The Enigma of America’s Skyrocketing Costs
There are a plethora of problems currently pressing the American economy; perhaps the most confounding of these problems is skyrocketing costs. In fields like education, healthcare, and infrastructure, costs have exploded in the past few decades. I’ve read quite a few articles/posts attempting to explain this cost phenomenon, many of which were inspired by this blog post on Slate Star Codex. Scott Alexander identifies (correctly I think) many contemporary American political and policy problems as second-order consequences of these costs: “‘LOOK, REALLY OUR MAIN PROBLEM IS THAT ALL THE MOST IMPORTANT THINGS COST TEN TIMES AS MUCH AS THEY USED TO FOR NO REASON, PLUS THEY SEEM TO BE GOING DOWN IN QUALITY, AND NOBODY KNOWS WHY, AND WE’RE MOSTLY JUST DESPERATELY FLAILING AROUND LOOKING FOR SOLUTIONS HERE.’” Sarah Kliff of Vox offers a similar assertion regarding the American Healthcare system here: “The biggest problem in American health care is one that the Republican health care plans won’t really try to solve. To be fair, it’s one that Obamacare didn’t touch, either. The biggest problem facing American health care is our prices.”
One of the most popular explanations for elevated American healthcare costs is the concept of an innovation premium; the theory effectively claims that the United State grants monopolies and wide degrees of latitude in pricing to American healthcare and biotech companies, which makes the United States an attractive destination for those companies. Healthcare companies choose to set up shop in the United States, and because they receive more revenue as a result of monopolies and latitude in pricing, they invest in R&D and create even more life-saving drugs. Noah Smith smacks this theory down quite easily: “Total U.S. biomedical research spending was only about $158 billion in 2015. Suppose, just for the sake of argument, that Canada, Germany, the U.K. and all the other countries where health care is dramatically cheaper than in the U.S. copied every last bit of U.S. R&D for free and didn’t do any of their own research. Even in that extreme case, they would only be saving $158 billion, which is a much smaller amount than what the rest of the developed world currently spends on health overall. So mooching off of the U.S. can’t explain the big gap between them and the U.S.”
Another theory seeking to explain high American healthcare costs (and one especially favored by some Conservatives) more or less blames the Affordable Care Act. John Cochrane sums it up nicely: “Our government wants to subsidize some people’s health insurance — poor, sick, old, disabled, veterans, children, people with specific diseases, and so on. And, in many cases, rightly so. But our politics are allergic to “tax and spend.” So, we hide it — we force some people to buy overpriced insurance to subsidize others.” The mechanism(s) he’s alluding to are the ACA’s exchange policies, including the individual mandate, community rating, and a host of other fairly arcane rules and regulations. The sum of these policies creates a system in which, because insurance companies cannot charge old and/or sick people exorbitant premiums, some of that cost is shouldered by young and/or healthy people on the exchanges. For a moment, accept this system as given; is it really so bad that we as Americans ask our relatively strong to pick up our relatively weak? The problem with this theory is that the ACA exchanges are a tiny portion of the overall health insurance market: ~12 million people get insurance on the individual marketplace, in a nation of ~330 million. Indirect cost sharing in this tiny market may have a small effect on nationwide healthcare costs, but it’s disingenuous to claim this as the primary cause.
My personal favorite explanation is this comment on the original SlateStarCodex post. fc123 explains (lightly edited for clarity): “In all of these problem sectors it seems the resources consumed in each industry have shifted to servicing and extending the definition of the marginal ‘customer’. This can explain I think some of the above: as an example, 40 years ago, hospitals would receive 100 customers/patients. Ranked, patients 1–20 died, and no one really tried to save them (some comfort roughly analogous to contemporary hospice care, but that was it). Today hospitals are trying (read: are obliged) to try to save patients 5–15 (e.g. the 85 year old with a triple bypass, 20 week premie). The total number of staff needed for this task swamps increases in individual productivity. You just need more people, even if each of them is more productive and/or trained than in the past. Thus, salaries for each do not go up much, but since there are more of them, total costs go up, and the outcomes of the patients treated are somewhat, but not much better (some of them now make it but some fraction still die).” fc123’s explanation struck me as accurate at the time, and when I saw this piece in The Atlantic, I had empirical evidence supporting the theory. In case you’re too lazy to click on that link, 5% of American patients account for 50% of American healthcare costs. The patients on the margin, the 85 year-old with a triple bypass, the 20 week premie — these are the patients driving up costs.
You may say that, to this point, I’ve focused almost entirely on skyrocketing healthcare costs, and I’ve yet to address the other fields that Scott Alexander mentions: infrastructure construction, education, or even housing. I’d respond by urging you to read the entirety of fc123’s comment (which I’ve excerpted above), though I will add a few of my thoughts on the economy more broadly below.
I want to briefly address another Conservative favorite: administrative bloat. In response to Alexander’s post, John Cochrane writes: “The unavoidable answer: The number of people it takes to produce these goods is skyrocketing. Labor productivity — quality adjusted output per number of people involved in the entire process — declined by a factor of 10 in these areas. It pretty much has to be that: if the money is not going to profits, to to each employee, it must be going to the number of employees…I think we know where the extra people are. The ratio of teachers to students hasn’t gone down a lot — but the ratio of administrators to students has shot up. Most large public school systems spend more than half their budget on administrators. Similarly, class sizes at most colleges and universities haven’t changed that much — but administrative staff have exploded. There are 2.5 people handling insurance claims for every doctor. Construction sites have always had a lot of people standing around for every one actually working the machine. But now for every person operating the machine there is an army of planners, regulators, lawyers, administrative staff, consultants and so on.”
I will say that there is at least a kernel of truth to this explanation. Take a look at the American government’s largest bureaucracy, the Department of Defense; roughly 20% of its budget ($125 billion!!!!) can be considered wasteful or redundant. But while there’s an element of truth to Cochrane’s theory, I ultimately disagree with his conception of the American economy.
There is a growing caucus on the left clamoring for a reevaluation of American antitrust policies. In their view, companies have grown too large in the last few decades, and are now exploiting their monopolies or oligopolies by demanding more money from consumers. Above, John Cochrane claims that the extra revenue from these skyrocketing costs is “not going to profits.” That is demonstrably false. Corporations are hoarding trillions of dollars in profits. They are choosing to invest less, pay their workers less, and profit more. Profits have risen from 2.2% of GDP in 1984 to 15.7% in 2014. Noah Smith writes “there is almost certainly some level of pure trickery in the economy,” and price-gouging (shout out to Martin Shkreli) is really only possible in the absence of competition. It seems to me that in addition to the quandary of the marginal customer/patient, there’s also the easily resolvable problem of corporate concentration. While there’s no way to address the first problem without seriously reevaluating our societal priorities, there is a very easy way to address the second problem: increase antitrust enforcement and make it more stringent.
I want to conclude this piece by discussing the moral implications of fc123’s comment. He/she writes (again edited for clarity): “So if you assume these industries for whatever reason shifted their focus to servicing deeper into the tail of the population in their aptitude/effort over the years (I am not making any normative comment with this statement), this would very much explain the overall cost rise, coupled with the lack of desired improvement in statistics measured across the population that now gets services as a whole.
In short, in the US we define policies that drive costs based on the tail of the population, but we evaluate performance on the average. As an immigrant from a third world country I think this is a big difference often invisible to the US-born citizens I talk to. Maybe this is why this is a great country and I am here. All I can say is that it is a world view that is not common world wide. Where I grew up, No Child Left Behind law would have been designed as 1 Child Left Behind. There were just not enough resources, but more importantly, it was just more socially acceptable to just halve the number of slots halfway through an academic program, for example.
So I guess the question is why are we so focused on pushing services into the tails and will we continue to do so? Does society really benefit from having a larger fraction of the population capable of doing crappy algebra? Clearly there will be some point where the cost becomes prohibitive and it will stop: maybe that is what we are seeing now. But it is stunning that this was a 50 year process — if the dynamics in social policy “markets” are that slow it is going to be really difficult to manage.”
I asked a rhetorical question earlier, effectively wondering whether the passing on of costs to young and/or healthy people was an acceptable system in the individual marketplace. I think it is. In the United States, we are (or we should be) willing to pay a premium to extend services on the margin. We decide to keep the 85 year-old with a triple bypass alive to see the birth of his great-granddaughter; we decide to make sure the dyslexic student receives a quality education. These are decisions made not out of rationality, but out of compassion, and they are what makes America great.
