The Agenda

Guest Post by Arpit Gupta: Geographical Variation in the Cost of Healthcare


I’ve written a lot here about the problems with a Dartmouth approach to healthcare. This school of thought owes a lot to the Dartmouth Atlas, which uncovered large geographical variations in the cost of medical care seemingly unconnected to health outcomes. The implication often drawn from the finding of high cost variation is that there is a lot of waste and unnecessary procedures in medical care, which ought to be cut through a medically centralized board of experts.

This basic framework regarding medical costs is prevalent in health economics. The assumption is that we have a medical cost problem as measured by the fact that US healthcare costs more than care in other countries; and by the fact that medical spending varies a lot domestically. This basic diagnosis of the problem directly drives a lot of health policy surrounding health care—such as the cuts to Medicare in PPACA and the creation of a Medical Advisory Board to determine best practices and cut Medicare reimbursements.

To think about the drawbacks of this approach, compare medical spending to other categories of goods. Spending on many complex services—such as higher education—tends to be higher in the US than other countries. There also tends to be a high degree of geographical variation in costs of other services like lawyers, which tend cost more in New York than Omaha. These cost differences persist even though the US tends to lag behind other countries in international comparisons of the number of people educated, and even though big city lawyers may not be delivering better services than those in other countries. 

By comparing healthcare to the cases of higher education or legal services, it’s easier to see what’s going on. Prices are set by supply and demand, and these tend to vary both across the world and within the US in complicated ways. Higher cost of living and expenses generally, combined with the benefits of agglomeration economies, tend to drive up the costs of delivering both medical and legal services in urban cities. Higher education costs in the US are driven in party by student demand for amenities like better dorms and gyms, just as medical costs are partially driven up by the prevalence of TVs in rooms and single-patient facilities in the US. Demographic mixes, and hence the costs of medical treatment and education, tend to vary in the US and other countries. 

These sorts of different cost drivers affect many types of services, but you will hear few analysts claim that we have a higher education cost problem that ought to be fixed by cutting education spending in high-cost states, or that we should respond to legal costs by capping lawyer billings in high-cost cities. Somehow, in medicine, the usual presumption that prices and costs represent fundamental factors is lost.

You can also see by comparison to other fields that costs may not represent problems by themselves. If students want to pay for better dorms or patients want to pay for better rooms, then we should let them do so, even if it means higher “medical” or “educational” costs. More medical and educational services are a perfectly reasonable way for richer countries to spend greater income, even if they do not narrowly contribute to measured educational attainment rates or life expectancy. There’s a separate issue of third-party payment in that people may over-consume if parents pay tuition or insurance companies cover medical care, but that’s a problem best served through people paying more of their own costs out of pocket.

Now, it’s still likely that there still are serious problems with waste and inefficiency in medical services (or healthcare or legal services). But the point is that geographical variation in costs alone is unlikely to provide a full diagnostic of that inefficiency. And if improperly attacked, cuts in medical spending may well worsen health outcomes.

John Goodman refers to a recent paper by Louise Sheiner on this topic, provocatively titled, “Why the Geographic Variation in Health Care Spending Can’t Tell Us Much about the Efficiency or Quality of our Health Care System.” Sheiner argues:

[T]he paper shows that the geographic variation in health spending does not provide a useful measure of the inefficiencies of our health system. States where Medicare spending is high are very different in multiple dimensions from states where Medicare spending is low, and thus it is difficult to isolate the effects of differences in health spending intensity from the effects of the differences in the underlying state characteristics. I show, for example, that the relationships between health spending (both Medicare and non-Medicare), physician composition, and quality are likely the result of omitted factors rather than the result of causal relationships. Insights into the relationship between health spending and outcomes are more likely to be provided by natural experiments such as that analyzed by Doyle (2007), who showed that among visitors to Florida who had heart attacks, outcomes were better at hospitals with higher spending, or the true experiment run in Oregon in which a group of uninsured low-income adults was selected by lottery to be given the chance to apply for Medicaid (Finkelstein et al, 2011).

Sheiner goes on to discuss how state health characteristics, such as obesity, help explain variations in state costs. State health characteristics can’t explain all of the variation in geographical costs, but they explain a sufficiently large fraction so as to cast in doubt the interpretation of the Dartmouth folks that “practice styles” of doctors in different areas explain all of the variation in geographical costs.

Additionally, Sheiner finds that Medicare costs (the ones examined in Dartmouth and other analysis) have a complicated relationship with total medical costs overall. This raises the concern that hospitals may cost-shift by charging Medicare more in order to subsidize care for the non-insured. McAllen, Texas for instance—cited by Atul Gawande as an example of an area with too high Medicare costs—tops the list of metros with a high uninsured population. Gawande’s narrative suggests that McAllen’s Medicare costs just happen to be bizarrely high. But is it simply a coincidence that doing medical business in an pricey urban area with a high share of overweight and uninsured patients is expensive? Does it make sense to concentrate Medicare cuts in these sorts of regions and expect zero changes in medical outcomes? Rather then seeing the medical cost issue purely as an issue of waste and cost, it’s worth thinking through harder on the issue of where medical costs come from. 

In passing, I’ll note that John Cochrane has written a wonderful essay on health insurance and care, and John Goodman has an excellent book on the subject as well. Both authors focus on the original sin of having insurance cover the majority of health spending, thus divorcing payment from care and forcing layer upon layer of additional kludgy regulations to address medical costs. The only real cure here is to free up the market for medical care so that it works as functionally as the markets for televisions or lawnchairs. 


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