Pushing on Air in a Balloon: Health Cost Growth and $1,000 Pills

Numerous recent articles have tried to address whether health cost growth is slowing more permanently. Though I have entered that debate at times , I must admit that it’s a complex question for which there is no definite answer. Policymakers and private practitioners have improved some of the ways that health care is priced and delivered, and more improvements are no doubt forthcoming. But the stories of Gilead and its $1,000-a-pill Hepatitis C drug make one point entirely clear: improving health care costs selectively is like making indentations in a full balloon. Pushing down the air in one place merely makes it pop out somewhere else.

Consider how the government has designed health insurance, particularly Medicare. Essentially, it has delegated its constitutional powers of appropriation to private individuals and companies like Gilead. Congress doesn’t vote to spend more on hepatitis cures. It lets Gilead, along with patients and doctors, make that decision and then shift the costs back to other citizens. As long as Congress refuses to exercise its appropriations responsibility, every cost-saving measure could be nullified by a new Gilead.

The original sin of health insurance, public or private, has been to allow patients to demand and providers to supply more health care while pushing charges onto others. In the extreme, at a zero price to the patient per service received and a potentially unlimited supply of services for which more compensation and profits can be made, it is not surprising that health costs in this country have grown from about 5 percent of GDP in 1960 to around 17 percent today.

Many efforts aim to limit some of our bites of the forbidden apple but not others: fixed payments to accountable care organizations, health maintenance organizations, and preferred provider organizations; bundling of payments; limits on payments for re-admitted patients to hospitals; and so forth. Yet, yet… without absolution from the original sin.

Hospitals and doctors adjust in newer ways not restricted by selective limits. They add extra treatments and service providers. The ability to add on services is often voiced as the problem with fee-for-service medicine, where the quantity of services increases even for those whose prices are regulated or constrained. But there’s more to it than that; adding services is only one way that the air pops out somewhere else. In an industry with significant technological breakthroughs—and make no mistake, Gilead’s hepatitis drug is a major breakthrough—costs can be increased simply by charging a lot more for the new item or shifting services quickly toward areas of high profitability or compensation.

Even where a health improvement might be well worth the cost in one sense, it might still be unreasonable in another. In a typical open-market industry, we might be willing to pay a lot more for any particular good or service than we do, but competition among suppliers helps reduce costs. With the current design of health insurance, competition is fairly limited. My own brief examination of growth industries in the United States shows health is the one sector where above-average growth in the quantity of goods and services sold was accompanied by above-average growth in prices. Think of electronics, or telephones, or other advanced industries as examples of how increasing quantity usually pairs with decreasing prices.

The hepatitis C drug debate often confuses this value proposition in another way. Let’s accept that the $84,000 treatment with Sovaldi—or the newer, perhaps only $63,000 Hepatitis-C treatment with Harvoni (Gilead’s latest offering)—improves patient well-being and even life spans substantially. If the improvements make retirement years happier and longer, rather than being matched by greater productivity and more years of work, then Gilead and its beneficiaries still shift costs onto society, and health costs rise as a share of GDP.

Now, you might ask, what constrains the costs of inventions in non-health industries during those initial years when patents provide a potential monopoly? You and I do. If the cost is too high, many of us simply don’t buy the good or service. The company keeps prices lower to expand market share before competitors come along when the patent runs out. If the government says it will buy the new good or service for us, the limited-demand constraint that we otherwise provide is removed. Government simply cannot promise both that an inventor can charge what he wants for an invention and that the government will buy it for anyone who wants or needs it.

Thus, regardless of the rate at which health costs rise, it will remain unreasonable as long as the original sin of health insurance remains. Without true budget constraints, improvements will be limited because incentives are limited. With government programs, my own view is that every health care subsidy must be put into a budget, with limits raised over time by Congress but in a fair competition with other societal demands, be they education, defense, or currently unsubsidized forms of preventive health care.

Let Democrats use price controls. Let Republicans use vouchers. Let both work on other efficiency improvements that are more likely to be adopted when budgets are constrained. There is no one-time, permanent solution to how best to regulate this rapidly changing industry. With a constrained budget for each government program, however, Gilead would be unable to charge $1,000 a pill, or other health care providers would face a more rapidly declining price for their services, or both.

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