Why do we choose to pay so much for medical care? The US spends about a trillion dollars a year on medical care with no medical benefit. Why? There are many reasons, but at least $105 billion of them involve prices that are too high. With that much money at stake it’s worth asking what a too-high price is, anyway.
Specialty Physician Compensation
Miriam Laugesen and Sherry Glied analyze physician compensation in the US and other highly developed countries (Australia, Canada, France, Germany, the United Kingdom). It’s a complex calculus, and well done. Physicians in the US get paid more, but you have to adjust this compensation for different systems of financing medical education and the different costs of practice: office costs, administrative costs, malpractice insurance premiums—all those irksome costs that make US medical practice so unappealing. When all these adjustments are made, US physicians are paid more than those in other countries.
Although Laugesen and Glied don’t go this far, it seems a further adjustment seems appropriate. After all, everyone in the US gets paid more on average, not just physicians. When you adjust the after-practice-cost compensation for differences in GDP per capita, an interesting pattern appears. Primary care physicians like pediatricians, family docs and gerontologists get paid almost exactly the OECD average, relative to national income. Specialty physicians like orthopedic surgeons get paid double in the US what they get paid in Australia or France, after adjusting for practice costs and differences in GDP per capita. Why double?
Laugesen and Glied conclude that it is higher fees that account for the difference, and no doubt they are right. Specialty physicians have considerable skill and extensive training. It’s reasonable that they be paid more than primary care physicians. But how much more? The differential in Europe is obviously adequate to ensure a steady supply of high-quality specialty physicians, so from an economic standpoint, the US is paying its specialty physicians too much. We could cut their pay by 50% or so and still have an adequate supply.
Setting One’s Own Pay
In other work Laugesen has shown why this gap occurs: the differential between primary care and specialty care compensation is set by the Resource-Based Relative Value Scale (RBRVS), which is in turn set by the RBRVS Update Committee, which is overwhelmingly staffed with specialty physicians. When specialty physicians set their own compensation, it’s no wonder it’s too high, but again, why double?
A striking parallel is in pharmaceuticals. Work by Bill Comanor and Stuart Schweitzer looks at the prices of on-patent and generic drugs in the US and in the rest of the OECD. Here again, prices are higher in the US than in the rest of the OECD, and again, if you adjust for differences for GDP per capita, the prices of generics are almost exactly the same, while the prices of on-patent drugs are almost exactly twice as high in the US as in the rest of the OECD, again adjusting for per-capita GDP.
Here the reasons are even less subtle than for specialty physicians. Most other OECD countries have a global expenditure cap—a budget for national healthcare expenditures—while the US does not. Within this cap, German insurance companies negotiate aggressively with drug manufacturers, the UK National Institute Health and Care Excellence places an effective limit on the price of pharmaceuticals, and so on. By contrast, the US has explicitly prohibited by law any such negotiations. Such a negotiation could save the public between $15 and $54 billion a year.
Capitalism with a Straight Face
In economics, there is a basic analysis about how a monopolist should set prices, which is at the level where marginal revenue equals marginal cost. Presumably that is the price level achieved for on-patent drugs in Europe, and if so, prices for on-patent drugs in the US are about double the monopoly price on average.
In the US, the rules governing drug prices are social, not economic, because consumers don’t pay for their own drugs—even indirectly. Consumers instead have money taken from them through taxes or reductions in wages whose use in healthcare is highly obscure and never tied to a particular drug. These retained wages are then given to government agencies or insurance companies, who then in turn reimburse providers. The consumer is at 3 levels removed from the cost of their care.
It is this environment that, for example, consumers are willing to pay—very indirectly but nonetheless concretely—$90,000 a year for a breast-cancer drug that doesn’t even work.
The Power of Two
This, then, is the social rule for price-setters in the US healthcare system: charge about double what the price should be. Any more than that and there will be large-scale protests that even the most well-resourced lobbying cannot overcome. Any less than double, and money is left on the table.
Prices are a social construct. Just because prices are fundamental to economics does not mean that economics are fundamental to prices. Sometimes a price reflects relative political power more than relative scarcity.