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Ignore the Hype: Health Care’s ‘Cost Disease’ Hasn’t Been Cured.

Fifty years ago, a prominent economist named William Baumol offered a new diagnosis for an old labor-market problem: Some sectors suffered from a “cost disease.” The symptoms? A persistent rise in spending, coupled with a pesky immunity to productivity improvements.

(Take universities, a sector with historically high labor costs. Although professors tend to resist efforts to make them more productive, a college needs to pay competitive wages; if a Berkeley teacher isn’t happy with his salary, he could always try and decamp to Stanford.)

At the time, Baumol was fixated on how the phenomenon manifested in education and the performing arts. Reining in health care costs — which were just 5% of the gross domestic product in 1960 — wasn’t a major policy focus.

But times changed.

Medicare launched and health spending spiraled up. Physicians began to help set national reimbursement levels, and costs curved some more. And new devices were devised, insurers ensured new layers of bureaucracy — a now-familiar story.

By 2009, health care costs were so overwhelming that President Obama cited them as his prime motivation when attempting to move a historic coverage expansion in the middle of a historic economic recession. And while the law contained cost control measures, no one expected that spending would immediately shift. Even after the Affordable Care Act was passed, Baumol speculated that health care spending could grow to encompass 60% of the U.S. economy in 2105.

But then a funny thing happened: Health care spending began to slow.

First one report hinted at it, then another. A few months ago, even the immovable jobs report began to slack. And this week, the White House’s Council of Economic Advisors put it in the starkest terms: Based on measures of personal consumption, “health care inflation is currently running at around 1 percent on a year-over-year basis, a level not seen since 1963.”

“Something has changed.”

Has it? California Healthline turned to someone who would know: William Baumol.

“There are periods when cost increases have slowed,” Baumol concedes, and we’re living through one now.

“But as long as the workings of the economy continue more or less in the same way … health care costs are bound to be back in the race.”

An Industry’s Affliction, Briefly Lifted

Baumol’s right that health spending has let up before, only to bounce back. Beginning in the late 1980s, national health expenditures grew (at double-digit rates), then fell (all the way to 5.3% in 1996) before rising again (to nearly 10% by 2002).

But the growth rate of health care spending has never been as slow as it is right now. Last year, it was 3.7% — a historic fourth straight year below 4%, and nearly one full percentage point below the growth in GDP (4.6%). Health care spending as a share of the economy fell from 17.3% to 17.2%.

In short, the sector shrank.

David Cutler, a Harvard economist who helped guide President Obama’s health reforms (and an expert who weighed in on last week‘s “Road to Reform”) has called this slowdown in spending “the single most important story in health care.” Other experts concur — even if they can’t agree on what’s causing it.

  • Is the slowdown because of the recession? It may have seemed that way several years ago, but the broad and ongoing trend has touched sectors that have normally been immune, like Medicare spending.
  • Is it Obamacare? Unlikely, given that the slowdown began before the law’s provisions took effect.
  • Is it because of productivity improvements? The White House’s new report certainly hints at that, pointing to electronic health records as a major boost for efficiency. But the evidence on electronic health records as a productivity lever is mixed.

The Council of Economic Advisors this week reiterated several additional factors — the rise in patient cost-sharing, or the decline in prescription drugs — that could be holding down spending. On their own, none fully explain the slowdown, economists tell California Healthline, but they help illustrate the downward pressure on spending when taken together.

Why Costs May Curve Again

On the one hand, defenders of Obamacare say there is substantial reason to believe that a spending slowdown could persist; the White House argues that once new ACA payment pilots kick into high gear, Medicare will be able to wield even more tools to slow spending.

But CMS’ projections account for a bounce-back in health spending, and many experts concede that the current low growth may be temporary, with several drivers poised to push up costs.

Policy provisions

Look no further than the ACA’s Medicaid and insurance exchange provisions: The law’s ongoing coverage expansion is in the middle of moving millions of Americans onto insurance rolls, with downstream effects on demand and spending.

Political will

“I think continued blunt reimbursement pressure through Medicare may have a limit to its impacts on productivity, too,” says Loren Adler of the Center for a Responsible Federal Budget. “That is, once the easier efficiencies have been achieved, I could see Congress backing down on those cuts eventually.”

(This is essentially what happened after the 1997 Balanced Budget Act passed by President Clinton imposed harsh new controls on health care reimbursement; the 2003 Medicare Modernization Act passed under President George W. Bush relaxed those pressures and subsequently boosted margins.)

Proton beams — and other products

In a National Bureau of Economic Research paper released last year, economists Amitabh Chandra, Jonathan Holmes and Jonathan Skinner ask, “Is this time different?” Yes and no, they conclude. While the rise in high-deductible health plans points to a potential systemic change, health care’s ongoing reliance on expensive technology leaves them pessimistic that a slowdown can continue. So although the researchers forecast slower growth in health care than some other pundits, they still estimate that the industry will grow at GDP plus 1.2%.

Looking Ahead

Not every prominent economist subscribes to Baumol’s theory of cost disease. Tyler Cowen, editor of Marginal Revolution, has long argued that organizations and regulation are as much to blame as the product itself.

“My view was [and] is that cost disease is not intrinsic in a particular sector,” Cowen tells California Healthline.

But Cowen acknowledges that a slowdown, “almost by definition …is temporary.” (Although temporary “may be good enough,” he adds.)

Meanwhile, we shouldn’t rush to declare that the cost curve has been cured, Kaiser Family Foundation President and CEO Drew Altman wrote last week.

“The more the nation believes the health cost problem is solved,” Altman warned, “the less likely we are to keep the pressure on to try new, more innovative, and perhaps more painful cost control strategies.” 

Around the nation

Here’s a look at what else is making news on the road to reform.

Looking at the latest Obamacare delay: Writing at The New Republic, Jonathan Cohn argues that the decision to allow Americans to keep on keeping plans that don’t comply with the ACA’s provisions may have been motivated by politics but should end up having little policy effect.

What made some ACOs successful? One key tactic: Having physician leadership, Farzad Mostashari and Ross White conclude. The Brookings Institution researchers looked at the first year of results from the Medicare Shared Savings Program.

Obamacare enrollment proves whatever you want it to prove: The latest ACA enrollment numbers can be seen as a disappointment or success, depending on your perspective, Bloomberg View‘s Christopher Flavelle writes. And that’s why both opponents and critics of the health law are using sign-ups through the law’s insurance exchanges to advance their pet points.

High-deductible plans, in context: At least one high-profile Wall Street Journal column suggested that the ACA has accelerated the use of high-deductible health plans. But writing at The Incidental Economist, Galen Benshoof reviews historical trends and concludes that HDHP adoption rates have actually slowed down since the ACA’s passage. 

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