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The Price Is Right

by Peter Laakmann

American health care costs about what it should

A tremendous amount of misinformation permeates the debate over U.S. health care. Much of this misinformation has become received wisdom, steered the debates over health-care reform, and convinced many intelligent and otherwise reasonable people that we can save trillions of dollars and millions of lives annually if only we duplicate the health policies of other developed countries. Working from such misguided premises has the potential to be very costly. Here are some counterpoints to dispel a few particularly pernicious myths.

Conventional wisdom attributes America’s high spending on health to some idiosyncratic features of the U.S. health-care system. However, while it is true that the U.S. spends much more on health than the average developed country, it is also true that health expenditures are strongly associated with GDP — and increase at a markedly faster rate than GDP. The U.S. is an exceptionally rich country, so we should expect it to spend an exceptionally large share of its income on health.

By applying elementary regression analysis to GDP data, many have argued that U.S. income levels still do not adequately explain U.S. health expenditures. This is correct as far as such rudimentary analysis goes, but it is also misleading. GDP is a measure of domestic production, and it predicts health expenditures only to the extent that it accurately reflects actual material living conditions. But the relationship between these two economic aggregates can vary quite substantially between countries, for many reasons. We routinely find the U.S. much farther ahead in comprehensive measures of household consumption and disposable income than it is in plain old GDP. The U.S. stands apart from other developed countries in that it combines very high GDP with an above-average disposable-income share of GDP.

The relationship between these alternative measures of material living conditions, Actual Individual Consumption and Adjusted Household Disposable Income, and national health expenditures (NHE) is consistently much stronger than the relationship between GDP and NHE, and using these measures as the basis of comparison puts the U.S. quite comfortably within the normal range of variation, either on trend or slightly above. There is little need to look for idiosyncrasies in the U.S. health system to explain high health spending, as the spending is adequately explained by larger macroeconomic forces.

This does not necessarily mean that high NHE is socially optimal or that we should disregard the merits of proposed cost-containment strategies, tax restructuring, and the like. Rather, it shows that health-care finance is not a solved problem, and that our ability to lower costs over the long run by copying the health policies of other countries is much more limited than proponents of such a reform would have you believe.

Moreover, the relative price of U.S. health care (i.e., the average price of health care after correction for domestic purchasing power in the rest of the economy) is not particularly high. The best available data, OECD Health Purchasing Power Parities (PPP), suggest that the weighted average price of health care in the U.S. is broadly consistent with what we would predict for a country of its wealth. According to 2014 estimates, the price of health care in the U.S. was just 10 percent more than the OECD average and very closely aligned with U.S. income compared with health-care prices in other countries.

These patterns were observed across multiple rounds of study, and study indices were carefully constructed to enable reasonably reliable apple-to-apple comparisons of countries (especially by making allowances for non-market transactions, such as surgeries performed in government hospitals or by government employees, in which conventional market prices are not meaningfully available). In short, reliable price estimates show that overall U.S. health prices are not significantly higher than we would expect from the economic data, and that we spend much more than other countries on health care because we consume much greater amounts of it (2.1 times the OECD mean in 2015).

By contrast, the figures typically cited by critics to suggest that U.S. health-care prices are obscenely high are unreliable and haphazardly selected. They often focus on labor-intensive categories, such as surgical procedures, which the health PPP studies show to be much more sensitive to income levels than are goods, and fail to report prices for enough high-income countries. Because of these many sources of error, most of their data cannot be relied upon to draw reasonable conclusions.

U.S. physicians’ pay is not particularly high compared with that of those in other countries, nor is it particularly influential as a driver of NHE. U.S. physician compensation accounts for less than 10 percent of NHE and has grown very slowly in the U.S. over the past few decades, slower in relative terms than in other OECD countries. In 2003–04, self-employed general practitioners earned 3.4 times the average wage in the U.S., whereas their counterparts in the United Kingdom, Canada, Germany, and the Netherlands earned at least 3.1 times the average wage in their own countries. If, as some economists argue, the wage ratio that U.S. physicians enjoy is mostly a result of monopoly powers (such as restrictions on the total number of licensed physicians and movement between practice areas) instead of returns to skills, time and money invested in medical training, lifestyle sacrifices, and so on, the U.S. is hardly unusual in this regard, and the price-setting powers of central governments have seemingly done little to curb physicians’ pay.

Outside of physicians’ earnings, are other health-care prices spiraling out of control? Although it is undoubtedly true that certain health-care prices have increased faster than incomes, standard estimates suggest that price increases explain somewhere between 0 and 22 percent of the observed increase in health spending between 1940 and 1990. Likewise, since 1990, growth in nominal GDP per capita has exceeded the average growth in the U.S. Bureau of Economic Analysis’s Personal Consumption Expenditure health-price index, one of the most widely trusted domestic health-care-price indices, which implies that rising prices explain none of the rapid growth in NHE over this period. The evidence within and between countries is quite consistent: The relative growth in expenditures is overwhelmingly attributable to the consumption of a much greater volume of health care. A variety of associated indicators, such as the growth of the health-care work force, are quite consistent with this observation. (Between 1965 and 2011, the share of the civilian health sector that the civilian work force employed grew from about 3.5 percent to 11 percent of the non-farming civilian work force.)

Additional data suggest that the U.S. private health-insurance system does not significantly increase net health expenditures over expenditures made under public alternatives. According to the federal Centers for Medicare and Medicaid Studies, insurers’ net cost of health insurance, which is the difference between the premiums they collect and the benefits they pay out, has averaged around 6 percent of NHE since 2003. Some of this difference ends up as profit and executive compensation (“bad” stuff in the eyes of some), but most of it goes toward vital expenditures such as contracting, claims administration, and fraud prevention. This suggests that even if one regards profit, executive salaries, and the like as completely worthless, the opportunity for cutting NHE by switching to an exclusively public system is greatly exaggerated.

On this point, we can compare per-beneficiary expenditures in U.S. public and private health-insurance programs. Both Medicaid and Medicare cost substantially more per beneficiary than private plans (44 percent and 119 percent more respectively). Admittedly, the populations they serve require more care because they are older and sicker, but public-plan expenditures are markedly higher than the OECD averages we would purportedly achieve if we scaled them out to the rest of the population.

Finally, it is unlikely that the structure of the U.S. health system explains much, if any, of the observed shortfall in American health outcomes. There are several reasons for this. One, cautious estimates suggest that medical care explains less than 10 percent of the variance in health outcomes within high-income countries, and that factors such as genetics, behaviors, lifestyle, and social environment are more significant. Two, relative to other highly developed countries, the U.S. has high rates of obesity and diabetes, car accidents, homicides, drug use, and more. Three, there are some very large geographic differences within the U.S., particularly in parts of Appalachia and the “Black Belt,” that go a long way toward explaining the U.S. shortfall. These are not closely associated with health-insurance status and other indicators of health provision, but are very closely associated with measured health behaviors and lifestyle.

Four, at least two studies in the U.S. have found that expanding access to health care has had no statistically significant effects on objective, measurable outcomes. Five, assertions of inadequate access to health care among certain groups are apt to be much overstated, as individual income does not predict markedly higher levels of health expenditure (somewhat the opposite, in fact; controlling for age and self-reported health status, it is estimated that lower-income groups might consume a bit more health care on average) and even uninsured Americans consume around half of what their insured counterparts do. Six, international data strongly suggest that returns on NHE diminish rapidly with respect to life expectancy (and other closely related measures) and that most of the OECD has already passed some threshold beyond which the returns are close to zero. Based on this, one would not predict a country with U.S. NHE levels to achieve outcomes significantly better than those of the median OECD country. Indeed, incorporating known behavioral and lifestyle differences, we would expect it to be substantially worse — and indeed, U.S. life expectancy is a year or two below that of most comparable OECD countries.

Suffice it to say that the weight of the evidence suggests that proponents of single-payer are wildly overpromising. This is not to suggest that the U.S. health system is perfect — far from it — but rather that a root-and-branch overhaul is unlikely to deliver the promised goods. As in all complex systems, there is room for real improvement, but this is best pursued carefully and incrementally in a way that preserves the more innovation-friendly elements of the system while rewarding valuable innovation. And in health care, rewarding innovation may be the most important point of all, because in the U.S., as in other highly developed countries, technological advancement is the main driver of health improvements and generates large spillover benefits for the rest of the world.

– Mr. Laakmann is a software engineer and entrepreneur. He blogs at

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