The Healthcare Economy Cost Challenges in 2013

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The healthcare economy has recently become a large focus of our nation’s attention, and justifiably so. In 2008, the US spent almost twice as much per capita on healthcare than Japan and the United Kingdom, while not necessarily producing better outcomes. Even more striking was a September 2012 article in the New York Times, explaining a recent finding that we waste 30% of the money that we spend on healthcare, or $750 billion a year. Continual cost-shifting and an increasing national debt has allowed us to incur this cost, but what policymakers and economists find most troubling is the rate at which healthcare costs continue to grow.

Interestingly, current data points to the fact that growth in healthcare costs has remained relatively constant from 2009-2010 as a percent of GDP (approximately 17.9%, as calculated by the Center for Medicare and Medicaid Services). However, the longer trend is an increasing one: US health expenditures have increased as a percentage of GDP from 12.55% in 1990 to 17.9% in 2010. At first glance, this doesn’t seem to be a problem: over time, as the US has become a richer nation, it has started to spend more on healthcare to ensure a higher quality of life to citizens. However, in 2009, the Social Security advisory board indicated that “the rising cost of health care represents perhaps the most significant threat to the long-term economic security of workers and retirees.” As services become more expensive, and the costs of healthcare continues to increase, retirees will start to spend more on Medicare premiums, and workers will spend more on health care, reducing their disposable incomes.

Not surprisingly, Washington D.C. looks to policy changes as ways of ameliorating the worsening situation of the nation’s healthcare economy. In other words, policymakers try to answer the question: what is the most equitable way of paying for our increasing healthcare costs? But, at the end of the day, as long as costs keep increasing, someone will have to pay for it. Instead of finding ways to cover the ever-increasing costs of healthcare, a more sustainable approach would be to simply cut costs. But of course, it’s not that simple.

Driving Factors

To discuss the recent trends in healthcare spending and possible ways to curtail its growth, YER sat down with Howard Forman, a Professor of Diagnostic Radiology and Public Health, Economics and Management, at Yale University. As Professor Forman describes, the first step in curbing the rapid rise in costs is to understand its driving factors: “A lot of people believe that almost half of the increase in spending relative to baseline is due to new technology and that a lot of new technology is driven by a wealth and income effect. In addition to that, there are non-market-based distortions of moral hazards/insurance and there’s a sense…that people, as they get older and richer, are willing to spend greater and greater percents of their disposable incomes on life-sustaining and life-improving technologies…All of these things tie together and lead to an increase in use and intensity of services”. Prof. Forman goes on to define “use” of services as the increase in the number of anything, citing increases in prescription drug use over time as an example, and “intensity” as improvements in our technology which make the technology more expensive but don’t necessarily result in better outcomes for the majority of patients. Thus, the first main driving factor is an increase in the use and intensity of new technologies.

But new technology is only one side of the story. The second main driving factor is, as Prof. Forman notes, government subsidized health insurance. Through a system of federal tax subsidies for purchasing employer-sponsored insurance (ESI), money spent on ESI premiums by employees is deducted from taxable income and payroll taxes. Thus, employees are incentivized to purchase ESI, and a Kaiser report indicates that this program cost the US Treasury approximately $200 billion in 2007. Economic theory explains that subsidies result in deadweight loss, removing the economy from equilibrium. Professor Forman clarifies that a subsidy makes a good cheaper relative to other goods, and results in its over-consumption. Health insurance is no exception, and the government-created distortions are likely to be causing adverse effects in the healthcare economy.

A third large contributing factor towards the unsustainable growth of healthcare spending in this country is information asymmetry. Prof. Forman explains, “right now, we know that there are some interventions for which the evidence is fairly strong that [they]don’t work, and yet in our current system, both current public payers…and private payers…continue to pay for these things”. He continues, “For more than half of all [interventions]we do in healthcare, there’s actually not very strong data about whether it works or it doesn’t… we’ve been surprised many times in the last 5-6 years about how many things we used to think with certainty worked, and now we discovered they don’t work”.

An August 2012 NY Times article describes such examples, of hormone replacement therapy often recommended to healthy women and a prostate cancer screening offered to older men. After years of these interventions, both were found to be more harmful than beneficial. An April 2012 article in Business Insider also provides a list of common practices that have been reported by sources such as the American College of Physicians to be ineffective. As a way of fixing this problem, Prof. Forman offers, “an investment in information may be one of the most important first steps”. This lack of value-added care is a crippling factor to the economy, and measures such as outcome-based analytics should be given more weight; and, although there are many ethical questions involved around it, further insight into cost-effective analytics may also be useful.

The Blame

While there are some very real factors which lead to the enormous amount of current spending on healthcare in the US such as new technology, distortions from the insurance market, and information asymmetries, some other factors are often incorrectly blamed for our high healthcare costs or are extremely difficult to control. Such factors include medical malpractice and defensive medicine, avoidable re-hospitalizations, and the current state of healthcare information technology.

Anderson et al., in a 2005 article in Health Affairs, show that the US has approximately 50% more medical malpractice lawsuits than the UK and Australia, and 350% more than Canada, but not necessarily more cases which result in favor of the plaintiff or a settlement. Moreover, US settlement payments were less, on average, than in both Canada and the UK in 2001. Factoring in the costs of legal fees and other variables, less than 0.5% of health spending in the US goes towards medical malpractice. Although the article stipulates that it’s difficult to accurately assess the amount of money wasted on defensive medicine, because it is hard to differentiate between what is defensive medicine and what is a truly legitimate concern, physicians estimate that between 25 and 35% of their practice is defensive. Professor Forman, however, describes: “Medical malpractice and defensive medicine do contribute to some healthcare costs, and it’s probably on the order of 2%…even 4% of total spending, but out of a 2.5 or 3 trillion dollar expense…it’s really a drop in the bucket. Then more importantly, there’s very low evidence that says it contributes to a growth in spending.”

Based on these numbers, reforming medical malpractice ought not be at the top of policymaker’s lists with regards to health reform. Additionally, spending on defensive mechanism isn’t necessarily something that can be avoided with legislation. Doctors will always be afraid of being wrong, and therefore will always practice a certain level of defensive medicine. The nature of medicine is to always achieve as much certainty as possible, and so defensive medicine will always remain. However, Prof. Forman weighs in, “the strongest argument to do anything about defensive medicine and malpractice is that it is something where you can actually lower costs without harming the patient [and secondly]that it ends up being a political stumbling block to reform because physicians always point to it as the real reason why things cost so much, when in fact, it economically isn’t”. In any case, malpractice reform may shift physicians’ blame from medical malpractice to more significant drivers of healthcare costs, and may start much-needed conversations in Washington.


Another commonly cited source of high healthcare costs is avoidable rehospitalizations. According to MedPAC, Medicare spends approximately $15 billion per year in hospital reimbursements due to avoidable re-hospitalizations. Additionally, one in five Medicare patients are re-hospitalized within 30 days after discharge – a number that is seemingly higher than warranted by avoidable readmissions. Prof. Forman takes a refreshing approach to the issue, noting “at the very least, if we can reduce readmissions, one would assume that patients are better off. That alone should be worth our investment. Whether it actually saves money to the system remains to be seen”. It is important for policymakers and healthcare providers to strike a balance between statistics and patient welfare – getting better patient outcomes should not be sacrificed for the sake of bottom lines. In reality, it is likely that hospitals are driven by profit-motives, and thus have never opposed hospital readmissions because of the additional revenue brought in from each hospitalization. Specifically with regards to Medicare patients, hospitals likely take advantage of Medicare’s thus-far uncapped entitlement system.

However, some hospital readmissions can be attributed to the areas in which the hospitals operate: hospitals located in areas with a large uninsured population are likely to see higher rates of readmissions because patients continually use the Emergency Room as their only source of care and can be readmitted within a short period of time for either related or unrelated medical problems. A 2012 article in the Washington Post discusses the fact that even though avoidable readmissions have been a focus of health policy in recent years, we haven’t seen any significant decrease in their occurrence. This leads us to believe that either the policies have simply been ineffective or that readmissions are a very hard variable to control. Nonetheless, much of the blame of current healthcare spending is placed on avoidable readmissions. The Huffington Post, in October 2012, suggested that one reason for the large number of avoidable readmissions is a lack of coordinated care, which can presumably be fixed by a strengthening of Health IT.

In recent years, the nation has made great strides towards achieving a more well integrated information technology system for healthcare. The goal has been to reduce medical errors, to decrease the amount of non-valuated care (repeat imaging scans), and to improve followup care or coordinated care amongst multiple healthcare providers. While the increase in coordination is very likely to reduce avoidable readmissions, and save money by eliminating redundant tests, it may also statistically lead to more medical errors as medical staff becomes more distracted by what is on the screen than on the breathing patient in front of them. Prof. Forman weighs in, “I have no doubt that it’s going to be an improvement in terms of patient care in the long run. I have much more serious doubts about how much it will actually save…I would not bet my money on it saving money in the long run, I would bet money that it will improve the lives of people in the long run”.

In February 2012, the Secretary of the Department of Health and Human Services announced that the number of hospitals using health information technology has more than doubled in the last two years. At the same time, however, $3.1 billion had been paid to doctors and hospitals in order to incentivize the use of health IT. Despite these initial costs, again, we must strike the balance between costs and quality care measures – if the dissemination of health IT saves lives or improves the quality of care, initial investments in it are worth it.

It is also important to keep in mind any ethical questions surrounding the matter, such as how easily accessible patient information is to anyone on a given health IT network; while also keeping in mind the utility of the system for advancing clinical research. Researchers could search patient files for critical data at the click of a button. The nation’s stance so far on this issue has been that health IT is favorable: resulting in better outcomes, cutting costs, and facilitating research and development. As its adoption continues to increase nationwide, issues such as patient confidentiality will be brought to the fore.

Is There Hope?


The first step is to identify the truly significant drivers of costs, and the factors that are often perceived to influence current spending but do not conclusively lead to large amounts of it. But, work remains to be done. The first recommendation is to conduct more research on which interventions work and which ones don’t, and how interventions which different costs vary in their outcomes. One of the biggest problems of our current system is a lack of data – investments in information are crucial to the development of evidence-based dialogues and legislative reform.

Secondly, the US needs to interpret the available information with a critical lens. An MRI in the US is four times more expensive than in France, and at least ten times more expensive than in Japan. While the nature of the US is to always encourage innovation and newer, state of the art machines, outcomes are not necessarily improved by these incredibly more expensive imaging vehicles. Without stifling innovation, the US must find a way to bend down its cost curve and improve patient outcomes. Taking away market and non-market distortions such as those created by insurance, and getting better evidence about which interventions work and which ones don’t are the first places to start in eliminating wasteful spending. While also keeping in mind the goal of achieving high quality of care, factors such as Health IT and avoidable readmissions should be controlled for, whether or not they result in a decrease in spending.

Physicians and economists alike remain hopeful for the future of the healthcare economy, because even though costs have increased dramatically in aggregate over the past few decades, patient outcomes have also improved significantly. Prof. Forman provides a personal example, “is it worth the fact that my father’s healthcare has probably been, in cost adjusted terms, $100,000 more than his father’s healthcare? Absolutely, his father…never got to enjoy a day of retirement; my father is 79!” As we continue to improve the quality of care, an increase in costs is only natural. As we move forward, we aim to decrease this proportion of spending to quality improvements, in the hope that we can continue to improve outcomes without going bankrupt.


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Devi Mehrotra is a junior in Saybrook College. She can be reached at

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