The Medical Care Cost Ratchet

March 6, 2014

Today's health insurance model drives up costs by encouraging the use of ineffective, and expensive, services, according to the authors of a study for the Cato Institute.

Despite major institutional differences between Organization for Economic Cooperation and Development (OECD) countries, the rate of health care spending growth is similar.

  • Since 1970, the annual growth in health care spending per capita in the United States (4.3 percent) has been more than twice the growth in gross domestic product (GDP) per capita (2 percent).
  • During that same time period, OECD countries have seen per capita health care costs grow at 3.8 percent, compared to only 2.1 percent growth in GDP. Eight of these 20 countries had growth rates higher than the United States.

Because these countries are all so different, the authors believed that the reason for such massive health care cost growth must hold true across all of them. They developed the "medical care cost ratchet" (MCCR), a model in which health care spending increases as new technologies that produce only modest benefits are incorporated into the standard of care.

  • Health insurance reimburses patients for use, and the conventional view as to why health care costs have grown is based in the fact that insurance drives the marginal price of care to nearly zero. Indeed, studies indicate that a population that is fully insured spends 40 percent to 50 percent more than a population with a large deductible, while gaining no measurable improvement in health status from the additional services.
  • This view has been challenged by those who attribute the rising costs not to increased services but to technological advancements.

Economist and Harvard University professor Joseph Newhouse, for example, dismisses the idea that too much insurance could lead to the use of non-welfare-enhancing technological advancements, which the authors see as incorrect. The authors see technological change as having increased health care costs in many cases without improving outcomes because medical insurance discourages patients from economizing their health care decisions. Insurance today, they contend, perpetuates the MCCR, because it encourages the use of services that have increasingly diminishing returns.

Market-based approaches to health care reform would reduce spending growth and upset the MCCR by incentivizing individuals to make more economical health decisions.

Source: Andrew Foy et al., "The Medical Care Cost Ratchet," Cato Institute, Winter 2014.

 

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