Physician Financial Incentives and Cesarean Section Delivery

Jonathan Gruber ^*

and

Maria Owings ^**

The "induced-demand" model states that in the face of negative income shocks, physicians may exploit their agency relationship with patients by providing excessive care. We test this model using an exogenous change in the financial environment facing obstetrician/gynecologists: declining fertility in the United States. We argue that the 13.5% fall in fertility over the 1970-1982 period led ob/gyns to substitute from normal childbirth toward a more highly reimbursed alternative, cesarean delivery. Using a nationally representative microdata set for this period, we show that there is a strong correlation between within-state declines in fertility and within-state increases in cesarean utilization.

Since the seminal work of Arrow ( 1963 ), it has been recognized that a central feature of the medical marketplace is the agency relationship between doctors and their patients. A standard model of this relationship in the health economics literature is that of "induced demand." This model holds that in the face of negative income shocks, physicians may exploit this agency relationship by providing excessive care in order to maintain their incomes. If true, such a model has important implications for both the design of private-sector insurance policies and the optimal government response to rising medical costs. Despite its theoretical importance, however, there is only mixed empirical evidence on the role of inducement in physician decision making.

The inducement model has traditionally been tested by assessing how two alternative changes in the environment facing physicians affect the utilization of medical procedures. The first is reductions in the fees paid to physicians, generally by government payers. The second is variations in the physician/population density across areas; increased density lowers the income of the existing stock of physicians, and it will lead to increased utilization of medical procedures in an inducement-type model.

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Each of these modelling approaches faces important problems, however. Fee changes cannot identify supply responses because there may be a contemporaneous demand response to changing prices; that is, if quantity rises when fees fall, this could reflect either induced or true increases in demand. Using fee changes to identify inducement also raises the problem that substitution and income effects go in opposite directions; even if there is no measured utilization response, there may be inducement, but substitution and income effects may simply be cancelling. Studies that use physician density differences to proxy for income shocks also face a fundamental identification problem. If there is some unobserved area characteristic that is correlated with taste for medical interventions, an area will feature both higher procedure utilization and more physicians, regardless of the extent of demand inducement. An obvious candidate for such an omitted variable is the average coinsurance rate in the area.

In this article, we propose a new means of identifying the effect of induced demand on procedure utilization. We exploit a plausibly exogenous change in the financial environment facing obstetrician/gynecologists during the 1970s: declining fertility in the United States. Fertility (births/100 population) fell by 13.5% during the 1970-1982 period. We argue that declining fertility increased the income pressure on ob/gyns and led them to substitute from normal childbirth toward a more highly reimbursed alternative: cesarean delivery. Used in only 5.5% of births in 1970, cesarean delivery rose by over 240% over the subsequent 12 years, and it is now the second most frequently performed major surgical procedure in the United States, with a rate of 23.5 cesarean deliveries per 100 births.1Unpublished tabulations, National Center for Health Statistics. This time-series correlation between the fertility decline and the cesarean utilization increase raises the possibility that inducement played an important role in the substitution of cesarean delivery for normal childbirth.

Our primary goal is to test for a causal role of financial incentives in the use of cesarean delivery over the 1970-1982 period. We do so by exploiting the dramatic change in fertility patterns across U.S. states during this era. Conditional on the characteristics of the mother and of the birth, statewide fertility changes should provide ...