an emergency. In addition, many health care markets are relatively concentrated, and in those settings, increased price transparency may lead to higher, rather than lower, prices for specific services by facilitating collusion among providers.

I would add that even without the third-party payment problem (which obscures the true cost of health care from the suppliers and demanders of that health care), and even when consumers are making their own, “independent decisions” about their health care purchases based on really good, objective information on the benefits and costs of various forms of health care, there would remain a big reason why demand for certain types of health care, and hence the market prices for such care, would be irrationally high.  That is that people cannot dispassionately, objectively, make rational economic choices–weighing costs against benefits–when it comes to life-and-death decisions.

I think that a family making decisions about health care spending, particularly end-of-life health care spending, is a lot like a parent making decisions about spending money on their children towards activities that might be considered “investments” in their kids (music lessons, sports training, braces, SAT prep classes, etc.).  Instead of following economic theory and consuming the amounts of these goods and services that equate marginal benefit to marginal cost (thereby maximizing net benefit), parents tend to go through the following calculus… Question 1:  Is there any reason to believe there’s any chance of some positive benefit to this activity, however small or uncertain–i.e., is MB>0?  Question 2:  Can I somehow afford it–i.e., does buying it fit in my budget constraint?…

To think any other way than this “irrational” way–i.e., to think more “rationally” like an economist, comparing (equating) the marginal benefit to the marginal cost (stopping oneself from consuming any more of these services once the benefit seemed low relative to the cost), would seem immoral–or at best a big time shirking of parental duty.  Because if you are a parent, you want to feel like you’ve done everything you could have to give your kids the best life possible; you don’t want to think that your being “cheap” caused your child’s life to end up falling just short of their “potential.”  (I have done a lot of informal polling on this issue with many fellow parents, including usually-rational economist parents, so I know this phenomenon to be true.) 

The New York Times article highlights this phenomenon as it applies to health care spending (more specifically the demand for prescription drugs), in its story on the costly cancer drug, Avastin.  Here are some relevant passages:

If Avastin were inexpensive or if it cured cancer or even held it at bay, as the drug Gleevec does for blood cancer, few might care. But like a half-dozen or so new biotechnology drugs with a similar combination — alluring promise, high price and only arguable benefits — Avastin raises troubling questions:

What does it mean to say an expensive drug works? Is slowing the growth of tumors enough if life is not significantly prolonged or improved? How much evidence must there be before billions of dollars are spent on a drug? Who decides? When, if ever, should cost come into the equation?

For a patient like Ms. Reeh, fighting for her life, the cost is not the main concern. If her insurer did not pay, she said, she would go into debt, find a way to raise the money.

But some in the pharmaceutical industry worry that such prices will raise concerns about whether the drugs are worth it, leading to a backlash like price controls or restrictions on use.

Roy Vagelos, a former chief executive of Merck who is considered an elder statesman of the industry, said in a recent speech that he was troubled by a drug, which he would not name but which was a clear reference to Avastin, that costs $50,000 a year and adds four months of life. “There is a shocking disparity between value and price,” he said, “and it’s not sustainable.”

The problem is largely one of cost.

The drug’s price, as charged by Genentech, can be $4,000 to more than $9,000 a month, depending on a patient’s weight and the type of cancer. Avastin’s cost to patients and insurers can be much higher, though, because doctors and hospitals buy the drug and then sell it to patients or their insurers, often marking up the price. So the $2.3 billion that Genentech recorded in sales of Avastin represents only part of what Americans spent on the drug last year.

… 

Medicare requires that the doctor or hospital buying Avastin be paid an amount equal to Genentech’s average selling price plus a markup of 5 to 6 percent. Of that amount, Medicare pays 80 percent and the patient pays 20 percent. Doctors and hospitals typically do not make much money on Avastin for Medicare patients, and can even lose money if they buy the drug at a price that is higher than average. But patients can end up paying thousands of dollars a month. Some have supplemental insurance to take care of it; others do not.

Other countries have different views about whether Avastin is worth its price. An institute that advises the British government on which drugs to pay for recommended against it, saying that the drug was not cost effective based on its cost per year of life extended.

In the United States, Genentech argues that it puts patients first, with free drugs for those who have no way to pay for them and donations to charities that can help with payments. It also capped the price for a year’s supply of Avastin at $55,000 (not counting markups by doctors and hospitals) for patients with incomes of less than $100,000 a year.

But progress against cancer has a price, the company says.

“The quest is to eliminate the disease,” Arthur D. Levinson, Genentech’s chief executive, said at an annual investor meeting. “And, yes, there is going to be a cost to that.”

Dr. Winer says that when he is not sitting in front of a patient, he thinks about whether drugs like Avastin are worth it to society. But when facing a seriously ill patient, who, based on clinical trial results, might benefit — even if only a little — from Avastin along with chemotherapy, he has to think about his patient’s needs.

“I can’t say, ‘Let’s not use Avastin; it’s a very expensive drug and I am worried about the cost to society,’ ” Dr. Winer said.

And so, Dr. Winer said, the answer you get when you ask whether drugs like Avastin are worth it very much depends on whom you ask.

“A person who hasn’t been affected by cancer will say, ‘Gee, why should we pay for an expensive treatment that doesn’t extend life when we have other needs?’ ” Dr. Winer said.

A person like Ms. Reeh will have a different response. She does not want to give up Avastin.

Ms. Reeh says she knows her cancer may very well kill her eventually. But what is it worth to feel better again?

“It’s really about living and not waiting to die,” she said.

And what if 5 percent of Avastin patients live a lot longer than they would have without the drug?

“I might be in that 5 percent,” she said.

The other way to think of our irrational consumption when it comes to our health care and our children might be that we do think about equating marginal benefit to marginal cost, but the marginal benefit of these things is perceived as close to infinite–whether it’s because when you have very few days left, each day is worth so much more (take any positive number and divide by a number that approaches zero), or because when you’re spending on your children you feel as if you’re effectively facing an “infinite horizon.”

In any case, there’s plenty of reason to believe that even without markets distorted by third-party payments or government subsidies, there would be plenty of people in the free marketplace who would have virtually unlimited demand for such services (and the means to afford it), so there’s plenty of reason to believe that things like cancer drugs and SAT prep tutoring will remain very expensive. 

6 Responses to “Why Health Care Will Always Be Unreasonably Expensive”

  1. comment number 1 by: BlueDog

    As someone who has been intimately involved in the medical decisions of a family member with serious injuries I can personally attest to this phenomenom. Although I am a rational non-economist, I made numerous decisions based solely on the criteria of whether it would improve her health and quality of life without regard to the cost, and in several instances worked to get approval for treatments and services that more “rational” claims examiners did not think were necessary. I was well aware of the fact that my actions exemplified why health care is so expensive, but did so unapologetically.

    This underscores one of my frustrations with the debate over long term entitlement spending. Whenever the issue of entitlement spending is raised the response invariably is that the real problem is health care costs and that talking about anything else (say Social Security reform) is at best a distraction and at worst an effort to confuse the issue in order to advance an ideological agenda. But it is precisely because we as a society want a health care system that provides the best possible care even when there is limited marginal benefit that we need to look at other parts of entitlement spending.

    There clearly is room for greater efficiencies and savings in the health care system, and we should aggressively pursue policies such as comparative effectiveness. Health care spending should not, and probably can not, continue to grow at 2.5% faster than the economy. But is it realistic to expect us to limit health care growth to GDP? Would we as a society really want to make the choices necessary to do that? My personal experience has given me some sense of the rational economic decisions that would have to be made in order to do so, and I don’t think we do.

    If we lower health care spending to something less than it’s current rate of growth but still faster than the economy, and over the long term revenues will grow at roughly the rate of the economy, something has to give in the rest of the budget. That is part of why dealing with the Social Security shortfalls is important — reducing the rate of growth in Social Security spending and the pressures that the Social Security system will place on the rest of the budget will provide breathing room in the federal budget to accomodate higher growth in health care entitlements.

    That is also why a heavy reliance on increased revenues to close the Social Security shortfall is dangerous. If as I suggest health care spending will continue to growh faster than the economy even under the most ambitious reforms, we will need to devote an increasing share of the revenue base to meeting those costs.

    Ultimately all taxes, whether they be payroll taxes, income taxes, corporate taxes, etc. come from the overall economic pie. Even if revenues increase as a percentage of GDP, as I believe they must, there are political and economic limits as to how much they can be increased. Every additional fraction of the revenue base that is used to close the Social Security shortfall leaves less room to increase revenues in order to keep pace with the growth of health entitlements.

  2. comment number 2 by: economistmom

    BlueDog: You’ve just said a lot of what I was going to say in a new thread about “why pick on Social Security” (similar to a “why pick on revenues” post I did early in this blog’s life). I’m going to have to quote from your comment when I do that later this week. So, thanks! :)

  3. comment number 3 by: Joshua Uy

    Hi Diane! My dad forwarded this to me. How cool. I agree with your article on health care costs. I can’t imagine that consumers (even physicians who are patients like me!) could possibly have the savvy to decrease costs. It won’t happen.
    josh

  4. comment number 4 by: coberly

    mom

    actually, it’s a good argument for a single payer who has the resources to evaluate costs and outcomes and to pressure providers to care about costs.

    but it is also necessary to get people to understand that it is “we” who pay those costs. not government, not insurance, not the boss.

    i think we could take a long step in the right direction of the government took over the role of the “company” as a provider of benefits. the gove could then negotiate, or let to bid, contracts for detailed maintenance by the existing insurance companies. leaving the gov with the sole role of collecting the money and overseeing, and paying, the contracts.

    themoney would best come from a dedicated tax that is really an insurance premium, like social security. folks who don’t make enough to pay an adequate insurance should probably be helped out by a special “minimum wage” boost dedicated to that insurance/tax.

    this would tend, i think, to keep everything transparent, and provide the only hope of controlling costs.

  5. comment number 5 by: coberly

    blue dog

    is quite wrong. social security is not even part of “the budget” much less just another pile of money that can be robbed for what he’d rather spend money on.

    wouldn’t it make just as much sense if i raided his car budget to get the money for medical insurance?

    it might help if he understood that social security is the money working people put aside during their working lifetimes to make sure there will be at least enough to retire on.

    even if you could legally, or morally, take this money, where would you then get money to pay for old people’s groceries and food.

    blue dog is like too many people. he thinks what he wants is vastly more important than what you want. even if it is your money.

  6. comment number 6 by: coberly

    in fact

    Blue Dog doesn’t even know what he is talking about. An increase in the Social Security tax of about 2% is the best guess for what it will cost to “save” Social Security for the rest of the century… and probably beyond. This 2% will come out of an income that is from 40 to 100% greater than today’s income.
    What this means in real dollars is that in 2040 the average person will be making 300 dollars a week more than he is today, and out of that he will have to pay 20 dollars a week more than otherwise to pay for the fact that he is going to be living longer.

    Even the projected cost of Medicare is less than a third of the projected increase in income.

    So blue dog is busily trying to make sure that we never spend a greater percent of our incomes on retirement or health care, while we have twice as much to spend on trips to las vegas and new lexuses.

    we could call this stupidity if it weren’t so common. it’s more like human nature. but the arithmetic is bad. really bad.