Market-Based Failure — A Second Opinion on U.S. Health Care Costs

By Robert Kuttner
New England Journal of Medicine
February 7, 2008

Relentless medical inflation has been attributed to many factors — 
the aging population, the proliferation of new technologies, poor 
diet and lack of exercise, the tendency of supply (physicians, 
hospitals, tests, pharmaceuticals, medical devices, and novel 
treatments) to generate its own demand, excessive litigation and 
defensive medicine, and tax-favored insurance coverage.

Here is a second opinion. Changing demographics and medical 
technology pose a cost challenge for every nation's system, but ours 
is the outlier. The extreme failure of the United States to contain 
medical costs results primarily from our unique, pervasive 
commercialization. The dominance of for-profit insurance and 
pharmaceutical companies, a new wave of investor-owned specialty 
hospitals, and profit-maximizing behavior even by nonprofit players 
raise costs and distort resource allocation. Profits, billing, 
marketing, and the gratuitous costs of private bureaucracies siphon 
off $400 billion to $500 billion of the $2.1 trillion spent, but the 
more serious and less appreciated syndrome is the set of perverse 
incentives produced by commercial dominance of the system.

Markets are said to optimize efficiencies. But despite widespread 
belief that competition is the key to cost containment, medicine — 
with its third-party payers and its partly social mission — does not  
lend itself to market discipline. Why not?

The private insurance system's main techniques for holding down costs 
are practicing risk selection, limiting the services covered, 
constraining payments to providers, and shifting costs to patients. 
But given the system's fragmentation and perverse incentives, much 
cost-effective care is squeezed out, resources are increasingly 
allocated in response to profit opportunities rather than medical 
need, many attainable efficiencies are not achieved, unnecessary 
medical care is provided for profit, administrative expenses are 
high, and enormous sums are squandered in efforts to game the system. 
The result is a blend of overtreatment and undertreatment — and 
escalating costs. Researchers calculate that between one fifth and 
one third of medical outlays do nothing to improve health.

A comprehensive national system is far better positioned to match 
resources with needs — and not through the so-called rationing of 
care. (It is the U.S. system that has the most de facto rationing — 
high rates of uninsurance, exclusions for preexisting conditions, 
excessive deductibles and copayments, and shorter hospital stays and 
physician visits.) A universal system suffers far less of the feast-
or-famine misallocation of resources driven by profit maximization. 
It also saves huge sums that our system wastes on administration, 
billing, marketing, profit, executive compensation, and risk 
selection. When the British National Health Service faced a shortage 
of primary care doctors, it adjusted pay schedules and added 
incentives for high-quality care, and the shortage diminished. Our 
commercialized system seems incapable of producing that result.