Health Care's Muddled Incentives

By Kling, Arnold | Freeman, November 2009 | Go to article overview

Health Care's Muddled Incentives


Kling, Arnold, Freeman


On the topic of health care, what empirical observations are reliable? Unfortunately, many "facts" come freighted with a great deal of ideological baggage. Those skeptical of markets, who favor a large role for government in health care, tend to emphasize statistics that disparage the American healthcare system. For supporters of markets, it is tempting to try to fight back by finding data that reflects well on American health care.

I think that the best strategy is to arrive at the most accurate understanding, even if it means that America's healthcare system does not come out looking superior.

This article will summarize empirical observations that I consider important in looking at the U.S. healthcare system. First, I look at international comparisons. Next, I look at the implications of studies that compare health care in different regions within the United States.

Differences Across Countries

People often speak as if the healthcare system is relatively free-market in the United States and much more socialized in other developed countries. However, whether this is the case depends on how one classifies private health insurance.

About 12 percent of personal medical expenditures in the United States is paid out of pocket, which is slightly below that of nearly all other developed countries, including Canada. Where the United States differs significantly from other countries is in how the remaining 85-90 percent of healthcare expenditure is financed. About half that remainder is financed by private health insurance, with the other half paid for by government programs, such as Medicare and Medicaid. In other developed countries, healthcare spending is mostly financed out of a government budget.

Private health insurance in the United States, like government health insurance, insulates the consumer from the cost of medical care. Strong regulatory and tax incentives induce businesses to include a large health insurance component in employee compensation. Looking at how private health insurance operates in this country, and why it takes the form it does, I detect considerable influence from government policy. It is hard to tell what kind of insurance, if any, would emerge in a market unaffected by government subsidies, taxes, and regulations.

Overall, I would argue that on the demand side, the United States healthcare system is essentially socialized. The fact is that close to 90 percent of healthcare spending is paid for by third parties, which means that individuals in this country generally experience a socialized process for obtaining medical services.

The United States deviates most from socialized systems on the supply side. What I believe is most distinctive about the U.S. healthcare system is that it combines fee-for-service compensation for healthcare providers with fairly unlimited access to medical services. This means that supply is limited neither by rationing nor by absence of compensation nor by any fixed government budget. Notwithstanding considerable regulation of medical practice, the supply of health care is relatively unsocialized.

The combination of socialized demand and relatively unsocialized supply explains one of the key facts about health care, which is that the United States spends far more on health care than other industrialized countries. We spend close to 17 percent of GDP on it, while other countries generally spend just over 10 percent. Because our GDP per capita is also higher than other countries', the differences in healthcare spending are even more dramatic in terms of absolute dollars per capita. We spend almost twice as much per person on health care as many other industrialized countries.

This additional spending is not inherently problematic. Indeed, one would think that it is a good thing that we can afford to spend so much on medical care. Unfortunately, another fact about international healthcare comparisons is that outcomes differ very little between the United States and other countries. …

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