March 7, 2009

Why Health Care Costs Will Not Go Down

Image by flickr's salimfadhleyWe see newspaper headlines almost daily bemoaning the increasing cost of health care. On Thursday, President Obama spoke at the "White House Forum on Health Care Reform", repeating the scary statistics that we hear so often:

You know, we're here to discuss one of the greatest threats, not just to the well-being of our families and the prosperity of our businesses, but to the very foundation of our economy. And that's the exploding cost of health care in America today.

In the last eight years, premiums have grown four times faster than wages. An additional 9 million Americans have joined the ranks of the uninsured. The cost of health care now causes a bankruptcy in America every 30 seconds. By the end of the year, it could cause 1.5 million Americans to lose their homes.(

The fact is, he is right. Health care is taking up a larger and larger portion of the average person's budget. Health care costs are increasing. The typical reasons given for high health care costs fall into one of three main camps:

1. People are greedy - this argument says that some group of people - typically insurance companies, doctors, or malpractice lawyers - are too greedy. Costs are increasing because they are taking a bigger and bigger slice of the pie.
2. Government is not involved enough - this argument is that socialized medicine allows the government to set prices and quality of care.
3. Government is too involved - this argument says that if we just let the free market work, then health care costs would come down. The huge influence of Medicare and Medicaid is actually raising prices.

I think that some, or maybe even all, of these camps could be right. I am sure that costs could be lower if we made some changes to the structure of how health care is delivered. However, I believe that there is a much more fundamental reason that health care costs are increasing.

The reason that health care costs are increasing is because health care in the U.S. is so good. Health is the classic inelastic good. People will spend whatever money they have if spending that money will save their life. As the better and better health care saves more and more lives, people live longer, and require more health care.

Since this is the main point of the whole post, I think that it's worth illustrating with an example. In hypothetical country Moribund everyone has a heart attack every 20 years. In Moribund there are two cities: in city A, there are 500 citizens, and a mediocre doctor, whose rate of successful heart operations is 50%. In city B, there are also 500 citizens, but they have a great doctor, whose rate of successful operations is 90%. In both cities an operation costs the society $100 (either the individual or the government - it doesn't really matter).

After 20 years in city A, there will have been 500 heart operations, costing $50,000, but only 250 people will have survived.
In city B, the cost will also have been $50,000, but 450 people will have survived.

After 40 years, city A will have only 125 citizens, and will have spent $75,000 on health care.
In city B, they will have 405 people, and will have spent $95,000 on health care.

Obviously, this little example is not true to the real world, but you get the point. The better health care is, the longer we will live. The longer we live, the more often we will require health care. And because health care is so inelastic, we will pay a greater and greater portion of our income for it.

Image by salimfadhley