The International Health Care Cost Crisis

Medical Expenditure Escalation in the U.S.

The U.S. has the highest absolute medical expenditures and highest per capita medical expenditures of any nation. The U.S. also has the fastest growing percentage of GNP devoted to the health sector (Schieber, Poullier, & Greenwald, 1992). The rate of medical expenditure growth has accelerated in the last two decades. Jencks and Schieber (1991) elaborate: "Since 1970, U.S. health care expenditures have grown at an annual rate of 11.6 percent, 2.9 percentage points faster than our gross national product (GNP)" (p.1). According to the Health Care Financing Administration, the U.S. spent approximately 13% of its GNP on medical care in 1991 and 13.5% in 1992. These expenditures could rise to 18%-20% of GNP by the year 2000. Figure 1 shows the extraordinary growth of American medical expenditures from 1929 to the present. Reinhardt (1990) predicted that if the health sector's share of GNP continued increasing at the present rate, in 82 years medical expenses would consume the entire GNP. Although such a prediction could never come true, the current trend indicates the urgency of the high medical expenditure situation in the United States.

This problem increased in severity during the early 1980s, when medical expenditures began growing approximately twice as fast as the Consumer Price Index (CPI). Numerous reasons exist for the faster growth of prices for medical services. Jencks and Schieber (1991) identify some of these as follows:

Figure 1. Growth of Medical expenditures in the United States: 1929-1993

Data source: Health Care Financing Administration.

1. insurance coverage and premium subsidies (third-party payment);
2. lack of price competition among providers;
3. open-ended payment systems (fee-for-service);
4. developments in technology;
5. malpractice litigation;
6. self-referral (many physicians own diagnostic equipment and labs to which they refer their patients to enhance income);
7. expenses related to containment policies (cost-containment systems increase both payer and provider overhead); and
8. increasing physician supply.

Price increases, however, are only part of the problem. Medical expenditure growth has two components: rising prices and increased utilization. Both are extremely difficult to control. Equation (1) illustrates the fundamental relationship that must be considered in all cost containment planning:

Medical Expenditures = Price of Medical Services x Utilization of Medical Services

Jencks and Schieber (1991) and Fuchs (1990) indicate that both medical prices and medical utilization have been growing faster than the corresponding prices and utilization of goods and services in other areas of the U.S. economy. Consequently, controlling medical expenditures is analogous to pushing on a balloon; if we squeeze in one place, it bulges in another. For example, if a government attempts to control medical prices by fiat, then the medical industry can, within certain limits, maintain target revenues and incomes through supply-induced demand-that is, suppliers of medical goods and services can increase the utilization of these goods and services through various means (Payer, 1992; Inlander, Levin, & Weiner, 1988; Wohl, 1984). Hence, trying to control medical prices while expanding health insurance coverage, as is currently being attempted by the U.S. government, may increase access to care, but total direct expenditures are still likely to rise dramatically.

Direct payments for medical care are only part of the problem. The indirect costs of ill-health constitute an additional large drain on the nation's economic and human resources. The indirect losses due to illness include lower productivity, increased absenteeism, and higher retraining costs. The total economic impact of an inadequate health care system greatly exceeds the direct payments of medical care. According to the U.S. Department of Health and Human Services (1990a):

Lost productivity due to disease and early death compounds the impact of this problem. In 1980 the total cost of illness equalled nearly 18% of GNP. Injury alone now costs the nation well over $100 billion annually, cancer over $70 billion, cardiovascular disease $135 billion. (p. 5)

If the total economic impact of poor health was 18% of GNP in 1980, it might be as high as 25% of GNP in 1992. Thus, total medical (indirect and direct) expenditure growth is a major problem for all of society.

The disproportionate allocation of resources to the health sector hurts national economies in the long term. Health and Human Services Secretary Dr. Louis W. Sullivan (1989) explains, "Employers are finding that health care costs consume a large proportion of their gross income-more than 10 percent of gross income for some companies" (p. 127). It is true that the short-term channeling of funds to the medical sector has created millions of jobs (Hiles, 1992), which in turn give the appearance of economic growth because national output of services has increased. More than eight million people today are employed in the medical services industry, and three million of those jobs were created in the last decade. However, economists concur that the net effect of this redistribution of resources weakens long-term growth and productivity. Robert Marks explained, "Unchecked health-care spending consumes resources that could be utilized more productively elsewhere and imposes considerable costs on the economy and the American people" (Koretz, 1992, p. 24). Employers ultimately pass on the effects of higher medical expenses to workers in the form of lower wages; instead of increasing employees' salaries, employers have had to contribute more and more each year to corporate health benefits packages. This is a major reason why real salaries and wages over the last 20 years have barely increased. Yet, as medical payments increase, actual health status stays the same or, in some areas, declines. Unchecked medical outlays divert funds away from the creation of new businesses and productive jobs, which might explain much of the current shortage of business investment and venture capital. In short, medicine is a nonproductive industry.

Soaring Medicare and Medicaid expenses are also undermining attempts to reduce the federal deficit. A recent Congressional Budget Office report warned that escalating medical spending "will reduce investment and substantially cut future incomes-by almost 2.5% in 2002 and even more thereafter" (Koretz, 1992, p. 24). Furthermore, a Government Accounting Office report states that the unduly complex and fragmented health insurance system in the U.S. enables unscrupulous medical providers to defraud insurers and the government of approximately $70-$80 billion a year-almost 10% of all health sector expenditures in 1992. Consequently,finding effective and affordable means of providing health care is a national pr iority.

U.S. Medical System Compared with Other Developed Nations

When compared with other developed countries, the expense and performance inadequacies of the American medical system become more evident. As mentioned above, the U.S. has the highest annual per capita expenditure for medical care in the world. Yet life expectancy is lower, infant and adult mortality rates are higher, and other general measures of medical performance are worse than those in many other developed nations (Schieber et al., 1992). Table 1 compares the expenditures and outcomes of selected developed nations.

In 1987, among the 24 member nations of the Organization for Economic Cooperation and Development (OECD), the U.S. ranked 21st in infant mortality, 16th in male life expectancy at birth, and 13th in female life expectancy. These poor health outcomes should be contrasted with their price. Schieber noted that "the United States spends almost twice as much per person and devotes 50 percent more of its gross domestic product (GDP) than the other major industrialized countries" (1990, p. 159). The data in Table 1 demonstrate the lack of any significant relationship between medical expenditures and health outcomes. Thus, one must infer that the United States needs to increase the effectiveness and efficiency of its medical system.

Table 1
1987 OECD Health Outcomes and Expenditures Comparison

...Male Life Expectancy
at Birth
Infant Mortality
Per 1000 Births
Health Expenditure
Per Capita as %
GDP Health
Australia73.$939< /TD>
Denmark 71.88.311.36.0 $792
France 8.6$1,105
Iceland 75.17.2 7.07.8$1,241
Netherlands 73.56.4 8.38.5$1,041
Norway 72.88.410.07.5 $1,149
United Kingdom $758
United States 71.510.08.7 11.2$2,051

Source: OECD Health Data Bank (Schieber and Poullier, 1989b).

Part of the problem appears to be negative growth in medical productivity in the U.S. medical sector, despite tremendous growth in technology (Jencks & Schieber, 1991). Productivity can be evaluated in many ways. If we compare American total outputs with the total expenses incurred to produce those outputs, the U.S. medical system appears to be extremely unproductive, especially in relation to other industrial nations. In an international comparison of medical systems, Schieber and Poullier (1989a) summarize the productivity of the U.S. medical system:

Several relevant facts are clear. First, the United States spends far more in absolute dollar terms and relative to GDP than any other country in the world. Second, this gap appears to have grown in recent years. Third, the higher GDP of the United States can explain only a small part of these disparities. The United States tends to have about the same physician-population ratio as the average for the OECD countries and fewer inpatient medical care beds. U.S. use rates in terms of physician visits, hospital days, and average length of stay are among the lowest in the OECD. Yet, the costs for medical procedures and the costs per hospital bed, day, and stay are the highest in the world by far. Americans appear to practice a much more intensive style of medicine. Nevertheless, on the basis of crude outcome measures such as infant mortality and life expectancy as well as access-to-care criteria, the achievements fall short of those in many other OECD countries. (p.7)

Among the industrial nations, the United States is also weak in primary care. Primary care is the first level of treatment after a disease or injury has occurred, and should prevent minor medical events from becoming serious and expensive problems. An inadequate primary care system may thwart attempts to improve health and contain expenditures. The inadequacy of the U.S. primary care system may be due, in part, to misplaced incentives. Most nations give greater prestige, awards, and larger income to specialists instead of primary care physicians. The disparity, however, appears to be more extreme in the U.S. Terris (1990) reports:

In Canada, 50 percent of all physicians are general practitioners, versus 10 percent in the United States. Although the ratio of physicians to population is about the same in both countries, the United States has 33 percent more surgeons per capita. It is hardly surprising therefore, that Americans undergo 40 percent more operations per capita than Canadians. Nor is it surprising that the costs of care are higher in the United States. First, specialists in both countries charge considerably more than general practitioners; U.S. specialists often pull in $130,000 to a quarter of a million a year, GPs only earn about $80,000. Second, specialists are trained to use expensive high-tech diagnostic and therapeutic procedures, whether or not these make a significant difference in the patient's health. (pp. 30-31)

The inadequacy of the U.S. primary care system is likely to persist for some time. Whitcomb and Desgroseilliers (1992) explained:

Between 1986 and 1991, the number of graduates matched to residencies (internal medicine, pediatrics, and family medicine) that might lead to careers in primary care medicine decreased by 19 percent. If the current trend persists, the percentage of U.S. physicians who are primary care practitioners can be expected to decrease from the present one-third to approximately one fourth by the turn of the century. (p.1469) Inadequate primary care leads to needless human suffering and contributes to escalating expenditures by allowing minor medical problems to degrade into serious and expensive tertiary care crises.

These high medical expenditures are an especially great burden for U.S. businesses, which pay a large and growing portion of the national health care bill each year. Businesses in the United States frequently feel unfairly burdened because they are competing in a global marketplace where their foreign competitors do not pay their employees' medical insurance. In 1965 business paid 17% of the cost of national health services and supplies, but in 1985 they paid 30% (Levit & Cowan, 1990). Firms often have paid 20%-30% increases in annual health insurance premiums in recent years. Eastaugh (1991) states, "For the past six years corporate health care spending in America has exceeded after tax profits and should surpass $175 billion in 1991" (p. 25). Group plans buy approximately 85%-90% of all health insurance. These plans are usually funded by employers, according to Standard & Poor's Industry Surveys (1990). A survey conducted by A. Foster Higgins in 1990 found that American firms paid approximately $3200 in average annual total health plan expenditures per employee. These expenditures are obviously beginning to have a tremendous impact on companies' profits and competitiveness, and many corporations are having difficulty caring for their employees and meeting their profit objectives.

However, in other countries where the government pays for most or all medical care, private business still pays indirectly for the medical system through higher taxes. The Canadian medical system, which is fully funded by the government, is an example.

The Canadian Health Care System

Policy leaders in the U.S. are studying various aspects of the Canadian health care system to find new strategies for lowering expenditures and expanding access to services. Some U.S. officials speak as if adopting the Canadian system would automatically solve all health sector problems. In fact, although the Canadian system has many commendable features, growth in medical expenditures is a source of economic distress in Canada as well. Rapid increases in medical outlays are impeding the federal and provincial governments' attempts to meet their fiscal responsibilities. Francis (1990) describes the growth in Canadian medical expenditures:

The latest figures show that, between 1975 and 1987, total Canadian health-care costs jumped fourfold to $47.9 billion from $12.2 billion. This represents 8.71 per cent of the nation's gross domestic product . . . compared with 7.15 per cent in 1975. (p. 19)

Thus the Canadian system appears to have an expenditure escalation problem similar to that in the United States. Although Canada's current percentage of GNP spent on medicine is smaller, it is also growing, if somewhat more slowly than in the U.S. These differences in growth rates may be the result of differences between the two medical systems. The Canadian government (as in most developed countries) controls the price of medical services; this helps to slow expenditure increases. The U.S. prices and utilization are controlled by neither the government nor market dynamics. Hence, Americans have the faster medical expenditure growth rate (Schieber et al., 1992).

Although the Canadian system is less costly, they are rapidly approaching a financial crisis. Since the Canadian national debt, per capita, is the largest in the world, the government has attempted to diminish budget deficits through several means, including reducing the federal government's contributions to the provincial medical care systems, in order to restore economic strength. At one time, Ottawa paid 48% of the nation's annual medical expenditures; now, the federal contribution is only 38%. Even more drastic cuts are intended by the mid-1990s. According to the 1993 President of the Canadian Medical Association, "The provinces are trapped between the public's unlimited expectations of a 'free' system-expectations which are fueled by politicians-and a federal government intent on reducing the debt" (Brown, 1989, p. 29). In response to the reduced federal contribution, the provinces have had to either increase taxes or ration medical expenditures more severely or both. These options are difficult and unpopular.

Overall, Canada has been more successful than the United States in slowing the rate of medical expense growth, especially with reference to the physicians' price component of health expenditures (Fuchs & Hahn, 1990; Hughes, 1991). Quebec, in particular, surpassed all other provinces in Canada in containing the price of physician and other medical services. Indeed, most of the total difference between the relatively high U.S. and low Canadian medical expenditures is caused by the extraordinary success of cost containment programs in Quebec. Yet the quality of care does not seem to have suffered: for example, Quebec has the lowest infant mortality rate of any province in the world.

Recently, however, increases in utilization have led to dramatic increases in medical expenditures even in Quebec. The Quebec Minister of Health and Social Services said the province will have a shortfall of at least $2 billion in the health care budget over the next five years if current trends persist. Medical care presently consumes $12.8 billion annually, or one third of the province's total budget. Consequently, a massive restructuring of Quebec's entirehealth and social services system is under way in order to lower expenditures and improve efficiency. Proposed changes may include deviating from the guidelines of the Canada Health Act by charging fees for some medical services to reduce capricious utilization.

Hughes (1991) found that increases in the supply of physicians have been a major contributor to increases in utilization. Barer et al. (1988) and Hughes (1991) provide cogent evidence for physician-induced demand phenomena in Quebec. Their analysis shows that new physicians generate utilization for their services in order to attain target incomes. Furthermore, established doctors respond to government fee-reduction schemes by increasing demand for their services. Once under a doctor's care, a patient sometimes become the victim of unnecessary treatment administered by the physician to maintain his or her target income. This unnecessary treatment generates high expenditures for the provinces.

One can see from Figure 2 that medical expenditures of other countries are simply a few years behind the United States. Thus, the health care cost escalation problem is not only an American or Canadian problem, but an urgent concern for policy makers worldwide.

Figure 2. International growth in medical expenditures from 1960 - 1990.
Data source: Hieber and Poullier (1989b) and Schieber et al. (1992).

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[The International Health Care Cost Crisis]

[The Need For Prevention: Identifying New, Cost-Effective Strategies]

[The High-Cost Case Phenomenon: A Way to Leverage Medical Expenditure Savings through Prevention]

[The Proposed Strategy]

[Conclusions and Future Research Directions]