We are bombarded with messages about the need for health-care reform. But we are not always clear about the problem we are trying to solve. Most Americans are satisfied with their health care: They rate their providers highly and are as happy with insurers and hospitals as they are with the average American business. And it is worth noting that the U.S. leads the world in personalized-medicine research, which identifies genetic mutations that cause medical afflictions in order to develop diagnostics and therapies. Because the fruits of this research could eventually cure maladies that today can only be palliated, its impact on our welfare and productivity may be as profound as that of the Industrial Revolution.

It is critical that we fully understand the health-care problems we are trying to address — before we act. Health care accounts for roughly one-sixth of the nation’s economic output, and political intervention in this sensitive sector will inevitably be accompanied by unintended consequences and changes to our quality of life. The last foray into health-care reform, via managed care, presents a sobering lesson: The problems that managed-care insurers sought to eliminate — overuse and overpayment — were not considered the top problems by consumers and providers. Patients and doctors deplored managed-care reforms, which caused many Americans to lose access to care and made doctors hostages to insurance-company restrictions. So counterproductive are these intrusions that, in my academic work, I constantly meet physicians who have essentially given up on their profession. Last, and perhaps worst, the aggressive search for discounts by managed-care insurers motivated many hospitals to consolidate into oligopolies and monopolies that could not be pushed around by the insurers. This consolidation grievously affected price and quality competition.

The present blizzard of reform proposals is similarly disconnected from consumers’ view of the problem. Those enrolled in employer-provided health insurance, for example, are not inclined to sympathize with the Democrats’ Medicare-for-all vision or with Senator McCain’s — and perhaps President Obama’s — proposal to tax employer-provided health-insurance benefits. Many are bewildered by these proposals, wondering, “Why would I want to give up my company’s health plan for Medicare? or “Why would I want a formerly tax-free benefit to be taxed?”

What, then, is wrong with our health care, and how serious is the problem? Although reformers can readily enumerate our system’s shortcomings, many of their proposed reforms entail measures that will almost certainly undermine health-care access and quality for many consumers. And practically all of the most popular reform proposals fail to address the underlying problem, which is the lack of a robust consumer market for health care.

One thing that is wrong: Many Americans are worried about their health insurance. Those enrolled through their employers fear losing coverage, particularly during this recession. And many of those who are uninsured simply cannot afford coverage. Would-be reformers propose to solve this problem through mandating universal coverage. But bringing 50 million or so new clients into the health-insurance system will only fuel the inflation in health-care costs that already is roiling our economy, just as the expansion of Medicare and Medicaid did in the 1970s. Higher prices will mean less access to care, not more.

Other reform proposals also contemplate remedies that are inconsistent with consumers’ real interests. For example, reformers criticize the erratic quality of medical care, which varies both by region — with vastly more utilization in Miami than Minneapolis, for example — and between health-care institutions. Quality even varies significantly within institutions, for no apparent reason other than the eccentric preferences of providers. Some critics aim to solve this problem by enforcing greater standardization in the practice of medicine. But those who lament the lack of innovation in health-care delivery should hope to see more variation, not less. Greater standardization would ill serve the needs of consumers who would benefit from new methods and models of care.

Some critics downplay institutional and economic factors and instead charge various agents in the health-care system — doctors, hospitals, insurers, governments — with greed and incompetence. These reformers would like to eliminate the guilty parties by transforming them into another type of entity. Some invoke the alleged saintliness of government programs and nonprofits, while others deplore their lethargy and aversion to innovation. And some blame the consumers, saying they neglect their health and then turn gluttonous when it comes to using health-care resources. Reformers with this view of consumers long for the return of managed care. But many consumers view managed care, not their own behavior, as the bigger problem.

So is there a definition of the problem that all can agree on? If not, then muddled and potentially disastrous policies could be imposed on this massive, vital, and fragile component of our national life. In my view, the core problem is that U.S. health care is a bad value for the money spent.

Unfortunately, I cannot prove my view of the problem because, unlike virtually every other sector of our economy, health care has no real measure of productivity. But an important fact supports my contention: The U.S. spends roughly 70 percent more for health care, as a percentage of GDP, than do most developed countries, and there is no corresponding improvement in health outcomes. It should be noted that those costs, swollen though they are, don’t even count the $34 trillion in unfunded Medicare liabilities we already owe to future entitlement holders.

These economic facts undermine our national welfare in many ways. For one, they threaten our global competitiveness, both because of our outsize costs and because, unlike most of our competitors, we disproportionately pay those costs through our employers. U.S. businesses thus carry an extra layer of fat as they waddle into the arena of competition. Companies that are labor-intensive or unionized are especially disadvantaged. General Motors, with health-care expenditures of $1,600 per car, has long been hobbled in its competition with Toyota, which spends $100 in health care per car. How can it make up this $1,500 difference?

Additionally, employer-based health insurance hinders the mobility of labor in our economy. Many smaller businesses cannot offer health insurance, so workers are locked into larger companies by their need for coverage. This imposes serious costs on our economy, because roughly 80 percent of new jobs are created by small businesses. And even those workers who are offered company plans frequently reject them because of their high costs — about $14,000 for a family in 2009. Some 30 percent of the uninsured earn more than the median U.S. family income but nonetheless feel they cannot afford coverage.

If the problem is indeed poor value for the money, then reforms should achieve either lower costs or higher value. There are two common approaches to achieving these goals: Some would alter the demand for health care by restructuring the health-insurance industry and the variety of health-insurance policies offered; others would alter the supply of health-care services and technology. Virtually no one has proposed changing demand in a way that would affect supply; but, in my view, that is the best way — in fact, the only way — to achieve better value for the money.

Those who favor demand-side remedies believe that the wrong buyers are acting on our behalf.

Many on the political left would like to create a single government entity to purchase our health care, in effect eliminating all private-sector health insurers. These reformers blame private insurance for the present poor value of health care, claiming the industry earns excessive returns (as much as 30 percent) to fund marketing, sales, and other business activities, and to be distributed as profits, which, in this analysis, add no real value. For comparison they point to Medicare: As a government program it need not earn a profit, and as a monopsonist it pays providers rates lower than those paid by private insurers.

It is difficult to argue that corporate purchases of health insurance have created good value for the money. In 2006–07, the general rate of inflation was about 4 percent, and Medicare expenses rose at a rate of about 5 percent, but corporate expenses for health insurance rose by 8 percent. In comparison, Medicare seems efficient — but only if some inconvenient truths are ignored. If Medicare followed private-sector accounting, its yearly expenses would increase by $1 trillion to reflect its $34 trillion in unfunded liabilities. And it must be taken into account that private insurance firms currently subsidize the discount of roughly 15 percent that the monopsonistic Medicare extracts from its suppliers. Who would absorb these costs if private insurers no longer existed? Either Medicare would be forced to increase its costs or those expenses would be imposed on providers, some of whom no doubt would flee to other occupations.

In the end, a public payer can reduce costs only by rationing health care, especially to the sick, who account for most of the expenditures. Thus, the United Kingdom’s single-payer system features the lowest usage of cancer drugs among the Big 5 European economies, and commensurately low cancer-survival rates; likewise, the U.K. provides only half the care for victims of end-stage renal disease that U.S. providers offer. Compared with the United States, the United Kingdom spends less, true, but it also gets less.

Reformers on the right argue for more private-sector competition, not less. They would like to create a national market for health insurance by lifting state regulations that prohibit a policy designed in Mississippi from being sold in Massachusetts. In this way, the Right hopes to enable the residents of Massachusetts, which regulates health-insurance heavily, to shop in states with less regulation. The McCain campaign estimated that these reforms could reduce costs by as much as 20 percent.

Many on the right also favor offering the same health-insurance tax breaks that employers now enjoy to individuals, in the hope of creating a consumer-driven market. Unfortunately, the pervasive view is that U.S. consumers are incompetent, and this causes many reformers to champion an oxymoronic “managed competition” in which insurers offer standardized products to a public thought incapable of distinguishing between insurance policies. The “managed” part of this proposal is clear, but how it would increase competition remains obscure. It is akin to running a supermarket in which all brands of yogurt are identical except for their names. Clearly, the proposal suppresses competition by inhibiting product innovation. In any case, the alleged incompetence of the consumer is belied by Americans’ ability, through their purchasing decisions, to steadily improve such complex goods as computers and cars, and by their ability to navigate the complex array of choices available in other segments of the economy.

Inefficiency in the supply of health care is the elephant in the room when it comes to reform. McKinsey & Company, a management consultancy, calculates that this inefficiency accounts for $500 billion of our excess annual costs relative to other developed countries.

Reformers on the left argue that most health-care suppliers are incompetent or venal. They point to the inexplicable variability in medical costs for patients with similar needs, the alleged manipulation of patients by physician-owned medical providers, and the alleged manipulation of physicians by the medical-technology industry. Because they distrust the sources of supply, these reformers seek to micromanage them through mechanisms such as chronic-disease-treatment protocols, limitations on physician ownership of health-care facilities, and limitations on advertising and other communication by medical-technology firms.

Payment mechanisms also are used for micromanagement. For example, Medicare’s pay-for-performance initiative mostly rewards by-the-numbers adherence to government-approved practices (glorified as “evidence-based medicine”) rather than actual performance, which is to say, measurable improvements in the rates of death and disability. These micromanaging initiatives would more accurately be labeled “pay for conformance.” Their formulae are all too often derived from a consensus judgment or a review of uncontrolled results rather than from scientific experiment. This makes medical practices vulnerable to self-interested defense of the status quo. For example, the physicians who discovered ulcer-causing bacteria, thereby threatening the conventional view that ulcers were caused by stress and exacerbated by certain foods, were roundly ignored. They were forced to resort to the publicity-seeking stunt of inducing ulcers in themselves by ingesting the bacterium to break through the silence. Not surprisingly, there is scant evidence of any positive impact from pay-for-conformance micromanagement, and considerable evidence that it is not cost-effective.

Surprisingly, the Right has no real supply agenda other than arguing against limitations on physician ownership and advertising. But insightful critics both right and left acknowledge that the major problem of supply is the payment system, which compensates providers for fragments of care — a hospital stay, for example — rather than for the complete health-care needs of the patient. For generations, systems-analysis research has demonstrated that optimization of one component of a system does not necessarily optimize the entire system. Nevertheless, our payment system reimburses on the basis of various subcomponents — a hospital stay, a physician visit — rather than on the basis of an entire system of care for a disease, disability, or medical procedure.

This payment system is especially problematic for the treatment of chronic diseases and disabilities, which account for 80 percent of health-care costs. Because the providers are not given incentives to optimize the overall course of care, patients receive suboptimal care that ultimately results in higher costs. The experience of Duke Medical Center in devising an integrated system of care for the treatment of congestive heart failure is instructive. Although this approach reduced costs by 40 percent in only one year, Duke as an institution lost virtually all that savings because it receives substantially higher compensation for treating sick, hospitalized people than for creating improvements in health that keep people out of the hospital in the first place.

The only viable cure for this litany of ailments is to create a health-care market by reforming demand in such a way as to motivate productive innovations in supply.

On the demand side, most health-insurance beneficiaries do not behave like real consumers: Employer-insured consumers are not motivated to shop carefully because they do not recognize that their health-insurance benefits are subtracted from their wages, while those insured by the government have someone else footing the bill. As a result, consumers do not exercise the normal value-for-the-money judgment that has caused goods and services in other markets to become simultaneously better and cheaper. The evidence from the Swiss consumer-driven health-insurance system, and from high-deductible health-insurance policies, demonstrates that middle-class consumers who pay a meaningful fraction of their health-care expenditures out of pocket will reduce spending without damaging their health.

On the supply side, providers currently are compensated for conforming to cookbook recipes for delivering fragments of care. These practices are not cost-effective and inhibit innovation. And because providers lack economic incentives to provide the best value for the money, patients receive suboptimal, unnecessarily expensive care.

Effective health-care reform would motivate consumers to shop carefully for insurance policies that offer the best value for the money while giving providers incentives to supply the best value for the money. Two reforms are needed to make that happen:

1) Change the income-tax system so that employed enrollees understand that their income funds the purchase of health benefits. The most direct way would be to make the money spent on health insurance available as cash, tax free, to employees. For example, my employer, Harvard University, could offer me a tax-free raise for the $15,000 of my income that it currently spends to purchase my health insurance. As I would, many of Harvard’s employees would opt to take the money and buy their own insurance, helping to create a genuine consumer-driven market.

2) Make insurers compete for customers with policies that offer better value for the money. The most important innovation would be to create networks of producers paid for providing the total care needed by victims of chronic diseases and disabilities. These networks would offer better and cheaper care because of their integration.

Reinvigorating the relationship between supply and demand is the only health-care reform that will avert the economic disaster that otherwise awaits us.