Why Medical Costs are Rising

Wealthier nations all spend more on health. However, the U.S. spends well above what would be expected, compared with its peers. McKinsey Global Institute used data from 13 industrialized nations to develop a measure it called Estimated Spending According to Wealth (ESAW). By McKinsey’s calculations, $477 billion of the $1.7 trillion the U.S. spent on health care in 2003 was in excess of what it should have spent based on its wealth. Analysts said the condition of Americans’ health did not explain the higher costs. Hospital and physician care accounted for 85 percent of the excess spending.

McKinsey said a huge driver of costs is the fact that providers are expanding capacity, in part because they can produce their own demand. This echoes ample research showing that health-care use rises when facilities expand or open, independent of population health. McKinsey also cited technological innovation that invariably delivers more expensive care, and the fact that patients are insensitive to high prices because their out-of-pocket costs are, in general, so low...

The reason for higher U.S. prices is that buyers lack negotiating power – or choose not to exercise it. Other nations consolidate their bargaining power either in their governments or as cooperatives. They negotiate one standard – and invariably lower – price for health services and pharmaceutical drugs. In the U.S., there is no government purchaser willing to bargain on behalf of constituents. The continuing consolidation of hospitals and physicians leaves health plans in weaker negotiating positions...

During the health-reform debate, the Obama administration dropped the “public option” insurance plan, even though it would have been one of several available options on the health insurance exchanges. It also decided not to seek to negotiate lower drug prices for Medicare. Other nations do not have a choice on whether to drive a hard bargain with health-care providers. If they spent the same portion of GDP as the United States did, the required tax burden likely would cripple their economies. The United States is not at that point, but is well on its way...