Cost of medical care - pricing failure

The Wonkblog has an excellent interactive graphic that captures the average cost of different types of surgical procedures. Two things stand out. One, United States is a consistent outlier in the high cost of treatment. Two, India stands at the other extreme, offering the cheapest procedures.



Conventional wisdom would have it that the higher cost of medical care in the US is because Americans use more health care services, see doctors more frequently and stay in hospitals longer. However, as Ezra Klein highlights by pointing to this 2003 paper by Uwe Reinhardt and Co, the reality opposite on all these counts. The real reason for the higher cost of medical care in the US, as the graphic makes amply clear, is due to higher prices.

The higher prices in the US health care market is yet another illustration of the failure of price signals in ensuring economic and allocative efficiency. In the United States, outside of the government run Medicaid and Medicare, prices are negotiated in a free-market between insurers and service providers. As Uwe Reinhardt has shown here and here, providers largely charge what they can get away with, often offering different prices to different insurers, and an even higher price to the uninsured.



Prof Reinhardt writes,

On average, the prices for health care goods and services negotiated by private health insurers in the United States tend to higher — about double or more — than prices for identical services and goods in other countries of the Organization of Economic Cooperation and Development. It is in good part so because insurers do not seem to have sufficient market power, especially vis à vis hospitals, to resist very rapid price increases.The varying degrees of market power among private insurers in the United States have led to pervasive price discrimination among payers, with prices for identical goods or services varying among payers by factors as high as 10.

In contrast, health care prices in the other countries is regulated, with the result that prices are considerably lower. Ezra Klein writes,

Other countries negotiate very aggressively with the providers and set rates that are much lower than we do... They do this in one of two ways. In countries such as Canada and Britain, prices are set by the government. In others, such as Germany and Japan, they’re set by providers and insurers sitting in a room and coming to an agreement, with the government stepping in to set prices if they fail.

I have blogged earlier highlighting the market failure problems associated with purchasing and pricing health insurance service.