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Government Will Control Medical Costs?

Steve Malanga
Real Clear Markets
July 1, 2009

In a recent poll, a majority of Americans surveyed said they wanted health care reform to include some kind of public medical plan that would compete with private insurers to hold down costs. Somehow, the respondents felt, adding a government-sponsored option would discipline the marketplace and keep costs in line.

The only way that will happen, however, is if government reverses course after nearly half a century in which it has been one of the biggest drivers of health care expenditures in the country. The public sector already pays half of all health care bills and has been subject to political manipulation, pressure groups and outright patronage in managing its portion of the health care system so expensively.

One indication of just how much of a culprit government has been in the rapid expansion of U.S. health care costs is a 2005 National Bureau of Economic Research study by economists Laurence Kotlikoff and Christian Hagist which examined the growth in public sector-care spending since 1970 in 10 industrialized countries including the U.S. The study found that the annualized rate of growth in government spending on health care was not only tops in the U.S., at 6.23 percent, but that the rate of growth here was the fastest relative to increases in gross domestic product among the 10 countries studied. That's one reason why today the U.S. devotes about 16 percent of it domestic product to health care, compared to an average of less than 9 percent in other industrialized countries.

Much of this growth, by the way, is not a function of demographic trends like the aging of the population, the economists estimated, but of a constant expansion of benefits by government. That accounted for nearly 90 percent of the increase in spending over the years.

And much of that expansion was driven by vast disparities between government spending in the U.S. and elsewhere on the elderly. Since health care costs are highest for seniors, the economists compared the difference in spending on seniors with spending on a control group aged 50 to 64. In the U.S., where seniors are covered by universal insurance in the form of Medicare, we spend a whopping 8 to 12 times more for medical care on the elderly than on those aged 50 to 64. By contrast, Austria, Germany, Spain, and Sweden spend only twice as much on health care for the elderly as the younger group, and Japan, Norway, the United Kingdom, and Canada spend just 4 to 8 times more. The economists attribute the vast differences between America and other countries to the fact that, "America's elderly are politically very well organized, and each cohort of retirees has, since the 1950s, used its political power to extract ever greater transfers from contemporaneous workers."

But let's not put all of the blame on seniors and Medicare. Government pays for health care in all sorts of ways in the U.S. and influences health care expenditures even in the private sector through state-mandated insurance rules. And in many places political pressure and special interests have served to elevate costs, often without medical justification.

One stark example is in staffing levels at hospitals and clinics. Advocates have argued for higher staffing levels and used political muscle to achieve their ends. One characteristic example is a 1999 effort by nurses in California to win a new law mandating that hospitals employ one nurse for every five patients-down from an average of one per six patients. Although hospital administrators argued the legislation would cost more than $1 billion annually and not benefit patients, the legislature passed it and Gov. Gray Davis signed into in law. Several years later, when Gov. Arnold Schwarzenegger tried to roll back the requirement, citing the burden on hospitals, nursing unions went ballistic. They ran a $100,000 a week ad campaign attacking the Governator and interrupted his speeches with chants of "safe staffing saves lives" and "hands off our ratios."

This kind of political pressure amounts to more than just small change, as a 2007 McKinsey & Co. report found. McKinsey compared costs in American healthcare to those of 12 other industrialized countries to determine why we spend so much and one differential, McKinsey found, was in labor costs associated with nursing. Adjusting for population and the wealth of nations, the report found that the United States spent on average $50 billion more annually on nursing and clinical care than the other industrialized countries because of significantly higher staffing levels. Meanwhile, in California, studies have shown that the additional staffing requirement had no impact on patient care.

This is nothing new. Political manipulation and pressure have played a role in undermining previous efforts to control health costs, which didn't begin with last year's presidential race. We've been at it, with little success, since the 1970s, when the federal and state governments were staggered by the unexpectedly fast growth of Medicare and Medicaid.

One notable effort has been to cut down on the cost of expensive hospitalizations by using more patient care in the home. The strategy has helped cut the length of hospital stays, but not costs. One reason is that as the ranks of home health care workers grew in response to demands for more outpatient care, unionization efforts drastically raised the cost of this strategy. In California, a push by one of the state's biggest unions prompted the state legislature to pass a bill in 1999 that financed big wage increases for home health care workers in state-run health care programs. The new demands raised state costs for home health care by three-quarters of a billion dollars in the first five years after unionization. In Washington State a well-intentioned government effort to pay family members and friends of bed-ridden people a modest salary to care for them at home backfired when a union persuaded the caregivers to organize and demand big pay and benefit increases.

Government isn't the only driver of whopping health care spending increases, of course. Some of our added expenditures are the price we pay for investment in medical innovation, which other countries' won't pay. That's made us a leader in adopting new technologies and drugs, but at a cost to the American consumer. And our system of having a third-party pay the bills, even for those with private coverage, hasn't encouraged Americans to be good consumers of medical care. Finally, our growing standard of living has pretty much guaranteed that health spending increase relative to GDP because as societies get richer people spend more on extending life. It's a greater utility, as economists say, then merely expending all of your additional wealth on acquiring more consumer goods.

But federal and state governments have played a long and large role in the surge in health care spending in the U.S., and until advocates of a government-directed reform plan explain how things will be different going forward, we should be skeptical.

Steven Malanga is an editor for RealClearMarkets and a senior fellow at the Manhattan Institute.

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